A few weeks ago both the IMF and the World Bank issued warnings about the dangers of rising inflation, higher interest rates and current asset valuations. Recent events have now brought these subjects into direct focus in the mainstream.
The sharp drop in equities earlier in the week is being blamed on market worries over the future path of interest rates and inflation. Global economic institutions once again telegraphed beforehand what was coming.
To elaborate, the rising yield on the U.S. 10 year treasury bond was cited as a major cause for the pullback in stocks. As of writing, it sits at over 2.8%. If we look back over the past decade, the 10 year has been significantly higher than its current level. The day Lehman Brothers collapsed in 2008, it was around 3.3%. It rose further in the aftermath to over 4% before dropping back to 2% come the end of the year. It then rose up towards 4% in 2009 and 2010 before falling away again.
By the end of 2013 it had risen to 3%, in line with the Federal Reserve’s decision to begin tapering their quantitative easing programme. The Fed ceased purchasing assets in October 2014 when the yield fluctuated between 2-3%.
2015 produced a range of 1-2%, a year which culminated with the first interest rate hike from the Fed since 2006. In 2016 – up until Donald Trump’s presidential victory – the yield was largely below 2%. It rose to around 2.5% in the weeks following Trump’s ascension.
2017 was when the Fed began a programme to ‘normalise’ both interest rates and their balance sheet. The yield was consistently between 2- 2.5% during this time. Since the beginning of 2018, however, it has gradually been creeping up to the 3% level once more.
The key aspect to take away from these percentages is that when the Fed began purchasing assets in 2008, it led to an eventual surge in stock prices. The Fed were backstopping the market, which in an environment of record low interest rates gave corporations and investors the confidence to go all in. It did not matter as much if the 10 year yield were to rise. The belief was that the Fed would be there to ensure ‘financial stability‘. This is no longer the case. The Fed are now actively raising rates and selling off assets.
The correlation between asset purchases and a rising stock market is evident:
What is likely to become equally evident is a sustained decline in asset valuations the further the Fed raise rates and advance their balance sheet reduction programme.
As economists such as Peter Schiff have pointed out, if the crash of 2008 occurred with the 10 year yield between 3 – 4%, it stands to reason that it will not need to rise by as much this time around. That’s because of the gargantuan increase in debt levels since central banks began artificially re-inflating the markets a decade ago.
Does Monday’s record points fall for the Dow Jones signify an impending market collapse? What we know for certain is that as stocks were rapidly falling, precious metals remained neutral. Capital was not being transferred over to gold or silver. If we start to see steep declines in indexes coupled with notable rises in commodities, this will lend credence to a sustained downturn.
The Federal Reserve’s response to all this has been abundantly clear. They have no intention of changing course on tightening monetary policy. Comments made in the wake of Monday’s record points loss on the Dow Jones confirm as much. Here is a brief selection:
Robert Kaplan, Dallas Fed: “It’d be wise for us to be removing accommodation, although in a patient and gradual manner.”
Charles Evans, Chicago Fed: “We still could easily raise rates three or even four times in 2018 if that were necessary. And I would support such a faster pace if the data point convincingly in that direction.
John Williams, San Francisco Fed: “The economy clearly can handle gradually rising interest rates, I’m not really worried about the downside risks of the economy slowing too much. Even four rate increases is very gradual.”
William Dudley, New York Fed: “The stock market had a remarkable rise over a very long time with extremely low volatility. My outlook hasn’t changed just because the stock market’s a little bit lower than it was a few days ago. It’s still up sharply from where it was a year ago.”
Given the co-ordinated behaviour of central banks, it is no surprise that the Bank of England have indicated an imminent rate hike in their latest inflation report. This will very likely happen in May.
The international agenda to ‘normalise‘ rates and retreat from stimulus measures presses on unabated.
- The Bank of England (BOE) has signaled the need for interest rate rises earlier and potentially larger than previously predicted, preparing markets for impending higher borrowing costs.
- In its first meeting of 2018, the Bank’s Monetary Policy Committee (MPC) judged that, were the economy to move broadly in line with its projections, “monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent over the forecast period,” than anticipated during its last report in November. This would be required to “return inflation sustainably” to its target and over a “more conventional horizon,” the report said.
- On its December 27 balance sheet, the Fed had $2,454 billion of Treasuries. By January 31, it had $2,436 billion: a drop of $18 billion in one month!
- This exceeds the planned drop of $12 billion for January. But hey, over the holidays, most folks at the New York Fed, which does the balance sheet operations, were probably off and not much happened. And so this may have been a catch-up action, with a sense of urgency.
- In total, since the beginning of the QE Unwind, the balance of Treasuries has plunged by $30 billion, to hit the lowest since August 27, 2014.
- Majority Leader Mitch McConnell unveiled the deal with Minority Leader Chuck Schumer on the Senate floor, which would boost military and non-defense spending by $300 billion over the next two years as well as add more than $80 billion in disaster relief. About $160 billion would go to the Pentagon and about $128 billion would to non-defense programs. The agreement also includes aid to respond to recent natural disasters.
- While December total consumer credit increased by less than the expected $20BN, it was still an impressive $18.45BN, of which $5.
- More importantly, with the latest $5.1 billion increase in revolving, or credit card, debt the total is now $1.027.9 trillion, the highest number on record.
- Meanwhile, non-revolving credit which with the exception of one definition change month, has never gone down, also hit a new all time high of $2.813 trillion, a monthly increase of $13.34 billion.
- “We’re always concerned when the market loses any value, but we’re also confident in the economy’s fundamentals,” an official said in a statement to CNBC Monday morning.
- The Dow Jones industrial average briefly fell more than 1,500 points before closing 1,175 points lower, or down 4.6 percent. The S&P 500 erased its gains for the year and closed 4.1 percent lower. Stocks fell Friday and posted their worst week in two years.
- Earlier in the afternoon, White House spokesman Raj Shah said “markets do fluctuate. Short-term we all know that.” He was traveling on Air Force One with the president to Ohio. Shah added the “fundamentals of the economy are strong,” referencing evidence of wage growth and unemployment numbers at their lowest in nearly two decades.
- Agustin Carstens, general manager of the BIS, an umbrella organisation for the world’s central banks, said in a speech that cryptocurrencies such as bitcoin were “probably not sustainable as money” and failed the “basic textbook definition” of being a currency.
- To prevent cryptocurrencies from becoming “parasites” on existing financial infrastructure, Carstens said that only those exchanges and products which met accepted standards should be given access to banking and payment services.
- “This means same risk, same regulation. And no exceptions allowed,” he added.
- Mario Draghi said the European Central Bank has no choice but to brace for the possibility that the U.K. will exit the European Union without a transitional agreement.
- “We always prepare for any eventuality but at the same time we are assessing the direction, probability and potential impact of risk,” Draghi told members of the European Parliament in Strasbourg Monday. “The bottom line is this one — either the negotiation is well managed and there won’t be substantial risk, or it is not and then the risks will be there, so we’re certainly looking at that and we’ve got to be prepared.”
- The UK services sector grew at its slowest pace in January since the aftermath of the EU referendum as the economy got off to a sluggish start in 2018.
- The monthly purchasing managers’ index from IHS Markit/CIPS fell from 54.2 points in December to 53.0 in January, its weakest since September 2016 and only slightly above the 50.0 cut-off point between expansion and recession.
- Registrations drop by 6.3 per cent in January, with increasing petrol and hybrid sales failing to offset falling popularity of diesel
- New UK car sales were down in the first month of the year, with 163,615 cars sold in January – a 6.3 per cent decline on the same month in 2017. Business sales were down by a hefty 29.7 per cent, with private and fleet buyers falling by 9.5 and 1.8 per cent respectively.
- The figures, released by the Society of Motor Manufacturers and Traders (SMMT), echo last year’s full sales figures, which showed a 5.7 per cent fall in sales across 2017.
- Britain’s retailers battled through “tough” trading conditions in January as consumers preserved their cash for essential food shopping and shunned big ticket purchases.
- Non-food sales declined by 1.2% in the three months to the end of January with furniture sellers, shoe shops and high street clothing retailers recording their worst performance since 2009, according to British Retail Consortium (BRC) and KPMG data.
- The volume of retail trade dropped 1.1 percent month-on-month in December, in contrast to the 2 percent rise posted in November. Sales were forecast to drop 1 percent.
- Sales volume of food, drinks and tobacco dropped 0.7 percent on month and non-food product sales decreased 1.2 percent.
- On a yearly basis, retail sales growth eased to 1.9 percent from 3.9 percent in the previous month. Economists had forecast sales to rise 1.8 percent.