Interest Rates
US Interest Rates are set by the FOMC (Federal Open Markets Committee) which meets approximately every 6 weeks. Federal Reserve Chair Janet Yellen sounds like she’s on a mission to raise interest rates this year — no matter what President Donald Trump does on tax cuts and spending.
The ‘Fed’ has an unwavering commitment to ‘normalising’ interest rates. The average key ‘Fed Funds’ rate (the rate at which banks lend to each other via deposits placed at the Federal Reserve) is 5.95% looking at the last forty years. The current rates is 0.50-0.75% per cent which is still a financial crisis inspired accommodative or emergency rate and perhaps not appropriate for a US economy getting a growth infusion from Donald Trump.
The odds of a quarter point rate hike at the Fed’s March meeting are between 30-40% depending on which gauge you look at.
Equities
US: Normally higher interest rates are bad for stocks as it slows economic growth and higher bank deposits rates are an alternative to equity investing but the opposite is happening. Banks make higher profits when interest goes up as they tend not to pass on all the higher interest rate to their deposit account holders so financial stocks are doing very well right now e.g. Goldman Sachs share price is up over 30% since the November 8th election compared to an overall market rise of circa 10%.
Banks have also benefitted from Trumps intention to de-regulate the financial industry (specifically repeal part of the restrictive Dodd Frank Act) which should allow this sector to enhance profits by perhaps returning to proprietary trading and similar.
With financial stocks a big component of US stock markets, shares have surged to record levels. The S&P 500 has just had had its first run of seven successive daily gains since 2013. The market is also supported by strong economic data and hopes for Trump’s personal and corporation tax cuts.
UK/Europe: In a global economy US stocks are dragging other stock markets higher. European shares are heading for longest run of gains since July 2015. The UK FTSE 100 touched a fresh one-month high as mining and financial stocks feature particularly strongly.
Whilst Brexit fears remain, the economy has remained robust since the Brexit vote last summer. UK unemployment has declined and the measure of the number of people in work rose to a record in the fourth quarter, pushing the labor market closer to “full capacity”.
Fixed Income
With the current inflation rate for the United States at 2.5% for the 12 months ended January 2017, coming in above expectations, it looks as though some of Trump’s proposed economic policies are filtering down to a more robust US economy and so bringing forward rate hike expectations. All this is bad for bonds with inflation eroding real returns and higher interest rates also driving up yields (therefore prices down!).
The yield on the benchmark 10-year US Government Bond is once again back above 2.50%. Remember, yields were 1.32% last summer. We have seen a broad 1% or 100 basis point rise in many bond markets over the last several months on higher growth/inflation fears.
Foreign Exchange
At the beginning of January the US Dollar was at 14-year high supported by prospects for stronger US growth and higher interest rates. However, the ‘Greenback’ fell 3-4% during most of January as investors took profits as they wanted to see hard evidence of Trump’s pro-growth policies. The US Dollar has had a strong last 10 trading days and has recouped approximately 1.5% of January’s loss.
Commodities
Gold: Not much price action in the gold market with the metal trading at $1,230 an ounce. The gold price is supported by the prospects of higher inflation with the former attractive as it hold its worth in inflationary times. Gold is undermined, however, by the prospect of higher interest rates i.e. Would you hold gold as an investment which pays zero interest if you can earn 3% in a US bank?
Oil: The oil price has also been remarkably steady at around $55 per barrel. This despite oil stockpiles building up in the US over the past few weeks. The OPEC agreement to cut production (both internally amongst OPEC member states and with external countries) is holding up.
Misc.
January saw huge issuance of bonds as corporations look to issue debt and lock in relatively low interest rates ahead of 2017 and 2018 interest rate rises. Managing bond issues is a profitable activity for investment banks. Remember banks have two Fixed Income / bond business models. They have a New Issue or Primary desk which handles new bond issues that often originate from their Corporate Finance clients. They also have a secondary market bond trading operation which handles all trading of bonds until the maturity of the bond i.e. in 2, 5, 10 or 20 years’ time. There are over 200,000 different bonds in existence although any single bank would only trade perhaps 15,000 of these.
Equities
S&P 500: 2340
Nasdaq: 5800
FTSE 100: 7300
Bonds – 10 Year Government Yields
US 2.50%
EU 0.40%
GB 1.30%
Foreign Exchange
EUR/USD 1.0600 (1 euro buys 1.0600 dollars)
GBP/USD 1.2500 (1 pound buys 1.2500 dollars)
Commodities
OIL: Brent: 55.00 (dollars per barrel)
GOLD: 1230 (dollars per ounce)
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