US
The two big questions facing traders are the path of US interest rates and the pace of ‘Fed’ balance sheet reduction.
US Central Bank Balance Sheet: The Federal Reserve is intent on making the unwinding of its $4.5 trillion balance sheet as boring as possible. (The ‘Fed’ accumulated this balance sheet from buying distressed debt from distressed US financial institutions during the financial crisis).
The European Central Bank has been making similar noises ahead of the tapering of its bond-buying program.
There is history here: in 2013 there was what was known in financial markets as a “taper tantrum” which was the something of a shock announcement of the withdrawal of Quantitative Easing which led to a sharp fall in asset prices at the prospect of a major buyer (the ‘Fed’) leaving the market.
US Interest Rates: The key US ‘Fed Funds’ rate (which influences all other US if not global interest rates) has been risen by 0.25% twice early in the year from 0.5% to 1%. The Fed is looking to ‘normalize’ interest rates perhaps taking this key benchmark rate gradually towards the 3% level. The markets were at one stage looking for a further interest rate rise this year and the Fed was talking as much as 3 x 0.25% next year.
However with:
- Inflation relatively subdued in the US
- US economic growth moderate (although US GDP grew at a healthy 3% in the second quarter)
- Trump failing to deliver on pro-growth policies
Financial markets have a very soft of ‘dovish’ view on the outlook for US interest rates. This is one reason why the US Dollar is so weak (see below) and equity markets are strong.
US Dollar
A major trend this year has been a weak dollar with Trump so far failing to deliver on his pro-growth policies, US inflation soft and the outlook for higher US interest rates muted. In January the USD Dollar Index reached a 14-year high of 103.82.It is now down at 92.28, its lowest since May 2016 – quite a downward move.
The opposite side of this coin is Euro strength. The currency traded this week just above $1.20 (1 Eur = $1.20) – the highest level against the dollar since January 2015 as Eurozone business confidence rose to a decade-high in August.
North Korea
Gold has jumped to a nine-month high as safe haven assets have been snapped up amid investors jitters over North Korea’s missile testing. This is a typical market reaction: see How-does-international-conflict-affect-markets/
Such concerns have led to investors going into a ‘risk off’ mode buying US Treasury bonds and selling equities and such moves affect global markets.
The 10-year US Treasury bond is trading at 2.12% yield-to-maturity as the low yield for 2017 of 2.10 per cent is within target. Note: Many investment bank research departments at the beginning of the year were predicting US Treasury yield rises throughout 2017 as the Fed raised interest rates predicting end 2017 10-year yield of 2.75-3.0%.They have been proved very wrong.
US and global equity markets have also sold off 1-2% on North Korean conflict fears, but to put into context, this relatively small down move is after a very strong ‘bull’ run and the main US equity indices are still very close to all-time highs. Whether Trump can finally deliver on his pro-growth US election promises will likely be key for the next major move in US, and indeed, global equities.
In recent years falls in asset prices have been consistently used as a buying opportunity for risk. This highlights the degree of comfort markets have about central bank monetary policy remaining benign.
Oil prices have moved higher over the last few days as Hurricane Harvey wrecks havoc on the southern Texas Coast. The US Gulf of Mexico is home to about 17 per cent of the US nation’s crude oil output. However, at the end of the day, oil prices have stayed close to $50 per barrel for several months now, unlike significant 2014-2016 price volatility.
Equities
S&P 500: 2450
Nasdaq: 6275
FTSE 100: 7400
Bonds – 10 Year Government Yields
US 2.12%
EU 0.38%
GB 1.11%
Foreign Exchange
EUR/USD 1.1900 (1 euro buys 1.1900 dollars)
GBP/USD 1.2800 (1 pound buys 1.2800 dollars)
Commodities
OIL: Brent: 52.00 (dollars per barrel)
GOLD: 1285 (dollars per ounce)
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