Equities
US equity ‘Bulls’ continued their post-election rampage on Wall Street as the Dow Jones Industrial Index closed above 19,000 for the first time and the S&P 500 topped 2,200. With the technology focussed Nasdaq index at just below 5,400 all the main US equity indices are at all-time highs for the first time since 1999.
Donald Trump’s pro-growth policies, which includes promises of corporate tax cuts, bumper infrastructure spending and looser banking regulation, have sparked a rally in equities since his shock victory on November 8.
Meanwhile, fears that his policies will fuel inflation and trigger aggressive interest rate rises by the US Federal Reserve have pushed bond yields higher and strengthened the dollar.
The US equity ‘bull run’ has pulled up other global equity markets but not to the same extent. The FTSE 100, for example, is trading at 6,840, below its 7,128 all-time-high reached in early October. The UK has Brexit developments to consider.
Interest Rates
The FOMC (Federal Open Markets Committee) is the monetary policymaking body of the main US Federal Reserve System. The FOMC schedules eight meetings per year, one about every six weeks or so. The FOMC issues a policy statement following each regular meeting that summarizes the Committee’s economic outlook and the policy decision at that meeting. A full set of minutes for each FOMC meeting is published three weeks after the conclusion of each regular meeting. From the last meeting’s minutes on the eve of the US Presidential election, policymakers appeared confident that the economy was strengthening enough to warrant an interest rate increase soon.
The key US interest rate is the Federal Funds or ‘Fed Fund’s rate: The Fed funds rate is the interest rate banks charge each other to lend Federal Reserve funds overnight. These funds maintain the Federal reserve requirement. That’s what the nation central banks require banks keep on hand each night. The reserve requirement prevents them from lending out every single dollar they get. It makes sure they have enough cash on hand to start each business day. The Federal Reserve uses the Fed funds rate as a tool to control U.S. economic growth. That makes it the most important interest rate in the world. Banks use the Fed funds rate to base all other short-term interest rates.
The next FOMC meeting is Dec 13-14. The interest rate futures market is predicting 93% probability that the Fed Funds rate will rise by 0.25% to a new range of 0.50-0.75% (currently 0.25-50%) at that meeting.
Fixed Income
Before the election of Donald Trump as the next U.S. president, bond investors took the approach:
- Don’t fight central bankers and their all-powerful monetary policies
- Don’t expect a sudden surge in inflation
- Count on ultra-low bond yields in Europe and Japan to continue pushing money out of those places and into the U.S.
In less than a month, it seems as if everyone’s ideas have changed. Now, investors are steadily increasing their inflation expectations. This is perhaps because Trump has talked about big infrastructure spending programs and negotiating new trade deals, both of which may lead to products being more expensive for U.S. consumers.
U.S. benchmark bonds yields surged, even as European yields remained low. US Treasury (Govt.) Bonds are paying the highest yields relative to similar German notes in more than a decade. Will U.S. policies and the subsequent sell-off in Treasuries force bond yields higher around the world? Or will the gap widen further, strengthening the dollar even more?
US 10 Year Government Bonds (Treasuries) at 2.35 annual yield-to-maturity are up 0.57% over the last month. German 10 Year Government (BUNDS) yield 0.25%, up 0.29% over the last month. UK Government Bonds (GILTS) yield 1.42%, up 0.29% over the month. Note: November yield rises (bond price falls) are on top of significant yield rises in October too i.e. UK gilts combined 10 year yield rises over the past 2 months come close to a full 1% rise in yields (same in US).This is a huge move in bond market terms representing huge price falls and losses for bondholders.
Foreign Exchange (FX)
The dollar surged to its highest level since March 2003 last Wednesday, bolstered by upbeat U.S. economic reports that showed the economy on track for steady growth as expectations of rate increases by the Federal Reserve next month and in 2017 were reinforced. The ‘greenback’ (US Dollar) also rose sharply against the yen, rising to an eight-month high, and climbed versus the euro to its highest in 19 months. Higher US interest rates and bond yields attracts global money into dollar denominated assets.
GBP: The pound spiked at $1.49 on the day of the EU referendum but has fallen since then to $1.24. UBS predicted a rise back to $1.55 in the years ahead as they see the UK a prime location for overseas investment despite Brexit concerns.
Oil
Oil prices are reasonably strong at $47 per barrel as OPEC (Organisation for Petroleum Exporting Countries) appeared to be moving closer to reaching a deal on production cuts before its meeting this week coming. Goldman Sachs turned “tactically bullish” on the likelihood of an OPEC deal and raised its price forecast to $55 a barrel for the first half of next year.
Looking longer term, an oil supply crunch could come as soon as 2019 as investment in new projects dries up following is price collapse (oil was trading at $115 p.b. 24 months ago). Barclays analysts forecast that 2019 would see “the lowest year for new capacity” on record, with just 1.2m barrels per day (bpd) of new supply. By contrast, the decline for existing fields and growing demand would together equal 4m bpd, resulting in gap of almost 3m bpd.
The analysis comes after the International Energy Agency last week warned that the world was headed for another boom and bust cycle in the oil market, with supply shortages likely to cause rapid price rises by the early 2020s.The IEA said that if project approvals remained at current lows next year it was “increasingly unlikely that supply will be able to meet rising demand without rapid price increases”.
Such supply projects inevitably have long production lead times.US shale gas production (which is inherently more production flexible) would inevitably ramp up production, but how much can it produce to fill the gap and how high an oil price is needed for shale gas producers to return to production are the questions. Many US shale gas producers closed production as oil fell below $60 p.b. with their production breakeven around this price area historically although such producers are lowering their production costs as they become more efficient as the industry matures.
Gold
Gold prices are under pressure because:
- Gold prices have an inverted relationship to movements in the US Dollar as gold is priced in dollars and in order for the commodity to maintain its intrinsic value the price of gold falls, all other things being equal, when the dollar rises and the gold price rises when the dollar falls. With the dollar very strong at the moment the gold price has been very weak.
- Buying gold is a ‘safe haven’ risk adverse investment strategy but the world is in a ‘risk on’ trading mode at the moment with US equity markets, particularly, trading at record high levels.
- With Donald Trump looking to boost the US economy via an expansionary fiscal policy i.e. spending, with such a policy it is likely that inflation will rise and so too with US interest rates accordingly in 2017 and 2018. This is bad news for gold on a relative attraction basis with the latter a non-interest paying investment asset.
Gold has fallen from $1,325 high on the news of Trump’s shock election victory to $1,185 today – a big fall by any standards.
Misc.
- Donald’s Trump’s pledge to pull out of the planned Trans-Pacific Partnership (TPP), a free trade deal with 12 nations on both sides of the Atlantic, could give China more power in determining the future of the global economy.
- UK Chancellor of the Exchequer, Philip Hammond delivered his Autumn Statement last Wednesday. This is effectively a mini-budget announcement. It contained no major news or surprises. Growth forecasts for 2017 and 2018 were revised down by the independent Office for Budget Responsibility, while government borrowing was revised up.
Equities
S&P 500: 2210
Nasdaq: 5395
FTSE 100: 6840
Bonds – 10 Year Government Yields
US 2.40%
EU 0.16%
GB 1.40%
Foreign Exchange
EUR/USD 1.0600 (1 euro buys 1.0600 dollars)
GBP/USD 1.2450 (1 pound buys 1.2450 dollars)
Commodities
OIL: Brent: 47.00 (dollars per barrel)
GOLD: 1185 (dollars per ounce)
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