Tags: rate | central bank | commodity | price

Reading Tea Leaves in a New World

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Thursday, 05 Feb 2015 08:05 AM Current | Bio | Archive

This is one nutty market. One day the Dow Jones Industrial Average plunges 300 points and the next day it soars 300 points. It seems like half the pundits are bullish on stocks and the other half warn of an impending crash. I have never seen such an utter lack of consensus on subjects so broad as the basic health of the economy and the intermediate-term direction of the market.

What's going on?

The world has changed dramatically in just the past decade. At the same time, central banks have intervened in markets on an unprecedented scale. We're in new territory here. And previously reliable economic and market barometers have lost their predictive powers.

For example, interest rates on bonds have historically been a very reliable economic indicator. Falling rates on intermediate- and long-term bonds typically portend a lousy economy in the next year or so. Interest rates typically rise when the economy is strong and fall when it is weak. Low rates on bonds further out on the yield curve mean the market expects lower rates in a weaker economy.

By that measure, we're headed for big trouble.

The 10-year Treasury is yielding just 1.8 percent, near historic lows and down from 3 percent just about a year ago. But that paints a rosy picture compared with rates in the rest of the world. Here are some recent yields on major international 10-year government bonds:

 Canada 1.365 percent
 Germany 0.36 percent
 U.K. 1.48 percent
 France 0.54 percent
 Japan 0.22 percent

The problem is that central bank meddling has corrupted the process. All over the world central banks have lowered benchmark interest rates to historic low levels in order to stimulate the economy and devalue their currencies. Where would market forces (without any central bank intervention) have taken today's rates? We can't be sure. So what do they really mean?

Commodity prices are also a strong indicator. Although they have always been volatile, they generally reflect business activity and economic growth. More oil, iron, lumber and other materials are demanded when economies are strong and prices tend to increase. Commodity prices have tanked. That's another bad sign.

But it's not that simple. The world experienced unprecedented global growth last decade as China and other emerging markets grew at a furious pace and became major players in the global economy. As commodity prices soared, the world scrambled to increase supply to match the rocketing demand. Huge new supply has hit the market just when demand stabilized.

Are falling commodity prices more of a supply and demand issue or the result of economic weakness? It isn't entirely clear. As well, the soaring dollar has also played a role in falling prices.

Look at oil. The U.S. energy boom has flooded the world with massive new supply. The balance of power in the energy arena has changed and OPEC is no longer all-powerful. That's not business as usual. Falling oil prices aren't just about falling demand amidst deteriorating economic conditions. There's a lot more to the story.

Our ability to read the economic tea leaves has been corrupted. The new world economy and massive central bank easing have changed the game. Now the future direction of the markets will depend heavily on the ripple effects of interwoven monetary policies, the effects of which are little understood.

Clarity will not be coming anytime soon. Expect more uncertainty and volatility in the markets.

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TomHutchinson
This is one nutty market. One day the Dow Jones Industrial Average plunges 300 points and the next day it soars 300 points. It seems like half the pundits are bullish on stocks and the other half warn of an impending crash.
rate, central bank, commodity, price
568
2015-05-05
Thursday, 05 Feb 2015 08:05 AM
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