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Global Investors Just Aren't Prepared for a Fed Rate Hike

Global Investors Just Aren't Prepared for a Fed Rate Hike
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Wednesday, 16 September 2015 07:55 AM Current | Bio | Archive

We will soon have that long-awaited important FOMC meeting where it will be decided if the Fed will embark on a path to “normalization” that will start a long period of “re-pricing” of the cost of capital.

In trying to understand somewhat of the Fed Chair Janet Yellen’s way of thinking, on May 22 in a prepared speech titled “The Outlook of the Economy,” she said: “… if the economy continues to improve as I expect, I think it will be appropriate at some point this year to take the initial step to raise the federal funds rate target and begin the process of normalizing monetary policy. To support taking this step, however, I will need to see continued improvement in labor market conditions, and I will need to be reasonably confident that inflation will move back to 2 percent over the medium term…”

Looking at her key points’ related data we see:
  • The Federal Reserve’s own Labor Market Index stood in August at 2.1, which was up from 1.7 in May;
  • The University of Michigan inflation expectation stood in August at 2.8 percent, which was exactly at the same level as in May.
Does the data, which are not bad but certainly could be better, mean the US central bank will raise its fed funds rate tomorrow? Nothing is less sure, but I wouldn’t be surprised if they finally do it.

Anyway, on Tuesday, just on the day before the 2-day FOMC meeting starts, the U.S. 2-year Treasury yield spiked 7.68 basis points to 0.82 percent, which was its highest yield since April 2011 and interestingly 18 basis points higher than the 0.64 percent yield where it was on the day Mrs. Yellen gave her speech in May.

For comparison, on Tuesday, the German 2-year Treasury yielded a “negative” -0.23 percent.

Comparing both yields we see an extremely important yield difference (divergence) between the 2-year U.S. and German Treasurys of a full 1.03 percent!

For long-term investors, this should give a hint the dollar has no other way forwards than to strengthen further against the euro (and other currencies) as the ECB is getting ready to launch its second quantitative easing program.

Besides all that, and because it’s very important, it’s a fact global economic growth, outside the U.S., continuous to be weak and even shrink.

When we look at a big part of global merchandise trade, the just released OECD “G-7 and BRIICS merchandise trade figures during Q2 of 2015 show:
  • Exports were down to their levels of Q1 of 2011; 
  • Imports were down to their levels of Q4 of 2010.
In context of these data, the OECD released its interim growth outlook wherein it raises U.S. GDP growth to 2.4 percent in 2015, up from 2 percent in June, and to 2.6 percent in 2016, down from 2.8 percent in June.

The OECD states global growth will remain sub-par in 2015 while some strengthening is expected in 2016, but doubts about future potential growth continue to build.

In its "Near-Term Policy Recommendations," the OECD says: “In the United States, shrinking slack warrants an upward interest rate path, but a very gradual one.”

Besides all that, the World Bank, in its study “The Coming U.S. Interest Rate Tightening Cycle: Smooth Sailing or Stormy Waters?” gives several warnings and explains: “… The impact of a 100 basis points shock (=1 percent) in long-term interest rate across G4 economies is estimated to reduce aggregate capital flows to EFEs (Emerging and Frontier Economies) by 2 percent of their combined GDP (45 percent drop in flows) … emerging and frontier market economies may hope for the best during the upcoming tightening cycle, given the substantial risks involved, they need to prepare for the worst.”

I’m afraid that the vast majority of investors all over the globe still greatly underestimates the coming “multi-year normalization cycle of the Fed,” which will ignite also “the multi-year normalization cycle of the cost of capital.”

In simple words, all this means is that interest rates will go up, that's it.

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HansParisis
I’m afraid that the vast majority of investors all over the globe still greatly underestimates the coming “multi-year normalization cycle of the Fed,” which will ignite also “the multi-year normalization cycle of the cost of capital.”
fed, rate, investors, hike
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2015-55-16
Wednesday, 16 September 2015 07:55 AM
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