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It's Time to Prepare for the Bad and Expect ... Even Worse

It's Time to Prepare for the Bad and Expect ... Even Worse

Wednesday, 30 December 2015 11:47 AM Current | Bio | Archive

This year was definitively not an easy year for long-term investors and 2016 looks like it could be something similar, if not worse.

The 2-year U.S. Treasury yield just hit its highest level since Q1 of 2010, which caused the U.S. Treasury yield curve, which is the yield difference between the 2-year and the 10-year Treasurys, to fall to 119 basis points. That is its lowest level of the year and even, which is important, 2 basis points below the nadir that was hit in the aftermath of the financial crisis in 2012.

Now, the actual flattening of the yield curve has mainly been caused by shrinking demand for the 2-year Treasury, which has caused its price to weaken and its yield to rise and has hereby diminished the yield spread between the 2-year and the 10-year Treasury.

Long-term investors should not, at least not for now, see the “flattening” yield curve as an early warning sign the U.S. is bound for difficult economic times or even recession. Nevertheless, should the yield of the 10-year start to weaken (= its price rising) substantially, then there would probably be “problems” in the air, which doesn’t mean “per se” troubles in the U.S.

Anyway, we are in very delicate times that won’t disappear anytime soon.

Also and last but not least, the flattening of the yield curve will not make the Fed’s task of deciding when to make the next Fed funds rate hike any easier, on the contrary.

Interestingly, markets at present expect at a more than 50 percent probability the Fed will raise interest rates again in March.

In case the Fed raises in March, the big question will then become how many rate hikes will we see in 2016 as there is, and this is also important, a clear difference in expectations between the Federal Reserve’s expectations and as shown in its own projections, which were released on December 16, wherein we see the Fed expects 4 rate hikes in 2016, when markets, till now, only expect 2 rate hikes in 2016, which indicates stress/volatility can be expected in the markets because: or the Fed, or the markets will be wrong in their expectations.

Investors should watch out if it turns out the Fed is more aggressive in raising rates than markets expect at present because that situation is not “priced in” into the markets.

Besides all that, Saudi Arabia just announced the new budget of the Kingdom wherein it announces a wide range of unprecedented spending cuts, which include cuts in energy subsidies of up to 50 percent while it plans to raise revenues from taxes and privatizations in order to shrink the State’s record deficit caused by low oil prices.

The new Saudi budget measures make it implicitly clear to all oil market participants the Kingdom will not change its overall oil policy despite the negative impact low oil prices have on its finances and the Kingdom is willing to continue tolerating cheap crude to defend its market share and wait, as long as it takes, for the market to balance without cutting supplies.

Saudi Aramco's chairman Khalid al-Falih, who is considered as a possible successor to the actual Saudi Oil Minister Ali al-Naimi and who is closely watched by traders and analysts for any insight into the kingdom’s “oil thinking” said at a press conference: “We see the market balancing sometime in 2016, we see demand ultimately exceeding supply and soaking up a lot of the excess inventory and prices in due course will respond regardless of when and by how much. Saudi Arabia more than anyone else has the capacity to wait out the market until this balancing takes place.”

Interestingly, there is already mainly unreported collateral damage to the Kingdom.

Bloomberg reported about the Saudi currency, the riyal (SAR): “Twelve-month forward contracts climbed 280 points to 755 as of 2:01 p.m. in Riyadh. That is the highest level, which means the weakest rate against the dollar, since March 1999, reflecting growing speculation the country may allow its currency to definitively weaken against the dollar and this for the first time in almost three decades.”

For oil prices all this means it probably will be “lower for longer,” which doesn’t bode well for High Yield Energy Bonds. The Bloomberg HY Corporate Bond Index Energy has already lost more than 30 percent since August of last year, and probably we haven’t seen the bottom yet.

I’m afraid, in 2016 many (unfortunately) investors are at risk of “Losing their shirts” if they don’t watch out and prepare their holdings for the worst.

Trying not being part of them could be not such a bad idea.

Etienne "Hans" Parisis is a Belgian-born bank economist who has advised global billionaires and governments on the financial markets and international investments. To read more of his articles, GO HERE NOW.

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I’m afraid, in 2016 many (unfortunately) investors are at risk of “losing their shirts” if they don’t watch out and prepare their holdings for the worst.
investors, year, stocks, fed
Wednesday, 30 December 2015 11:47 AM
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