Is crisis over? Fed expected to move toward normalization
Five big themes likely to dominate thinking of investors and traders in the coming week
1. Fed comes alive
The US Federal Reserve is widely expected next week to announce plans to begin unwinding its $4.2 trillion portfolio of Treasuries and mortgage-backed securities in its latest step toward monetary policy normalization nearly a decade after the global financial crisis. A larger question looms, however, over whether the Fed resumes interest rate hikes later this year. While the Fed and most economists see the US economy continuing to plod along in slow-growth mode, the bulk of data describing the economy’s health has surprised to the downside for months as measured by Citigroup’s US Economic Surprise Index. Persistently weak readings of inflation have been a particular conundrum for policymakers vexed by an inability to coax consumer price pressures upward toward their annual growth target of 2%.
In the last month, however, the margin of downside surprises has narrowed substantially and this week witnessed the first upside surprise on an inflation reading since the spring. Interest rate futures have responded accordingly, and expectations for a December rate hike have risen so far in September. The chance of a quarter-point increase to 1.25 to 1.50% in December has climbed to roughly 50% from 31% in early September, according to CME Group’s FedWatch tool.
2. Boom-bust or boom-boom?
Stocks hovering around record highs during the second-longest bull market in history have for months led to concerns about an overheated market. But on one measure the rally may have some justification. The Boom-Bust Barometer, an indicator of economic health and momentum, shows that stocks have “a far healthier fundamental foundation than most perceive,” according to James Paulsen, chief investment strategist at The Leuthold Group. The barometer – which measures a spot price of a range of industrials such as copper, steel and lead scrap, divided by unemployment claims, according to Yardeni Research – has been rising steadily with the S&P since the trough in 2009. Paulsen said the market was not necessarily as extended as people think. While investors were primarily concerned about the Fed “taking the punch bowl away,” they should take greater note of a weaker dollar and lower bond yields since year-end, he said.
3. Scorched by Sterling
The British pound has just posted its best week since 2009 as a sharp reassessment of the Bank of England’s interest projections sent those with large bearish bets scrambling to cover. On Thursday, the Bank of England doubled down on its new warning that official interest rates are likely to rise soon. Sharp moves in the currency have a serious impact on all UK assets which have been in thrall to the pound since last year’s shock outcome in the Brexit referendum.
Sterling’s rally dealt a blow to UK bluechip stocks with the FTSE 100 slipping more than 2% in the last week while yields on short-dated gilts rose to their highest since the Brexit vote. Global fund managers are more “underweight” in the UK than any other asset class or geography relative to historical allocations, according to the latest Bank of America Merrill Lynch survey of portfolio managers. Sharp, sustained strength in sterling will change the calculus significantly going into the final quarter of the year.
4. Bitcoin in the balance
After a vertiginous ascent to record highs just below $5,000 early in the month, bitcoin plunged as much as 40% in the 12 following days, dipping below $3,000 on Friday BTC=BTSP. A combination of fears of a crackdown in China, worries that its prise rise had been too sudden, and a warning from JPMorgan CEO Jamie Dimon that bitcoin was a “fraud” and was set to “blow up” drove the sell-off, and hundreds of copycat cryptocurrencies that have sprung up and surged in value in recent months tumbled along with it. But after rumors of Chinese exchange shut-downs were confirmed, traders seem to be getting a case of the “buy the rumor sell the facts”. Bitcoin bounced 20% in four hours, and other cryptocurrencies also followed. Focus will now turn to other regulators to see whether they too will take steps to curb trading – no evidence of this has been seen so far. Has the crypto-bubble really burst, or was this just a temporary blip?
5. Kiwi shake-up
As they head into national elections on Sept. 23, New Zealand’s markets are facing major political uncertainty for the first time in a decade and bracing for a shake-up of monetary and economic policy. Opinion polls show the main opposition Labour party has once again grabbed the lead from the incumbent National party. Labour’s platform includes not just a reduction in net immigration but also a change to the Reserve Bank of New Zealand’s (RBNZ) mandate, by ending its sole focus on inflation and adding an employment goal. And if the Nationals do form a government, they are likely to have to seek support from the minor New Zealand First Party, which also wants changes to the RBNZ’s mandate.
The kiwi NZD has tumbled from a two-year high of $0.7557 it hit in July, when a Nationals victory was expected, as the polls have turned. It is still up about 4% against the US dollar so far in 2017, but the uncertainty around a Labour win – both on expectations of monetary policy being less hawkish on inflation and slower immigration softening growth – could weigh on both the currency and the quite richly valued stock market .NZ50. The stock index is up 12.8% this year and trades at a PE of above 17.