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Fed tea leaves leave market wanting more
Patti Domm | @pattidomm
3 Hours Ago
CNBC.com


The Fed remains on track to hike interest rates this year, and the minor tweaks to its post-meeting statement were just vague enough to keep the debate going on when it will raise them.

Fed Chair Janet Yellen has said the central bank could boost its fed funds target rate for the first time in nine years sometime this year. Economists, by a slim margin, have been expecting the first increase in September, but others see a December hike.

In its statement, the Fed upgraded its view of the economy and labor, but left questions about the course of inflation, which is tracking weaker than the Fed would like.

"I don't think this change should affect anyone's thinking about when the Fed goes," said Ward McCarthy, chief financial economist at Jefferies. McCarthy expects the first hike in December.

However, Peter Boockvar of The Lindsey Group sees the first rise in September, and he believes the Fed confirmed that view with an upgrade of the language on labor.

Read MoreNot yet: Fed keeps rates at zero

Federal Reserve Board Chair Janet Yellen
Getty Images
Stocks were initially boosted and Treasury yields sank, suggesting a dovish statement. But Treasury yields reversed some of those moves, and stocks remained somewhat elevated.

The central bank noted that the economy is expanding moderately, dropping a reference to it being little changed in the first quarter. "The labor market continued to improve, with solid job gains and declining unemployment. On balance, a range of labor market indicators suggests that underutilization of labor resources has diminished since early this year," the Fed said.

"Assuming all else is equal, I think they're more likely to go in September based on their upgrade of the labor market," Boockvar said. "If you look at this statement and compare it to June, to me they're setting up for a September rate hike."
McCarthy noted that the Fed had blamed the decline in inflation in part on energy prices, and in its June statement said energy stabilized. However, oil has sold off since and it removed the reference to energy stabilizing.

He said that was a slightly dovish development. "They were rightly more optimistic about growth and they were less confident about inflation because they at least stopped claiming energy prices were stable. It was a split decision on the dual mandate," McCarthy said.

David Ader, chief Treasury strategist at CRT Capital, said the Fed did nothing to change the market debate on timing, though he expects the first hike in September.

Strategists pointed to the addition of the word "some" in a sentence where the Fed described the further improvement it would like to see in labor and inflation before raising rates. Ader saw that as a slightly hawkish tempering of the language.

The Fed statement said: "The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term."
"This is nuanced and the Fed doesn't do this glibly in terms of changing their language. When they add something, they add something," said Ader. "On the inflation front, it's a little bit more dovish. But I think the labor side is more interesting. That's been their focus."

Deutsche Bank's chief U.S. economist, Joseph LaVorgna, also said the addition of the word "some" was important.

"Some further is less than further," said LaVorgna. "These little tiny tweaks certainly suggest they want to raise rates. I don't think they decided which meeting it is. To them it's a tossup—September or December. This is very much in line and consistent with what Yellen has said and the Fed has said."

LaVorgna said the Fed made it clear that it wants to raise rates, and that it would base its decision on the economy. "The data now is very important.," he said. "If we get another month were jobs are over 200,000 and the employment rate slips, that's enough for me to think they go in September."

Patti Domm
Patti Domm
CNBC Executive News Editor

OPINION Jul 30 2015 at 3:54 PM Updated Jul 30 2015 at 4:17 PM

Two more reports and investors will know everything


by Philip Baker

A decent US economy. A lacklustre global economy. A strong US dollar and a Federal Reserve on the prowl, poised and ready after leaving rates at close to zero since 2008.

The upshot: there's two unemployment reports and two inflation numbers to see before the next meeting of the Fed.

They will reveal all.

True to its word the Fed has always said that any move is "data dependent" and anyone looking for more clues from the latest meeting that finished on Wednesday night was perhaps always going to be disappointed. These well-crafted statements have taken on a life of their own since interest rates around the world have been slashed to record lows.

Federal Reserve chair Janet Yellen can't increase rates higher than 2 per cent.
Federal Reserve chair Janet Yellen can't increase rates higher than 2 per cent. Reuters
And this one was no different. Not surprising there was something in it for everyone. For those thinking a September hike is still on the cards the statement made sense, while it did as well for those that favour the first strike to be in December.

But for all the talk about looming rate hikes by the Fed, the real question for investors is just how high can it raise them?

Not very high is the answer: 2 per cent tops.

It's hard to see interest rate cycles of the future having the highs and lows, or extremes, they have had in the past.

That can cause some angst in financial markets as they like it when rates are either going up, or going down, and in large moves. That in turn gives them more scope to make money betting on moves in either direction.

But if the future is a low-growth one then it follows that moves in monetary policy won't be as wild.

If there were any key takeaways from the latest statement it was the line about "solid job gains and declining unemployment".

A look at the previous statement and the Fed at the time saw "the pace of job gains picked up while the unemployment rate remained steady".

One other word was added to the Fed's statement: "some". The Fed now says it will raise interest rates "when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 per cent objective over the medium term".

That implies the Fed doesn't need to see that much more improvement in the labour market before it presses the green button.

THE GROWTH NUMBERS

Next Friday economists expect the latest report to show that 218,000 jobs were created and the unemployment rate is tipped to be unchanged at 5.3 per cent. One sticking point perhaps is the low rate of inflation that at just 0.1 per cent is way below the Fed's comfort stage of around 2 per cent. However, the Fed's preferred measure of prices, core inflation excluding volatile food and energy, rose 0.2 per cent in June and 1.8 per cent over the past year.

For those that think September is the month they also believe that inflation will rise toward 2 per cent as labour markets continue to tighten. The fall in the oil price over the past year, that has also helped to drive inflation down, will also drop off, while on Barclay's numbers inflation in the US has already begun to firm, rising at a 2.25 per cent annual rate pace so far in 2015.

Ironically the latest growth numbers, that really do show how the US economy is growing, will be released on Thursday night. While the Fed looks to the employment and inflation numbers it might just throw a spanner in the works if this latest set of numbers disappoints.

Remembering that much of the growth data has been mixed, this time round domestic product in the three months to June should show the US economy grew at 2.5 per cent, according to the median forecast of economists surveyed by Bloomberg. Those economists who favour a September tightening think the growth rate is closer to 3 per cent.

Still, it's some improvement from the cold snap in the first quarter that showed the economy contracted by 0.2 per cent. Consumer spending, which makes up about 70 per cent of the economy, is forecast to rise 2.7 per cent.

Fed has excellent excuse for a rate rise delay
671 words
31 Jul 2015
The Australian Financial Review
AFNR
English

The US central bank has only given itself a grade of 50 per cent in its latest scorecard, believing that although it has succeeded in reviving the flailing US jobs market, it has failed to do the same with inflation.

But while most of us would start looking for another job after such a mediocre performance review, the US Federal Reserve need have no such fears.

Indeed, investors cheered the statement put out after the Fed's latest policy meeting, believing that it pushes the date for any interest rate rise even further into the future.

By highlighting the patchy progress it is making in achieving its "dual mandate", the US central bank has given itself an excellent excuse if it decides to postpone the difficult decision of whether to raise interest rates until 2016.

Janet Yellen, the Fed's chairwoman, has previously warned investors to expect rate rises this year, although she has always added the caveat that the Fed would look to the economic data before moving its key interest rate, which it has kept close to zero since December 2008.

And at this stage, the data is giving decidedly mixed signals. On the unemployment front, the Fed has reason to boast, with the US jobless rate almost halving from 10 per cent in 2009 to 5.3 per cent in June.

In its latest statement, Fed officials congratulated themselves on the "solid job gains and declining unemployment". They also pointed to the pick-up in hiring and the reduction in the amount of slack in the labour market, suggesting that they believe the economy is getting closer to their full employment goal.

But Fed officials had no choice but to concede that they have failed in their attempts to fan price pressures. The Fed's favourite inflation measure remains stuck below 2 per cent - where it has been for three straight years.

Even worse, there are more deflationary pressures brewing. The sharp slowdown in China has caused commodity prices to tumble. At the same time, the stronger US dollar has sliced the cost of imports, putting pressure on US producers to cut prices to maintain market share.

After its meeting in June, the Fed hopefully noted that energy prices had stabilised, which suggested that it was hopeful that the downward price pressures from lower oil prices were fading. But the sharp drop in the oil price in the past few weeks meant there was no mention of stable energy prices in Wednesday's statement. Instead, the Fed warned that it would continue "to monitor inflation developments closely", a sign of its concern that price pressures continue to languish. Rates would only rise when the Fed is "reasonably confident" that inflation will move back to its 2 per cent target.

But the Fed's critics believe that the US central bank - and particularly its policy of keeping interest rates close to zero - is itself to blame for the dearth of inflation.

They argue that artificially low interest rates encourage investors to borrow money and buy existing assets, such as real estate, that already generate dependable income streams, rather than take the risk of investing in new plant and equipment that create jobs.

What's more, they encourage the misallocation of resources. It's unlikely that the US oil and gas exploration boom, which saw US investment banks making around $1 trillion in loans to energy companies (most of which they then sold to investors) would have been possible without such extremely low interest rates.

But such massive misallocation of capital causes the economy's growth rate to tumble, even though debt levels continue to rise.

Eventually, they warn, the economy reaches a point- even with interest rates close to zero - where the return on capital is less than the cost of capital. As nervous investors start to sell, they trigger a plunge in asset prices. And the Fed once again finds itself struggling to contain a financial crisis.


Fairfax Media Management Pty Limited

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US rate rise likely to hit Australian economy hard
THE AUSTRALIAN AUGUST 03, 2015 12:00AM

David Uren

Economics Editor
Canberra
US trade
US trade Source: TheAustralian

The Reserve Bank has been ­quietly looking forward to the US Federal Reserve lifting its benchmark rate above zero — not only because it will confirm the world’s most ­important economy is returning to normal but also because it will produce a rise in the US dollar against our own currency that will improve competitiveness.

But IMF research shows the impact on Australia’s markets and commodity prices will be both ­severe and sustained.

The likelihood of the Fed lifting rates at its meeting next month is now more than 50 per cent in the wake of the upgrade to US growth figures last week and the slight strengthening of language in the Fed Open Market Committee’s post-meeting statement last week.

Financial markets have at least one rate rise fully priced in by the end of the year.

The International Monetary Fund is confident the US can start raising rates without repeating the turmoil that followed the Fed’s decision to wind back its quantitative easing program in May 2013 — the so-called “taper tantrum” that sparked a near-100 point jump in the US 10-year bond rate and led to an exodus of capital from emerging countries.

IMF managing director Christine Lagarde commented last week that everyone was more prepared this time, with many countries having taken measures to resist a recurrence of the volatility.

Emerging country bond yields are already much higher relative to US bond yields than two years ago, with less foreign capital ­exposed to high-risk positions.

“I think that tapering tantrum was painful, but it has been a good warning of how prepared we should be, and I think the level of preparedness has significantly ­improved,” Ms Lagarde said.

However, the fund acknowledges that rising rates in the US are likely to cause collateral damage to emerging countries. Its study shows that, from 1970 to 2014, periods of US dollar appreciation have brought slower growth in emerging economies and vice versa.

And controlling for the effects of real US exchange rate appreciation and real GDP growth, an increase in US rates further reduces growth in the emerging world.

The study says the unwinding of expansionary monetary policy will keep the US dollar rising and commodity prices falling, with pressure on the external sectors of emerging countries.

“As the dollar appreciates, commodity prices fall, weaker commodity prices depress domestic demand via lower real income and real GDP in emerging markets decelerates.”

These effects outweigh any increased in US spending on emerging country products. The study says the impact on emerging country economies has started to be felt since the US dollar started appreciating in mid 2014, and it says such periods are highly persistent, lasting six years on average.

Emerging countries are confronting downturns in demand for both commodities and manufactured goods. Whatever their policy preparedness, their overall economic outlook is much more vulnerable now than two years ago during the taper tantrum.

Downward pressure on exchange rates is much less welcome in many emerging countries than in Australia, as their foreign liabilities are expressed in US dollars. A fall in their currency increases their foreign debt. Most of Australia’s foreign debt is hedged or borrowed in Australian dollars.

While the impact of a rising US dollar on commodity prices affects Australia, our economy is more diverse, with the non-commodity sectors gaining in competitiveness.

The biggest threat to the emerging world, according to ANZ global markets research head Richard Yetsenga, is it has been on “a credit party” for the seven years since the global financial crisis. The Philippines is the standout, with the value of mortgages outstanding rising fivefold since the GFC.

China and Indonesia are not far behind, with the stock of mortgages rising more than threefold. Although China is a different story, the credit boom across most of Asia has been the result of advanced-country monetary policy depressing rates around the world.

Emerging country economies are already slowing. The need to reduce domestic leverage is coinciding with a recession in world trade that is affecting both commodities and manufactured goods. Global trade volumes have contracted 3.8 per cent in the past six months, according to the Dutch government’s economic research bureau.

Mr Yetsenga notes the US recovery has not generated the usual boost to global demand for manufactured goods that has propelled the Asian economies in the past. Normally growth in the US relative to the rest of the world results in a blowout in the US trade deficit as the economy sucks in imports.

Since 2012, the US trade deficit has been hovering at about $US40 billion ($55bn) a month with no noticeable trend. Imports have remained almost flat at about 13 per cent of total spending. That partly reflects reduced purchases of oil, but even non-oil imports have increased only modestly.

This is hurting the region. For example, Taiwan reported on Friday its GDP had contracted 2 per cent in the June quarter, dragged lower by a slump in exports. Sales of electronics and information technology products were 31 per cent lower in June than a year earlier.

Asia is also suffering from the loss of momentum in the Chinese economy, where imports having fallen for each of the past eight months.

Many economists are finding it hard to square the evidence of weak Chinese demand with the official GDP figures showing growth meeting the government’s target of 7 per cent.

“We think underlying Chinese growth momentum is much weaker than official statistics reflect,” Citigroup chief Asia economist Joanna Chua noted, suggesting the real number was below 5 per cent.

A Bank of America Merrill Lynch survey of institutional investors found only 20 per cent thought China’s growth was in the 6-7 per cent range, with a similar number nominating a range of 4-5 per cent. The slowing of Asia’s economies presents a challenging outlook for Australia. Emerging nations now account for two-thirds of the nation’s exports, compared with a little more than 40 per cent when the Asian financial crisis hit in 1997-98.

Will China's devaluation delay a US rate rise?
Date
August 12, 2015 - 12:29PM

Rose Powell
Journalist


A US Federal Reserve rate increase is expected in September or December. Photo: Reuters
China's surprise devaluation of its currency has hit global markets, with some investors fearing a new currency war as well as declining Chinese economic momentum, possibly even prompting the US Federal Reserve to delay "liftoff" in interest rates.

On Tuesday, the Chinese government devalued the yuan's midpoint against the US dollar by 1.9 per cent, the most on record. This caused a sudden surge in US dollar buying, causing the Australian dollar to plummet from an intraday high of US74.36¢ to as low as US72.85¢ overnight. Neighbouring Asian currencies and global equity markets were also hit by the move.

The significance of China's exchange rate policy move could not be overstated.

Diana Choyleva, Lombard Street Research
"The significance of China's exchange rate policy move could not be overstated," Lombard Street Research's chief economist Diana Choyleva said.

The yuan's drop ended the bull market for the ASX 200.
The yuan's drop ended the bull market for the ASX 200. Photo: Reuters
Ms Choyleva said China's growth had been weakened sharply by the ongoing overvaluing of the yuan and capacity excess.

"But while the [Chinese] economy desperately needs a weaker currency, joining the other saver economies such as Japan and the euro area in the global currency war could push the world towards another crisis."

In light of the significant fiscal policy shift in the world's fastest-growing economy, analysts have turned their attention to whether China's decision will influence the next likely economic catalyst: the US Federal Reserve rate increase expected in September or December.

"While the depreciation seems small in the scheme of things, the announcement is a game-changer, but a key unknown at present is how far the yuan will be allowed to depreciate. But the larger the decline, the more rising import prices will ease endemic deflationary pressures, but it may also limit how far the US Fed can raise rates given the rising US dollar has already tightened financial conditions," Perpetual head of investment strategy Matt Sherwood said.

Nine central banks had attempted to raise rates since the global financial crisis, Mr Sherwood said, only to have to reverse the policy after growth and inflation declined. He said US Federal Reserve chair Janet Yellen would be acutely aware of the relationship between the US tightening cycle and US dollar appreciation.

"It will be interesting to see if investors begin to downgrade US earnings in the process, as the currency effect is larger on US equities than on the US economy."

Citi Research is tipping a September rate increase by the US Fed, as well as further weakening of the yuan, from the 1.9 per cent announced on Tuesday to 4.5 per cent by the end of the year, which could have further flow-on effects.

Analyst William Lee said the ongoing volatility sparked by the devaluation and possible similar decisions in the future could be a factor in delaying the rate rise until December.

Market in freefall
Mr Lee said the move to re-peg the yuan against the dollar should be viewed as another step by Beijing to bolster its rapidly weakening expansion that complemented the government's intervention in its equity markets in July.

"The Fed does care about persistent disorder in financial markets: not just volatility but apparent freefalls. This could delay liftoff," Mr Lee said.

"The most relevant impact on the US economy would be additional deflationary forces which would further the Fed's goal of achieving its inflation target.

Capital Economics chief global economist Julian Jessop played down the global relevance of the move. In a research note he said the renminbi's devaluation was unlikely to have a significant influence unless it was followed by more currency action from Beijing.

"The reduction in the daily reference rate for the renminbi has been widely interpreted as the first of many moves whose main purpose is to regain competitiveness by devaluing the Chinese currency," Mr Jessop said.

"This has prompted talk of a fresh round of 'global currency wars', additional monetary easing elsewhere and even speculation the Fed will be slower to raise interest rates. However, we are sceptical that the People's Bank of China's announcement is truly a game-changer."

While some analysts anticipate further devaluations given the US dollar is strengthening while the Chinese economy slows, Mr Jessop said it made more sense to him to focus on the PBOC's official explanation that is was a "one-off adjustment".

"The idea that some additional, relatively limited moves in the renminbi-dollar rate will have a material impact the economies of Europe or the US, let alone the rate decisions of the Fed, is frankly ludicrous."

Nomura researchers described the devaluation as a "potentially healthy, if only very incremental" source of reflationary impetus for China, rather than a new source of global deflation.

TD Securities chief Asia-Pacific macro strategist Annette Beacher said China's recent move would not challenge the US dollar's strength or reserve currency status.

"The bottom line is that the renminbi will not challenge the dollar as the world's foremost reserve currency in the foreseeable future. America's deep institutional advantages ensure that it will retain its position as a dominant global reserve currency."

Ms Beacher added China's growth model, based on an undervalued currency and leveraged net foreign investment, meant China's domestic economy was not yet strong enough to handle the flow of foreign goods needed to see the renminbi become a reserve currency.

OPINION Aug 19 2015 at 5:16 PM Updated Aug 19 2015 at 6:27 PM

Rates to stay lower for longer says Obama adviser

There is more to low rates than government policies. James Davies
Philip Baker

The prospect of rising interest rates in the United States has got many investors worried but The Council of Economic Advisers, the Washington based agency that offers advice to President Obama, has issued a report that suggests in the long run, interest rates will always be lower when compared to where they were before the financial crisis took hold.

Interest rates around the world have been falling since 1982 so investors have certainly got used to the benefits of cheap money.

But not everyone thinks they will stay at these historically low levels.

The former chairman of the Federal Reserve, Ben Bernanke, argues that rates are at record lows thanks to government policies that have forced everyone to save.


His tip is once these policies are reversed then interest rates will rise back to more normal levels.

Not so fast, according to Larry Summers, the former Treasury Secretary.

He believes rates are low because there is no "demand" in the US economy and under a theory of his called "secular stagnation" he argues that prolonged low interest rates are here to stay unless the government starts spending up big-time again on infrastructure projects.

As for the CEA they believe that some of the drivers that have kept rates so low, such as shifting demographics and lower long-run growth and productivity rates will keep them low for quite some time yet.

But the other drivers that have also kept rates low, such as fiscal, monetary and exchange rate policies along with inflation risk, term premium and private-sector deleveraging will be shortlived factors.

In the end though they claim that once all the factors are taken into account, it "suggests that long-term interest rates will be lower in the long run compared with their levels before the financial crisis."

In 2007 the benchmark US 10-year government bond yield was around 4.25 per cent compared to 2.18 per cent on Wednesday, while in Australia the 10-year bond yield was just over 6 per cent eight years ago before the crisis, compared to 2.74 per cent.

Falling interest rates and lower bond yields have been a key driver behind any gains in the sharemarket, despite a lack of earnings.

The accompanying graph shows the fall in the market's forward earnings yield, which is the inverse of the forward price-earnings ratio, has coincided with a fall in the 10-year government bond yields.

The main point about the analysis is the comparison of the yield on a 10-year government bond to the "earnings yield" of the sharemarket.

The earnings yield is the flipside of the price-earnings multiple, so instead of dividing the P by the E, the E is divided by the P.

It shows the amount of earnings you buy for every dollar worth of stock.

The forward earnings yield of the major S&P ASX 200 index is around 6.3 per cent, while the 10-year bond yield is close to 2.74 per cent – implying an earnings to bond yield differential of 3.56 per cent, which is well above the longer-run average differential of 2.5 per cent.

One oft-cited reason for further gains by those in the bullish camp is that stocks represent better value than a bond market investment.

Compared with the 10-year bond yield of 2.74 per cent, stocks appear more attractive.

·        OPINION
 
·         Aug 20 2015 at 10:41 AM 
 
·        Updated 1 hr ago
Financial turbulence continues as US Federal Reserve debates rates rise
Janet Yellen chairs the Federal Reserve, which has put a positive spin on the split among policymakers as to whether to raise interest rates. Reuters

by Karen Maley
Will the US central bank raise short-term interest rates next month and will Beijing be able to cushion the slowdown in the Chinese economy? They're the two big questions roiling global financial markets at present.
Investors are no closer to an answer to the first question with the minutes of the US Federal Reserve's July policy meeting, showing that US policymakers are deeply divided on whether to raise US interest rates.
The Fed's minutes, released on Wednesday, put a positive spin on the split, saying that although most US central bank officials considered that the time was not yet ripe for raising rates, "they noted that conditions were approaching that point".
All the same, it's clear there's a heated debate on whether US inflation is on track to reach the US central bank's 2 per cent target.
Janet Yellen chairs the Federal Reserve, which has put a positive spin on the split among policymakers as to whether to raise interest rates. Reuters
The official, more sanguine, line is that US inflation is likely to edge higher towards 2 per cent "as the labour market improved further and the transitory effects of earlier declines in energy and import prices dissipated".
SCEPTICS
But some Fed officials questioned this position, pointing out that further declines in oil and other commodity prices, along with the strengthening US dollar, will keep US inflation low.
And these sceptics are likely to be proved correct, particularly as the downward pressure on US prices has only increased since China's surprise move last week to devalue its currency, the yuan.
A lower yuan means that Chinese exporters are able to sell their products in global markets at even cheaper prices, forcing competitors to cut their prices in order to maintain market share, and spreading deflationary pressures through global markets.
In addition, a lower Chinese currency increases the cost of commodity imports such as oil, aluminium and copper, which are denominated in US dollars. This will further reduce China's demand for commodities, which has already wilted as a result of slower Chinese economic activity.
Worries about a sharp contraction in demand due to the slowing Chinese economy have sparked a massive sell-off in commodity markets, the oil price plunging to a fresh six-year low overnight.
At their July meeting, some US central bank officials were concerned that a rise in US interest rates would push the US dollar higher, "extending the downward pressure on commodity prices and the weakness in net exports".
In addition, others noted the risk that a "material slowdown" in Chinese growth "could pose risks to the US economic outlook".
It's precisely this question of whether Beijing will be able to avert this "material slowdown" that's troubling investors at present.
And they found little reassurance from the rebound in the Chinese sharemarket in late trading on Wednesday. The Shanghai Composite Index, which had fallen by as much as 5 per cent in trading, closed up 1.2 per cent at the close after several companies disclosed that state-backed companies were among their top shareholders, which reassured investors that Beijing was continuing to support the sharemarket.
But although Beijing has shown that it is willing and prepared to manipulate the prices of financial assets, such as shares and its exchange rate, investors are deeply concerned that the Chinese leadership is struggling to avert a sharp slowdown in the world's second-largest economy.
As a result, the latest outbreak of turbulence in financial markets shows little sign of abating.

• Aug 23 2015 at 1:35 PM 
   
  
  
•  Updated Aug 23 2015 at 2:25 PM 
  

US will ride out market turbulence

[img=620x0]http://www.afr.com/content/dam/images/g/i/x/k/b/d/image.related.afrArticleLead.620x350.gj5jnj.png/1440303937497.jpg[/img]The Dow Jones last fell 10 per cent way back in 2011. Bloomberg
[Image: 1435474325700.png]

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by John Kehoe
The global sell-off in stocks by panicked investors in the past week is not all doom and gloom for the United States, though it may be a signal of tough times ahead for other parts of the world, particularly China and emerging markets.
The bearish sentiment that swept through global markets gathered a life of its own on Thursday and Friday, pushing down the blue chip Dow Jones Industrial Average into 10 per cent correction territory since its record high in May. The benchmark S&P 500 has dropped a more moderate 7.5 per cent, because big blue chip stocks such as Apple have fallen hardest.
The Dow Jones last fell 10 per cent way back in 2011.
Concerns about China's souring economy, a crashing crude oil price, plunging currencies in emerging market economies and a looming US interest rate rise are the chief causes of the market meltdown around the world.

Yet on Wall Street, the pullback is probably healthy. Stocks had been priced for perfection after a six-year bull market run. The market was overdue for a breather.
In the US, there is little evidence to suggest the economy is heading for trouble. The jobs market is robust. Housing construction is picking up. Consumers are showing early signs of belatedly spending their windfall from lower petrol prices.
It is difficult to see a recession hitting the US, even with the Federal Reserve poised to gently raise rates before the end of the year.
More worryingly, China's slump in manufacturing activity to a six-year low suggests policymakers will struggle to hit their 7 per cent growth target this year unless Beijing pulls out a major government stimulus.


KNOCK-ON DAMAGE
The recent yuan devaluation is hurting emerging market economies that compete with China to supply the world with manufactured goods. It is little surprise we have seen countries such as Vietnam devalue their currency in response to offset Beijing's competitive depreciation.
Emerging market equity funds have experienced seven straight weeks of investment outflows and debt funds posted their biggest outflow last week since January 2014, Bank of America Merrill Lynch says.
Brazil, Malaysia, Mexico and Russia are hurting from sinking commodity prices.

Forecasting where China and emerging market economies will head from here is almost impossible given the opaqueness of their economic and financial systems and dubious economic data.
For commodity exporters such as Australia and Canada, the performance of China in the months ahead will prove crucial.
Yet for the US, the tumult overseas is unlikely to have a material effect on its economy, barring a financial market catastrophe abroad.
The US is essentially a domestically driven economy and the Fed will be cautious in raising rates.

Exports only account for 13 per cent of US gross domestic product, compared to about 20 per cent for Australia and 45 per cent for Germany, according to the World Bank.
Germany's DAX index has plunged 11 per cent so far this month. Germany's automobile makers and industrial manufacturers rely on Chinese demand.
On Wall Street, the glorious bull market of recent years is unlikely to return as corporate earnings growth flattens out.
But unless irrational pessimism takes over, the US economy and market will likely prove more resilient than most of the world.

Is the ‘Fed put’ losing its power?

• BUSINESS SPECTATOR
  
• AUGUST 24, 2015 8:13AM
  

Alan Kohler
[Image: alan_kohler.png]
Business Editor at Large
Melbourne

[b]The Chinese meltdown was an obvious trigger for this sharemarket correction, leading, as it did, to a wave of selling of emerging market assets.[/b]
But underlying it may be something deeper.
The ‘Fed put’, shorthand for the willingness of central banks to bail out investors by printing money, may be losing its power, especially in the context of the increasingly crowded global bond trade.
In recent weeks a debate has started up about the potential for a rush out of retail bond funds when US interest rates start going up, resulting in a crush at the exits.
This was added to over the weekend by a report from big US fund manager AllianceBernstein, warning that the popularity of ‘risk parity’ funds has worsened the liquidity risk.
These are funds that invest in equities and bonds, but increase both the risk and return of the bonds in the portfolios to parity with equities through leverage. According to the Financial Times, AllianceBernstein says the risk parity industry now controls about $US1.4 trillion in leveraged bonds.
“Each investor is making a rational decision, but put them all together and it has caused a dramatic change in markets,” it says. “It has made the system more fragile.”
Paradoxically, the concerns about growing risk, sparked by what’s going on in China, have led to a flight towards bonds in the past few weeks, not away from them.
Since late June, the US 10-year bond yield has fallen from 2.5 to 2 per cent, and the Aussie 10-year yield has fallen back below 2.6 per cent after rising almost a full percentage point in April and May to 3.1 per cent.
At the same time, the flight to safety has jerked gold out of its bear market with a spike of 7 per cent in the past three weeks.
So at this stage what we’re seeing is just another ‘risk off’ correction: the shifting of investment assets at the margin out of equities and other risk assets and into safer ones.
There have been six of these during the six-year global bull market since March 2009 (now seven), none of which has derailed the fundamentally rising trend.
But if it turns into a flight out of bonds as well, then all hell could break loose. Hopefully that won’t happen, because before then the Fed not only formally puts off the planned rate hike but also launches QE4.
The concern is that like a drug addict, the market needs more and more QE to get high, which is another way of saying that monetary policy is losing its potency — something that central banks have consistently been saying.
Meanwhile the yuan devaluation has already led to an exodus from emerging market bond and equity funds as pressure comes on the currencies and economies of countries from Kazakhstan to South Africa, Russia to Malaysia. Share prices in these countries are tumbling.
Also, the six-year bull market has made equities relatively expensive, although after bigger fall than most global markets this year and less of a bull market before that, the average Australian price earnings ratio is back to average.
The Australian market will obviously fall again today after Friday’s 3+ per cent fall on Wall Street, but the ASX has already done more correcting than most. In response to problems in China and the tumbling oil price, the local sharemarket got in early to beat the rush.

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