Monetary Policy in a Vaccuum
Monetary policy does not occur in a vacuum; what is done on this side of the Atlantic (or Pacific) is what other countries react to in order to keep their economic engines humming. While we are engaging in an inherently inflationary policy that is pushing down our currency, Australia and China are raising their rates to thwart potential inflationary pressures from building in their countries. In fact, we have been called irresponsible by many countries at our latest efforts to boost asset prices, so consumers will spend enough to force companies to hire and start the economic ball rolling. So in the end, what maybe in our best interests is seen as “currency manipulation” by others, as we effectively devalue our currency by flooding the financial system with dollars. The threat of an interest rate hike in China in response to higher inflationary pressures sent the dollar higher and commodities tumbling. If China, the savior of the global economy, is beginning to step on the brakes to slow inflation, where does the rest of the world generate growth? The coming two weeks will begin to focus on retail sales as the Christmas selling season is already at hand, keep an eye on parking lots and shopping bags!
A correction has been due for quite some time and the past week’s decline was certainly needed, however it may not be enough to shake investors’ confidence that the Fed policy of buying assets will keep stock/commodity prices rising. Nearly every sentiment reading I use is at either a yearly or multi-year high for the bullish camp. And the way to look at these figures is if everyone is bullish (bearish), who is left to buy (sell). But based upon the Fed policy of driving asset prices higher, expectations are for short and sharp sell-offs that hopefully convert some of the ebullience to concern about the sustainability of the market's rise. For now, many of the momentum indicators have come off their very high levels, but are nowhere near a “buy” signal, but have merely taken the edge off the rampant bullishness. So this week, no different than the past few, the dollar will be the key to the financial markets, as the dollar goes, the markets will likely go in the other direction. Much of the economic data released over the coming weeks is likely to be muted by the new Fed policy.
For only the third week since mid-March, the bond model has changed to bearish, indicating that yields are likely to rise in the future. As with the other two occurrences earlier this year, two weeks in a row would provide some level of confidence that this signal is a bit more permanent. However, over the past two weeks, the 30-year yields have increased by more than a quarter percent from just under 4% to now just over 4.25%. Short-term rates are rooted in the zero range until the Fed decides that inflationary pressures are rising (not for a while). As a result, the yield curve is once again getting steep as the difference between short and long-term rates is at six-month highs, potentially a sign of still weak economic activity. We’ll see if long-term rates continue their march higher this week.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.
About Paul J Nolte CFA
Paul J Nolte CFA Archive
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