Hollywood sorrow gripped the world and the market got what it expected.
Written by: Benjamin Bimson CIMA® / BCJ Financial Group
Thanks to entertainment news, we all know that Brangelina is now over, and just so you know, it didn’t affect the markets.
Now let’s talk about what really happened last week.
(Of actual importance anyways.)
The market got what it expected! Hurray! Going into this week, every single ounce of attention (apparently attention has weight now) was on the Fed and the Bank of Japan (BOJ). Expectations were looking for some clarification and redirection from the BOJ about their asset purchase plan, a hope that they would not reduce interested rate targets any further into negative territory and that the Fed would leave interest rates alone and clarify when they expected to raise rates next. It was another no-surprise week and markets really liked it!
Last week I brought up the difficulty of the Fed raising rates when their stated inflation rate has not yet been achieved. That is exactly what they did. It was not an amazing revelation and perhaps more of an indication that the Fed is exceedingly aware that their statements need to be clear in order to retain (or regain) the confidence that they are “in control of the situation.” Furthermore, they indicated that due to the persistence of low inflation, they will likely raise rates even slower than they have indicated over the past year.
It is possible that with general slowing of economic activity, the Fed is serious about being cautious, but the economic expansion is getting a little old. It is also likely that the combination of general debt and slowing, the sensitivity of the consumer to rising rates, and persistently low price of energy and oil are major contributors to Fed caution.
We have talked a lot about various economic readings like manufacturing, employment, income and inflation over the months, Debt is another concern, and both private and public debt are growing worldwide. In fact, the latest publications of total indebtedness, not including the financial sector, are at record highs. In the following chart you can see total debt on a worldwide basis (blue), including private debt (black), and public debt (red) as a percentage of world GDP.
Higher rates when there is so much debt is a risk, and one reason that the Fed has to be very careful how fast rates rise. In an environment where the economy was quickly rising, it might not be quite the same risk, but in the current environment it is a large issue.
Developed markets actually look to be better off than when data is looked at including emerging markets. The private debt has not grown nearly as much in developed markets like the US. This is good news for the average American and corporations in developed counties. When the Fed does raise rates, it likely will have a much more subdued impact on households than it would if we had higher private debt. Higher rates are still a risk to total debt payments so the Fed is likely to continue to be cautious.
Below is just what the developed world looks like for public and private debt.
As you can see the public debt in the QE world has dramatically increased. Again, I think QE may be one of the largest scale public experiments ever. It is so big, it is just possible that it will shape global economics for who knows how long.
As a result of all the patience and statements from the Fed, here is what the rest of 2016 likely looks like. For the next month and a half to two months, most of the attention will be on the election. Debates, polls, reactions… However, after the election, even the week of the election, the Fed will dominate the scene again. Here is the current market expectation: no movement on the Fed in November (the next meeting). The following chart is what expectations of the futures market looks like as of last Friday for the November 2nd meeting.
Contrast that with what the expectation is for December and you can see, the market currently is believing the Fed that they will raise rates this year.
So for now the market rally seems to be intact, or at least it doesn’t see any major short term reason to be driven down. However, political uncertainty is a risk and can cause volatility. Seasonal weakness of late September and early October can also contribute to that.
Absent any real negative news, markets will over-analyze every political move and debate. Speeches of the Fed committee members will be analyzed, market experts will make wild speculations and we will continue to try and walk the straight and narrow of data.
Now, if we could all have a moment of silence for the Brangelexit and the folks who began their relationship with an affair, who watched their 2 year marriage come to an abrupt end after 8 long years of living together… Another Hollywood drama has played out per the script.
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