In today’s ‘new normal’, investors are like drug addicts.
Punters are hooked on cheap money — all they care about is the next central bank move. If there’s a slight hint of change, they stampede towards the exit. Poor economic news is celebrated these days, because it leads to more central bank intervention.
This fairy tale ‘of bad news is good news’ continued late last week.
European Central Bank (ECB) President, Mario Draghi said ‘the degree of monetary policy accommodation will need to be re-examined at our December monetary policy meeting’. In other words, the ECB is caught between a rock and a hard place. Its money printing program — unsurprisingly — isn’t creating growth or inflation.
The solution: print more money.
Punters lapped up the news.
Draghi’s words of wisdom crashed the euro and sent the US dollar screaming higher. The Dow Jones jumped 320.55 points or 1.87% on the news, closing the session at 17,489.16 points. Commodities, on the other hand, were hit across the board — albeit gold fell only slightly by US$1 to US$1165.
With the ECB news out of the way, the market will look towards the US Federal Reserve meeting next week. I’ve long said that the US Fed will raise rates in either September or October, with a second rate lift in December.
With the benefit of hindsight, September’s meeting was a shocker. For the majority of this year, the Fed talked up a September rate rise. It didn’t happen and, ever since, punters have questioned the Fed’s credibility. (Something we’ve said was lost long ago, but forgive the mainstream for being late to the game.)
This month should be no different. US numbers have been mixed recently, which has reduced the likelihood of a rate hike this month. The US Fed futures market is pricing less than an 8% chance of this happening. As such, it’s more likely that we’ll be looking at first rate lift-off in December.
But you can never be sure…
We may be in for an October surprise.
I discussed the possibility of an October Fed rate rise in Money Morning a fortnight ago. You can find that here. In further support, US Fed Vice Chair Stanley Fischer said last weekend that ‘The US economy may be strong enough to merit an interest-rate increase by year end.’
San Francisco Fed President John Williams said similar words this week. In an interview on Bloomberg TV, Williams said ‘I do see the time to start raising rates in the near future’. He argues that the board needs to be ‘forward looking’.
Others aren’t so sure…
William Dudley, the president of the New York Fed, thinks the Fed should be conservative. Although, according to Business Insider, Dudley said he ‘would be prepared to raise interest rates in December if the U.S. economy performed in line with his forecast of continued moderate growth’. His comments backed two other Fed governors who also urged caution last week.
While the odds are for no rate hike this month, it’s likely to be a close call. Plus, Fed Chair Janet Yellen said she expects a rate hike will be needed by the end of this year.
Yellen’s pledge is enough for investment banking firm Goldman Sachs. In an update this week, Goldman said ‘our economists continue to expect a 25 basis point [0.25%] rate hike at the December meeting, and for a further 100 basis points [1.00%] of rate increases during 2016.’
Of course, Goldman isn’t certain either. In fact, it went onto say it was only 60% sure of a rate hike. It’s possible that the economic and market environment could be worse than everyone thinks.
Talking about a worse-than-expected macro environment, Citi Bank has made a ‘global recession in 2016’ its most likely scenario. It went on to say:
‘The global economy is being hit by the third major disinflationary wave of the past ten years, with the Great Financial Crisis of 2007-09 and the Euro Area crisis of 2011-12 now followed by a major and widespread [emerging market] slowdown.
‘We have been gloomy on China’s growth prospects for a while, and remain so even with the apparent resilience in the official data. With the twin supports from China’s credit boom and the commodity-related investment boom fading, year on year growth of GDP for [emerging markets] (ex-China) is now below 2%.’
Perhaps Citi doesn’t believe that bad news is good news?
Nevertheless, with the gloom and doom scenario on the cards, Citi seems to think that the first rate rise will come in March 2016. Morgan Stanley thinks this sounds about right. They’re also looking towards a March 2016 rate hike.
On the other hand, Deutsche Bank analysts have said that the ‘Fed may not be able to move away from a zero Fed funds rate in 2016, let alone in 2015.’
While I still think we’ll see a rate hike this year, no one really has a clue what’s going on at the Fed. Unfortunately for an institution that’s worried about volatility, markets hate uncertainty with a passion.
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More bad news, good news?
Adding to the uncertainty…
Earlier this month the World Bank lowered its projections for economic growth in China, saying the world’s second-largest economy will grow by 6.7% in 2016 and 6.5% in 2017. That’s down from projections for 7% and 6.9%, respectively.
Unfortunately for the World Bank, data this week proved that — yet again — it’s one of the world’s worst forecasters. The facts show that the World Bank’s projections are merely political, more hope than reality.
Although it’s holding up slightly better than thought, Chinese data confirmed China’s economy is still slowing. It showed fixed asset investment, the economy’s long time backbone, is still softening. While consumption, long thought to be the weaker part of the economy, was actually doing OK.
Adding it up, Chinese GDP came in at the adjusted annual growth rate of 6.9%. And while this was better than the 6.8% number expected, it’s the first time since the Global Financial Crisis that GDP growth fell below 7%.
Still, it’s better than expected data. The academics who only look at ‘data’ over at the US Fed may relax a little. Last month, they cited concerns over the Chinese economy. So this data could lead towards a surprise rate hike this month.
Stock market correction looms
If the Fed does raise rates later this month, the US dollar will jump significantly higher. Stocks and gold will get crunched.
And if they don’t raise rates?
Well, that’s already priced into the market. Remember, the bond market’s only showing less than an 8% chance of a rate lift-off this month.
If rates don’t rise there may be an initial jump of investor euphoria. But it won’t last. In fact, I wouldn’t be surprised to see stocks and gold sold off. This is why they say, ‘Buy on the rumour and sell on the news.’ Punters are buying gold on the rumour that the Fed won’t raise rates. If this happens, those punters will sell and lock in profits.
Either way, it will be the start to a major stock market correction. We’re more likely than not going to take out the August low on Dow Jones. The ASX 200 will surely follow.
Resource Speculator readers have been aware of this forecast for some time now. Resource Speculator involves a lot of big picture analysis like the above — which is imperative if you want to survive and prosper in the resources bear market. Especially since I expect that we’re months away from the true bottom in resources. If you want more information on how to best play these markets, you can start here.
Resources Analyst, Resource Speculator