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Weekly

Fed douses hopes of policy normalization

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By dispelling the illusion of a potential normalization of U.S. key rates, the publication of the FOMC minutes served as the rain on the global capital markets’ parade. The market’s bluff, which consisted of fearing the Fed would take a hawkish turn while hoping it would do just that (thus lending weight to the theory of a U.S. economy strong enough to forego the Fed’s easy money policy), has been unmasked. The Fed will not change the direction of its monetary policy in the foreseeable future and, as we expected, this scenario raises a number of questions:

  1. On the fundamental economic situation,
  2. On the credibility of the consensus that long-term interest rates would rise and the dollar would see a healthy appreciation.
  3. On the foundation of hopes developed on the markets and therefore their valuations.

That the market reaction has been negative to this point is entirely understandable.

Cheaper oil, a stabilizing force for growth

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Our forecast for a sharp drop in commodity prices seems to have materialized since the summer. Despite a tense geopolitical situation, the fall in the price of oil has already reached 15% and, helped by sagging consumption, the global oil price tag has contracted by 1 GDP point since the start of the year. Each country has different exposure to this adjustment but, generally speaking, it has been more favorable for developed economies than emerging markets. Regardless, lower oil prices have maintained a stabilizing effect that could provide vital support given the present situation.

When globalization is thrown in reverse

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One of the most striking illustrations of the changes that have occurred since the 2008 crisis is the 180° turn that international trade has made. Once discounted as a one-off phenomenon, reverse globalization has taken an increasingly permanent turn in the past two years. The paradigm shift in the Chinese economy is the main factor behind the trend. The consequences of this sea change are sizeable for global growth, corporate valuations and geopolitical risk.

Could US Housing Prices Plummet Again?

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In the past two years, the contradictions on the U.S. housing market have continued to get worse. Higher property prices, often seen as an indicator of a healthier market, now seem disproportionate compared with the reality of a market that is still limping from the battering it took during the crisis. As Fed members seem increasingly impatient to trigger a rate hike cycle, the imbalances resulting from this distortion pose a serious threat that prices could fall again.

T-Bonds or S&P, which of these markets has got it wrong?

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Improving economic indicators, ongoing accommodative monetary policy from the Fed and the bountiful reporting season have propelled U.S. equity indices to new highs in recent days: the S&P has added gains of 6% in the last three months making for a YTD gain of 18% and has even flirted with the 2,000 point level. The confidence backing up these trends is, however, a far cry from the signals the bond markets are sending us. Since the end of April, the yield on 10-year T-bonds has fallen to below 2.50%, i.e. 25 basis points less than mid-April levels and 50bps off from where it started the year. Such distortions between equity and bond markets are tough to reconcile over the duration and will end up being corrected. It is merely a question of when and to what extent. The response will come from economic changes in the coming months. So what should the market being taking a very hard look at?

U.S. Real Estate, Does It Still Matter?

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The U.S. housing recovery, considered a slam dunk by the vast majority of economists since spring 2012, has sputtered since summer 2013. Even though most economic indicators have been pointed higher in recent months, real estate has been the odd man out. Housing starts have been wildly unstable from one month to the next and are hardly increasing at all. At less than 900,000 housing units in June, they are on par with end-2012 and still a long way away from returning to their long-term average, while many observers predicted they would do so by the end of this year.
How worried should we be? What would happen if activity in this sector failed to return to normal levels during the current cycle? What weight will the Fed give to these disappointments in its decision-making process?

No QE, so we’ll have to settle for the minutes…

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The ECB says it needs time to beef up its anti-deflation measures. Let’s not kid ourselves, the bank is in no hurry. There seems to be but one justification for its move to space out its meetings from every four to every six weeks and the innovation that consists of publishing its minutes: deflate ballooning expectations of future intervention.
This, in reality, was the only take-away from the ECB’s monthly monetary policy meeting held this week. In other words, there is no revolution under the European skies: the pace of change is still in slow motion and lacking in ambition.