The Global Markets Weekly – 12/18/15

Posted December 22, 2015 by rvillareal

Loose Noose[private]

The Fed finally took at the plunge and started to remove the “extraordinary accommodation” of the 2008-15 period.  Initial reaction in the markets was very comforting, with the 2-year yields remaining near 1%, 10-year yields pretty steady, and the stock market more concerned about weak oil prices than the FOMC.

As we discussed last week, there is some discomfort on the edges of the credit markets, especially in junk land.  This discomfort could increase as the Fed drains the swamp and slowly increases interest rates.  How slowly is the question.  The Fed looks for four 25 bps rate hikes in 2016, which would tighten at a pace only a little slower than taken in 1999, when the economy was enjoying its “great moderation” of 4% growth and 3% inflation.  Increases of the order of 200 to 300 bps have been more common, leading many to predict that this will be the “loosest tightening” on record.

However, investors are looking for an even smaller changes in policy rates, more like a modest 50 bps next year.  Implicitly investors expect that a combination of slower than anticipated growth and further problems in the credit markets will deter the Fed.

Outside of the EM sector which may face even greater capital outflows, the greatest concern is the potential for fire sales in the mutual fund industry.  MMMFs are banks without backstops, operating without insured deposits and more importantly, a direct line of credit from the Fed if they screw up.  If redemptions accelerate, they may not be holding enough reserves to prevent a panic, as everyone tries to get to sell first.  Not pretty.

In addition, investors think that inflation may be a “phantom menace,” with the EM sector ready to produce more than the developed world can buy.  But they forget that the core CPI is already at 2% and service sector inflation is approaching 3%, which may cause the Fed to “strike back.” and “awaken the force” of more rapidly rising interest rates.  In any event, investors would be amazed if the Fed acted again before the March FOMC meeting or until the latest Star Wars movie earned at least $2 billion at the box office.

• U.S.:  The calendar remains busy, with steady housing sales updates (Tu, Wed) and a weak durable goods report (Wed).  There will be considerable interest in holiday sales, which have been ho-hum so far.
• Eurozone: The data schedule is already thinning out.  Even so, there are a few important added insights into the consumer this week, all the more important as this part of the economy is recognized by the ECB as the main engine of growth.  First up is the Eurozone Consumer Confidence flash reading on Monday.
• UK: The issues of productivity and overall supply side remain key considerations for the BoE, alongside the inter-related subject of (now decreasing) wage pressures. All of which makes the Q3 Productivity data due on Wednesday all the more important for the BoE and for markets.
• Japan: The all industry update (Mon) and the employment report (Fri) may be upbeat.  Still, DE does not look for BOJ action at the January meeting, expecting them to keep their powder dry.
• Emerging markets:  In Turkey, after continuing to hold rates for much of the year despite considerable political pressure to take action, a rate change is predicted for this month’s meeting from the central bank (Tu).

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