Category: General (Page 8 of 17)

The euro has weakened considerably versus the US dollar this year and is currently testing support levels reached just a few months ago. Our concern is that there may be further weakness ahead as economic activity continue to be sluggish on the Continent – the key German economic engine appears to have stalled as the Bundesbank expects Q3 to exhibit zero growth although officials expect that to be temporary. Consensus forecasts (the dotted line on the chart below) may catch up to current prices placing further downward pressure on the currency. This is happening at a time when the ECB has indicated that it will begin to end quantitative easing exercises towards the end of the year.

A little late with this week’s chart, but the last couple days have been critical in making this point — With interest rate spreads reaching levels that investors have not witnessed since the pre-crisis era, and in the case of Europe all-time wide measures, some wonder if this may be a precursor to an imminent market event. This cycle may be different. The US Federal Reserve will likely remain highly transparent as they reach what they consider to be neutral policy rates several quarters out. The wild card could be the ECB, and their interest rate trajectory and QE management in what we view as a fragile economic environment. Our sense is that central banks will tread very carefully as they manage policy rates upward, keeping in mind the precarious global economic state. The risk, from our perspective, is that further out, extensive monetary policy may create another adverse market event.

Interest rates have been of paramount concern for investors for several years given extremely low, and in some cases negative, levels in much of the developed world. The yield on the 10-year US Treasury has recently pierced the 3% level and now stands at 3.1%. The US Federal Reserve is poised to raise the upper band of the fed funds rate another 25 basis points to 2.25% on September 26 and many Fed watchers expect the central bank to continue raising rates until at least June 2019. Market participants are concerned that Fed activity will ultimately lead to an inversion of the yield curve and when that has occurred in past cycles, recessions often have followed. What is different this cycle is that the real federal funds rate is negative due to the Fed’s highly accommodative policy stance and, as shown in this week’s chart, have only experienced a yield curve inversion when the real fed funds rate is in positive territory.

There are many other factors that may influence this relationship and a considerable force, in our opinion, is central bank policy and the direction of interest rates in the rest of the world. In August, the Bank of England raised their policy rate to the highest level since the financial crisis and the European Central Bank may begin to raise borrowing costs by the end of this year.

The yield on the US Treasury bond, currently 3.06%, has pushed through the 3% level for the fourth time since the beginning of the year. We view this as a positive development and further confirmation that economic trends in the US continue to improve. The state of the US economy and corporate America is arguably more robust than at any point in the post crisis era. Our concern is whether risk assets can sustain materially higher interest rates and, so far, US stocks have proven resilient while the rest of the world has struggled, particularly the emerging markets.

Our chart of the week comes courtesy of Bloomberg. The National Federation of Independent Business released its US Small Business survey this morning and the sentiment index reached 108.8, the highest reading in its 45 year history, even surpassing the previous peak reached in September, 1983. Other highlights in the report include: 1) capital spending plans are the highest since 2007; 2) inventory investment is the strongest since 2005; and 3) a record 26% of business owners plan to expand hiring. As the chart below shows, strong sentiment has been supportive of further gains in US stocks and in some cases for several years. But then, as sentiment wanes, equity prices weaken.