The main event of last week was, of course, the US Federal Reserve meeting which finally delivered the long awaited interest rate rise of ¼%. The other big news was the announcement from China that they would now be measuring the performance of the Yuan against a basket of currencies. We believe that this is just a cover story that will allow them to weaken the Yuan against the US Dollar which could have significant implications for the global economy.
First, a few thoughts on the Fed. We doubt that a quarter point rate rise will have any meaningful impact either way on the US economy next year. We actually think that Janet Yellen had her best press conference yet, and the committee must have been congratulating themselves on Wednesday night on a job well done. Equity markets seemed to cheer the news, the bond market was not overly concerned and the Dollar rose in what seemed like a vote of confidence.
The problem is that, despite what appeared to be a good performance from the Fed, the problems that have been affecting both markets and the global economy for months remain in place. Commodity prices remain low, corporate debt remains too high and emerging markets continue to struggle. Furthermore, although Janet Yellen continues to characterise the US domestic economy as strong, it does appear to be slowing down, and because nominal growth is already so slow, the US economy remains vulnerable to exogenous shocks.
By the end of the week, US equity markets had relinquished all the mid-week gains which is either indicative of just how choppy these markets have become, or more worryingly, a sign that investors are worried that some of the existing problems are going to swamp the Fed going into 2016.
Chart 1 – The S&P 500 weekly chart with 40 week moving average
As noted above, the other major news was the announcement from China that they would measure the performance of the Yuan against a basket of currencies. If we are correct that this just gives them flexibility to weaken the Yuan against the Dollar, then this is a big deal. We have noted before that China has significant deflationary problems in smoke-stack industries and debt levels in the State owned Enterprise sector are simply enormous. A weaker Yuan will only export their deflation to the developed economies which would be a worrying development.
Chart 2 – The US Dollar v. Chinese Yuan (Offshore Rate)
Although financial markets are likely to quieten down now for the holidays, there could still be some interesting moves in increasingly illiquid trading conditions. Our focus is very much on 2016 now and with none of the structural problems having been solved this year, we expect choppy trading conditions at best. We continue to see the worst case being a US recession which would, in our opinion, co-exist with a sizeable bear market in many assets. We will update our specific views in early 2016.
Stewart Richardson
Chief Investment Officer, RMG Wealth Management
