Credibility is hard to gain. And once gone, it is very hard to regain. That is the challenge facing the US Federal Reserve today. The New York Times is just one of the mainstream media now starting to highlight the issue, as last week’s Fed meeting led to a further deferral of the promised rise in interest rates:
“Fed officials said they expected to begin the process in June, but they are now delaying at least until September in part because economic growth has once again disappointed. In a retreat that has become a ritual for the overly optimistic central bank, officials said in a new round of economic forecasts published Wednesday that they expected the economy to grow this year by 1.8% to 2%. In March, they predicted growth of 2.3% to 2.7%.”
Major fund managers are also giving up on Fed-watching, as Columbia Threadneedle told the Financial Times:
“There’s a real dichotomy out there. We’ve got central banks where models of inflation and price expectations have failed. They can’t explain a lot of what has actually happened in their domestic economies. Yet market participants still rely ever more on their guidance to deliver market expectations, and that relationship at some point has to change.”
Even more importantly, investors are not just talking but acting. $9.3bn was withdrawn from emerging markets 2 weeks ago; and last week saw $10.3bn withdrawn from US bond funds.
This behavior confirms the analysis I received from one of the world’s top money managers in December:
“His view was that the lower oil price would help to keep inflation low, and so delay interest rate rises till Q4 2015. This view means he has to continue investing in the markets, even though he thinks they are all wildly over-valued.
“His argument was simple, namely that the Fed and Bank of Japan and others are forcing him to invest in stocks as the money earns nothing sitting in the bank. He is being effectively held hostage by the central banks.
“His own personal worry, having experienced the bond crash of 1994, is that whilst everyone thinks they will get out ‘before the market turns’, common sense also says everyone will try to stay in until the last possible moment, to maximise returns. Then everyone will charge for the exits at the same moment, and there could be blood on the street.”
There has never been any evidence for the Fed’s belief that boosting stock markets to create a ‘wealth effect‘ would deliver economic recovery. But it suited investors to go along with the story, as it made their lives easier and kept the bonuses rolling in. Now, however, reality may well be starting to dawn:
- The Fed assured us that its $4tn of debt would be wiped out by a mix of economic growth and inflation
- But now investors are starting to worry that growth and inflation may continue to remain elusive
This may well be the reason why 10 year interest rates have begun to climb around the world. Many bond market gurus are now forecasting the end of the 30-year SuperCycle. And if they are right, it would certainly be safest to head for the exits today, before more bullish investors start to stampede in that direction.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 41%. “In Europe, the upcoming holiday season across July and August is likely to curtail derivative production and demand for benzene.”
Brent crude oil, down 39%
Naphtha Europe, down 39%. “Prices have declined on the back of a drop in upstream Brent crude oil futures, abundant supply from refineries and softening demand from the gasoline blending sector.”
PTA China, down 30%. “Despite the squeezed margins faced by PTA producers in China, operating rates at PTA facilities were maintained at high levels. This had spot prices to come under downward pressure due to oversupply conditions, especially on the back of weak demand in the downstream sectors.”
HDPE US export, down 17%. “Domestic export prices remained unchanged”
¥:$, down 20%
S&P 500 stock market index, up 8%