On the 16th of December the Federal Open Market Committee will meet to decide whether to increase the federal funds rate (e.g. the interest rate). There is an expectation of around 70% that rates will rise 25bps at this meeting. If this goes ahead it will create a policy divergence between the Fed and the ECB, who have opted the opposite approach. The ECB has lowered interest rates to -0.3% and is committed to an extended QE program.
- Stronger dollar. The dollar is likely to strengthen, as high yields in the USA attract capital inflows. This could be damaging to emerging market economies who predominantly sell commodities. The dollar denominated value of a commodity (e.g. Oil is valued in $) decreases as the value of the dollar increases, therefore emerging markets receive less payment for their resources, decreasing their income. A depressed global economy may affect future USA growth.
- Bond prices. Interest rates have an inverse relationship with bond prices. This is because newer bonds are available at a higher interest rate, decreasing demand for the lower yielding bonds. Therefore we could see the value of portfolios decreasing. Furthermore the increase in the cost of borrowing may mean companies issuing riskier ‘junk’ bonds begin to default.
- Euro carry trade. With interest rates in Europe approaching negative (in real terms) it is a viable trading tactic to borrow Euros, use them to buy Dollars, then use the Dollars to invest in higher yielding USA assets, making money from the spread in the interest rates. This occurred between the Yen and the Dollar in the build up to the financial crisis and is one of the contributing factors to the over-valued collateralised debt market.
- Confidence. It has reached a point where it is almost necessary for Janet Yellen to increase interest rates. It will signal to the market that the Fed sees the USA in a position of strong economic growth, increasing confidence in the USA recovery.
Commodity Prices & Chinese Growth
This past Friday the FTSE100 fell, for its seventh consecutive daily decline. This decline has been attributed to a fall in the value of commodities and mining companies, such as Anglo American (down -21.89% this week) and BHP Billiton (down -11.81% this week). Furthermore Old Mutual is down -21.93%, due to their exposure to the South African economy where the finance minister has been fired and there is turmoil in the economy.
Why are we interested in commodity prices? China is the largest importer of commodities in the world, if the demand for commodities decreases from China it is signaling a weakening economy.
- Globalisation. China importing less commodities means emerging markets receive less income, which can have a knock on affect because emerging markets will receive less income and they account for nearly 50% of world demand.
- Commodity firms. Low prices reduces future expectations of profits for commodity firms, as seen above this reduces the value of their stock. Investors with interests in commodity firms will have seen losses.
As noted in my previous post Terrorism and the stock market conflict caused by terrorism may affect the market in a number of ways. It reduces consumer confidence, as individuals become more fearful travelling or visiting high profile shopping destinations, it increases the likelihood of full conflict, which implies increased government spending on defense (rather than +ve externality goods), interrupts global trade and causes an emotional backlash, as a result of uncertainty following an attack.
The recent airstrikes by the UK Government in Syria have increased conflict in the region and may have caused uncertainty for investors about the future of our relationship with the middle east. However as seen in my blog post, terrorism tends to have a muted effect on the stock market. Both because historically the effect has been muted, so rational traders are aware of this, and because whilst some stocks suffer, others gain.
There has been a meeting of global leaders in Paris to discuss a new climate deal. The tone of this meeting has been ramped up since Copenhagen with a pre-determined clause that every country will commit and contribute to a new climate deal.
- Sustainable energy sector. The renewable energy sector is likely to see a boost following these talks, especially if negotiations are successful. This is because there will likely be higher subsidies for this sector, increasing their profitability and potential to grow.
- Government spending. Increased subsidies will mean increased government spending, this could be detrimental to countries such as the USA and UK who are trying to cut spending. However it will likely been seen as positive, as the long term effects should be considerable.
- Emerging markets. They will see a boost as a result of increased actions against climate change. Developing countries tend to be less equipped to deal with the damaging effects of the climate and therefore will benefit from increased aid and reduction in potential climate change in the future.