Monetary policy disruption was on full display last week: The U.S. Federal Reserve (Fed) announced a momentous change to its normalization plan, the yield curve inverted and sparked investor concerns, and a noted Fed critic was nominated to the central bank’s Board of Governors.
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The United States has always had a difficult, complicated relationship with the concept of central banks. Early on, critics sought to prevent the establishment of a U.S. central bank, while today, politicians in the U.S. and around the world seek to use central banks as tools to further their policy aims. In my view, central bank independence is critical to their ability to counteract the economic effects of geopolitical chaos.
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There is an old Chinese proverb that states, “When the winds of change blow, some people build walls and others build windmills.” In other words, some people embrace change while others fear it. I’ve come to the conclusion that the speed of the change has much to do with how a change is received. Just look at the past week, when we saw abrupt changes in the direction of the wind for central banks, followed by largely negative reactions.
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Two key risks – trade and central bank normalization – have had an outsized impact on global stocks for more than a year (sometimes positive and sometimes negative). This past week saw developments in each of these key issues.
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An informal Invesco poll of North American institutional investors recently revealed that geopolitical risk was a top concern for 2019. And they’re not the only ones worried: European Central Bank President Mario Draghi recently noted that the risks to the downside have increased, blaming, among other things, “the persistence of uncertainties related to geopolitical factors and the threat of protectionism…” In his annual letter to investors in January 2019, Seth Klarman of Baupost warned of the threat of geopolitical disruption: “Social frictions remain a challenge for democracies around the world, and we wonder when investors might take more notice of this.”
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Last week was momentous for one specific reason: The Federal Open Market Committee (FOMC) released minutes from its January meeting, which detailed the significant “about face” that the Federal Reserve (Fed) has made over the last few months. In my view, the FOMC’s insights, along with apparent progress in U.S.-China trade talks, could enable stocks to move higher in the short term – but I’m also wary of negative implications that could lie beneath the surface.
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From key data releases to international tensions, there are five issues that I’m watching closely this week. Before I detail those, let’s review what we’ve learned in recent days that could impact markets going forward:
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In Greek mythology, the “sword of Damocles” is a powerful morality tale. King Dionysius is a leader who grows weary of a young sycophant, Damocles, who is constantly extolling the benefits of being king. To teach Damocles a lesson about the pressure and insecurity that comes with leadership, Dionysius allows him to sit on the throne for a day – but over the throne, the king has suspended a large sword, hung by a single hair. Damocles quickly learned what it feels like to be a leader who exists in imminent danger and jeopardy.
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The biggest American football game of the year was played last night, and for the first three quarters, it looked as if both teams forgot how to score a touchdown. But great teams find a way to win, even when their tried-and-true game plan seems to be faltering.
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Last week was momentous as experts in Davos warned about the dangers of debt, more signs of a European slowdown emerged and the longest government shutdown in U.S. history came to an end. In today’s blog, I discuss what we learned last week – and highlight eight things to watch during the final week of January.
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Last week saw government dysfunction on full display in several different countries. While politicians in the U.K. and U.S. continued to make headlines, expectations for lower economic growth emerged in a report from the International Monetary Fund.
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There has been no shortage of drama across the macroeconomic and geopolitical landscape so far in 2019. However, it appears that investors may be tuning out much of the political theatre around them. Which storylines are moving markets now, and which may become more integral to the plot in the weeks ahead?
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Students of history may recall the War of the Roses, which was waged more than 500 years ago. It was an epic battle between two rival branches of the English royal family that both had claims to England’s throne – the House of Lancaster, represented by a red rose, and the House of York, represented by a white rose. While the House of Lancaster ultimately won the War of the Roses, by some measures there was no real winner. The war lasted for many years and resulted in very significant damage to both houses. In fact, by the end of the war, the male lines in both houses had been eliminated.
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At the start of 2018, I warned about two significant forms of disruption that posed risks to markets: geopolitical disruption and monetary policy disruption. The solution to the global financial crisis – experimental monetary policy – had created greater wealth inequality, which had led to geopolitical disruption, and the situation was poised to worsen in 2018. This experimental monetary policy, especially large-scale asset purchases, was beginning to be unwound – and that was an experiment in and of itself which also had the potential to cause disruption.
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Last week saw major swoons in the stock market and U.S. Treasuries. As of this writing, the sell-off has been continuing. However, I still hold out hope that we could see stocks finish higher than where they are now by year-end. Yes, Virginia, there still is the possibility of a “Santa Pause.”
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U.S. stocks began a dramatic sell-off on Tuesday that has continued and spread to other parts of the world, creating intense headlines across the globe on Thursday. There has been a flight to the perceived safety of sovereign debt. The yield on the 10-year U.S. Treasury fell dramatically, from more than 3% at the start of the week to 2.83% as of this writing1 – and other major sovereign debt yields also followed suit. Some areas of the yield curve inverted, and the 2-year/10-year yield curve is in danger of inverting.
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When I was in high school, I worked as a lifeguard. I loved the job, but I was always aware of the enormous responsibility that came with it. I found the key to success was to anticipate trouble before it happened – to watch swimmers for any early signs of distress before they ever came close to drowning. Today, I see similarities between lifeguards and policy-makers such as the U.S. Federal Reserve (Fed), which must try to anticipate economic downturns before they start. For the past several weeks, I have written in my blog that signs of a global slowdown are starting to appear. The good news is that policy-makers appear to be reacting to those early signs – which I believe could help spur a “Santa Pause” rally for markets.
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Stocks continued to slide last week, and most major indices are negative for the year-to-date period – some having posted double-digit losses. As I noted in my commentary last week, there are hints of an economic slowdown appearing. In this environment, expectations are increasing that central banks may loosen their monetary policy in response, but I’m not sure that central banks will come to the rescue this time. In fact, I believe central banks are more likely to be a risk factor going forward.
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This past weekend, I had the opportunity to see a production of Macbeth. Though I’ve heard the words many times before, I was particularly fixated by a verse from one of the witches: “By the pricking of my thumbs, something wicked this way comes.” The “pricking of thumbs” was originally intended to represent the historic belief that people could sense when evil was approaching. However, I couldn’t help but think this was a timely analogy for the sensations some market participants are feeling that an economic slowdown is approaching.
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Last week, the U.S. experienced a deepening split in political leadership, which dominated headlines. And yet, that was just the tip of the iceberg in terms of events that are impacting global markets. Below, I recap five key events from last week and highlight five issues to watch moving forward, including whether there are grounds for new alliances among U.S. President Donald Trump and the Democratic House.
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