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Scotiabank Warns “The Fed Is Cornered And There Are Visible Market Stresses Everywhere”

August 5, 2015

Scotiabank Warns “The Fed Is Cornered And There Are Visible Market Stresses Everywhere”

Part One, China

An economic slowdown is underway in China.  This is reflected in the steep drop in the commodity complex and in the currencies of emerging market countries. Large imbalances are being worked off as Beijing attempts to shift the composition of its growth.  Policy decision are not always economic.

New sources of growth are being sought by Beijing as deleveraging occurs.  Since officials care foremost about social stability, they try to preserve as many current jobs as possible during their attempt at economic transformation.  During this period, banks might be averse to calling in loans.  State owned enterprises (SOEs) are pressured to keep producing, so that workers can continue to receive a pay check.  The result is over-production and downward pressure on prices.

Part Two, The Seven Year Fed Subsidy

The Fed’s zero interest rate policy has provided a subsidy to investors for the past 7 years.  The lure of easy profits from cheap money was wildly attractive and readily accepted by investors. The Fed “put” gave investors great confidence that they could outperform their exceptionally low cost of capital.  These implicit promises by central banks encouraged trillions of dollars into ‘carry trades’ and various forms of market speculation.

Complacent investors maintain these trades, despite the Fed’s warning of a looming reduction in the subsidy, and despite a balance sheet expected to shrink in 2016.  It has been a risk-chasing ‘game of chicken’ that is coming to an end.  Changing conditions have skewed risk/reward to the downside.  This is particularly true because financial assets prices are exceptionally expensive.

Maybe investors do not believe ‘lift-off’ looms, because the Fed has changed its guidance so many times.  Or maybe, investors are interpreting plummeting commodity prices and the steep fall in global trade as warning signs that global growth and inflation are under pressure.  

…click on the above link to read the rest of the article…

 

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