Divergence and the Dollar
This past week in the markets set the scene for a diverging picture in terms of monetary policy in the United States versus the reset of the world. Through speeches and congressional testimony, US Fed Chair Janet Yellen made clear that a December rate hike remains on the table as the US Federal Reserve looks to lift off of rock bottom interest rates on December the 16th. This would be the first rate hike by the Fed in ten years. On the other side of the Atlantic, Mario Draghi and the ECB perhaps fell short of investor’s expectations Thursday, but nonetheless remain in an accommodative stance as they extend the duration of their bond purchasing program and cut key policy rates. The path of rate hikes by the US Fed and how their policy diverges from their fellow G7 nations continues to be heavily debated and will be one of the foremost important themes for the global economy in 2016.
There is no question the decision makers at US Fed sit between a rock and hard place. A report out of the Financial Times at the end of last week revealed more than a trillion dollars in US corporate debt has been downgraded so far this year. This represents a 72 per cent jump in the total value of US debt that was downgraded in the first 11 months of 2014. Much of the story is related to the energy picture and US companies that face declining revenues with weaker commodity prices, but also linked is the fear and pressure created from higher interest rates from the path of Fed rate hikes.
Fitting in the commodity story is another very relevant question. The old adage use to be the cure for lower oil prices is lower oil prices. This current down period in energy markets is certainly putting pressure on that theory. As OPEC meetings finalized in Vienna this week, there is only more excess supply uncertainty for the market with the cartel opting not to constrain output and abandon a production target until their next meeting. Relating to the dollar story, it’s not only higher interest rates in the US prompting a strong dollar trade, but also a continued outlook for weak commodity markets.
Tying this together speaks to investor caution of whether the credit cycle seen in global bond markets is nearing its end. Eight of the largest US banks were downgraded by rating agency Standard and Poor’s this week and four of them including Bank of America, Citigroup, Goldman Sachs, and Morgan Stanley were stripped of their coveted A ratings. Only 3 US corporations now have AAA rated credit (and potentially soon to be 2 as one is ExxonMobil) whereas five years ago that number was over 20. In broad terms, as creditworthiness declines and risk increases, investors must look for preservation and return of their capital.
It was interesting to see gold Friday surge over 25 dollars an ounce against the backdrop of fundamentals that would otherwise be bearish for the precious metal. By no means am I attempting to call a bottom in gold prices, but as commodity markets got hammered Friday with the OPEC news and the dollar strengthened with Fed rate hike anticipation, gold as well traded higher in tandem. This rare occurrence when gold and the dollar strengthen together can often signal investors are in search of a safe haven at a time of heightened uncertainty. Whether gold has bottomed is to be determined, but with limited opportunity from relatively stretched credit markets, and an uninspiring equity market backdrop, diversification to gold is worth examining in 2016.