Just when it seemed that the economic and financial engines of the world were starting to stop spluttering and start to purr, with the economy of the US in positive territory and the EU economy forecasting a rebound of 1.1 per cent in GDP for 2014, what happens?
There is a disagreement in the US Congress between Democrats and Republicans. Result: the US of America shuts down and the US Congress cannot reach agreement on the debt curbing. Surprisingly, the markets do not seem to be all that fazed.
They know that funds are available but need to be released and therefore are expecting some kind of compromise to be reached. Let us all hope and pray that this is achieved in the short term. Meanwhile, of course, the US dollar must get weaker, as it is now doing against the euro, But when this built-up pressure is released… up it will shoot again and so will the US stock markets.
We have been experiencing one of the longest recessions in history – certainly the longest in modern times – six semesters in a row of no growth for Europe up to now. It seems we can feel the start of the rising phase for the long-term interest rate cycle already in the US.
The strong steepening in the interest yield curve starting in April 2013 is a clear economic indicator – in fact, a leading one at that – for a steady growth in economy in the medium term, for now. Ten-year yields have risen from 1.6 per cent in April 2013 to 3 per cent earlier last month; this always under Fed control of monetary policy. All eyes were on how the declared “tapering” policy would kick in, but the expected autumn start of this policy has now been delayed and changed to “wait and see”, meanwhile granting another dose of liquidity into the market to keep mortgage rates under control. There is no doubt the seeds of change have been sown.
In the US, once interest rates start to rise, bond yields must also start to rise, and bond prices must fall
The stock markets are feeling this wind of change, more so in the US. Presently it is a cool breeze that the economies are going through, that cool breeze that signals the advent of much needed rain in autumn.
We must now be prepared. In the US, once interest rates start to rise, bond yields must also start to rise, and bond prices must fall. What a relief this news must be, especially to pensioners who rely on some additional income to supplement their meagre pensions.
In Europe, the Central Bank has given signs that it will keep interest rates low for a prolonged period of time. A signal to infuse more support and confidence into the economy and the markets. So in 2014 we should start to see this expected rise in the five- to 10-year euro yield curve.
So at this stage, with bond prices expected to go lower, stocks and shares should have more of an appeal for the next months to come. We have already seen this advance on NY Stock Exchange, and indeed Europe should follow suit. It is the exporters who are leading the game as the world economies start to purr once more. In Europe, of course, it is Germany who leads, as always. We are seeing signs of export improvement even in the battered economies of Italy and Spain. These products must be going somewhere and therefore some other country must be buying – the US, of course, or perhaps China?
In the present bond scenario, some investors must be thinking of taking profits on their bonds and going liquid to a certain degree. Current rates of interest are still low and do not give the necessary income, so while profits should be taken, what does one do to make the necessary income? Why not the stock markets? What with that risk? Not entirely. There is always risk when investing in the stock markets, but as said, these are expected to rise.
The wind of change brings interesting times.
This article is the objective and independent opinion of the author. The information contained in the article is based on public information. Curmi and Partners Ltd is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.
Neville Curmi is a director at Curmi & Partners Ltd.