October reserves a few special days that may change the course of equity markets in the short term. The one that will garner most attention, if not the most important, will be the US Federal Reserve meeting on the 28th as, once again, markets gamble on whether the Fed will raise interest rates.
In my opinion, the Fed has put itself in a difficult position by maintaining an accommodative stance this long; the last time the Fed raised rates was on the May 10, 2006, nearly 10 years ago. Rates have been at 0.25 per cent since 2008.
My argument is more about the starting point rather than the rate hike in itself. Let me clarify; rates should only be close to zero if an economy is at dire straits. Zero rates (allow me to call 0.25 per cent zero) are not an antibiotic to an economy slowing down but mouth to mouth respiration when all else has failed.
The US economy is nowhere near its final breath. GDP growth is over two per cent, headline employment figures are close to worrying levels, on the too much side, personal consumption is increasing and the housing market is showing sign of life. Corporations continue to pump out profits and margins are at very high levels. Equity markets are also trading near all-time highs.
Not all is perfect. Inflation remains well below the Fed’s target, and the number of potential workers effectively looking for work is on the decrease. But the main point is; the US economy is nowhere near the critical situation that would merit zero rates.
It is also important to highlight that zero rates do not come without costs. In this case the costs are borne by savers; pensioners who suddenly find that their lifetime savings are not giving them their projected return, conservative savers that normally shun risky assets, are now advised to take on unnecessary risk because their typical fixed-income bond has negative yield. Risk has become unfashionable.
One reason the US Federal Reserve may be holding back is because it wants to protect Wall Street, but that is not its mandate. It may be holding back because it fears the reaction from emerging markets. But once more that is not its mandate.
Monetary authorities serve as a damper cushioning the effects of the economic cycle. In my opinion the US Federal Reserve is so far behind the curve that the US economy may well end up in a slowdown without the possibility of monetary support. This will happen if, as projected, US economic growth slows to more realistic levels.
When this happens, and it will probably happen in months not years, US markets will probably already have pulled back. The US Federal Reserve without any bullets in its interest rate gun will revert to its financial bazooka… QE. And we head back to square one.
Disclaimer: This article was issued by Antoine Briffa, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.