Market Analysis – Tuesday, March 29, 2016

Overview

This market analysis examines recent actions by the Federal Reserve and its impact on financial markets, with a focus on emerging equity markets, and the outlook for Fed activity from the perspective of an analyst/trader that utilizes fundamental, technical, quantitative, and intermarket analyses.

All Eyes On The Fed

Fed actions continue to act as the primary driver of developing economies and financial markets. The mere suggestion of liquidity tightening by Fed Chair Bernanke in May 2013 sets off the Taper Tantrum that sucks capital out of risky assets, propelling emerging equity and debt markets downward in weeks (far left, Chart 1). This leads directly to QE3 and a resurgence in risky assets, including emerging equities, which reaches a 3-year high to form the peak in a HS pattern (center, Chart 1). But, stoppage of US liquidity injections (end of QE3), results in emerging markets exit, despite liquidity infusions from BOJ, ECB, BOE, Riksbank, SNB, and DNB (right, Chart 1).

China’s credit-fueled investment expansion grinds to a halt that, combined with a strengthening USD, sends commodity prices plummeting (Chart 2).

In Dec 2015, the Fed finally raises the target Fed funds rate (and indicates a total increase of 300 bps over the next several years), after threatening to do so for two and half years, despite signs of a slowing US economy, shattering US energy companies, lackluster Europe, and imploding China, shoving emerging equity (and debt) markets into freefall (first green down leg, Chart 3). By mid-Feb 2016, the Fed, once again, reverses course to deliver a dovish spin, halting the equity correction in a near perfect “W” bottom reversal. At the widely anticipated Mar 15-16 FOMC meeting, the Fed confirms no raise and then Chair Yellen, at a speech at the Economic Club of New York on Mar 29, implies that not only would the Fed not be implementing its original three hikes this year but, perhaps, none at all, depending on the “data” (Chart 3).  What the heck is happening?

Set-Up for NIRP

The BIS and major CBs coordinate monetary actions since the 2007-2008 Financial Crisis to prevent a meltdown in global financial markets. Eight years later, and after rounds of traditional monetary policy, quantitative easing, qualitative easing, and ZIRP, global financial systems remain on life support. Now, European CBs and BOJ are employing NIRP to support the Fed’s effort to strengthen the greenback and normalize interest rates as official US national debt soars over $19.2 trn, or 102% of GDP. But, with the US economy teetering on recession, energy companies facing bankruptcy, at-risk banks and financial institutions confronting massive write-downs, and US presidential elections just seven months away, the likelihood of a rate hike diminishes by the day. The pretend wealth effect must continue for a little while longer.

By early 2017, once the energy sector has completed its current round of capital raisings, lenders off-loaded much of their exposed risk, and the new president sworn in, the Fed and banks may likely stand aside and let markets re-price. Would this be the ultimate cleansing discussed in earlier reports? Unlikely. More probably, similar to the 2008-2009 equity sell-off, after a 50%, or so, drop, the Fed would enact NIRP and, even, QE4, in a final (hopefully) effort to let the new administration and Congress find a solution to the financial morass.

Obviously, monetary actions have proven ineffective, so political leadership and regulatory, legislative, and structural changes are required to normalize the banking and financial systems and labor markets so that the real economy can grow, once again. If the actual problem of excess debt is not directly addressed, the US faces lost decades of fudged numbers and economic decline, just like Japan. But, under NIRP (see Market Analysis for Mar 11 2016), the unraveling may come much sooner. Throughout, of course, savers suffer and receive the blame for the ineptitude of borrowers.

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