Market Commentary 5/7/2017
I would be the first to agree that interest rates should normalise. However, I believe this could take up to a decade to achieve due to the mountain of debt accrued at these ridiculously low rates which the Central Banks have imposed over the past nine years.
The biggest benefactors of the low rates have been the banks that created the sub-prime in the first place. They have been able to take in very cheap money and lend it back out at much higher rates, profiting from the wide spread, thereby increasing their capital reserves back to pre-subprime levels.
If Central banks need to curb spending and drain money from the system they should start selling out part of their massive portfolios of assets they are sitting on.
Public debt is already back to pre-subprime levels and every quarter percent the Central Banks raises rates will hurt the public in their pocket and reduce their disposable income. Soon they will be back to buying what they need rather than what they want.
The key issue is public earnings has not increased and therefore purchases have been based more on credit rather than from earnings. Although unemployment is low companies have been spoilt for many years having their choice of skilled labour without having to pay more for it.
If rates increase any more than half a percent per year the next recession is just around the corner.
USA: The economic condition, according to recent data, is not as strong as most expected and this will mean the Fed must slow their rate increases. This will only change if Trump begins to have success with his expansion plans and this will depend on if he can persuade Congress to start supporting his plans. He will benefit from any asset sales by the Fed, providing much needed funds to initiate his fiscal policies.
EU: Germany have benefited immensely from the weak Euro which is reflected in their trade surplus. Here lies the problem though, as Germany have continued to prosper many other countries within the EU such as Greece, Italy and Portugal are still fighting to recover from the sub-prime and recession.
Draghi has a very difficult task balancing the diverse economic situations of countries within the Eurozone. He is also being pressured by the Germans to reduce the monetary easing bias which will become more relevant when Draghi retires as President of the ECB in 2019 as Weidmann is being promoted by the Germans to replace him. This would probably lead to an end to Quantitative Easing and negative rates.
UK: Brexit and a disastrous general election has left the UK in a weaker position. The UK is resilient though and we love to spend! Inflation is an issue due to the weaker Pound leading to higher import prices. As long as negotiations do not disintegrate the Pound should strengthen over time.
Inflated cost of leaving the EU is now up to €100 bln. Whatever the final number we should not forget that as one the top contributors into the EU we must own a large share of the €1.5 trln of assets the ECB are holding, which should mean the EU would still owe the UK when the final figure is agreed.
The Bank of England could act to increase rates, however, as another debt driven economy it would really impact the spending of low to middle income households.
I believe as consumers generally make up around 70% of an economy it is key not to reduce household’s disposable income, especially with inflation higher or the economy will grind to a quick halt and lead to another recession.