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Low Rates Forever ?

Updated: Sep 25, 2020

BentinPartner Weekly

Dear Reader,

The major take way from the virtual Jackson Hole meeting last week offered a confirmation by Federal Reserve Chairman J. Powell (Fed statement) that it would basically get rid of the Philips curve (that establishes a theoretical link between declining unemployment and rising inflation) and the formal 2% inflation target, replacing it by an “average inflation” target of 2%. The Fed also said it that it would focus more intently on seeking full employment, adding (pro forma perhaps) that it will continue to monitor and foster financial stability as part of its mandate.

The message was that interest rates will stay at rock bottom levels for many years to come (Low rates Forever!) and that the Fed will take its time to adjust interest rates higher until well after inflation has bottomed. There was some initial post meeting “noise” but the lasting message was the logical one; stocks rallied, the dollar fell and precious metals rallied. We can now reasonably expect more of the same for a while longer.

As a wink to history which was marked by the seminal speech of B. Bernanke in 2002 (“Deflation: Making sure “it” does not happen here…”) that kickstarted the still ongoing and accelerating monetary experiment, it seems that with last week’s announcement, the Fed has gone through the near entire laundry list of measures it stood ready to take to end deflation. Perhaps the Fed can still start buying equities like Japan but ending deflation, it will. The question is what happens when they do and they do nothing. Will it end smoothly?

Will it start a currency or a bond crisis or both? In the meantime, speculative bubbles have received the green light to grow bigger, unhinged. Many will conclude that the current situation does not define “financial stability” and that the Fed looks more like it has capitulated on this mandate, at least for now.

Over the past week, the S&P500 rallied another 3,3% (8,9% YTD, Z-score 2,1) while the Nasdaq100 rallied 3,8% (37,6% YTD). The US small cap index gained 1,6% (-5,2% YTD).

CBOE Volatility Index rose however 1,9% (66,6% YTD) to 22,96, suggesting investors are piling up calls and protective puts as equities continue to “go nuts” with the most shorted stocks continuing to do best. Despite lingering fears about a second wave of Covid infections, the index of US airlines rallied +14%. Tesla also added another 8% (despite showing signs of losing ground in Europe) , reaching a market cap of USD412bn.

The Eurostoxx50 gained 1,8% (-9,5%), underperforming the S&P500 by -1,5% with dollar weakness still handicapping performance (accounting for dollar weakness this past month, S&P500 returns are matching, give or take 1%, the performance of the Dax so far this month).

Diversified EM equities (VWO) rallied 2,7% (1,5%, Z-score 2,1), showing renewed vigour, supported for the most part by rallying commodities and renewed dollar weakness.

The Dollar DXY Index (UUP) measuring the USD performance vs. other G7 currencies dropped -1,0% (-4,0%, Z-score -2,1) while the MSCI EM currency index (measuring the performance of EM currencies vs. the USD) gained 0,9% (-2,3%).

10Y US Treasuries underperformed with yields rising 9bps (-120bps) to 0,72%, as bonds suffered a setback from the stated relaxed attitude of the Federal Reserve on any future increase in inflationary pressures. The curve steepened as well. 10Y Bunds climbed 10bps (-22bps) to -0,41%. 10Y Italian BTPs rose 10bps (-37bps) to 1,04%. On the economic data side, new-home sales in the U.S. jumped to the highest level in 14 years in July as low mortgage rates (and covid stay at home growing habits) helped fuel a suburban construction boom. The median selling price also rose 7.2% from a year earlier to $330,600, skyrocketing since May.

US High Yield (HY) Average Spread over Treasuries dropped -26bps (139bps) to 4,75%, taking their cues from equity markets. US Investment Grade Average OAS closed unchanged (38bps) to 1,39%. EM debt enjoyed some revival last week, supported by a weaker dollar and news that EM economies that implemented stimulus measures similar to those in the DM world, were able to raise fresh money mostly in local currencies as opposed to USD, which is good news for this asset class as well, with the notable exception of Turkey which is facing challenges of its own.

Turkey said it will make no concessions in the eastern Mediterranean, T. Erdogan said as France announced that it would join naval exercises in the region amid a mounting stand-off over hydrocarbons.

In European credit markets, EUR 5Y Senior Financial Spread dropped -3bps (9bps) to 0,61%.

During particularly volatile week for precious metals, Gold added 1,3% (29,5%) while Silver rallied 2,7% (54,1%). Major Gold Mines (GDX) rallied 2,6% (43,3%).

Goldman Sachs Commodity Index rose 1,9% (-26,0%). WTI Crude gained 1,5% (-29,6%).

Over the week end…

Ø B. Buffet who had announced last week that he was building a position in Barrick Gold, conceding a new faith in the merit of the old relic, also announced over the week end that while he was continuing to dispose of US banks (Goldman Sachs being one of them), he had acquired slightly more than a 5% stake in four Japanese brokers (committing to buy no more than 9.9% in each of them).

Ø Along with the aftershock of the fed announcement last week, this gave a jolt to Asian markets overnight (Nikkei +1.8%, CSI300 +0.75%) and the S&P future (+18 points) which is on its way to close the best month of August in 28 years (+7.2% as per last Friday’s close).

Ø ByteDance Ltd. will be required to seek Chinese government approval to sell the U.S. operations of its short-video TikTok app under new restrictions Beijing imposed on the export of AI technologies.

Ø Thousands of protesters gathered in the Belarus capital, capping a third week of demonstrations against President A. Lukashenko, facing calls for fresh elections by the EU.

Ø China’s purchasing managers’ indexes for August are likely to show the economy continued to make progress, albeit at a more moderate pace.

Have a nice week ahead.

Marc Bentin, BentinPartner GmbH

Founder, Chief Investment Officer


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