US dollar weakness at the end of 2017 and the start of 2018 has made it clear that traders are going to have to be careful with dollar futures. On Friday, 12thJanuary 2018, the euro was trading at 1.2202 against the US dollar with an increase of 1.41% for the day (+0.0170). That the dollar is weakening seems odd as the Fed has clearly given forward guidance for three more interest rate increases in 2018. Given that, one would expect a stronger dollar especially as QT (Quantitative Tightening) has only begun.
Did you know that one of the most popular keywords in the Google searches last month, was “yield curve flattening”? There is a lot of discussion these weeks about the narrowing spread between the long and short term maturities in the Treasury Notes yields. Such a spread has shrunk at the lowest levels since 2007. Why is this a cause of concern? The yield curve is the difference in reward the investors receive for locking their investments for longer periods of time, which means greater uncertainty. A compensation for investors who tolerate the extra risk is usually called risk premium. But when such premium fades away then the yield curve is flat, when the spread is negative, the curve is inverted.
Various market observers have remarked that the yield curve is flattening. That means that the spread, that is, the difference, between the yield of short-term Treasuries (US government bonds) is decreasing in relation to the yield of long-term Treasuries. The two-year bond, which is to be considered short-term, is currently at about 1.75% ($UST2Y 1.75) and should be compared with the five-year yield ($UST5Y), which is at 2.07%, and the ten-year yield ($UST10Y) at 2.43%.
The majority of market observers presently consider it a foregone conclusion that the Fed will raise interest rates by 25 bps in December and arrive at a base rate of 1.25% to 1.50%. At the same time QT (Quantitative Tapering) is supposed to be progressing at US$ 10 billion monthly. More rate hikes are expected in 2018. As in the past such a Fed policy will probably result in a recession as higher interest rates and tightened credit will slow down growth.
This Monday I was at Lantern Fund Forum of Lugano, and the main speaker was John Mauldin. One of his main reflections was on how it is possible to manage money in a world where central banks and governments buy assets massively and indiscriminately, without assessing the value of what they buy.
October has come and gone, and the market rally goes on and on. Numerous observers and pundits have warned of a crash or strong correction, given the length of the rally and the fundamentals of the economy, which have been noted in earlier Newsletters. The FANGs and Microsoft seem not to be influenced by any disturbing geo-political news. The Fed will probably announce another rate hike in December and possibly three more in 2018 in addition to QT at 10 billion a month.
Trump announces nomination of Fed board member Jerome Powell to be next chair of US central bank. A Fed governor since 2012 and former Treasury official under the George H.W. Bush administration, Powell will replace current Fed Chair Janet Yellen. Yellen was nominated in 2013 by President Obama. Her term as the central bank's first female leader expires in February.
Central banks are moving towards the ‘QE exit’. The US Federal Reserve (the Fed) this month began reducing the total size of its asset holdings bought under successive rounds of quantitative easing (QE). The European Central Bank (ECB) has just announced a planned reduction in the value of its monthly asset purchases. And the Bank of Japan (BoJ) has been quietly reducing the pace of asset purchases since it began targeting bond yields.
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