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Global stock markets seem to have calmed down a little since the rollercoaster ride of May and June – but investors are still jittery.
There are plenty of good reasons to be nervous. The global liquidity cycle is turning – in other words, interest rates are rising across the world.
The lax monetary policy of recent years has left consumers across the Western world mortgaged up to their eyeballs with wallets full of debt-laden credit cards. That means they’re vulnerable to higher interest rates.
At the same time, rising inflation means central banks have no choice but to jack up rates if they want to prevent rising costs from taking hold.
These problems are affecting every country, from Australia to the UK. But the one that the markets are focusing on, of course, is the US. So what does Federal Reserve chief Ben Bernanke have in store for the global economy?
Ben Bernanke hasn’t had an easy time of it in his first few months as Federal Reserve chairman. That’s by no means unusual however – his predecessor Alan Greenspan had to contend with the 1987 stock market crash just two months after his appointment, while Paul Volcker faced a bond market crisis shortly after he took the Fed chairmanship in 1979.
Mr Bernanke hasn’t had to face anything quite so challenging yet. In fact, you could argue that most of his problems have been of his own making. Having a casual ‘off the record’ chat in May with a famous female journalist about US monetary policy isn’t the kind of mistake you’d expect a senior policy-maker to make – particularly when the details contradicted everything he’d told the markets just a couple of days earlier.
That gaffe sent stocks tumbling in May, and since then, the fear that the Fed would tighten ‘too much’ and send the US economy into recession has seen stock markets dive at the faintest hint of inflationary pressures.
But Mr Bernanke seemed to pull it together with last week’s testimony before Congress at which he suggested that the slowing economy should keep a lid on inflation. That suggested there would be no more rate rises – which cheered markets up for a while.
But now it looks as though Wall Street is starting to worry that the slowdown has already arrived. Data from the Fed’s ‘Beige Book’ survey yesterday suggested that inflationary pressures were moderate. But the market didn’t leap in reaction, as it might have done a fortnight ago – instead stocks were muted, with the Dow Jones ending a point lower at 11,102.
The signs are not good. The US housing market continues to cool rapidly – mortgage applications fell for the second week in a row last week, while homebuilders’ confidence hit a 14-year low this month. Retail sales fell 0.1% in June, compared to May. And second quarter corporate earnings have so far been mixed, with the latest batch of disappointing results coming from internet retailer Amazon and aerospace giant Boeing.
So what can be done about it? The clamour is already building for an interest rate cut. Tom Kilgore on MarketWatch says: ‘Basically, unless Bernanke changes the current course of interest rates, a recession is on the horizon.’
There’s every possibility that Mr Bernanke will be unable to resist dropping interest rates – emulating Alan Greenspan’s trick of clearing up the fall-out from one asset bubble bursting by attempting to inflate another.
But that would leave the dollar looking very vulnerable indeed. The suggestion that US rates may not rise next month was enough to push the greenback down sharply against both the yen and the euro yesterday.
A falling dollar means imported inflation. It also means that all those foreign investors who have been lending the US money will become less keen to do so as they realise that the US has no intention of protecting their investment from inflation. That would drive up bond yields, which would in turn push up mortgage costs – so the housing market is doomed either way.
What people can’t seem to accept is that it’s sometimes the Fed’s job to trigger a recession. You can’t have a boom without a bust – it’s nature’s way. If we simply allowed the markets to set interest rates, then the cycle would probably be smoother – people would take fewer risks if they didn’t expect an all-seeing Fed to bail them out at the first hint of trouble.
But if we will insist on having central banks, then sometimes their task is to spoil the party – to take the punchbowl away just when everyone is starting to loosen up and have fun. Unfortunately for Ben Bernanke, his predecessor Alan Greenspan preferred to spike the punch with the cheap whisky of negative real interest rates. Everyone has partied harder, and sung Mr Greenspan’s praises, but now the resultant hangover will be far far worse.
And if Mr Bernanke decides to simply follow the Greenspan method of central banking and slash rates again – well we all know what happens when someone drinks far too much. They collapse – which is the most likely fate of the dollar under that scenario.
That’s bad news for most investments – but to find out how to protect yourself and your portfolio from a falling dollar, click here: How to survive the dollar collapse (/file/12676/how-to-survive-the-dollar-collapse.html)
Turning to the wider markets…
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The FTSE 100 ended up 25 points at 5,877 on Wednesday. Banking group Northern Rock jumped 8% to £11.28 after raising its long-term target for annual profit growth to 20% from 15%. For a full market report, see: London market close (/file/15921/london-close-footsie-ends-on-top-form.html)
The FTSE 100 ended up 25 points at 5,877 on Wednesday. Banking group Northern Rock jumped 8% to £11.28 after raising its long-term target for annual profit growth to 20% from 15%. For a full market report, see: London market close (/file/15921/london-close-footsie-ends-on-top-form.html)
Over in continental Europe, the Paris Cac 40 gained 18 points to 4,933, while the German Dax rose 17 to close at 5,583.
Across the Atlantic, US stocks were flat to lower amid uninspiring results from internet retailer Amazon and aerospace group Boeing. Shares in power tool maker Black & Decker also slid 7% as results fell short of analysts’ hopes, due to weaker hardware sales. The Dow Jones Industrial Average fell 1 point to 11,102, while the S&P 500 closed barely changed at 1,268. The tech-heavy Nasdaq fell 3 to 2,070.
Investors were more upbeat in Asia. The Nikkei 225 soared 295 points to 15,179 as car maker Honda beat earnings expectations. Meanwhile, the world’s biggest consumer electronics maker Matsushita raised its first-half profit forecast.
This morning, oil was edging higher in New York, trading at around $74.10 a barrel. Brent crude was also higher, trading at around $74.25.
Meanwhile, spot gold was higher too, trading at around $628.60 an ounce as the dollar weakened. Silver also made gains, rising to $11.10 an ounce.
And in the UK this morning, oil giant Royal Dutch Shell has beaten profit forecasts as second-quarter earnings came in at £3.4bn. As with BP before it, disappointing production levels were more than offset by high oil prices.
And our two recommended articles for today…
What is the biggest threat to the global economy?
– Although financial markets appear to be betting that the situation in the Middle East will remain manageable, the risk to the global economy is very real should an oil-producing nation such as Iran get dragged in, says Charles Stanley’s Jeremy Batstone. And then there’s the threat of a growth slowdown caused by aggressive US monetary tightening. Will oil hit $100 a barrel? Will US rates be hiked to 5.5%? To find out how likely these scenarios are, and which would be most damaging for the global economy, read: What is the biggest threat to the global economy? (/file/15908/what-is-the-biggest-threat-to-the-global-economy.html)
Why history is telling us to invest in commodities
– Ignore all the noise about a commodities bubble, says Puru Saxena for the Daily Reckoning. We are now living in an inflationary war cycle and, if the 1970s commodities boom is anything to go by, that means that commodities are set to outperform every other asset class. For more on what the past can teach us about commodities prices, see: Why history is telling us to invest in commodities (/file/15915/why-history-is-telling-us-to-invest-in-commodities.html)
Why history is telling us to invest in commodities
– Ignore all the noise about a commodities bubble, says Puru Saxena for the Daily Reckoning. We are now living in an inflationary war cycle and, if the 1970s commodities boom is anything to go by, that means that commodities are set to outperform every other asset class. For more on what the past can teach us about commodities prices, see: Why history is telling us to invest in commodities (/file/15915/why-history-is-telling-us-to-invest-in-commodities.html)