Week in Review: Markets Take Fed’s Rate Signal in Stride

Review of the week ended 23 September 2016

  • Fed holds rates steady but makes case for late-2016 hike
  • BOJ shifts policy focus
  • Global bond issuance pace fastest since pre-financial crisis
  • OECD: World economy in low-growth trap

Global equities firmed this week, with investors breathing a sigh of relief after important meetings of Bank of Japan and US Federal Reserve rate-setters. The market took in stride the BOJ’s policy shift and the Fed’s signal that tighter policy is likely later this year. Volatility fell in the wake of the meetings, with the Chicago Board Options Exchange Volatility Index (VIX) slumping to 12.3 from 17 a week ago. Oil prices got a lift from talks between Saudi Arabia and Iran ahead of next week’s OPEC meeting in Algiers. West Texas Intermediate crude oil rose to $46.25 per barrel from $42.80 a week ago while global Brent rose to $47.75 from $45.65. Saudi Arabia is said to have offered a production cut in return for Iran capping its output. US 10-year Treasury note yields fell to 1.62% this week from 1.69% last Friday.


Fed hints at rate hike before year-end
The Federal Open Market Committee, the Federal Reserve’s rate-setting body, said the case for a hike in the federal funds rate is strengthening, the clearest indication to date that it hopes to hike rates by the end of 2016. A November hike is unlikely given that there is not a scheduled press conference associated with that meeting. Also, the November meeting is scheduled to take place just days before the presidential election, another deterrent to a policy change. While signaling that a rate hike is likely in the months ahead, Fed officials lowered their economic growth forecast and trimmed the number of rate hikes they foresee in 2017 from three to two.

Bank of Japan shifts gears
After a comprehensive review of its monetary policy, the Bank of Japan this week altered its policy mix. Previously, the BOJ had focused on expanding the money supply to spur economic growth and inflation. After not having had much success on either front, the bank this week adopted an interest rate target. Going forward, it will seek to keep the 10-year Japanese government bond yield at around zero. This may allow the long end of the Japanese yield curve to steepen, a development that would be welcomed by Japanese insurance companies and pension plans, which have struggled in a low-yield environment.

Global bond issuance nears pre-crisis record
Bond issuance around the world is running at its fastest pace since 2007. A total of $4.88 trillion of debt has been sold globally year to date, nearly matching the $4.91 trillion sold in the same period of 2007. Issuance is running 9% ahead of the pace set in 2006, when a record $6.6 trillion in new debt was issued. These figures do not include sovereign bonds sold at auction, or municipal bonds. Super-low borrowing rates are spurring companies to lock in cheap financing, and in some cases issue debt in order to buy back shares or pay dividends.

China’s credit growth raises alarm
Excessive credit growth in China risks a banking crisis in the next three years, according to a report from the Bank for International Settlements. China’s debt-to-GDP ratio is expanding rapidly, standing at 255% at the end of 2015, up from 220% two years earlier. Recent bank lending figures showed a doubling of new loans in August compared with the prior month on a surge in mortgage demand.

Bundesbank: Withhold UK’s passport
Jens Weidmann, the president of Germany’s Bundesbank, said this week that British banks face losing access to the European Union’s single market if the United Kingdom were no longer part of the European Economic Area. EEA members include all 28 members of the EU plus Norway, Iceland and Liechtenstein. A precondition for EEA membership is the free movement of labor, a nonstarter for the UK after the contentious campaigning around the Brexit referendum in June. Weidmann, in an interview with the British press, also offered that Frankfurt is a significant financial center and will welcome newcomers, though he said he does not expect a mass banking exodus from London destined for Frankfurt.

Global economy stuck in low-growth trap: OECD
The weak global economy will persist into 2017, warns the Organization for Economic Co-Operation and Development, predicting that global gross domestic product will rise an anemic 2.9% this year and 3.2% next year. Brexit impacts offset gradual improvement in emerging market commodity-producing economies, according to the OECD. Weak global trade is the main drag on growth, it said.

Merkel suffers another blow at the polls
German Chancellor Angela Merkel suffered another electoral setback last weekend, this time in local elections in Berlin. Merkel’s Christian Democratic Union secured 17.6% of the vote, it’s worst-ever showing in the German capital. Analysts are concerned that Merkel’s controversial immigration policies will hurt the party’s chances in next year’s general election. The anti-establishment Alternative for Germany party (AfD) took 14% of the vote.

Real estate debuts as own sector
Real estate was launched as its own sector by Standard and Poor’s this week, the first addition to the lineup since 1999. Previously, real estate–linked equities were part of the financial sector. Many of the companies in the sector are real estate investment trusts.

Obama administration rolls out self-driving car guidelines
With momentum building in the autonomous automobile space, the US government this week set out guidelines for vehicle producers. The National Highway Transportation Administration asserted oversight over the software that operates autonomous vehicles. The federal guidelines are meant to outline best practices for the safe design, development and testing of automated vehicles before their commercial sale or operation on public roads, according to the Detroit News.

Decent demand but not much supply
US existing homes sales dipped 0.9% in August versus economists’ expectations for a 1.1% rise. The National Association of Realtors attributes the drop to tight inventories. There is a 4.6 month supply on the market at the present sales rate, below the 6 month supply that realtors deem a healthy balance between supply and demand. The median house price rose 5.1% to $240,000 in August from a year ago.


  • ECB President Mario Draghi testifies before the European Parliament’s Committee on Economic and Monetary Affairs on Monday, 26 September
  • Oil ministers from OPEC gather in Algiers to discuss a production freeze from Monday, 26 September to Wednesday, 28 September
  • Fed chair Janet Yellen testifies before the House Financial Services Committee on Wednesday, 28 September
  • Yellen speaks at a Kansas City Fed forum on Thursday, 29 September
  • The US fiscal year ends on Friday, 30 September, necessitating quick congressional action to keep the government open
  • Revised Q2 US GDP data are released on Thursday, 29 September

Stay focused and diversified
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Sources: MFS research; The Wall Street Journal; The Wall Street Journal Online; Bloomberg News; Financial Times; Forbes.com; CNNMoney.com; NBCNews.com.

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