Wealthy Nations Daily Update - QE4 / FED

What a difference a day makes. Chinese stocks have reversed the recent sell-off, which had sent shockwaves across global markets earlier in the week, rebounding over 5% today. In fact, some stock actually had to be suspended having rallied 10%, the maximum allowable daily movement. Markets remain nervous but sentiment has been supported by New York Fed President Bill Dudley’s dovish comment yesterday that a September rate hike “now seems less compelling”. Futures markets have been quick to react; the probability of a rate rise in September has shifted markedly lower from roughly 55% earlier this month to 24% today.

Earlier in the week we also heard from Atlanta Fed President, Dennis Lockhart who suggested that he expects interest rates to go up “sometime this year”, but lacked the conviction of timing this time round. He noted that a combination of stress on the domestic economy (such as the strong dollar) and global economy, i.e. falling oil prices and wobbly financial markets are “complicating” the Fed’s outlook.

There seems to be a clear divide in opinion not only within the Fed, but also the wider investment community, so much so that some are calling for another round of quantitative easing; “QE4”. Former Treasury Secretary, Lawrence Summers wrote in an opinion piece in the Financial Times, “a reasonable assessment of current conditions suggest that raising rates in the near future would be a serious error that could threaten all three of the Fed’s major objectives - price stability, full employment and financial stability.”

QE4 is something we have discussed in-house, however, we believe that this would be a last resort measure, not only does the post-QE-fueled economy need to adjust to an equilibrium, but the last thing the Fed needs is a backlash of criticism and potential political risks. Plus domestically, the US economy has been showing some strength; today saw further evidence of growth, the second reading for Q2 GDP was released above-expectations at 3.7% up from 2.3%. The housing market has been recovering, job creation is on the up - although wage acceleration remains tepid. But, on the flipside we have tumbling crude prices - WTI is floating around $40 per barrel and Brent, sub-$45pb - uncertainties on the inflation picture and a dollar which is up over 5.5% so far this year (measured by the DXY index). In fact the Fed do not use this widely used index, a trade weighted dollar index (TWDI) is prefered; the difference being that the dollar is weighed against a wider range of currencies compared to the DXY Index. This index currently shows the dollar up ~8%.

Back to the inflation picture, Summers echoed our sentiment that inflation remains below the Fed’s 2% target and once the Fed start to normalise rates there will be further downward pressure on inflation. Core PCE inflation in the second quarter was up 1.8%, however this preceded the recent currency corrections which sent shivers through the emerging market world; further dampening global growth expectations. We will be looking for more clues from Fed vice chair, Stanley Fischer, who will be discussing “Inflation Dynamics and Monetary Policy” at the Jackson Hole conference which starts this evening.