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Stan Druckenmiller recently elucidated: “Earnings don’t move the overall market; it’s the Federal Reserve Board… focus on the central banks and focus on the movement of liquidity… most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.”

Even with the bond market’s muted response to the Federal Reserve’s plan to begin winding down its almost $4.3 trillion portfolio of mortgage and Treasury securities, there are plenty of reasons why the calm probably won’t last.

Out of style for almost a decade, volatility may be on its way back if you take a closer look at the mechanics of the Treasury and mortgage markets. Despite the Fed’s mantra of seeking to carry out its policy shift in a “gradual and predictable manner,” analysts say the effects of ending the reinvestment of the proceeds from maturing securities will still be felt.

This is the “most highly anticipated event in central-bank history,” said Walter Schmidt, senior vice president of structured products at FTN Financial in Chicago. “We’ve known this for two years. We’ve been waiting for this.”

While the three rounds of Fed asset purchases that became known as quantitative easing sapped volatility, former Fed Chairman Ben Bernanke’s comments in May 2013 that the central bank was considering scaling back purchases showed how quickly that can change. The so-called taper tantrum sent yields surging.

As the Fed begins to unwind, here are four reasons why we may see a renewal in volatility:

1. MBS Supply/Demand Shift

The Fed owns $1.77 trillion of agency mortgage-backed securities, about 31 percent of the market. As the central bank’s MBS holdings begin to roll off, mortgage spreads to Treasuries are going to have to widen to adjust for the additional supply, which some analysts estimate will begin at around $5 billion a month.

Since the Fed concluded quantitative easing in October 2014, the spread between Fannie Mae 30-year current coupon and Treasuries has been sitting between 90 and 114 basis points, below its historical average of about 137 basis points. Mortgage spreads may widen five to 10 basis points once the market prices in a certainty of tapering reinvestments and another 10 to 20 basis points over the longer term, Citigroup Inc. analysts estimate.

2. Increased Convexity Hedging

If the Fed decides to pause interest-rate hikes while letting the balance sheet shrink, mortgage rates are still going to rise because a large source of demand is disappearing. As a result, prepayment speeds, the pace at which borrowers pay off loans ahead of schedule, are going to fall, which will cause the duration of the securities to increase.

It’s still a double whammy if the Fed continues to raise rates. Fed tightening would push up the effective fed funds rates, also reducing prepayment speeds and increasing the average duration of the securities.

When rates rise, hedging against so-called convexity risk grows as the expected life of mortgage debt increases. That happens when refinancing slows and tends to leave holders more vulnerable to losses as lower-duration securities are more vulnerable to rising rates. By protecting against those potential losses (selling Treasuries or entering into swaps contracts), traders can end up making the bond market more turbulent.

3. Rise in Term Premium, Withdrawal from Risk Assets

As the market prepares for the Fed’s unwind, it should place upward pressure on the 10-year term premium, a measure of the extra compensation investors demand to hold a longer-term instruments instead of rolling over a series of short-dated obligations. The premium could rise 47 basis points over the course of 2018 and 2019 due to the reduction in duration, according to Bank of America Merrill Lynch strategists. Higher term premiums, coupled with increased mortgage duration could also cause a steepening of the five- to 10-year yield curve.

There’s also a chance that an increase in term premium triggers a withdrawal from risk assets such as equities, which have risen to record highs during almost a decade of accommodative Fed policy, though “the risk asset link is not as certain,” according to Bank of America strategist Mark Cabana.

4. Surge in Front-End Treasury Rates

The front end of the Treasury market will have its own set of issues when the balance sheet starts to shrink. The Treasury Department will have to decide which portion of the curve it wants to issue more securities: The front-end, where Treasury bills outstanding comprise less than 13 percent of marketable debt, or the long-end to take advantage of 30-year bonds trading around 3 percent.

“Treasury is going to need to increase front-end supply pretty notably,” Cabana said. “Banks losing reserves will be looking to replicate those assets.”

Assuming Treasury ramps up bill supply, rates on debt maturing in less than one year would likely rise, forcing up the overnight rate on Treasury repurchase agreements. That may cause usage at the Fed’s fixed-rate overnight reverse repurchase agreement facility to sink, as investors will pivot away from the operation.

“Overall, this should pressure rates higher, with banks having relatively more securities to finance in the repo market as time goes on,” said Scott Skyrm, managing director at Wedbush Securities in New York.

Courtesy of Bloomberg

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What Are The 7 Signs Of A Bear Market?

Wall Street pros say bull markets don’t die of old age. But after eight years of rising stock prices, being on the lookout for signs of a market peak makes good financial sense.

No bull lasts forever. Good times eventually are followed by bad ones, as investor euphoria gives way to fear and despair. The performance history of the Standard & Poor’s 500 stock index drives home the point: The 12 bull markets since the 1930s have all been followed by bear markets, or downturns of 20% or more, according to S&P Dow Jones Indices. The average bear market decline is a sizable 40%. Then there’s the mega-bears like the 2007-2009 rout during the financial crisis that knocked the S&P 500 down 57% and the nearly 50% slide after the internet stock bubble burst in 2000.

The current bull run, the second-longest in history and one that's generated a fourth-best gain of 254%, will eventually tire out, hit one final peak and head lower like all the rest.

The only question is when?

James Stack, a market historian and president of money-management firm InvesTech Research, says there are seven warning flags that can signal trouble ahead. The more flags that are present at one time, the more danger there is. Only one of those warning signals is now flashing yellow, he says.

The other good news, he adds, is that bull markets don’t typically “end with a big bang.” Market tops are usually slower-moving events that play out over many weeks, which gives investors time to prepare.

Here are Stack's seven warning flags:

The more bullish, optimistic and confident the investing public is, the riskier the market becomes. “Bear markets bottom in doom and gloom," says Stack. "Bull markets peak when optimism is highest.”

So what are signs of “extreme optimism”?

Bullish headlines in the news, such as the recent Barron’s cover story, “Next Stop: Dow 30,000.” Hot IPOs, like Snap's 44% jump in its debut last week. A dearth of scared investors, measured by a closely followed "fear gauge," dubbed the VIX, which is now hovering near an all-time low. Skyrocketing consumer confidence measures, such as the Conference Board’s February survey, which registered its highest reading in 15 years. The Dow Jones industrial average’s recent run of 12 record highs in a row also fits the bill. Rising stock valuations are another red flag, and currently the market is trading at close to 20 times earnings, well above the historical average and double where it traded back in March 2009.

“We have exuberance now,” Stack says, noting this is the only yellow flag from the market so far.

The 8-year-old bull has been powered by zero interest rates for nearly a decade. But the Federal Reserve has hiked short-term rates twice in the past 15 months to 0.75%. Fed chair Janet Yellen warns that three more hikes of a quarter percentage point apiece could come this year, with the next hike possibly coming at the Fed's meeting next week. Future markets place nearly 90% odds of a rate increase on March 15, according to CME Group.

In the past, stock market uptrends have been derailed by the Fed hiking rates faster and more aggressively than expected. Higher rates slow down the economy, which hurts the profitability of U.S. companies, a key propellant of stock prices. Higher rates also make it harder for borrowers to keep up with their debt payments, which could dent consumer spending and undermine the health of businesses with high debt loads.

“Fed policy," Stack says, "is a very important wildcard.”

“Bear markets and recessions go hand in hand,” Stack says. Seven of the past eight bull markets were undone by economic contractions, RBC Capital Markets data show. Recessions cause job losses, crimp consumer spending and squeeze corporate profits. Signs of trouble include weaker-than-expected incoming economic data, especially the Conference Board’s Leading Economic Index, which consists of 10 data points that predict future economic performance. If quarterly GDP, or economic growth, starts to slow, that’s another red flag, Stack warns. Any signs that the manufacturing or services segments of the economy are turning down is also a bad sign. The latest reading on fourth-quarter 2016 GDP, however, was 1.9%, down from 3.5% in the third quarter, but far from the recessionary danger zone. First-quarter 2017 economic growth is estimated at 1.9%, Barclays says.

American shoppers account for roughly two-thirds of U.S. economic activity. So any signs that consumers are not spending as much is cause for alarm. In February,  the Conference Board's closely followed consumer confidence index hit 114.8, its highest level since July 2001. That’s a far better reading than when confidence plunged below 30 in 2008 during the financial crisis.

When stock market leaders, or bellwether stocks that are sensitive to changes in the economy, start to turn down after profitable advances, that's an early sign that investors are losing confidence in the market, Stack says. Stocks to watch: ones that do best when times are good, such as banks, transportation companies and businesses that sell stuff to consumers that isn’t needed for daily survival.

A rising market driven by fewer and fewer stocks is a bearish sign. Clues  include more stocks going down than up on a daily basis and more stocks hitting 52-week lows than highs. “It is one of the most reliable bear market warning flags,” says Stack.


When the number of stocks hitting their lowest price levels in a year starts to swell, and if the new low list grows day after day, it’s a sign that the "smart money," or professional investors, are bailing out of the market. “It means investors are becoming desperate to sell, even ... at a loss,” Stack says.

For now, most of these warning flags are not flashing yellow, says Stack. But the fact the bull market has lasted so long makes him “nervous and more watchful of these warning flags.”

Courtesy of USAToday

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I found this interesting (the rise) however I have my own reservations because of the possible change in rates and inflation in 2017.  When inflation rises, interest rates also normally rise to maintain real rates within an appropriate range. PE ratios need to decline to reflect the increase in the earnings discount rate. Another way to look at it is that equities then face more competition for money from fixed income instruments. The cost of equities must therefore decline to keep or attract investors.  Then there is the Rule of 20 to consider.  Rule of 20 equals P/E + long term interest rates (average of 10 and 30 yr bond rates).  If at or below 20 minus inflation -- the market is a buy.  If above 20 minus inflation -- the market is a sell. Today we're at just about 20.  I think I'll keep my cautious side up.  Keep moving up my alerts and stick to only brief swings.  Something tells me it's going to be an interesting year.  All focus on the Fed and inflation.  

During the past week (on February 15), the value of the S&P 500 closed at yet another all-time high at 2349.25. As of today, the forward 12-month P/E ratio for the S&P 500 stands at 17.6, based on yesterday’s closing price (2347.22) and forward 12-month EPS estimate ($133.49). Given the high values driving the “P” in the P/E ratio, how does this 17.6 P/E ratio compare to historical averages? What is driving the increase in the P/E ratio?

The current forward 12-month P/E ratio of 17.6 is now above the four most recent historical averages: five-year (15.2), 10-year (14.4), 15-year (15.2), and 20-year (17.2).

In fact, this week marked the first time the forward 12-month P/E has been equal to (or above) 17.6 since June 23, 2004. On that date, the closing price of the S&P 500 was 1144.06 and the forward 12-month EPS estimate was $65.14.

The Drivers of Change

Back on December 31, 2016, the forward 12-month P/E ratio was 16.9. Since this date, the price of the S&P 500 has increased by 4.8% (to 2349.45 from 2238.83), while the forward 12-month EPS estimate has increased by 0.5% (to $133.49 from $132.84). Thus, the increase in the “P” has been the main driver of the increase in the P/E ratio to 17.6 today from 16.9 at the start of the first quarter.

It is interesting to note that analysts are projecting record-level EPS for the S&P 500 for Q2 2017 through Q4 2017. If not, the forward 12-month P/E ratio would be even higher than 17.6.

Courtesy of Factset

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Is The Fed About To Experience A Repeat Of 2016?

In the most recent Summary of Economic Projections, Fed officials penciled in three 25bp rate hikes for 2017. The reality, however, could be very different. We all remember how “four” became “one” in 2016. The median dots are neither a promise nor an official forecast. As 2016 progressed, forecasts associated with a lower path of SEP “dots” evolved as the consensus view of policymakers. Will the same happen this year? I don’t think so; it is hard to see the Fed on pause for another twelve months.

As a starting point, I think it best to assume the US economy is near full-employment. But the US economy was near full-employment at this time last year as well. I think the key difference between then and now is that then the after-effect of the oil price slide and dollar surge placed a drag on the US economy sufficient to ease hiring pressure. At the same time, labor force participation perked up, setting the stage for a flat unemployment rate for most of the year. Inflationary pressures eased as well; the January inflation pop proved to be short-lived:

PCE1116In effect, the US economy settled into a nice little equilibrium in 2016 that obviated the need for additional rate hikes. To expect a repeat scenario in 2017, one would need to assume that the US economy does not pick up speed and threaten that equilibrium by pushing past full employment.

Evidence, however, piles up suggesting that the slowdown of the past year is drawing to a close. ISM manufacturing and nonmanufacturing surveys are stronger, temporary help employment is heading up again, new manufacturing orders for nondefence, nonair capital goods have flattened out, and the broader inventory overhang is easing:

ISRATIO1216All of this occurs in the context of an unemployment rate that suddenly dipped toward the lower end of the Fed’s estimates of the natural rate of unemployment. And if the demographic forces reassert themselves, there is likely to be further downward pressure on the unemployment rate – job growth is well above estimates necessary to hold unemployment constant.

But would a total of 75bp of hikes be necessary to hold inflation in check? That depends in part the sensitivity of inflation to greater resource utilization. Greg Ip of the Wall Street Journal noted last week:

Unlike in 2009, this fiscal stimulus will be hitting when the economy is close to full employment with far less spare capacity. Yet it’s premature to assume inflation will therefore jump. In the last decade inflation, excluding swings due to energy, has proven surprisingly inertial, barely moving in response to high unemployment. The same is likely true if unemployment drops further below its “natural” level.

It is true that inflation is fairly inertial, although some policymakers will dismiss the lack of response to high unemployment as a consequence of downward nominal wage rigidity. Moreover, others will claim the reason for inertial inflation is that the Fed has properly responds to weak or strong economic conditions to hold inflation and, importantly, inflation expectations, in check. In other words, you won’t see inflation if the Fed acts preemptively.

Still, the broader point remains true that while further declines in unemployment will pressure the Fed to hiking rates more aggressively, low inflation like seen in November will temper that response.

In addition, policy going forward depends on the relative tightness of financial markets in general, and the dollar in particular. And the dollar has been on a tear in recent weeks:

Dollar1216The dollar serves as a break on the US economy. If activity expands as I anticipate, and the economy is near full employment as I believe, then some demand will be offshored as the rising dollar prompts the trade deficit to widen. Consequently, the Fed needs to be wary of feedback effects from the dollar as they tighten policy.

Bottom Line: The economic situation on the ground is very different from December of last year. Whereas the decision to raise rates at that time looked ill-advised, this latest action appears more appropriate given the likely medium-term path of the US economy. Assuming the US economy is near full employment, that path likely contains enough upward pressure on activity to justify more than one more rate increase in 2017. Three I think is more likely than one. That said, the change in administrations and the path of fiscal policy creates uncertainties in both directions.

Courtesy of EconomistsView

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Predicting The Feds Interest Rate Forecast

This is one of the stranger things we've seen recently.

The research team at the San Francisco Fed earlier this week published a letter analyzing one startup's analysis of Fed communications.

Economist Fernanda Nechio and researcher Rebecca Regan looked at data from Prattle, a textual analysis specialist, as part of an examination of the Fed's communication strategy following the financial crisis.

The short of it is that Prattle was accurately able to predict what the Fed's infamous "dot plot" would look like upon its next release.

Since 2012, the Fed has released a Summary of Economic Projections (SEP) — which contains economic projections from meeting participants — after every other Federal Open Market Committee meeting. The SEP also includes the dot plot, which is an aggregated forecast of where Fed officials see interest rates at various points in the future.

Prattle's findings show that Fed communications ahead of SEP releases can indicate where the Fed's median expectation for interest rates is likely to fall.

This is significant, as the median rate projection is an important number and serves as a guide to the Federal Reserve's view on the future path of interest rates.

The chart below shows the medium-term projections for the policy rate two to three years ahead released between September 2013 and June 2014.

Screen Shot 2016 09 08 at 4.54.06 PMFRBSF

Prattle uses a machine-learning algorithm to give each Fed communication a score, with a positive score providing a hawkish sentiment, and a negative score a dovish sentiment. 

This chart shows Prattle scores for FOMC meeting participants’ speeches given in the weeks leading up to the FOMC meetings in September and December 2013 and March and June 2014. (Fed officials can't speak publicly for a week ahead of FOMC decisions.)

Screen Shot 2016 09 08 at 4.54.37 PMFRBSF

They look alike, right?

The San Francisco Fed also analyzed the median interest rate projection and the median sentiment score. The median score is especially important, as Fed officials have said this is the most accurate prediction of the path of the policy rate. Once again, Prattle's sentiment score was found to be pretty accurate.

"The figure shows a statistically reliable positive relationship between the median sentiment scores and the median medium-term SEP interest rate projections," the note said.

"This positive relationship suggests that, on average, speeches preceding the meeting that carry a more hawkish sentiment are associated with a higher projected level for the policy rate in the medium term."

Screen Shot 2016 09 08 at 4.50.05 PM

Courtesy of BusinessInsider

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Fed Speak Shakes Market

Tranquility that has enveloped global markets for more than two months was upended as central banks start to question the benefits of further monetary easing, sending government debt, stocks and emerging-market assets to the biggest declines since June. The dollar jumped.

The S&P 500 Index, global equities and emerging-market assets tumbled at least 2 percent in the biggest rout since Britain voted to secede from the European Union. The yield on the 10-year Treasury note jumped to the highest since June and the greenback almost erased a weekly slide as a Federal Reserve official warned waiting too long to raise rates threatened to overheat the economy. German 10-year yields rose above zero for the first time since July after the European Central Bank downplayed the need for more stimulus.

Fed Bank of Boston President Eric Rosengren’s comments moved him firmly into the hawkish camp, sending the odds for a rate hike this year above 60 percent. He spoke a day after ECB President Mario Draghi played down the prospect of an increase in asset purchases, while DoubleLine Capital Chief Investment Officer Jeffrey Gundlach said it’s time to prepare for higher rates.

“Dovish Fed members getting called up to bat for a hike is putting people on edge,” Yousef Abbasi, a global market strategist at JonesTrading Institutional Services LLC, said by phone. “The more hawkish-leaning investors are grabbing onto that and it’s certainly one of those days where people are positioning for that September hike being back on the table.”

Calm had dominated financial markets in late summer with equity volatility and bond yields near historic lows and measures of cross-asset correlation at the highest levels since at least the financial crisis. The rise in the influence of different markets on each other has been attributed to the growing impact of central bank policy on prices, and rising concern that the era of easing may be nearing an end roiled assets from bonds to currencies and stocks on Friday.

Concerted declines of this size in stocks and bonds are rare though not unheard of, and are usually associated with central bank hawkishness. Adding up the percentage losses in the SPDR S&P 500 ETF and the iShares 20+ Year Treasury Bond ETF, the last time the moved in a similar manner was Dec. 3, 2015, when Fed Chair Janet Yellen indicated the conditions for higher rates in the U.S. had been met.

The last time the two ETFs each posted declines comparable in size to today’s was June 20, 2013, the start of the so-called taper tantrum, when then-Chair Ben S. Bernanke said the Fed may start reducing bond purchases that had fueled gains in markets globally.


The S&P 500 dropped 2.5 percent to 2,127.91 at 4 p.m. in New York, the lowest level in two months. The rout halted a period of calm that saw the index no more than 1 percent in either direction for 43 days. It also sent the gauge below its average price during the past 50 days for the first time since July 6. The Dow Jones Industrial Average lost 394.40 points, or 2.1 percent, to 18,085.51.

Shares of defensive stocks led declines on U.S. exchanges as trades that investors piled into in search of dividend yields reversed amid the spike in Treasury rates. Utilities and phone stocks plunged more than 3.4 percent, while real-estate investment trusts tumbled 3.9 percent. Financials, which benefit from rising interest rates, were the best performers in the S&P 500 with a drop of 1.9 percent.

The MSCI AC World Index fell 2.1 percent, the most since June 27. The Stoxx Europe 600 Index slid 1.1 percent, taking its weekly drop to 1.4 percent. A Bank of America Corp. report showed fund managers withdrew money from Europe’s equity funds for a 31st straight week.

The MSCI Emerging Markets Index fell for the first time in six days, losing 2.2 percent, as stock indexes from Brazil to Poland tumbled at least 2.2 percent and benchmark gauges in Taiwan, Indonesia, the Philippines and Poland lost more than 1 percent. The Kospi index slid 1.3 percent in Seoul after North Korea conducted its fifth nuclear arms test.


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Draghi’s reticence accelerated a selloff in bonds that extended from Europe to the U.S. and Japan, with longer-dated securities, which have been outperforming in recent months, being the hardest hit. While yields are still low compared with historical averages, they are quickly rising from records reached earlier this year, recalling the bond rout of 2015, which saw German 10-year yields climb more than a percentage point in less than two months.

The yield on German 30-year bonds climbed 10 basis points to 0.60 percent, adding to a nine-basis-point jump the previous day. The rate on similar-maturity U.S. securities rose seven basis points to 2.38 percent.

Chances of the Fed raising rates at the September meeting climbed to 38 percent, up 16 percentage points from Wednesday, according to fed funds futures.

The U.K. and Japan, two markets which have help drive the global bond rally this year, also saw losses. The yield on 10-year gilts rose to a one-month high of 0.84 percent and the Japanese 10-year yield, which has been below zero since March, climbed to minus 0.02 percent.


The dollar climbed for a third day while emerging market currencies from South Africa to Brazil to Mexico plunged as traders boosted bets on an interest-rate increase. The Bloomberg Dollar Spot Index, which tracks the greenback against 10 major peers, rose 0.5 percent. The U.S. currency gained 0.3 percent to $1.1229 per euro and was up 0.2 percent to 102.68 yen.

The Canadian dollar fell as an above-forecast gain in August jobs wasn’t seen as strong enough to reverse Bank of Canada policy makers’ concern that risks to economic growth have increased.


Oil fell the most in five weeks after the biggest U.S. stockpile slump in 17 years was seen as a one-off caused by a tropical storm that disrupted imports and offshore production. West Texas Intermediate dropped $1.74 to settle at $45.88 a barrel, paring the weekly increase to 3.2 percent.

Gold futures fell for a third day, dropping 0.5 percent to settle at $1,334.50 an ounce in New York. It was the longest slide since July 12. Higher rates make bullion less competitive against interest-bearing assets.

Visual Mode

See video at Bloomberg

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Byron Wiens Top 10 Surprises For 2016

Byron R. Wien, Vice Chairman of Multi-Asset Investing at Blackstone, today issued his list of Ten Surprises for 2016. This is the 31st year Byron has given his views on a number of economic, financial market and political surprises for the coming year. Byron defines a “surprise” as an event that the average investor would only assign a one out of three chance of taking place but which Byron believes is “probable,” having a better than 50% likelihood of happening.

Byron started the tradition in 1986 when he was the Chief U.S. Investment Strategist at Morgan Stanley. Byron joined Blackstone in September 2009 as a senior advisor to both the firm and its clients in analyzing economic, political, market and social trends.

Byron’s Ten Surprises for 2016 are as follows:

1. Riding on the coattails of Hillary Clinton, the winner of the presidential race against Ted Cruz, the Democrats gain control of the Senate in November.  The extreme positions of the Republican presidential candidate on key issues are cited as factors contributing to this outcome.  Turnout is below expectations for both political parties.

2. The United States equity market has a down year.  Stocks suffer from weak earnings, margin pressure (higher wages and no pricing power) and a price- earnings ratio contraction.  Investors keeping large cash balances because of global instability is another reason for the disappointing performance.

3. After the December rate increase, the Federal Reserve raises short-term interest rates by 25 basis points only once during 2016 in spite of having indicated on December 16 that they would do more.  A weak economy, poor corporate performance and struggling emerging markets are behind the cautious policy.  Reversing course and actually reducing rates is actively considered later in the year.  Real gross domestic product in the U.S. is below 2% for 2016.    

4. The weak American economy and the soft equity market cause overseas investors to reduce their holdings of American stocks.  An uncertain policy agenda as a result of a heated presidential campaign further confuses the outlook.  The dollar declines to 1.20 against the euro.

5. China barely avoids a hard landing and its soft economy fails to produce enough new jobs to satisfy its young people.  Chinese banks get in trouble because of non-performing loans.  Debt to GDP is now 250%.  Growth drops below 5% even though retail and auto sales are good and industrial production is up.  The yuan is adjusted to seven against the dollar to stimulate exports.

6. The refugee crisis proves divisive for the European Union and breaking it up is again on the table.  The political shift toward the nationalist policies of the extreme right is behind the change in mood.  No decision is made, but the long-term outlook for the euro and its supporters darkens.  

7. Oil languishes in the $30s.  Slow growth around the world is the major factor, but additional production from Iran and the unwillingness of Saudi Arabia to limit shipments also play a role.  Diminished exploration and development may result in higher prices at some point, but supply/demand strains do not appear in 2016.

8. High-end residential real estate in New York and London has a sharp downturn.  Russian and Chinese buyers disappear from the market in both places.  Low oil prices cause caution among Middle East buyers.  Many expensive condominiums remain unsold, putting developers under financial stress.

9. The soft U.S. economy and the weakness in the equity market keep the yield on the 10-year U.S. Treasury below 2.5%.  Investors continue to show a preference for bonds as a safe haven.

10. Burdened by heavy debt and weak demand, global growth falls to 2%.  Softer GNP in the United States as well as China and other emerging markets is behind the weaker than expected performance.   

Added Mr. Wien, “Every year there are always a few Surprises that do not make the Ten either because I do not think they are as relevant as those on the basic list or I am not comfortable with the idea that they are ‘probable.’”

Also rans: 

11. As a result of enhanced security efforts, terrorist groups associated with ISIS and al Qaeda do NOT mount a major strike involving 100 or more casualties against targets in the U.S. or Europe in 2016.  Even so, the United States accepts only a very limited number of asylum seekers from the Middle East during the year.  

12. Japan pulls out of its 2015 second half recession as Abenomics starts working.  The economy grows 1%, but the yen weakens further to 130 to the dollar.  The Nikkei rallies to 22,000.

13. Investors get tough on financial engineering.  They realize that share buybacks, mergers and acquisitions, and inversions may give a boost to earnings per share in the short term, but they would rather see investment in capital equipment and research that would improve long-term growth.  Multiples suffer.

14. 2016 turns out to be the year of breakthroughs in pharmaceuticals.  Several new drugs are approved to treat cancer, heart disease, diabetes, Parkinson’s and memory loss.  The cost of developing the breakthrough drugs and their efficacy encourage the political candidates to soften their criticism of pill pricing.  Life expectancy will continue to increase, resulting in financial pressure on entitlement programs.

15. Commodity prices stabilize as agricultural and industrial material manufacturers cut production.  Emerging market economies come out of their recessions and their equity markets astonish everyone by becoming positive performers in 2016.

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Over the years, it's become essential (to me) to understand monetary policy and money flows across the globe. With all of the recent 'pining' over whether the Fed will begin to raise rates this year, I felt this piece from Financial Times gave a great representation of who is worried over what, and why.  I truly recommend you give if it a read.  There's also more discussed on this article.  Enjoy.

Why is the Fed considering raising interest rates now?

America has seen its longest private sector hiring spurt on record, and unemployment has halved since its peak. The Fed thinks the hot jobs market could spur a pickup in inflation and wages. Given it is tasked with keeping inflation low, it is considering raising the cost of borrowing to keep the economy on an even keel.

Why have rates in the US been held so low for so long?

The US was hit by the crash in its housing market and banking sector between 2007-09. The Fed felt it needed to pull out all of the stops to prevent the economy from collapsing into a new Great Depression. One way of keeping things afloat was by cutting the cost of borrowing to rock-bottom levels.

Is the US economy ready to cope with interest rate rises?

That is the trillion dollar question - and opinions vary widely. To optimists, the Fed has managed to engineer a respectable recovery that is outshining many other economies. They say a quarter-point increase would have a negligible impact but is a sensible first step to ensure the Fed stays ahead of inflation. Sceptics warn that inflation remains on the floor and the Fed risks roiling world markets and pushing up the dollar if it acts too soon.

How fast are rates likely to rise?

Not fast at all - if the Fed is to be believed. One of the mantras adopted by Chair Janet Yellen this year has been that rate rises will be gradual. The pace of increases - when they begin - is expected to be less than half the tempo of the Fed’s last round of rate rises, which started in 2004. And the ultimate rate they stop at is likely to be very low too, at not much more than 3 per cent.

Federal reserve interest rate predictions from June 2015 meeting

Will they return to the levels seen pre-crisis?

Not for the foreseeable future, according to Fed policymakers’ own projections. The Fed believes the rate compatible with stable growth and prices has sunk sharply because of the lingering effects of the crisis and will increase only gradually. In this subdued post-crisis world, the central bank will need to keep its foot on the accelerator for some time to come.

How does a rise in central bank interest rates get transmitted to the wider economy?

Adjusting the federal funds rate - the rate banks charge each other for short-term loans - affects other short term rates paid by firms and households. These movements also have knock-on effects on long-term rates, including mortgages and corporate bonds. Changes in long-term rates will have an influence on asset prices, including the equity market. During the crisis the Fed also purchased longer-term mortgage backed securities and Treasury bonds to lower the level of long-term rates.

US Business

Are businesses ready for an increase in borrowing costs?

Many corporations have taken advantage of the low rate environment to borrow money via the bond markets. Most companies say they are relaxed about the impact of a small rate hike, believing the market has already priced their bonds or such an event. However, some economists say the interest payments for companies who have issued low-grade debt could rise more quickly.

What are zombie companies and why are we concerned about them?

Zombie companies are enterprises that have been able to stay in business primarily because of the persistence of ultra-low interest rates, and which would be unable to survive a rate hike. Many of these companies will go under when their borrowing costs rise, but some, such as “bond king” Bill Gross, think this could be a good thing. They argue that when weak companies file for bankruptcy, their owners and employees often go on to work for more successful ventures, which is ultimately a good thing for the economy.

US Consumers

What will a rate rise mean for my personal finances?

An upward move in short-term interest rates will be positive for savers who have been missing out on interest on their deposits. But the change could also be transmitted to a range of other interest rates, including car loans, credit cards and mortgages, which would make them more costly.

Are US consumers in general prepared for rates to rise?

The burden of household debt has fallen since the crisis, reaching 114 per cent of net disposable income last year, according to OECD statistics, suggesting consumers are better prepared for higher borrowing costs. In addition, a quarter-point hike would still leave rates at historically low levels.

Financial Markets

How will investors react to higher US interest rates?

This is the hottest and most disputed question in markets today. Some say the Fed has telegraphed a move so clearly that markets will take any interest rate increase in their stride. Others fret that some turbulence is inevitable after seven years of “ZIRP” - zero interest rate policy - and trillions of dollars worth of bond-buying by the US central bank.

How are currency traders positioning themselves in the anticipation of rate rises?

Currency markets are fickle, but differences in interest rates tend to drive movements in the longer-run. For example, if a European investor can borrow cheaply in Berlin and buy a higher-yielding US bond, then all else being equal the dollar will rise versus the euro. As a result, the dollar started the year in rip-roaring fashion, with an index measuring the US currency against a basket of its peers rocketing to a 12-year high, as investors bet on the Fed tightening monetary policy and bond yield differences widened.

Since then it has continued to beat up emerging market currencies but the broad rally has fizzled out as the euro and the Japanese yen have regained their footing. However, many analysts and fund managers expect the greenback to continue to climb higher in the coming years, as the Fed raises interest rates further.

What investments are most sensitive to interest rate rises?

Almost every asset class on the planet exhibits some evidence of frothiness these days, but some seem more vulnerable to higher interest rates. Although stocks look expensive, higher interest rates indicates that economic growth is firm, and that is good for listed companies. Gold typically loses its shine when interest rates climb, as the metal doesn’t pay any interest like a bank account will, but has already been beaten up heavily recently. The bond market looks more exposed. Highly rated debt is trading with very low yields, which means they are vulnerable to even a modest rise in Fed interest rates, while bonds issued by companies rated “junk” could suffer if more expensive borrowing tips some weaker groups into bankruptcy.

How does the recent China turmoil affect the Fed’s decision?

In theory, the Fed makes its decision on raising rates based on its appraisals of domestic economic issues. However, with emerging markets accounting for 39 per cent of global GDP in nominal terms and 52 per cent in purchasing power parity terms, a US monetary policy that enfeebles emerging markets risks depressing global demand and therefore impacting US growth further down the line. This is particularly the case with China. In a specific sense, a Fed rate hike runs the risk of increasing the attractiveness of US-dollar assets relative to those denominated in renminbi, thus accelerating capital outflows from China and leaving Beijing with fewer resources to invest in US Treasury debt.

What about the UK?

Will the UK automatically follow the US in raising rates?

There is no automatic or formal link between US and UK interest rates but the widespread expectation is that the Bank of England will be the next central bank after the US to raise rates. The UK’s economic recovery is well on track, with solid growth and a strong labour market.

The Bank of England typically follows the Federal Reserve's lead

Historically, US and UK market interest rates, as measured by government bond yields, have also moved in tandem. These are the rates, set by the financial markets that feed down into the real costs of borrowing for households and companies.

Bond yields move in tandem

What are we expecting from UK interest rate rises?

Bank of England governor Mark Carney has stressed that while the next move in rates is likely to be upwards, the path of increases will be “limited and gradual”.

While refusing to be drawn on precise timing, Mr Carney said the decision of whether to start lifting rates was likely to come into “sharper relief” around the turn of the year. Analysts are not predicting the first rise until February at the earliest, with many pushing the timing back into the late spring.

The rest of the world

Are all major central banks around the world thinking of raising interest rates?

No. The Bank of England is widely expected to follow the Fed and raise rates, most likely some time in the new year. But as the prolonged weakness in oil prices continues to keep inflation low, many central banks in the rich world are expected to loosen monetary policy further, for example expanding their programmes of quantitative easing. Mario Draghi, president of the European Central Bank, paved the way for an extension of QE last week and the Bank of Japan may well decide to go the same way to bring inflation back to target. In China, the central bank may also cut rates further to stimulate growth. The outlook for emerging markets is harder to gauge: were a Fed hike to trigger turmoil across Africa, Asia and Latin America, countries there may choose to cut rates to help the economy, or increase them in order to dissuade investors from taking their money abroad.

Why would a rate rise in the US impact the emerging market countries?

We have already seen the antecedents of the main impact: a stronger US dollar, backed by higher US interest rates, tends to depress the values of emerging market currencies at a time when many EM economies are already weakening and their currencies have already slumped against the greenback.The Fed’s rate rise could exacerbate the EM currency turmoil, and even help precipitate a full-blown crisis.

Jargon buster

What is tightening and loosening?

When a central bank “loosens” or “eases” policy it essentially increases the supply of money in the economy and pushes down the cost of borrowing. This could be by lowering interest rates, or buying more assets with the aim of putting more money into circulation and encouraging greater economic activity.

“Tightening” is the opposite. If policymakers worry that an economy is begin to overheat, potentially generating too much inflation, they can tighten policy – such as raising the interest rate they charge banks to borrow from them, to make the cost of credit more expensive.

Changes to interest rates can take-up to 18 months to feed through into the real economy.

What is monetary policy?

Central bankers control more than just interest rates. “Monetary policy” is a broad brush term for a whole range of actions, including things like selling or buying assets such as government bonds, raising or reducing the amount of capital banks need to hold against liabilities, and raising or lowering interest rates.

All of these actions impact the cost and supply of money in an economy which are the main levers central banks use to try and keep inflation at its target level and the economy growing at a sustainable speed.

Changes in monetary policy can take-up to 18 months to feed through into the real economy.

See more at ft.com

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BofAML When Will The Fed Raise Rates?

From BofAML's latest Global Fund Manager Survey: more than 50% of investors now expect Fed to lift off in Q3 or later.  Courtesy of MatthewB

Obviously June seems off the table.  Markets however, tend to bake in any moves long beforehand therefore remain long and accumulate banks and if you haven't already, lighten up on the utilities.  There's still money to be had; just in the right areas.

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More On Why Raising Rates Matters

It's not just about big business being able to borrow and refinance debt at low (ZIRP) rates.  It also impacts home buying affordability, consumer spending, higher chargecard APRs for the little guy who can barely afford it and yes, yield for the big dogs.  From an investment standpoint, large investors will pay attention.  As an example the 10 year yield is now at 2.15.  Yesterday, it crossed the dividend yield of the S&P 500. This means it is now more profitable to buy bonds than to invest in the stock market.  An interesting perspective.  Check it out at MrTopStep

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As it stands, JPM believes the Fed will not being to taper until their December meeting UNLESS labor improvements continue as they have the last six months; at which point then they look to the September meeting as the most obvious time (after Jackson Hole).

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When Will The Fed Raise Rates?

The following from CalculatedRisk with my notes added as an afterthought:

Short answer: it is very unlikely that the Fed will increase the Fed funds rate this year. There are a series of steps the Fed will most likely take before raising rates1: • First the Fed needs to complete the $600 billion “QE2” large-scale asset purchase program. This is currently scheduled to be completed at the end of June, however, to “promote a smooth transition in markets”, it is possible the Fed will decide to "gradually slow the pace" of the purchases like they did with QE1 (quoted text from QE1 related FOMC statements). If the program is extended and purchases tapered off (but the size remains at $600 billion), this will probably be announced at the conclusion of the two day FOMC meeting in late April and the program will probably then be completed in August. • Next the Fed will end the reinvestment of maturing MBS and Treasury Securities. This could be concurrent with the end of QE2, or the Fed might wait a few more months before halting reinvestment. • Then the Fed will need to remove or change the extended period FOMC statement:

“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”
If we look back to the “considerable period” language in 2003, the FOMC last used the “considerable period” phrase in the December 9, 2003 statement, and the first rate increase was on June 30th, 2004 – just over 6 months later. This suggests a timeline for the earliest Fed funds rate increase: • End of QE2 in June (maybe tapered off into August). • End of reinvestment 0 to 2 months later. • Drop extended period language a couple months later • Raise rates in early 2012. A few items I think the author did not address would be the new, voting FOMC members who are already pushing for an early end to POMO, the already-creeping rates since October and otuside influlences such as ECB and BOC tightening.  Then there are those rumors still being bandied about that Ben is whispering in ears for QE3 but I cannot believe anyone will let him get away with it.   Personally I believe we'll see rates rise in Q3 or Q4 as they have done numerous times historically but only time will tell.  My thought, however, is that markets are forward looking and that we will see the market begin to *bake in* the lightening up of POMO going towards June so that once it is actually announced, most of the move will have already taken place.   Anyone's thoughts and comments are appreciated.

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