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  • Welcome to FT Markets. "Sorry, not today, come back another time."

  • That was the message from Janet Yellen and her Federal Reserve colleagues.

  • As the U.S. central bank decides to keep rates on hold at their September meeting,

  • as worries about the global economy persist.

  • So, what was the reaction in Europe?

  • Well, the Euro was up, bond prices also went up, equities have gone down.

  • So, what are the short-term and medium-term implications of the Fed's decision?

  • With me to discuss this, is the FT Markets editor, Mike Mackenzie.

  • Mike, let's start with the Euro, which has seen a slow down, which is moving towards 1.15,

  • which has been pretty weak as far as the dollars concern.

  • Stronger Euro, weaker dollar, that's been the story for the last few weeks.

  • And looks like it's going to be continuing along that path.

  • Yes, as you can see from here, you've had a nice jump. Basically one figure change from below 1.14 to over 1.15 in the last 24 hours.

  • And that's essentially disappointment trade, the Fed, by sort of not raising rates, has kind of tempered the dollar Bulls.

  • As a result, the Euros picked up some steam.

  • The implication of this, of course is quite profound for equity investors in Europe.

  • Yes, so in terms of the trend that's... remember the days where we were talking about the Euro-dollar parity?

  • I mean, that's now to the point where by we have two central banks both wanting pretty weak currencies.

  • Well, I'm not sure the Fed wants a weak currency. They've seen a tiny financial condition in the U.S. economy

  • because the dollar has been picking up steam,

  • and because the dollar has been strengthening, it's hit commodity prices hard.

  • And it has put a lot of pressure on emerging markets.

  • And if you look across the emerging market economies, they have a lot of dollar-denominated debt.

  • So, the last thing you want when your currency is weakening

  • is the dollar goes up and you're now having to pay back that debt in depreciating local currency terms.

  • So, the Fed has essentially said. We're worried about China, we're worried about the local economy,

  • we're holding fire, they want to see the dollar sort of, come down a little bit.

  • But, yes, you're right. You talked about the Euro-zone, this is the economy that's still pretty much on life support.

  • You've got a central bank in Europe that's doing an enormous amount of bond-buying,

  • they want, and they need a weaker currency.

  • And it's funnily enough when we are talking about, or the market was talking about

  • potentially the dollar and Euro reaching parity earlier this year

  • that coincided with the peak in the European stock prices.

  • And you're way away from the peak now.

  • Let's look at the next chart, which probably tells us that Mario Draghi, president of the European central bank,

  • is going to have to extend quantitative easing.

  • He's going to have to do something because he wants to weaken its currency, and he wants to fire up the stock market

  • so you have a greater wealth effect.

  • And this is not a pretty picture if you're an ECB official.

  • This was once a great equity Bull run but it's been coming off for quite a while.

  • What's the likely direction depending on how the dollar goes against the Euro?

  • Well, if you get a stronger dollar and a weaker Euro, there are exporters in Europe get higher foreign revenues.

  • And if you think back to the U.S. bull run in 2011, 2012,

  • When QE was being done by the Fed and the Fed was weakened and that was it.

  • Actually saw the dollar weakened quite a lot.

  • The Bulls in New York loved it because every time the companies produced their earnings,

  • they were getting great for them from the fact that they were getting stronger foreign revenues.

  • So this is what European investors and this is sort of the investment bookcase in part for why you want to earn European stocks

  • so that's why the currency is so important.

  • So, the bond mark. Let's see how that's been playing.

  • The European bonds have pretty much been tracking what U.S. treasuries have been doing.

  • Is that right?

  • Yes, well treasuries got a nice boost yesterday.

  • The treasury market has long felt that the Fed's projections for interest rates and the economy generally has been far too rosy.

  • And yet again yesterday the bond market prevailed the Feds didn't raise rates.

  • And, as a result, you've had a nice rally last night in the U.S. treasury market,

  • and that's now spilled over here in the Eurozone and also for the UK.

  • And interesting thing about the UK is that they, along with the Feds, are really the only two major central banks

  • in the position to actually raise rates in the next few months.

  • So, we've seen a pronounced drop in yields and a rise in prices for UK gilts, and the same here for France and Germany.

  • That's a little bit more of a concern in the Eurozone

  • given that the global environment is not too good here.

  • And instead of owning stock in the Eurozone, you're more comfortable earning bonds,

  • which is essentially, as you can see in Germany and France,

  • don't really give you much for coupon.

  • Well, the general environment is not great anywhere.

  • And our final chart is about the Feds thinking on whether rates are gonna happen this year.

  • The prospects are receding in general, aren't they?

  • Yes, they are. I mean the bond market now prices in less than a 50% chance the rate.

  • This is how the federal reserve members think what their expectations of rate movings is going to be.

  • Yes.

  • Here, we see the first arrival of a negative rate for some time.

  • Yes, so though, again, the Fed is a committee, and whilst you had one official yesterday saying he thinks rate should be negative,

  • you have another official Jeffrey Lacker who dissented and said the Feds should've raised rates.

  • So you can see the polarization of the opinions on the Feds.

  • The general trend is, these dots have been coming down.

  • By the end of 2016, they're expecting it to be a lot lower than where they were saying a year ago.

  • So, in general, the Fed is slowly coming around to the bond markets' view of the world,

  • which is at rates can be very low. Even if they do finally raise rates,

  • the increases in borrowing costs are gonna be very small.

  • Even if they do finally raise rates.

  • Is there... (Does it) ever get to a point in the cycle where it just becomes too late to raise rates?

  • There is a risk there.

  • The bare case the U.S economy is very much one of where,

  • okay, you're looking at S&P 500 earnings,

  • they're weakening, they actually went negative last quarter on the year basis,

  • revenue growth is anemic for major U.S. companies.

  • That reflects the stronger dollar, which has hit their foreign earnings, or foreign revenues.

  • You've also got a situation now where banks in the U.S. is going to start calling in their earns

  • for their oil and gas industry, and shale gas and oil exploration U.S. has been a huge huge driver economic activity last few years.

  • But now with oil prices having fallen so much, which is part of the commodity story.

  • You could make a case that you're not going to see as much CapEx in the U.S. economy, and that filters through.

  • So, things aren't looking so good. And also, what was lost in all the focus on the Feds yesterday,

  • the U.S. Bureau of Labor Statistics came out with a revision.

  • Hence for the 12th month till March of this year, they've knocked just over 200,000 jobs off payrolls.

  • I thought payrolls are going gangbusters.

  • And again, if you're looking at the labor participation rate,

  • unemployment rate is low, but the labor participation rate is also very very low.

  • It has come off dramatically.

  • So, you're not seeing any wage of pressure.

  • I mean, the key here now, the Fed has basically told us: "Don't worry about China."

  • If you're a bullish investor on U.S. equities,

  • generally, one question you're asking yourself is,

  • "What does the Fed know that I don't?"

  • Mike, thanks very much indeed.

  • So, there we have it, the Fed has kicked the can down the road.

  • But the question is, whether the road is going to start running out?

Welcome to FT Markets. "Sorry, not today, come back another time."

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    Kristi Yang posted on 2015/09/22
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