- Dark clouds are gathering over global markets.
- A mix of economic, political, and seasonal factors weigh.
- The perfect storm could be beneficial for the US Dollar at the expense of all the rest.
While many traders were on holiday during the summer, markets were not at ease with quite a few issues emerging, so far hitting only emerging markets. September may see a culmination of these adverse developments in what could turn into a perfect storm. The trouble may hit stocks quite hard and benefit the safe-haven US Dollar that also enjoys other advantages.
Here are five reasons to be gloomy:
1) Fed rate hikes
The Federal Reserve initially raised interest rates in December 2015, but these hikes began biting the global economy only recently. The lift-off from rock-bottom zero-bound rates took some time to reach other countries that became reliant on cheap funding in the trustworthy US Dollar.
Moreover, the pace of rate hikes has accelerated of late. There was only one raise in 2015, one in 2016, three in 2017 and four expected this year. Also, the change of guard at the helm of the Fed resulted in a more hawkish tone. Jerome Powell and the current voting members of the FOMC are more determined to battle inflation than Janet Yellen’s committee.
The increase in US rates makes the US Dollar more attractive, thus making the dollar-denominated debt payments dearer. Rising ratesmake recycling dollar loans more expensive as well. It also makes an investment in stocks less attractive.
Despite executing a gradual, predictable and well-telegraphed tightening cycle, the Fed’s moves are the root cause of the issues in Emerging Markets that also have an impact on developed economies that rely on EMs as the source of growth.
Another Fed rate hike in September is all but done. And signaling another move in December is also highly likely. More trouble in EM and making safer investments more attractive could weigh on stocks and push the greenback higher.
2) Trade wars leaping forward
US President Donald Trump did not hurry to fulfill his election promises on trade early on. Things changed in 2018 with steel and aluminum tariffs that were quickly expanded to slapping China with duties on $50 billion of Chinese goods. So far, China and other countries retaliated in kind. The next move will be too much.
The US intends to slap the world’s second-largest economy with levies on $200 billion of imported goods. China just does not import that much from the US. However, it could respond with other measures that may hurt US interests in China.
Higher tariffs worsen global trading conditions. Trade has usually exceeded worldwide growth and pushed it forward. Without this engine, the world’s economies could suffer. It is not only a fight between the globe’s two largest economies. Supply chains are spread across many countries. Fewer American orders from a Chinese factory may result in fewer orders from factories in Vietnam or Indonesia. The same goes for the whole world.
And for trade that continues under the tariffs, the result is more expensive products for importers and eventually for customers. Fewer spare dollars in consumers’ pockets means they will buy less of other products.
A significant leap in trade wars will, therefore, slow the world down, hurt US stocks (which have been sanguine so far) and send money into the most robust economy, the US, in forms of cash and bonds, not stocks.
3) Oil prices can choke consumers
A drop in global growth means lower demand for oil, lower petrol prices and giving consumers some extra cash to spend, that cash that may be missing due to the tariffs.
However, there are other factors in play.
The withdrawal of the US from the Iran deal (officially known as the JCPOA) will soon result in the US imposing sanctions on the Middle-Eastern nation. Iran is a significant producer of oil. The US will not only refrain from buying Iranian oil but will also impose its will on its allies. Iran is scrambling to find alternative buyers in Asia and is also in great need of investment in developing its outdated oil infrastructure.
Without new investment, Iran will find it hard to produce oil to satisfy its dwindling customer list. Iranian oil output is already falling, and other petrol producers are not in a hurry to ramp up production. Countries such as Saudi Arabia and Russia need higher prices.
If this trend continues, it could be another impediment to global growth.
4) Even the strongest economy is seeing weakness
The UK has Brexit, Europe has political and structural issues, and the signs of a Chinese slowdown may be trade war-related. Yet the world’s largest economy has been going strong.
The US economy enjoyed an annualized growth rate of 4.2% in Q2, the fastest in four years. US equity indices have hit record highs, contrary to markets in Asia and Europe. Unemployment is low, and consumer confidence is high.
Nevertheless, not all is perfect in America. The forward-looking purchasing managers’ indices from ISM have been dropping of late. This is partly related to trade wars.
The more worrying figures come from the housing sector, which is a bit more isolated from global trends. Existing home sales recorded their fourth consecutive decline in July, a phenomenon that was last seen in 2013. New home sales, pending home sales, and house prices all disappointed in the data for July.
These may be early days, but we all remember where the 2008 financial crisis began. A few more disappointing housing figures released in September and markets will already have to take note.
5) Seasonality
September is usually a tough month for stocks. This is an old phenomenon dating back to the 1920s. From 1950 and onwards, the Dow Jones Industrial Average dropped by 0.8% on average. Other indices have followed suit. One explanation is that traders come back from the summer vacations and begin realizing profits, executing their plans.
A phenomenon that does not always happen in September or any month is the inverse correlation between stocks and the US Dollar. A more significant drop in equity prices, this time also in the US, could, therefore, result in a leap in the greenback.
Conclusion
The perfect storm is brewing with another rate hike, a significant escalation in trade wars, rising oil, first signs of weakness in the strongest economy, and also the seasonal factor. Apart from the regular drop in stocks, September 2018 could see a surge in the US Dollar.
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