1. Fixating on the Fed
Investors awaiting the nomination of the next Federal Reserve chair are hoping whoever is nominated pursues the same monetary policy that has supported rising stock prices for the past nine years.
Led by Janet Yellen since 2014, the Fed is about to allow its $4.5 trillion portfolio of securities to shrink, and in late 2015 it began raising interest rates from the low levels seen after the 2008 financial crisis. A new Fed chair who argues for tightening monetary policy more aggressively is seen putting economic growth at risk, along with corporate earnings, and the long stock market rally.
A faster rise in short-term interest rates would likely flatten the yield curve, narrowing the gap between short and long term debt yields, which could crimp bank profits and strengthen the US dollar, hurting exporters’ sales.
US President Donald Trump has selected a pool of five candidates from which to choose the next Fed chair: current Fed Chair Janet Yellen; Trump’s chief economic adviser, Gary Cohn; former Fed Governor Kevin Warsh; current Fed Governor Jerome Powell, and Stanford University economist John Taylor.
Cohn and Powell are the two most likely to follow current Fed policy, while Taylor and Warsh are seen likely to push for raising interest rates at a faster clip and to argue for a quicker run-down in the bond portfolio accumulated after the 2008 crisis.
2. Taper time
After weeks of speculation, the European Central Bank is set to sketch out plans on Thursday to scale back its ́€2.3 trillion stimulus scheme, probably from the start of next year.
Economists polled by Reuters expect Mario Draghi and co will cut their monthly purchases of mainly government bonds to €40 billion from €60 billion although the reduction could be larger.
The bigger haggling point is whether to keep the plan open ended by putting a nine or six months time frame on the reduction rather than a potential date at when it ends altogether. There have also been hints at altering the ECB’s forward guidance to make clear a rate rise remains some time away.
It’s a scenario that should cheer bond investors — they’ve already pushed euro zone bond yields to 5-week lows in anticipation of what would effectively be a prolonged tapering. The euro has backed off recent 2-½ year highs and regional stock markets are trading near four-month peaks.
A divergence in rate views in the US and Europe meanwhile have pushed the gap between short-dated bond yields in the US and Germany to around 229 basis points, the widest in 17 years.
The high-flying “FAANG” stocks – Facebook Inc., Amazon.com Inc., Apple Inc., Netflix Inc. and Alphabet Inc. – have risen strongly since mid-July. The exception is Amazon.com, known as the 800-pound gorilla of the group.
While revenue growth remains stellar, Amazon has been in big spending mode, which is weighing on profits. In August, Whole Foods shareholders and federal regulators approved Amazon’s $13.7 billion acquisition of the organic grocer.
Amazon shares, which have posted total returns of about 32% so far this year versus Netflix’s 58%, could surprise on the upside next week as it announces its third quarterly report on Oct. 26 and against the backdrop of how Amazon stock has underperformed over the past three months.
Indeed, Netflix reported a strong third quarter, beating analyst expectations in terms of revenue and subscriber growth. The company reported $2.99 billion in revenue and 5.3 million new subscribers, a record for third quarter growth.
4. Abenomics lives another day
Prime Minister Shinzo Abe’s ruling bloc expected to win around a two-thirds majority in Japan, according to exit polls last night. A victory of that scale would likely provide Abe with a strong endorsement to stay on, which would make him Japan’s longest-serving post-war prime minister.
The yen has weakened in the run-up to the election, hitting a more-than-three-month low against the dollar on Friday. That’s helped the Nikkei stock index, which recorded its longest run of daily gains in over half a century, after a 14-day winning streak.
Those share-price gains signal that markets have become less worried about domestic political risks and that Abe’s gamble to take advantage of a weak opposition may pay off.
If Abe does wins a convincing victory, the yen is likely to strengthen modestly, analysts say, which could in turn weigh on the Nikkei. But a continuation of Abenomics means a continuation of ultra-loose monetary policy, spelling downward pressure on Japanese bond yields and the yen and further fuel for stocks.
5. Minsky moment
China’s central bank chief Zhou Xiaochuan gave an unprecedented warning on the 30th anniversary of the Black Monday Wall Street crash: the world’s second largest economy must avoid the risk of a “Minsky moment.”
This refers to a sudden collapse in asset prices after long periods of growth, sparked by debt or currency pressures. The comment drew attention to China’s debt pile, which is at levels that preceded crises elsewhere, at a time when Chinese leaders, meeting at a twice-a-decade Communist party congress, are obsessed with stability.
But while China has accumulated record amounts of debt, its stock markets are well below 2015 peaks and the property sector is cooling, as Thursday’s third-quarter growth data showed. Zhou did not say the risk was imminent, noting leverage will continue to rise. Policymakers will be relieved the warning came from Zhou, who is set to retire soon, and not from the market itself.
6. What next for Macri-nomics?
On Sunday, Argentines head to the polls for midterm legislative elections that could determine the future of market-friendly President Mauricio Macri’s reform agenda. The vote will give a sense of the fallout from Macri’s unpopular subsidy cuts and other fiscal tightening measures.
But what’s really at play is whether his political nemesis and populist predecessor Cristina Fernandez can get enough support to pose a serious challenge in the 2019 presidential election, when Macri is expected to run for a second term.
Investors, eyeing the country’s vast oil and mineral wealth, want Macri’s coalition to block any chance of Fernandez with her growth-at-all-costs policies returning to the presidency in Latin America’s No. 3 economy.