The U.S. stock markets continued to move higher as we move past the Q1 correction of 2018. However, there was a hiccup on Thursday as the Brazilian stock market dropped 8% in one day! Why? As U.S interest rates move higher there is a butterfly affect on emerging economies that link their currencies to the US dollar. As interest rates rise so does the value of the US dollar verses the local currency of Brazil, in this case. In order to maintain exports to the USA, the emerging economy is forced to devalue its local currency which in turn causes inflation and local interest rates to spike to stem the devaluation of the local currency. The chart below shows what happened to Brazil’s 10YR bond yields and you can see how dramatically their interest rate complex rose thus causing a drop in the Brazilian stock market. This is a downward spiral that can be very tough to break for an emerging economy so this tough situation for Brazil and other emerging countries will continue as long as the dollar continues to gain strength. It is very likely that the Brazilian stock market could fall dramatically in the coming year given the relationship with the US dollar is unlikely to end in the near term.
What happened with Brazil illustrates how inter-connected the policy of the Federal Reserve is to the global economy. The Fed is uncorking their ultra-low interest rate and quantitate easing program and we will now see how volatility eventually returns across the globe. We will see more examples of this in the coming 1-2 years and it is likely that the next recession will be global and emanate from interest rates, currencies and central bank policies. We have spent decades becoming inter-connected and this is one of the early tremors before the piper comes to collect his payment. We are also seeing this in developed countries like Italy and Japan but the effect is much less pronounced, for now. Brazil’s performance this week is a good example of what could unfurl over a longer period of time for the developed countries wrestling with a secular shift to a rising interest rates environment.
In contrast, Brazil’s affect on the U.S. stock markets was fairly short lived and I expect that we will continue to see good things from technology and the S&P 500. Below is a chart of what happened this past week in the S&P 500.
As I mentioned last week, the technicals are shaping up to be positive for the U.S. markets as we move into the summer months. The triangle in this chart is showing growing evidence to be complete which implies new highs in the U.S. stock markets. Tough to know how long this move lasts but it should be several months (at least).
Chart of the Week!
Economic & Central Banking Snippets
- The European Central Bank (ECB) scaled back the proportion of its bond-buying program directed at Italy last month, an admission that could fuel suspicions by the new Eurosceptic government in Rome that the central bank is seeking to punish it. The ECB purchased a net €3.6bn of Italian government debt in May, new figures show. Although this is higher than the amount it bought in some recent months, such as March and January, it was smaller as an overall proportion of its purchases.
- The April trade deficit narrowed to $46.2B from $47.2B in March. That was about $3B less than expected and as a result should lead to a rise in Q2 GDP forecasts by a few tenths. Exports were up .3% m/o/m to a new record high, helped by our new energy export business, while imports fell by .2%. (Boock Report)
- The U.S. had more job openings than unemployed Americans this spring. That’s the first time that’s happened since such record-keeping began in 2000, Eric Morath reports. Federal Reserve policy makers are watching closely. Emergence of worker shortages and stronger inflation could signal the economy is overheating, raising the need to lift interest rates more aggressively. (WSJ)
- German factory orders in April disappointed again with a 2.5% m/o/m decline vs the estimated gain of .8%. The weakness was all within Europe and Germany itself as non eurozone orders were up. Orders have now fallen for the 4th straight month – are the trade tariff threats finally having an impact? (Boock Report)
- Eurozone GDP cooled in the first quarter to the weakest pace since mid-2016, according to figures released on Thursday. GDP by 0.4% in Q1 which was the lowest since Q3 of 2016. (FT)
- China’s trade surplus with the U.S. jumped in May, rising 11.7% to $24.6B, worsening the imbalance at the center of tensions between the world’s largest economies. It also means for the first five months of the year, China’s surplus with the U.S. crossed the $100B mark. The figures may reinforce Washington’s determination to move forward with new duties against Chinese imports.
- SpaceX is pushing back the timeline for launching a pair of space tourists around the moon, missing another deadline for putting humans in its Dragon capsule. A new timetable for the flight – now postponed from this year until at least mid-2019. The delay comes amid SpaceX’s own projections of a nearly 40% drop in launches next year from as many as 28 anticipated for 2018. (FT)
- Microsoft said it is buying the software-code repository GitHub for $7.5 billion in stock, a move that could help the software giant convince more developers to create applications for its cloud-computing business. The deal puts GitHub, a popular service where developers share and collaborate on code, into the hands of a tech giant that is among the leaders in so-called cloud computing, where customers rent digital resources and applications on demand.
- The Social Security program’s cost will exceed its income this year for the first time since 1982, forcing the program to dip into its nearly $3 trillion trust fund to cover benefits. By 2034, those reserves will be depleted and Social Security will no longer be able to send its full scheduled benefits, according to the latest annual report by the trustees of Social Security and Medicare. Unless Congress acts to bolster the program’s finances, beneficiaries would receive about three-quarters of their scheduled benefits after 2034.
That is all for now until next week’s Market Update. If someone forwarded you a copy of this report, you can sign-up directly at www.kiscocap.com.
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Paul J. McCarthy, III
President – Kisco Capital