The Federal Reserve has lifted interest again (0.25%) this week to close out Q3 – which went out with a whimper. It does not look like the Fed’s rate hike policy will end soon as the debt markets are pricing in another 0.25% move in December and perhaps three more in 2019. This is part of the normalization process of the yield curve as the Fed has held its thumb on the scale since the financial crisis ten years ago. Market behavior will finally begin to rationalize good from bad and strong from weak as higher interest rates will return discipline to the capital markets. Expect more idiosyncratic risk in the coming year where companies like Tesla, for example, are punished for their weak balance sheets and inability to generate positive cash flow (more below).
On a macro level, interest rates in the U.S. are generally much higher than in Asia and Europe and that trend is not going to stop anytime soon. Eventually, overseas rates will be dragged higher and the process of rationalization will soon follow as ultra-low interest rates tend to cover-up poor management decisions and weak balance sheets. In other words, investors will be more fickle and less forgiving when it comes to bad news. The world likes U.S. stocks and bonds as emerging markets become the roadkill of the Federal Reserve’s polices while other central banks hem and haw on their next move (they don’t want to get left too far behind the Fed). But that is probably the story for 2019.
September is usually a rocky time for U.S. stocks so let’s see how October and earnings season opens up in the next two weeks.
What to watch for next week:
- How we open up Monday/Tuesday will be a good sign on the strength of the uptrend.
- Jobs numbers released next Friday but don’t look for any surprises.
- Domestic car sales on Tuesday. I’ve read that some are expecting weak numbers.
Chart of the Week!
Debt bubble anyone?
Economic & Central Banking Snippets
- The September Conference Board consumer confidence index was 138.4, well above the estimate of 132.1 and up from 134.7 last month. This level of confidence is the highest since September 2000 while the “Jobs are Plentiful” component also rose to the highest since January 2001. Age wise, the jump in consumer confidence was dominated by those under the age of 35. (Boock Report)
- The IMF will lend an extra $7.1B to Argentina as part of its bailout package, which is now the multilateral lender’s biggest program ever, its managing director Christine Lagarde announced on Wednesday. The changes swell the size of the total bailout package to $57bn, of which $15bn has already been disbursed and a further $35bn can now be disbursed by the end of 2019. The path to the agreement was smoothed by the resignation of Argentina’s central bank governor, Luis Caputo, on Tuesday over what was understood to be a disagreement with the IMF over how much the central bank could intervene in foreign exchange markets. (FT)
- The Federal Reserve raised interest rates 0.25% this week and penciled in one more interest-rate increase for 2018. Officials also anticipate three more in 2019, a measured pace amid solid economic growth. What could throw off their plans? “The main thing where we might need to move along a little bit quicker would be if inflation surprises to the upside. We don’t see that,” Fed Chairman Jerome Powell said this week. (FT)
- Industrial production in Japan grew at a slower pace than forecast in August while retail sales posted the fastest rise in eight months, according to government figures released on Friday. The reading showed a pick-up from the 0.2% rise in July, however it remained short of the 1.5% growth forecast in a Reuters poll. (FT)
- Central banks have emerged as some of the biggest buyers of gold this year, with purchases hitting their highest level in six years, according to analysts at Macquarie. Central banks have bought a total of 264 tonnes of gold this year, “by far the most at this stage of the year of any period in the last six years,” the bank said. While gold buying has been dominated by Russia, Turkey and Kazakhstan, Poland also bought gold for the first time since 1998, Macquarie said. “The only unambiguously positive sector for gold at the moment is central banks,” the bank said. (FT)
Macro Snippets
- Italian government bonds and bank stocks took a heavy blow on Friday after the country’s populist government agreed to a more fiscally aggressive budget than investors anticipated. The coalition government will target a budget deficit for 2019 of 2.4% of GDP, a significant increase from 2018 and an indication that Italy’s new leaders intend to stick to the election promises that took them to power. The yield on the benchmark Italian 10-year bond jumped 24 basis points to 3.15%, while the two-year note yield was 26bps higher to 1.05%.
- The costs of insuring Tesla’s debt against a default surged to its highest level ever on Friday a day after US regulators accused founder Elon Musk of securities fraud and sued to bar him from serving as an officer or director at a public company. Tesla’s five-year credit default swaps jumped by 56 basis points to 712.73 bps on Friday according to IHS Markit data. The sharp moves suggest bond investors are increasingly concerned over the company’s financial viability. Tesla’s $1.8bn bond due in August 2025 traded as low as 84 cents on the dollar (8.274% yield). This means that for every $10 million in protection, investors will have to pay $2.28 million upfront. This also means that the implied probability of default over the next 5 years is at an all time high of 48%!
- Canada’s Barrick Gold is to combine with Randgold Resources, its UK-listed rival, in an $18bn deal that will create the world’s leading gold miner. The new company will produce more than 6.5 million ounces of gold a year, eclipsing its nearest competitor, US-based Newmont. Barrick’s shareholders will own 64% of the merged entity.
- Sirius XM is buying Pandora. Placing a $3 billion bet on streaming music, the satellite-radio company is buying the online-music firm as competition for listeners continues to grow.
- McDonald’s is getting healthier. The burger chain is stripping out artificial ingredients found in its food to reverse a sales slump in the US. The Big Mac, Quarter Pounder with Cheese and burgers in Happy Meals are now among items free from artificial preservatives, flavors and coloring. (WSJ)
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Paul J. McCarthy, III
President – Kisco Capital
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