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Markets Sell Off As Perfect Storm Hits
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The long anticipated correction in markets ahead of the general election looks like it just began. U.S. stock markets took a nosedive Friday on a combination of fears that the Fed will actually raise rates and that they are running out of effective policy tools. A world wide bond selloff accompanied the stock market retrenchment. The Italian referendum and banking crisis is continuing to simmer in the background. Against this backdrop, the Bank of England is keeping all policy options on the table. All of the latest turmoil is supporting gold.
Selloff in Stocks and Global Bonds Driving Rates Higher
Friday saw a sharp selloff in stocks and global bonds that caught many investors off guard. The Dow Jones declined nearly 400 points at the same time as 30 year bond prices rose nearly 10 basis points. Initial blame for the severe market pullback that looks set to continue at the open Monday fell on the remarks of Federal speaker Eric Rosengren. The President of the Boston Federal Reserve Bank claimed that “low interest rates are increasing the chance of overheating the U.S. economy. Gradually tightening monetary policy is appropriate to maintaining full employment.” This comment raised the spectre that the Fed might find a way to justify higher interest rates as early as this end of September meeting.
It is not just the threat of higher interest rates that have markets spooked. The Chief Strategist and Economist of Gluskin Sheff, David Rosenberg, also believes that a sharp market retracement is imminent. He points to other factors besides the possibility of the interest rate hike. Rosenberg considers the U.S. economy to be sluggish, the stock market to be highly valued, and investors to be overly complacent.
There is also the rising fear that central bank policies are nearing the limits of their effectiveness. Both the yields of Japanese and German sovereign bonds rose to multiple month highs at the end of last week. This dragged U.S. Treasury yields higher. Morgan Stanley Head of Currency Strategy Hans Redeker has warned that these spiking bond yields could cause risk assets to come under significant selling pressure.
As if this were not enough to threaten financial markets, oil is also continuing its recent declines. Significant losses on Monday took the West Texas Intermediate futures down to under $45 per barrel with Brent crude holding below $47.50. Reuters blamed the latest oil price drop on more American oil drilling activity. It all bears watching as this could be the beginning of a significant stock market pullback just in time to influence U.S. Presidential elections.
Federal Reserve Speaker Watch
Despite the fact that interest rate fears are taking some of the blame for the powerful selloff in stocks and bonds, the fed funds futures are still not fully pricing in a rate hike until December. This week, all eyes will be watching the last Federal Reserve Board Governor speech for final clues before the pre-meeting blackout timeframe begins in advance of the September meeting. Fed Governor Lael Brainard and her speech represent the final chance for the Fed to adjust market expectations before the big meeting, as analysts at Credit Agricole Bank pointed out in a research note. Analysts think Brainard's comments may now echo those of Rosengren that helped to upset markets on Friday.
Bank of England Monetary Easing Still on the Table
Despite what the Federal Reserve may do to tighten monetary policy in the U.S., in Britain monetary easing is still a real possibility. Last week Mark Carney the Bank of England Governor kept the options for additional monetary policy loosening on the table. This week the Bank of England will meet to decide measures on Thursday. At present they are not anticipated to come out with new policy measures beyond the program for purchasing assets they restarted just last month. Still investors and analysts will watch and listen closely for any hints at additional upcoming action in the next few months.
Italian Constitutional Referendum and Banking Problems Looming
Another geopolitical event quietly simmering in the background is the upcoming referendum in Italy on constitutional reform. It has recently taken on the overtones of the Brexit referendum of the United Kingdom. Italians are increasingly viewing it as a chance to express their overall dissatisfaction with the economy and the establishment government policies. Italian Prime Minister Renzi had pledged he would leave his post and politics in general if he did not win the referendum on constitutional reform of the gridlocked Italian government system. The problem is that the consequences of him stepping down are far reaching, and not just for Italy. If the referendum fails and Renzi is out, a new national election would quite possibly see the anti-Euro, Eurosceptic Five Star Movement party take over the country's government at a critical time.
What makes now so critical for Italy and Europe are the ongoing banking problems of Banca Monte Paschi, Italy's third largest lender. The European wide stress tests showed this to be the weakest financial institution in the continent in July. The Italian government is desperately trying to avoid a government bailout that could lead to catastrophic or even total losses for thousands of Italians account holders. Their alternative is to try to get investors to pour in another €5 billion into the gaping hole that this bank has become. At stake is the stability of the entire Italian banking system and potential contagion spreading to other troubled banks throughout the European Union.
Markets hate uncertainty, and that is what this late November Italian referendum represents. Should Renzi lose the vote, a caretaker prime minister would head the country's government until another national election is called. The President of Italy might feel no choice but to call for the elections right away, bringing in the fourth Italian Prime Minister in only a few years. The populist Five Star Movement, which leads the polls in Italy, has called for a Euro referendum in Italy the third largest economy on the continent. The European Union can not afford another major country to bail on the project after Great Britain. Now more than ever is the time to hold onto your gold retirement holdings.