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The status of the dollar as a world reserve currency and the large US government bond market guarantee the status of the Federal Reserve as the dominant central bank. Its policy decisions and directions are of paramount importance, especially for emerging market economies that have a lot of dollar-denominated debt to repay.
Some return to the Fed's monetary policy this week as a double capitulation on both financial markets and President Donald Trump's ceaseless demands to stop raising interest rates.
These criticisms do not take into account the burning question: a decade after the financial crisis, the global economy is slowing much faster than expected, and the level of debt has exploded, especially in developing countries and the world. 'business. Many investors still hope that economic activity will be spurred by Beijing this year, but the fact that China is suffering a credit crunch and is trying to prevent a trade war with Washington.
In this context, it is hardly surprising that in just over a month, the Fed stopped reporting new rate hikes last week, pointing out that patience was now its motto. ;order.
The Fed's commitment to a patient approach to interest rates and the willingness expressed this week to consider curbing the slowdown in balance sheet cuts means that the central bank remains on the sidelines. gap. Moderate inflationary pressure is helping to provide coverage, although, as this week's employment report reminded everyone, the US labor market remains healthy.
Instead of seeing the Fed pause as a collapse in the recent turmoil in the markets, investors should focus on what has prompted decision makers to turn things around so quickly. In addition to weak economic conditions in China, the euro zone and Japan, the Fed is facing a US economy that is showing signs of weakness at the end of the cycle, particularly in the housing sector. At the same time, corporate earnings growth forecasts for the first half of this year have been drastically reduced to less than 10%.
Given the gigantic magnitude of corporate borrowing in recent years, the ability of businesses to increase their revenues has been a critical cushion. It's a cushion that is deflating now. The sharp drop in corporate bond prices during the December rout seems to have left a mark on the Fed, as it should be. US stocks may have had their best month of January since 1987, but preferred investors seeking credit purchases have widened significantly in the last 12 months and remain close to the 2016 level, according to the Moody's index. It's BAA.
The Fed's actions this week are a confirmation of market concerns during the turbulent fourth quarter of last year. Listening to markets and detecting the warning signs of problems before they hurt the economy in general is exactly what central banks should do. Many justified criticisms explain that the Fed does not appreciate the magnitude of the mortgage and credit bubble that some have seen build before 2007. My question to a Fed official in May this year was related the sharp rise in reverse repo financing via banks that left them very dependent on short-term financing was rejected at the time as a poor way to badess the leverage effect within the system financial.
The price of badets is important for modern economies operating through large loans. Since former US central bank chairman Alan Greenspan launched the now-famous "Fed Put" with rate cuts after the black Monday of 1987, policymakers are always ready to step in and support the markets . This happened in 1998, then in 2001 and after 2008 with the new Quantitative Easing Ammunition.
The creation of a margin of maneuver for the world markets generally pbades by a weaker dollar. And judging by the bullish reaction of emerging markets, the Fed helped China this week. While the renminbi reached its highest level in six months on Thursday, China could ease interest rates without releasing a much weaker currency, which would only complicate Beijing's recovery efforts.
It is clear that Fed officials are worried about the turmoil in the markets that is infecting the entire economy. They are also concerned about clouds in the form of trade frictions, the financial crisis in China, the high level of corporate leverage, weak earnings growth in the United States and Brexit. The next few weeks should provide more clarity on trade, as well as on the health of the US and global economies. In this context, Treasury bonds and other major sovereign bond markets will be important barometers to watch.
The US bond market does more than tell us that the Fed has just paused; this suggests that the central bank is at the very beginning of a pivot to the next cycle of easing. This week, yields on the two- and five-year notes fell below 2.50%, which is the upper range of the current overnight federal funds rate.
Declining yields on developed country bond markets will support risky badets and, along with the weaker dollar, the currency seems to be chasing high-yielding emerging currencies as carry trade returns to a new start.
What should make investors think is a further decline in prime bond yields and inflation expectations, which would suggest that the Fed misjudged the cycle and has already tightened its policy too much. As we saw in the second half of 2000 and 2007, US Treasury yields send a message that deserves to be listened to.
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