By Everett Millman, head content writer at Gainesville Coins, a leading gold and silver distributor.
ABSTRACT: A rising dollar had the greatest effect on the markets this week, driving most commodity prices lower. This was especially true for the precious metals, which all neared (or in the case of silver, surpassed) yearly lows. The emergence of a massive international coalition against the terror group ISIL seemed to abate negative investor sentiment regarding the conflict, although the yen, the dollar, and U.S. Treasury notes did see some safe haven demand.
GOVERNMENT & POLICY
Two Fed Presidents Share Telling Comments
As the stock market continues to march on boldly in the face of growing asset bubbles, increased scrutiny is being placed on any and all discourse originating from the Federal Reserve. Focus has been especially trained on the looming question, When will the Fed raise rates?
With this in mind, two influential bankers—both presidents of their respective branches of the Federal Reserve—made statements this week that implied a diametrical difference of opinion on how soon the Fed ought to raise interest rates.
On Monday, New York Fed President William Dudley posited that the continued appreciation of the dollar can have adverse consequences on the recovery of the American economy. Growth, and particularly the Fed’s target of 2% inflation, may be hindered by a strong dollar. It would exacerbate the U.S. trade deficit by encouraging imports and stifling exports: American consumers would have greater purchasing power for foreign goods, while U.S. exports would be more expensive for other countries.
The Dallas Fed President Richard Fisher subsequently commented on Thursday that he expects the markets (read: investors) to “test” the Fed and European Central Bank’s accommodative monetary policies. More specifically, he referred to the increasingly high risk appetite shown in the equities and securities markets.
“We’re beginning to see extreme risk taking in the junk bond markets,” Fisher said, alluding to the creation of high-risk, high-yield asset bubbles. This comes after the Fed’s “forward guidance” warned banks against such practices back in 2013, saying that banks may be required to hold greater capital behind their loans or be forced to deleverage. This did not, however, slow the volume of high-risk deals nor improve the credit standards of those deals.
According to a report released by Barclays Plc on September 12, bank leverage on new deals has continued to rise to 4.95x EBIDTA (earnings before interest, depreciation, taxes, and amortization). The Fed has gone on record that leveraging 6x EBIDTA “raises concerns,” and many financial institutions are nearing this threshold.
Fisher’s comments seem to call for an imminent hike in interest rates in order to correct for oversold and overleveraged markets, whereas Dudley errs on the side of waiting longer to raise rates in order to keep the dollar from becoming too strong. If we take these opposing views as outworkings of the Federal Reserve’s internal debate about monetary policy, one must wonder if the Fed has any clearer picture of when it will raise interest rates than the market speculators.
Changes Looming for Chinese Policy?
There were rumors this week that China may be considering replacing the governor of its central bank, Zhou Xiaochuan, who has served in the position since 2002. The head of the People’s Bank of China has been largely successful in growing the Chinese economy, but indications are that President Xi Jinping would like to insert one of his loyal supporters into the position. The greatest concern for the PBOC going forward may be the issue of liberalizing deposit rates for banks, an issue that has been put on the back burner for the moment. Although it remains undetermined, the removal of Zhou from his post at the central bank may signal an impending overhaul of China’s economic policy.
A stronger dollar has been placing downward pressure on commodities prices, including oil and precious metals. The DXY index marched ever-higher to 14-month highs, closing above 85 for the first time since 2010. This marks 10 consecutive weeks of gains for the greenback as growth (and confidence) in the American economy has been picking up slightly. Favorable housing data and manufacturing numbers released this week in the U.S. and China helped improve growth projections for the world’s two largest economies.
Risk appetite still appears overly high in the stock markets, even as all the major U.S. indices receded by week’s end. The markets responded well to the meeting of the UN General Assembly on Wednesday, perhaps spurred by the global consensus on combating the terrorist group ISIL. Yet, all gains were given back on Thursday as the Nasdaq, S&P 500, and Dow Jones all fell more than 1.5%. By Friday’s open, all of these indices remained well in the red: the Dow was below 17,000, the Nasdaq was below 4,500, and the S&P was below 2,000. The yen and 10-year Treasury note both saw some safe haven demand throughout the week, although gold ostensibly did not.
Gold retested its lower boundary of $1,215 throughout the week, bouncing up above $1,220 each time before settling back near $1,217. Despite robust demand for physical silver bullion with prices depressed, the white metal continued to drop to 4-year lows, falling some 30 cents (-1.69%) from Tuesday’s open to Thursday’s close of $17.52. This would seem to imply that the physical market for precious metals has far less influence on prices than the paper markets, among other factors, although we may simply be seeing some profit-taking as investors closed out or rolled over their positions on Thursday, when options on gold and silver on the Comex expired. Both platinum and palladium continued to slide to yearly lows, as well.
In global markets, the Nikkei 225 hit a 7-year high on Prime Minister Abe’s reaffirmation that the Bank of Japan will proceed with its highly accommodative monetary policies. Both the yen and Japanese stocks rose on the news. Meanwhile, the rest of the Asian markets slumped, partly due to the lack of further stimulus or monetary easing by the Chinese. As China presumably turns toward austerity, Japan and the EU are employing extreme quantitative easing, resulting in boosts for their respective stock exchanges–at least temporarily.
GEOPOLITICS & WORLD EVENTS
ISIL in International Community’s Crosshairs
After the U.S. conducted airstrikes against the Islamic State in Iraq, they were joined by the West’s Arab partners in the attacks. The monarchies of Saudi Arabia, Qatar, Bahrain, and the United Arab Emirates all launched their own strikes on the terrorist group, who poses an equal threat to the Middle Eastern establishment and the balance of power in the region. Concerned about growing regional instability, France also authorized airstrikes against ISL, while the U.K. has signaled it may consider deploying aerial attacks as well.
A meeting of the United Nations General Assembly on Wednesday showed that the developed world is firmly against the Islamist extremists in Syria and Iraq, as well as similar groups such as Boko Haram (meaning “Western education is forbidden”) in Nigeria. At least 104 sovereign nations voiced their support for President Obama’s international initiative against ISIL, a consensus rarely seen in the chambers of the UN. The Heads of State of many different nations attended and spoke at the summit, including delegates from the Russian Federation and the People’s Republic of China. In order to combat the recruitment of ISIL fighters, who it has been observed are motivated far more by disaffection with the world order than by religion, the General Assembly resolved to take steps in addition to military force; the president implored the body that “words must be matched and translated into . . . concrete action.” While the gesture was well-received, we must wait to see how long the resolve of the broad international coalition holds against an enemy who will not be so easily defeated by sanctions or rhetoric.
Russia Quietly Struggling With Sanctions
Despite widespread public support for Russian President Vladimir Putin within his own country, the Russian economy has been battered of late. Though the Russian’s position as an energy supplier and a key geopolitical partner with both sides of Eurasia gives them unique leverage, their unpopular territorial conquests and staunch resistance to Western influence have ravaged the country’s finances. The ruble was trading at a record low earlier in the week, and consumer inflation sat at a lofty 7.6% in spite of multiple increases in benchmark interest rates by Russian banks. In addition, the amount of cash available for the government to operate has been dwindling, as the central bank canceled nine straight auctions of government bonds.
Yet, this week’s de-escalation by both sides in the Ukrainian conflict brought a minor reprieve from Russia’s woes. The Russian central bank was finally successful in selling 10 billion rubles worth of bonds on Thursday. (For perspective, 10 billion rubles = about $259 million.) The currency was further strengthened by the central bank’s addition of 232,510 troy ounces (over 7 tonnes) of gold to its reserves during the month of August. Like China, Russia has been steadily increasing its gold reserves over the last 5 years in an attempt to marginalize the dollar’s hegemony as the world reserve currency. The Russians were joined by their regional partners Turkey, Kazakhstan, and Azerbaijan in significantly increasing its holdings of gold, perhaps for the purposes of hedging against the unrest and uncertainty in the nearby geopolitical hotbeds of the Levant and the Black Sea.
A LOOK AHEAD: Pending Home Sales data is scheduled to come out on Monday morning, bringing greater clarity to the positive housing numbers released this week. The PMI Manufacturing Index and the ISM Manufacturing Composite Index will both be released for July on Wednesday, the 1st of October.