Economic Slowdown is Coming; Caution is the Word

While FED continue to raise rates, bond yields are determined to go higher, but the same leads to the possibility of a slower economy. With the combination of higher Govt debt, economic slowdown expected. In this challenging time, it is advised to be cautious.

“When America sneezes, the World catches a cold”, does it really happen or has it just become a phrase now? Well, the old saying seems existing in the business, as the bond yields are rising to lead investors to vanish from emerging markets. Whether it is Equity or the currency in the emerging markets, it is not making any difference as they are bound to see the bottom. The 10-year bond yields are very near to its 52 weeks high of 3.13%, expecting the FED to come up with another rate hike this month, and overall two hikes till the year-end.

The Majority of experts are expecting rates to rise to a range of 2.25-2.5% from current 1.75-2%, which will certainly take the bond yields beyond the current levels. The FED is raising rates on the USA’s stronger economy and the world is yelling for help. Jerome Powell, chairman of the Fed Reserve is very confident in the economy and the inflation which makes him comfortable in taking rates on highs even after the notorious tweets of their president Donald Trump. The FED has hiked its rates by seven times to 1.75-2% range since 2015 and the committee is determined to do it further more aggressively.

The rising bond yields are triggering chaos in the world economies as investments are drying and currencies are plunging in the emerging markets, but the rising bond yields are changing history or it may be that the history is very old to be changed, as whenever bond yield rises, Equity markets plummet and vice versa but this rally in yields are taking equities along with it and helping the USA’s Equity Market to reach the new highs. The USA is enjoying its tax rate cuts and strong earnings, which took their equity market to scorching green levels.

In the currency market, the rising bond yields are making Dollar stronger in comparison to the emerging market currencies.

The US Bond yields have risen 40% in a year and the emerging market currencies are struggling against the dollar, Turkish Lira, Brazilian Real and Indian Rupee have been hit really hard.

Bond yields are led by FED rates and FED has indicated that it keeps on raising rates at the time to come, so what really makes the FED hike the rates and what would the impact of such hike? Let’s have a look:

  1. A stronger Economy – FED is betting on a stronger US economy, as rates were dropped to support the US economy to help overcome it from the great recession and slowdown, now when the economy is growing with the faster pace FED is taking its support back from hiking rates.
  2. But raising rates too quickly could sniff out the economic recovery, which has finally begun to gain after years of sluggish growth. Russ Koesterich CIS at BlackRock has also said that “What has been scary about the last couple of weeks is that rates have been rising without a clear improvement in the economy”

The Rising bond yields are making the leveraging expensive and it does have an impact on the economy too, which can be seen as the growth is down in last 4 QTRs except in the June QTR.

Higher inflation – Increasing inflation in the states is further tempting the Fed to hike rates. The inflation has remained high throughout the year up till August, where it has witnessed some ease. The year 2018 had begun with an inflation of1%, which is quite near to the FED target of 2%. Going forward, the FED looks very optimistic for a stronger economy, which is making it confident of taking borrowing cost higher for cars, homes, mortgages and personal loans. Doing this will also eventually take the inflation down to the target level, therefore the Fed believes this is the best time to do it.

  1. Lower Unemployment Rate – US President’s “America first policies” are helping US unemployment data to come down to help FED to hike rates. The FED is forecasting the unemployment rate at 3.6% by year’s end, down from the forecast of 3.8% in March this year, indicating the stronger performance of the economy.
  2. The bond yields have just reached at its 5 years high at 3.13% on the expectation that the FED will hike rates more aggressively than before as FED said: “The economy is strong, the labour market is strong, growth is strong and the economy is rising at a solid rate”. But the dark side of the coin exists too, as the higher bond yields are making investors cautious on the economy to not in the position to sustain the growth and to maintain at the same level. Higher yields could even slow down the economic growth potentially frustrating Mr Trump. Urjit Patel, the Governor of the RBI has warned of a currency war led by the increasing FED rate and increasing debt level of US treasuries to pay for the tax rate cuts.

USA’s total debt has already reached an alarming level of $21.5 trillion, which is 1.8% of the total GDP which is the highest level since 1947. The highest ever debt and the higher yields are the same combinations as what has happened at the time of the 2008 financial crisis. High debts on the giant economies are growing faster as Governments are spending more, cutting their tax rates and pushing it to the ballooning fiscal deficits which are questioning the depleting wealth of the world economy.

In the time to come when FED continue to raise rates, bond yields are determined to reach higher, but the same leads to the possibility of a slower economy and with the combination of higher Govt debt, there are dark clouds hovering all around the world for the economic slowdown. In this challenging time, it is advised to be cautious. 

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