Why All The Volatility?

August 31, 2015

August is ending and with it a month of volatility in all financial markets.  Some thoughts on this follow from the founder and president of RateLink,  a mortgage rate newsletter to which I subscribe:

“Trade in all asset classes (stocks, bonds, commodities and currencies) remains volatile with large intra-day moves.  The global financial markets are intertwined.  What happens in China no longer stays in China.  Just like the US, what the Federal Reserve does affects every country in the world.  When lightning speed computers are added to the mix, the volatility increases exponentially.  Investors hate uncertainty.  Global traders are uncertain when it comes to future Fed policy and the economy in China. Trade will remain volatile until they get more confidence in both of these areas.

The Federal Reserve:  The Fed has been jawboning a rate hike all year long.  This is called “forward guidance” and is used to make sure the market is not shocked when the Fed actually raises rates.  A Fed rate hike in the near future is almost a given.  However, even the Fed is uncertain of the timing and the trajectory.  The Fed has two mandates, full employment and stable prices.

Hiring has been strong and by many measures the mandate has been fulfilled.  The Fed would like to see wages rise, the middle class has not seen wages rise above inflation since the 90’s.

Price stability is another issue.  Inflation has been stubbornly low.  Europe is battling deflation.  While it sounds like falling prices would be a bonus for consumers, it actually causes them to delay purchasing goods and services opting to wait and see if they can get a better deal later.  This causes an economy to contract (lower GDP) and can create a “death spiral” for economic output.   One irony the Fed faces is the US dollar.  Global commodities are priced in dollars.  When the Fed raises rates the dollar will strengthen and commodities will get cheaper, creating a downward push on inflation.  In addition, a strong dollar makes US goods more expensive overseas, which can cause the economy to slow.  These are just a few examples of how complicated global economics can be.

China:  They have been a major driver in the global economy for the past two decades.  As they grew, the demand for commodities grew which supported many emerging economies.  Wages in China have risen to the point that many companies are looking to Vietnam and other places to produce goods.  China needs to transition from a smokestack economy to one driven by consumer consumption and financial services.  The events in China will cause global volatility for a long time.”

 

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