(MENAFN- Khaleej Times) The Federal Reserve has a dual constitutional mandate. Maximize employment consistent with a two per cent inflation rate. Eight years after the failure of Lehman Brothers forced the US central bank to slash the overnight borrowing rate to zero and expand its balance sheet from $900 billion to almost $4.5 trillion via money printing, the Fed has reached the limit of its dual mandate. Money market futures contend a 80 per cent probability of a rate hike by December.
The US economy created 299,000 jobs in June, 255,000 in July and 151,000 in August. The unemployment rate is now 4.9 per cent while wage growth is above 2.6 per cent. This is good enough for a Fed rate hikes at the December FOMC, which is after the election and thus allows the central bank to preserve its "political independence". Last December, Janet Yellen raised rates for the first time since 2007 and warned the world to expect four rate hikes in 2016. Then China's financial markets went ballistic in January and Europe's bank stocks lost 30-50 per cent due to fears above systemic risk in Italy, Brazil/Russia recession and Brexit. When Chicken Little did not see the sky fall in 2016, the Yellen Fed began to talk tough on rate hike. China, Brexit and Italian banking have stabilized for now but global risks will continue to concern the Federal Reserve. There is still deflation risk in Europe and Japan while Chinese growth has fallen to 25 year lows. A rate hike in December is now Wall Street's consensus scenario. The stock market rallies in the US and Europe since January mini-crash triggered by China were due to central bank money printing and a fall in interest rates, not earnings growth. Now $12 trillion in global securities, one third of world sovereign debt, trades at negative yields while the S & P500 index trades at 17.8 times forward earnings, up from 11X in 2011. Interest rates will now rise and hyper rate sensitive global markets trading at stratospheric valuations will pay the price. The financial markets no longer believe that there will be no rise in interest rates in 2016. This is the reason gold fell to two month lows at $1315 an ounce. Bank shares have begun to surge since late July, the reason an activist hedge fund (and this columnist!) accumulated Morgan Stanley, up 30% from its recent low. HSBC Holdings has surged 20 per cent in London and Hong Kong in the past six weeks as its $400 billion Treasury excess deposits makes the shares soar when the US Treasury debt yield curve steepens. Even Japanese bond yields, the Empire of the Rising Sun and Helicopter Money, have just risen 25 basis points on no news. I am also worried about the rise in three month London Interbank Offered Rate (LIBOR), the rate at which global banks lend to each other, a barometer of global bank risk. The rise in LIBOR does not just reflect regulations over US money market funds, but a rise in systemic risk in global banking. A higher LIBOR means higher cost of bank funding and a potential shock to the leveraged global economy. Foreign central bank reserves at the Federal Reserve Bank of New York have begun to fall. As I learnt in 2008, this means a shortage of US dollars in the world currency markets.US inflation, dampened by the 60 per cent fall in crude oil since June 2014, will only rise in the next 12 months. This means the world could be on the eve of a major US dollar uptrend - King Dollar on steroids. It also means the yield on the ten year US Treasury note can rise from its current 1.56 per cent to as high as 2.50 per cent by next spring. This will be a financial neutron bomb on global risk assets, mainly property and bond proxy equities. This will mean a bloodbath for Private Bankerji's leveraged bond clients. This columns caught the 100 per cent rally in the Gold Miners index fund (GDX). Now is the time to book profits and short the miners and yes, even spot gold, to my $1270 target. The big money will be made shorting the long end of the bond market and buying the world's most interest rate sensitive banks - Bank of America, Daiichi, HSBC. Short? Utilities and telecom. My credo from a lifetime in global markets? Risk is a four letter word. So is ruin! - Share
More > Vote