Oct 7, 2016

Brexit Timeline causes Havoc. IMF Warns of Unstainable Global Debt Levels


The month of September has many potential market moving events: US, Japan and EU central banks meeting. US presidential debates, OPEC oil production reduction meeting and worries about the financial state of Deutche Bank. Turns out, most of these events did not cause too much impact on the financial markets, despite having some volatility at some point in time.

However, the actions from central banks are creating confusion within the market rather than bringing more certainty.

The hawkish comments from many US Federal Reserve officials despite not rising interest rates have investors questioning if the Fed is politically motivated by the upcoming presidential elections. Meanwhile, Japan's central bank, contrary to expectations that they will perform even more QE, it decided selectively purchase bonds to adjust the bond yield, creating the impression that they have actually ran out of ammunition. Rumors that the European central bank may start tapering soon, in view of the ineffectiveness of the QE program contributes to the impression that the time of easy money may be over soon.

To add to the worries, IMF issued a warning about the possible consequences of a record global debt  since the 2008 global financial crisis. The low interest rate environment has also led to a record expansion in debt in emerging markets in which it can disrupt the growth engines of these markets. A sudden record surge in property prices in major cities in China along with a record corporate debt level had the IMF officers worried that China's reluctance to let its inefficient state owned enterprise carry on their business, may lead to a huge disruption in the Chinese economy should the Chinese government mismanage the economy.




Lastly, the setting of a definite timeline by the UK prime minister has the world worried about the possible consequences of Brexit all over again. The UK pound fell to its record low level and is currently seeing huge swings in its value against major currencies.

In my opinion, the world is balancing on a tight rope, with the easy money keeping the balancing act in place. However, the recent reluctance by central bankers to either cut interest rates to even deeper negative regions or to increase the QE program has indicated that the central banks have run out of options to keep the economy going via monetary policies. In the world of investing, expectation is the key that keep asset prices going up, but once the expectation changes, market shocks tend to occur.
  
At this moment in time, bond prices and equity prices are at record highs, a phenomena that is almost never seen as bond prices and equity prices tend to move in opposite direction. This situation can only be explained by the impact of the QE and things may get ugly once investors come to realization that the central banks are helpless to do anything.

The only value I see in the market is the commodity market, thanks to the corrections made in the past 2 years. Other than that, I am generally reluctant to invest in long term bonds or equities given that the risk is great while the return is slim.

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