Investors have become unhinged. The increased volatility and dramatic market moves challenge even the most robust investment strategies. This sets off a chain reaction of money and risk management that further amplifies the price action, like an echo chamber. Then a cottage industry of reporters, analysts and bloggers offer explanations often without distinguishing the initial sound from the echo.
At the same time, that which we have come to think of as terra firma has turned into quicksand. Interest rates are bounded by zero. Of course, there had been a few exceptions, like when Germany and Switzerland in the 1970s discouraged speculative foreign inflows, but it was not a generalized phenomenon. Now it is widespread. German and Japanese yields are negative out eight to nine years while Switzerland has negative rates through 15 years. All told more than $8 trillion of debt has a negative yield.
Negative yields in Europe and Japan complement the expansion the central banks’ balance sheets. Such extremely accommodative monetary policy is associated with depreciating currencies. Yet, the yen has surged, and the euro has rallied against the greenback, despite the dollar being backed by higher interest rates.
In 2008, when oil prices were near $150 a barrel, and peak oil was the rage, the concern was that it was a major headwind on growth. Oil prices have plunged since mid-2014. They have fallen below $30 a barrel, but now this has been associated with weaker economic activity. Capital expenditures have slumped. Industrial output has fallen. Even Japan, which imports nearly all of its energy (slowly a few nuclear plants have re-opened) has not benefited.
In fact, Japan Q4 15 GDP will be released in the week ahead, and it will likely confirm that the economy is still struggling to find any positive traction. The world’s third-largest economy contracted in Q2 15 while the contraction that was initially reported for Q3 was revised away. However, weakness in consumption and residential investment likely more than offset the stronger foreign demand, pointing to a contraction of around 0.2% in Q4.
Nearly a year after the Federal Reserve wound down its asset purchase program, it raised interest rates. However, the world’s largest economy nearly stagnated in Q4 15, and neither the decline in oil and gasoline prices nor still low interest rates and a very accommodative Federal Reserve have deterred recession talk.
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