All week markets were waiting for the star event: a small increase in the
Fed Funds Rate, which didn't materialise.
It is actually an important development, because the Fed had been
preparing markets for a September rate rise for some months, and then just
backed off.
It's looking very difficult, perhaps impossible, for the Fed to escape the
zero bound. The macroeconomic view, that money at close-to-free interest
rates would kick-start the economy, has turned out to be incorrect. Since
December 2008, the Fed Funds Rate has been held at the 0-0.25% range: unless
one believes the Fed will try negative rates, there is nowhere left to go.
That is the message from yesterday's pass. In the FOMC statement greater
concern was noted, that "recent global economic and financial
developments may restrain economic activity..." and the FOMC "...is
monitoring developments abroad." This is indeed the problem.
Huge dollar-denominated losses are developing in China and
commodity-related businesses in the emerging markets, due to the sharp
slow-down in Chinese economic activity. Furthermore these losses are now
triggering further problems for corporations in emerging markets that relied
on refinancing maturing loans and facilities. It was for this reason that a
rise in rates would have been wholly inappropriate; a point often missed by
most commentators, but clearly indicated in the FOMC extracts above.
This being the case, to contain a worsening offshore dollar problem, the
Fed will have to extend its currency swap lines to key central banks in the
emerging markets, or face a deepening global slump. Swaps are another way to
inflate the currency, which at some stage should be reflected in precious
metals prices. If, for political reasons, swap lines with the Peoples Bank of
China are ruled out, another means of getting dollar liquidity into China
will have to be found; otherwise she will have no option but to continue
selling US Treasuries to raise USD liquidity.
In the markets gold and silver prices rallied this week from last Friday's
lows. Gold is up $38 on balance at $1137 mid-morning in London and silver up
96c at $15.25.
The increase in prices over the last seven days suggests that precious
metals markets were correctly beginning to discount the Fed's interest rate
policy. The speculative money is still short, though the position is not as
extreme as it has been in recent weeks.
An enduring mystery is how gold prices could remain at these low levels
while physical demand continued to exceed supply, to the extent that
backwardations between cash and future delivery dates persisted for prolonged
periods. If gold was as freely available as futures and forwards suggest,
this should not have happened. It appears therefore that gold and silver have
been mispriced in physical markets, a situation that can only be corrected by
a diminution of physical demand relative to supply through higher prices.
Suppressed physical prices are accelerating Chinese demand, and last week
this rose to 73.63 tonnes, the highest weekly delivery this year so far.
Next week
Monday.
US: Existing Home Sales.
Tuesday.
UK: Public sector Borrowing, CBI Industrial Trends. US: FHFA House Price
Index.
Wednesday.
Eurozone: Flash Composite PMI, Flash Manufacturing PMI. US: Flash
Manufacturing PMI.
Thursday.
Japan: All Industry Activity Index. UK: BBA Mortgage Approvals. US:
Durable Goods Orders, Initial Claims.
Friday.
Eurozone: M3 Money Supply. US: Core PCE Price Index, GDP (2nd Est.).
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