Financial Review


…Fed minutes point to more tightening. Tax cuts lead to big deficits and moves to cut Social Security and Medicare. Small stocks suffer. BofE leery of leveraged loans. Why Saudis won’t weaponize oil prices. Legalization Day in Canada.

Financial Review by Sinclair Noe for 10-17-2018
DOW – 91 = 25,706
SPX – 0.71 = 2809
NAS – 2 = 7642
RUT – 7 = 1589
10 Y + .02 = 3.18%
OIL – 1.88 = 70.04
GOLD – 2.60 = 1222.90


Minutes of the Sept. 25-26 Federal Open Market Committee session were released today. Federal Reserve policymakers remain convinced that continuing to gradually increase interest rates is the best formula to preserve a steady economy. A summary of the Sept. 25-26 Federal Open Market Committee session reflected both confidence in the rate of economic growth and some hesitancy over the impact that tariffs might have on the future path. Ultimately, the committee unanimously voted to approve a quarter-point hike to its benchmark rate target, with members indicating that more increases are on the way. The increase took the Fed’s overnight target to a range of 2 percent to 2.25 percent.


Policymakers discussed what the future path would be, with members saying that there might be a period where the Fed even will need to go beyond normalization of rates and into a more restrictive stance. That would be to control inflation from overshooting the Fed’s target and to address “the risk posed by significant financial imbalances.” According to the minutes, officials said “there is considerable uncertainty surrounding all estimates of the neutral federal funds rate.”


The Fed’s determination to continue raising rates comes in the face of increasingly heated levels of disparagement from Trump. While most presidents have veered away from public comments about monetary policy, Trump has been vocal in his disdain for what the Fed is doing. He has called FOMC members “loco,” openly criticized Fed Chairman Jerome Powell, and asserted that higher rates are the single biggest threat to the economic recovery. At the meeting, Fed officials voted to lift their benchmark federal-funds rate to a range between 2% and 2.25%. Officials agreed that, beyond September, “further gradual increases in the target range for the federal funds rate” would be needed. That’s a sign that another rate hike in December is likely.


There’s an old saying that when the Federal Reserve tightens policy, something breaks. That’s because rising interest rates expose borrowers who have taken on more debt than they can handle. In past tightening cycles, the Fed has sometimes gone too far, raising rates too much or too quickly, and ended up hastening an economic recession. So, here is what you need to watch carefully as the Fed continues to tighten policy. First, watch for a flattening or inverted yield curve. Over time, as the Fed raises short-term rates, borrowing becomes more expensive and investors begin to expect slower economic growth in the future. That usually causes longer-term yields to decline. At some point, short- and long-term yields converge, and the yield curve – which normally curves upward – becomes flat, or even inverted (meaning short-term rates are higher than long-term rates). An inverted curve almost always means recession.


As the Fed tightens monetary policy, making borrowing more expensive and slowing economic growth, investors’ expectations for future inflation usually soften. This can also be a sign that bond yields have peaked. Compare the yield of a Treasury Inflation-Protected Security (TIPS) with the yield of a comparable-maturity traditional (that is, non-inflation-protected) Treasury security. TIPS generally offer lower yields than Treasuries, because their coupon payments rise as inflation rises, while the principal value of a traditional Treasury is fixed. The difference between the two yields is called the breakeven rate, and is a key measure of what investors expect in terms of future inflation. Another late-cycle phenomenon is tightening credit conditions—that is, loans become harder to get and more expensive. To date, there are few signs of tightening credit conditions.


According to a RealClearPolitics survey, 39 percent of Americans approve of the 2017 Tax Cuts and Jobs Act and 42.5 percent disapprove of it. An internal poll commissioned by the Republican National Committee and obtained by Bloomberg last month said that, by a two-to-one margin, Americans see the tax bill as benefiting large corporations and rich Americans over the middle class. Most voters aren’t noticing a personal benefit to their finances, either. A recent Gallup poll found that 64 percent of Americans said they hadn’t seen an increase in their take-home pay, and 51 percent said the cuts hadn’t helped them financially. The Center on Budget and Policy Priorities estimates that while most Americans will benefit at least somewhat, the top fifth of earners get 70 percent of the bill’s benefits, and the top 1 percent get 34 percent. The new tax treatment for “pass-through” entities — companies organized as sole proprietorships, partnerships, LLCs, or S corporations — will mean an estimated $17 billion in tax savings for millionaires in 2018. American corporations are showering their shareholders with stock buybacks this year thanks in part to their tax savings.


The Treasury Department said this week that the federal budget deficit had increased to $779 billion in fiscal year 2018, a 17 percent increase from the prior year, in large part because of the tax cuts Republicans had claimed would pay for themselves. So, how will we pay for the record deficits?Trump told  each of his Cabinet secretaries to cut 5 percent of their respective budgets. This proposal was thin on details and will likely be thin on implementation. And then, just like clockwork, Senate Majority Leader Mitch McConnell is now saying Congress should target Social Security and Medicare cuts in an attempt to address the debt.


Earlier this year, small stocks were a big trade. The bet was that smaller American businesses had less to lose in the global trade fight than big multinationals, and more to gain from tax cuts. With this backdrop, small stocks surged ahead of the giants that make up the Standard & Poor’s 500-stock index, beating them for much of the year. That’s over now. Instead of being insulated, small companies are actually more likely than larger ones to be impacted by investors’ big new worry:  rising interest rates. After peaking in August, the benchmark for so-called small caps, the Russell 2,000-stock index, is down more than 8 percent.


The Bank of England is sounding the alarm on a quiet corner of the debt market now worth $1.4 trillion The Bank of England raised the alarm about the growth of so-called leveraged loans in the UK, saying that the sector’s rapid growth should be a cause for concern for policymakers and market participants going forward. In the bank’s record of the October meeting of its Financial Policy Committee— the body tasked with ensuring financial stability in the UK — the BoE mentioned leveraged lending almost 20 times, variously calling it “concerning” and likening it to what happened in the USA with sub prime mortgages in the run up to the financial crisis. At their most basic level, leveraged loans are loans extended to people and companies with either pre-existing high levels of debt, or a poor credit rating. These loans, therefore tend to have higher interest rates meaning that rewards for lenders are higher, while the risk of default is also higher due to the nature of the customers. Leveraged lending to corporates has ballooned in recent years, with the global market reaching a value of around $1.4 trillion, according to recent estimates. In the UK alone, £68 billion ($90 billion) of these loans have been issued in the last two years, the Bank of England said on Thursday. This represents around 20% of total UK corporate debt, when also including high yield bonds.


U.S. crude stockpiles rose 6.5 million barrels, almost triple what analysts had forecast; that helped push WTI crude down to almost $70 a barrel. Oil had been rising this week on worries about Iranian sanctions and tensions between the United States and Saudi Arabia after the death of Saudi journalist Jamal Khashoggi. The Saudis are by far the largest oil exporter in the world and if they restrained supply they would drive up oil prices and cause severe economic damage in the U.S. and around the world. But the use of oil as a weapon would hurt the Saudis in the near and longer term far more than would hurt the U.S. or anyone else. They’ve spent 45 years earning a well-deserved reputation as a reliable supplier. If they went ahead there would be an immediate release of the strategic oil reserve, new areas opened up for drilling and a concerted policy push and it would undermine the Saudis’ reputation as a supplier. Saudi Aramco also runs the largest refinery in the U.S.



Today, Canada becomes the first industrialized nation to legalize the recreational use of marijuana. Two decades after medical marijuana was legalized, Prime Minister Justin Trudeau makes good on one of his more progressive campaign promises: to legalize recreational use with the hopes of reducing related crime and underage usage. Canada is the only country other than Uruguay that allows recreational use nationwide. It is a new industry with the potential for big growth, and Canada has now positioned itself to be the largest global marketplace for cannabis and cannabis-related products. Several cannabis companies have already started to go public with IPOs, providing investors with new opportunities. Major retailers such as Walmart Canada and several beverage companies are seeking ways to integrate these new offerings into their own product lines. Separately, Public Safety Minister Ralph Goodale said the government would waive the fee and waiting period when people who have been convicted of possession of up to 30 grams of marijuana apply for pardons, after they’ve served their sentences. The legislation will be introduced by the end of the year. So, how will Canadians celebrate Legalization Day? Well, for most Canadians who choose to light up, they will be lighting illegal marijuana. The have been few licenses granted for legal stores in Canada’s biggest cities, and even if pot stores do have licenses, they are finding it difficult to stock the weed.



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