The fed is now unwinding the biggest monetary experiment in history, which saw $3.6 trillion of asset purchases from the Fed between 2008 and 2015. This is unknown territory, so when we sat down with Charlie Jamieson, CIO at Jamieson Coote Bonds we took the chance to get his perspective.
He identifies major problems manifesting in the US housing market as well as global markets as this unwinding commences, explaining that: “unless you can continuously keep throwing money onto the fire, the fire finally burns out. And that starts to happen in the United States in 2019”. Watch (or read the transcript) for the full story, which includes a clear warning for all equity investors.
“The major issue around quantitative tightening for the U.S. economy is that as that's rolling off, it has a major effect on mortgage interest rates, so a lot of the securities that are rolling off are mortgage-based securities and so once we've got a higher interest rate, risk-free interest rate, we're also getting widening in that mortgage spread. That means for Joe and Jenny Average in Nebraska, they're being asked to pull a lot more money out of their pocket to fund their mortgage obligations.
Now, we are seeing a slowdown in housing in the United States. If we look at the home-builder’s index in terms of equities, that is out and out in bear market territory, new home sales are down over 20%, prices are slipping. All of these types of lead indicators are showing that there's a tightening and we can combine that with we know that the fiscal drag starts to run off, plus we've had a very strong dollar environment, and you can see that financial conditions are really starting to tighten. I guess the other ones that we look for is that volatility in the equity markets and wider credit spreads as we touched on.
So all in all, 2019 looks to be a very, very interesting year where in many respects, as we often said, the dominoes are lined up, the sequencing of how they'll fall is very interesting and the timing around it but I'm pretty sure that they will fall at some point as the year progresses and things get harder.
That is a bit of a bearish outlook for the United States, but when we go on these rate hiking cycles, you've got to remember that at the start of the cycle we're hiking because things are going so well, and we need to come away from accommodative, but towards the end, we are finalising on the inflation mandate and going into restrictive territory. Now anybody that drives a car knows when you jump on the brakes, things slow down quite quickly, and the Federal Reserve are jumping on the brakes as we head into 2019.
It was only a year ago we were talking about global synchronised growth, and that lasted for all of three months, and all of a sudden, emerging markets are in turmoil via a strong dollar. There is something like $26 trillion worth of international U.S. dollar-based loans, and so clearly as the dollar gets stronger that gets more expensive to fund out of a domestic currency. Some of it, of course, is swapped, but a lot of it isn't, and we've seen the problems with emerging markets over 2018. That's unlikely to turn around quickly, the ground that they have been standing on for so long has disappeared, being that of very low interest rates, cheap borrowing and excess liquidity.
Quantitative tightening has taken away that excess liquidity; the cheap interest rates are gone and they are getting more expensive. And the thing that we've got now is we've got viable alternatives. Those short-dated bonds in the United States are now very, very, attractive as a risk-free asset holding and so we're not seeing the same levels of financial tourism as we were under the oppressive quantitative easing methodologies where people were forced to find income and yield. Income and yield is now available in treasury bills or short-dated bonds, and so there are alternatives where there haven't been for more than ten years.
We try not to comment too much on equities, we're not an equities expert. A lot of equity guys like commenting on bonds, but we don't return the favour often. But clearly, as those risk-free alternatives become more attractive there becomes a sponsorship problem, and people look at the market volatility that they've experienced and think "how much more upside is there in this cycle?" I think it's fairly clear to see that this cycle will come to an end at some stage in the near future, how quickly and how asymmetrically that plays out is the source of great debate, and what those real triggers will ultimately be.
But as the Federal Reserve continues to tighten and tighten and tighten and we can't keep spending fiscally like we have been, the Democrats simply won't allow it, we need to keep feeding this monster. When you getting yourself into this fiscal deficit situation, unless you can continuously keep throwing money onto the fire, the fire finally burns out. And that starts to happen in the United States in 2019 without some extraordinary spending package of infrastructure or the like.
And it seems unlikely the Democrats would be in agreeance to that as it would certainly help Trump into his 2020 re-election programme and that's the last thing they want to do. They want to lock him up, and they literally want to lock him up, and they will try very hard to do so I'm sure"!
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Americans have Fixed Rate mortgages, Charlie!