The easy market for investors supported by the Fed’s quantitative easing is already over, and now the question is merely when, not if, the asset bubble bursts in several markets. The assets in a bubble are stocks, bonds and the dollar.
The Fed has ended its QE programme and is now in a process of raising interest rates. Will the US stock market be okay? It can never be okay as the central bank has injected trillions of money and is now going to retrieve it, but the market is manifesting groundless optimism.
The greatest premise investors believe in is the strong US economy and thus the strong dollar. However, the time is near for the uptrend of the dollar to be fading out. Why, how, and when? We will explain it in this article.
Strong America, until when?
The US economy is the only large economy in the world that is growing at a decent pace. The euro zone is still struggling to recover from the debt crisis. Japan once had a decent growth due to the QE but ruined it with the ill-timed consumption tax hike.
China, which claims to be growing by 7% annually, is actually not growing at all. Except its fictional GDP, the relatively reliable indexes show a negative growth.
Consequently, the global economy and the optimism of the financial markets immensely depend on the US economy. Then, what would happen if this premise turned out to be false? Unfortunately, the most recent GDP data shows a symptom.
Deflation will be exported to the US
Can the US support the rest of the global economy alone? Will the rest of the world grow as the US does, or will the US grow as the rest of the world does? The answer is obvious: the low growths of the other countries will be gradually exported to the US via trades, not vice versa.
Moreover, rate hikes will even strengthen the dollar and worsen the situation. The Fed is nevertheless willing to raise rates. Why? We explained in the following article.
Then, what will happen if the Fed continues to raise rates? The dollar decides everything.
Where will the dollar go?
Investors have been appreciating the dollar as one of the very few currencies they can hold. They could not buy the euro or the yen due to the QE. They could not buy commodity currencies as commodities utterly crashed.
- The commodity market crash leads to worldwide deflation: gold, crude oil, natural gas, copper and iron ore
The dollar as well as the pound was one of the very few choices. However, if the Fed raises interest rates, the uptrend of the dollar might eventually be reversed.
Once or twice of a rate hike would not affect the economy too much, but if it becomes 0.75% or 1%, interest rates will start to affect it through loan rates and mortgage rates. The strong dollar will also hinder exports. The more rates are raised, the more likely the uptrend of the dollar would be reversed.
At some point, the Fed will have to admit it cannot raise rate any more and will be then forced to cut rates to support exporters and the property market. This is the timing for everything in the markets to be reversed.
The revenge of commodities
The biggest consequence would be a rebound of commodities. Money, which has stayed long in the dollar and the pound, will suddenly flow into gold. The bear market of gold will finally end, and gold will be a bubble.
It is not only gold that will rebound. Oils and natural gas will be also appreciated. Rising commodity prices will fuel inflation, so that the ECB and the BoJ (Bank of Japan) will lose a reason for the ongoing quantitative easing.
What will happen if central banks are unable to ease when economies suffer from increasing commodity prices? When central banks become unable to move freely, it will be the end of the QE bubble, which has lasted for a long time.
Investors must remember the cause of Black Monday in 1987 was central banks failing to be in unison. A similar occasion is going to take place.
The US economy will slow down. The dollar, stocks and bonds will go up and go down. Gold and other commodities will rebound.
The question is when we observe the US economy slowing down, and when the Fed changes its mind and start cutting rates. The economic growth might appear below 2% in the first quarter of 2016 at the earliest, but it would not be enough to call it a slowdown. Cheap oils might also support consumption and postpone the timing.
However, in the third or forth quarter of 2016, we will be sure of the trend, and then the Fed would finally admit it in later 2016 or early 2017.
We presume the Fed’s rate hikes will be at most 4 times, up to 1%. With this assumption, in 2016 we sell the dollar to gradually buy gold, estimating when the stock market crashes. We will analyze each market individually in the upcoming articles.