Global equities traded up last week, with investors breathing a sigh of relief after important meetings of Bank of Japan and US Federal Reserve rate-setters. The market took in stride the BOJ’s policy shift and the Fed’s signal that tighter policy is likely later this year. Mixed economic data resulted in 10-year US treasury note yields falling from 1.69% to 1.62% week to week. Mid- and small-cap indices outpaced the large-cap S&P 500, in a reversal of trend which has favored larger companies thus far in 2016.
Projections for the global economy continue to underwhelm, providing a more sober outlook than a purely US-centric forecast. The weak global economy will persist into 2017, warns the Organization for Economic Co-Operation and Development (“OECD”), predicting that global gross domestic product will rise an anemic 2.9% this year and 3.2% next year. Brexit impacts offset gradual improvement in emerging market commodity-producing economies, and weak global trade is the main drag on growth.
The Federal Open Market Committee, the Federal Reserve’s rate-setting body, said the case for a hike in the federal funds rate is strengthening, the clearest indication to date that it hopes to hike rates by the end of 2016. A November hike is unlikely given that there is not a scheduled press conference associated with that meeting. Also, the November meeting is scheduled to take place just days before the presidential election, another deterrent to a policy change. While signaling that a rate hike is likely in the months ahead, Fed officials lowered their economic growth forecast and trimmed the number of rate hikes they foresee in 2017 from three to two. The lower rate forecast seemed to win the day for investors worried about the imminent rate hike in December.
Meanwhile, in Japan, the Bank of Japan shifted gears yet again. After a comprehensive review of its monetary policy, the central bank altered its policy mix. Previously, the BOJ had focused on expanding the money supply to spur economic growth and inflation. After not having had much success on either front, the bank this week adopted an interest rate target. Going forward, it will seek to keep the 10-year Japanese government bond yield at around zero. This may allow the long end of the Japanese yield curve to steepen, a development that would be welcomed by Japanese insurance companies and pension plans, which have struggled in a low-yield environment.
In response to ultra-low interest rate policies that incentivize “cheap debt,” global bond issuance is nearing a pre-2007 financial crisis record. A total of $4.88 trillion of debt has been sold globally year-to-date, nearly matching the $4.91 trillion sold in the same period of 2007. Issuance is running 9% ahead of the pace set in 2006, when a record $6.6 trillion in new debt was issued (These figures do not include sovereign bonds sold at auction, or municipal bonds). Super-low borrowing rates are spurring companies to lock in cheap financing, and in some cases issue debt in order to buy-back shares or pay dividends. Beware of certain forms of financial engineering, and beware the law of unintended consequences.
By way of China, and asking for reader forbearance, we include one more potentially troubling debt note. Excessive Chinese credit growth risks a banking crisis in the next three years, according to a report from the Bank for International Settlements. China’s debt-to-GDP ratio is expanding rapidly, standing at 255% at the end of 2015, up from 220% two years earlier. Recent bank lending figures showed a doubling of new loans in August compared with the prior month, citing a surge in mortgage demand.
On that happy note, on to tonight’s debate. Or perhaps the Monday night New Orleans-Atlanta tilt. Pick your poison.