This week stocks fell dramatically, oil prices tumbled, and the U.S. dollar continued to slide, as investors took risk out of their portfolios. Money poured into safe-haven U.S. Treasuries, where the 10-year Treasury yield fell by a whopping 40+ basis points intra-day on Wednesday, dipping below 2% at one point.
Concerns about the weak global economy, escalating geopolitical risks in Asia, the Middle East and Eastern Europe, and the Ebola scare, have all made investors feel that the world is falling apart. While this spike in volatility seems to be an annual October event, this year’s price actions also stem from fresh fears about the wildly divergent economic performance around the globe.
Until recently, the financial markets felt that the U.S. is the one leading the global economy out of recession and eventually leading core inflation higher so that the Fed could start raising interest rates by the middle of next year. Stocks were pricing in these expectations, together with Federal Funds Futures and the bond market. However, this week’s global numbers defied this hope and raised concern that it was the other way around; with weaker countries weighing down the U.S. economy. The U.S. Producer Price Index fell to 1.6%, below the desired 2% target. The U.K.’s inflation rate is down to 1.2%. Germany downwardly revised its economic forecast, and the market eagerly waited for the European Central Bank to announce some form of quantitative easing (QE) to combat the evident deflation. Japan was originally scheduled to stop its QE by the end of this year, but pressure is mounting for it to continue in 2015. Now some say that China has contracted deflation with its recent 1.8% drop in factory-gate prices.
On top of all this, crude oil prices continued to plummet this week, reaching two-year lows. It’s bad timing and, unfortunately, a problem that was man-made. Key OPEC members have decided to continue to flood the market will the same amount of oil supply – despite lower demand – just to maintain their market share. (In the past they would decrease supply to maintain the price.) And there is a sense that we have still not seen the floor for crude oil, which has further added to deflation fears.
My View: : The tug of war between inflation and deflation continues, and volatility will continue to remain high, fueling fears. But let’s remain calm. Sure, Europe’s economy is down, as is Japan’s and other parts of Asia. But I don’t think the U.S. will be dragged down along with them. Extended Fed tightening and low oil prices will actually support the U.S. economy going forward.
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