It Seems the Only Financial Instrument Gaining Value is Interest Rates

On a day which has resulted in increased volatility and lower pricing in U.S. equities, it appears that the only financial instrument gaining value is interest rates. At the same time, we have seen the dollar come under massive pressure over the last three trading days, resulting in an almost 2% decline in value. Add to the mix that precious metal markets are under pressure, resulting in lower pricing for gold, silver, platinum, and palladium.

While on the surface it is not typical for U.S. equities, the U.S. dollar, and safe haven assets to simultaneously move to lower pricing, this occurrence has been evident during equity market meltdowns. The rationale behind such a move is that there is a mass liquidation of all asset classes to cover or account for the decreasing values of equities.

However, on this occasion, one of the major underlying factors is that the central banks in both the United States and Europe are becoming less accommodating as they wind down their respective quantitative easing programs. The massive infusion of capital and dramatic reduction of interest rates that characterized quantitative easing programs have concluded, as the European Central Bank and the Federal Reserve normalize their actions and policies.

After almost ten years of consciously keeping interest rates at a minimum and flooding the financial markets with capital, these measures have in fact taken global economies out of the deep economic recession that began in 2008. Now both the ECB and the Federal Reserve are making a concerted effort to reverse that trend as they become less accommodative.

This month’s FOMC meeting made it crystal clear that not only will the Federal Reserve continue to ratchet up interest rates slowly, but they will also begin a process of normalization through the liquidation of much of their assets that compose their 4.5 trillion-dollar balance sheet.

As reported by CNBC, “Earlier this week, European Central Bank President Mario Draghi said: "The threat of deflation is gone and reflationary forces are at play," sending European yields higher and dragging their U.S. counterparts with them. The ECB tried to walk back those comments later in the week, but the sell-off in the U.S. and European bond markets did not abate.”

According to Jim Wyckoff of Kitco News, “An important feature in the marketplace this week has been rising world government bond yields. Earlier this week central bank officials, many of whom were speaking at a conference in Portugal, sounded a more hawkish tone on their monetary policies. It appears the central bankers of the world are now embracing the U.S. Federal Reserve’s notion that the time has come to start raising interest rates and winding down the extraordinary quantitative easing programs that have been in place for nearly ten years.”

This new global trend has shaken the financial markets as market participants attempt to gauge the net effect of the ECB and the Federal Reserve’s unwinding of a 10-year program.

One thing that is certain is that both the Federal Reserve as well as the ECB will unwind the policies created during quantitative easing in a timeline that is substantially shorter than the timeline they used to initiate their respective monetary stimulus programs.

Wishing you as always, good trading,