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Economy

Out-of-equilibrium economy will keep the Fed 'hostage' to stock market, strategist argues – MarketWatch

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It’s the time of year to look back over the last 12 months, but one strategist reached back to the 19th century to describe what’s going on.

In 1898, Swedish economist Knut Wicksell said equilibrium was only attained if the marginal return on capital is the same as the cost of money, notes Kit Juckes, the London-based head of currency strategy for French bank Société Générale. (Here’s a nice summary of Wicksell’s views, from the St. Louis Federal Reserve.)

Fast-forward a bit, and Juckes points out that the yield on the U.S. 10-year Treasury has averaged 6.2% over the last 50 years. During that time period, nominal gross domestic product growth (real GDP growth plus inflation), also has averaged 6.2%.

That is, of course, a far cry from present conditions, where the 10-year yield can’t break 1%, and the economy has been contracting over the last 12 months. And even over the last decade, 10-year yields have been trailing GDP growth.

Juckes nearly summarizes what has happened. “Central banks spent the 1980s getting inflation under control, but the 1990s saw the emergence of downward pressure on CPI [consumer price index] inflation in particular, from a number of sources: baby boomers entered the labor force, the Soviet Union’s collapse massively boosted Europe’s labor force, China’s entry into the world economy changed supply of a host of goods, technology had a similar effect and for good measure, labor unions became far less powerful,” he writes.

After the 2008-09 financial crisis and during the COVID-19 pandemic, “interest rates are glued to the floor.” But even as inflation is under control, Juckes says it is obvious economies aren’t in equilibrium, as low interest rates have sent “asset prices into orbit. And while that is lovely for those who own assets, it increases inequality, fuels political division between asset-rich and asset-poor, and leaves the Fed hostage to equity markets because they can’t afford to trigger a correction in indices that would send the U.S. economy back into recession. That gives markets far too much power over policy,” he says.

The next rate hike cycle will peak even lower than the last one — the effective Fed funds rate was 2.4% in 2019 — “because equity valuations will make it so.” Juckes says this disequilibrium will leave the global economy fragile and prone to another crisis.

The buzz

Pharmaceutical company AstraZeneca
AZN,
+1.05%

on Wednesday said the coronavirus vaccine it has developed with the University of Oxford has been approved by the U.K. government. The U.S., meanwhile, said the U.K. strain that spreads more quickly has been identified in Colorado. Hospitalizations reached a daily record of 124,686 on Tuesday, according to the COVID-19 tracking project, as California extended its lockdown.

Congressman-elect Luke Letlow, a Louisiana Republican, has died at age 41 from coronavirus.

The fate of both the $2,000-per-person stimulus check, as well as the defense bill previously vetoed by President Donald Trump, is still in question in the U.S. Senate. Analysts expect the upper chamber to kill the additional stimulus-check legislation approved in the House, but the proposal has won support from a handful of Republicans even as Majority Leader Mitch McConnell has blocked a vote.

With polls extremely close on the key Senate races in Georgia, President-elect Joe Biden and Vice President-elect Kamala Harris will separately travel to the Peach State to campaign for the two seats, the Biden press office said. Democrats would take control of the Senate if they win both elections.

The U.K. Parliament is expected to easily clear the trade agreement reached with the European Union.

The markets

After the S&P 500
SPX,
-0.22%

and Nasdaq Composite
COMP,
-0.38%

fell all the way to the second-highest level in history, U.S. stock futures
ES00,
+0.35%

NQ00,
+0.39%

were again pointing upward.

The U.S. dollar
DXY,
-0.29%

fell. The yield on the 10-year Treasury
TMUBMUSD10Y,
0.950%

was 0.95%. Bitcoin
BTCUSD,
+2.99%

rose as high as $28,752, a fresh record, according to CoinDesk data.

The tweet

iframe.twitter-tweet
width: 100% !important;

There was a lot of discussion on social media about this CNBC interview with Interactive Brokers
IBKR,
-1.20%

chairman Thomas Peterffy, where he said for the first time in its history, its customers were net short out-of-the-money stock options. “It’s usually about Tesla
TSLA,
+0.35%

and Amazon
AMZN,
+1.16%

and Apple
AAPL,
-1.33%

— that’s where most of the action seems to be. So the Robinhood folks are long these options and Interactive customers are short these options,” said Peterffy. Robinhood is the brokerage that many young investors trade on.

Random reads

A Greek nurse erected his own intensive care unit after not liking the treatment options available when his wife, her parents and her brother got COVID-19.

Archives reveal a comedian’s prank call to test out an impersonation may have saved the government of former U.K. Prime Minister John Major.

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Economy

Bank of Canada seeing signs of cooling in hot housing market

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The Bank of Canada is starting to see signs that the country’s red hot housing market is cooling down, although a return to a normality will take time, Governor Tiff Macklem said on Wednesday.

The sector surged in late 2020 and early 2021, with home prices escalating sharply amid investor activity and fear of missing out. The national average selling price fell 1.1% in May from April but was still up 38.4% from May 2020.

“You are starting to see some early signs of some slowing in the housing market. We are expecting supply to improve and demand to slow down, so we are expecting the housing market to come into better balance,” Macklem said.

“But we do think it is going to take some time and it is something that we are watching closely,” he told the Canadian Senate’s banking committee.

Macklem reiterated that the central bank saw evidence people were buying houses with a view to selling them for a profit and said recent price jumps were not sustainable.

“Interest rates are unusually low, which means eventually there’s more scope for them to go up,” he said.

Last year, the central bank slashed its key interest rate to a record-low 0.25% and Macklem reiterated it would stay there at least until economic slack had been fully absorbed, which should be some time in the second half of 2022.

“The economic recovery is making good progress … (but) a complete recovery will still take some time. The third wave of the virus has been a setback,” he said.

The bank has seen some choppiness in growth in the second quarter of 2021 following a sharp economic recovery from the COVID-19 pandemic at the start of the year, he added.

(Reporting by David Ljunggren and Julie Gordon; Editing by Peter Cooney and Richard Pullin)

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Economy

Toronto Stock Exchange opens flat as investors eye Fed comments

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Toronto Stock Exchange index treaded water on Wednesday, tracking the Wall Street, as investors awaited comments from the U.S. Federal Reserve on when it would ease its monetary stimulus.

* At 9:31 a.m. ET (1331 GMT), the Toronto Stock Exchange’s S&P/TSX composite index was up 10.92 points, or 0.05%, at 20,242.24.

 

(Reporting by Amal S in Bengaluru; Editing by Amy Caren Daniel)

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Economy

Canadian dollar steadies as inflation climbs

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Canadian dollar

The Canadian dollar was little changed against its U.S. counterpart on Wednesday as domestic data showed consumer prices rising at the fastest pace in a decade, with the currency steadying after falling on Tuesday to a near seven-week low.

Canada‘s annual inflation rate accelerated to 3.6% in May from 3.4% in April, driven by surging shelter and passenger vehicles prices, Statistics Canada said. That was slightly ahead of analyst expectations and the highest since May 2011.

The Bank of Canada has said it expects inflation to ease later in the year as the statistical comparison to tanking prices last year diminishes and slack in the economy exerts downward pressure.

With U.S. inflation also on the rise, investors were looking to the Federal Reserve policy statement at 1400 EDT (1800 GMT) for signs of a response. Currency market activity was generally quiet ahead of the announcement.

The Canadian dollar was trading nearly unchanged at 1.2184 to the greenback, or 82.07 U.S. cents, after trading in a range of 1.2170 to 1.2189.

On Tuesday, the currency touched its weakest intraday level since May 6 at 1.2204. It has pulled back from a six-year high earlier this month at 1.2007.

Oil, one of Canada‘s major exports, notched its highest level since October 2018 at $72.83 a barrel before pulling back to $72.10, supported by a recovery in demand from the coronavirus pandemic and a drop in U.S. crude inventories.

Canadian government bond yields were little changed across the curve, with the 10-year flat at 1.383%. On Monday, it touched a 3-month low at 1.365%.

 

(Reporting by Fergal Smith; Editing by Andrea Ricci)

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