Stocks rise marginally and yields fall after data disappointments. The S&P rises 0.1% to 2,122 and the Dow rises marginally to 18,272. Data today showed that industrial production fell 0.3% last month, whereas no change was expected. Consumer confidence also fell unexpectedly to a seven month low. As a result of this data, the ten year bond yield falls 10 bp to 2.14% after reaching 2.37% on Tuesday. This large fall in yields is due to expectations that the Fed will hold rates down for longer as a result of disappointing economic data. The dollar index continues its slide with a 0.2% drop for the fourth straight day, extending its slide to 7% from its peak in March. The euro appreciates to $1.145. Gold prices are pushed higher as a result of the dollar’s slide, as the metal has increased 3.1% on the week.
Since the financial crisis in 2008, central banks all around the world have used monetary easing policies to support their economies. Monetary easing has been used extensively in the form of cuts to interest rates, as well as asset purchase programs or quantitative easing. Policies around the world are about to diverge, with the United States and England set to tighten while the rest of the world continues to ease. Both the Fed and the Bank of England are set to raise interest rates this year. On the contrary the ECB and the Bank of Japan are both supporting their economies with asset purchases, and China is also cutting interest rates. Premature tightening in the U.S. could have negative implications all around the world, as a negative shock to the U.S. economy would be bad for exporters all around the world. In addition regardless of the timing, emerging markets face outflows, volatility, and illiquidity. Some economists and policy makers have suggested cooperation among central bankers in order to minimize shocks to the global economy. However this is not legal, as central banks have domestic mandates and international ramifications are not to be considered.
A popular carry trade in recent months has been to borrow in euros (a currecy that was previously expected to depreciate going forward) and buy high yielding bonds in foreign countries such as emerging markets. The euros unexpected appreciation has hurt the carry trade, as the strategy has lost around 3.5% since March. In the carry trade, if the currency in the country in which money is being borrowed appreciates against the currency of the destination country, then the profits of the carry trade are reduced. In addition to the euro’s appreciation, some emerging market currencies, such as the South African rand and the Turkish lira which are popular destinations for the carry trade, have been underperforming.
Emerging market countries have begun to invest in other parts of the world as growth is showing signs of slowing in some developing countries, particularly in Asia. Foreign direct investment out of developing countries totaled $484B last year, up 30% from the previous year. Of this total, almost all of it comes from Asian countries. This trend is a reversal from previous years, when these countries were a target for FDI as opposed to a source. Slowing growth domestically has forced companies to look abroad for investment opportunities. This is a sign that investor confidence is increasing. Most of the FDI outflows were reinvested earnings from cash reserves in foreign subsidiaries.