Stocks rise as monetary policy continues to be the theme of the week. The S&P500 gained 0.9% to 2,013 and the Dow Jones rises to 17,050. The VIX continues it’s downward momentum to 17.64. The Fed minutes show that the FOMC still expected to raise rates before year end 2015 in spite of holding off in September. Reflecting these expectations the two year yield rose 1 basis point to 0.64% while the ten year rose 5 basis points to 2.11%. However the minutes show that global factors weighed in on the decision. In particular the FOMC is focused on how a rate rise will affect the global economy and in turn how that potential downturn will affect the domestic US economic growth. In Europe the Bank of England expressed cautious tones when deciding to keep interest rates at the low level of 0.5% citing Chinese concerns. Similar to the situation that is going on with the Fed, the BoE will wait until the CPI shows signs of rising inflation. Similarly the ECB also appears uneasy about the inflation outlook and the global economic landscape.
The Fed minutes highlight inflationary concerns and the affects of the global economy on US growth. The FOMC expects the global economy to have minimal affect on the US however members want to wait for extra evidence to reinforce this view given the uncertainty. These are the minutes leading up to the September 16 and 17th meetings. Since that meeting markets have priced down the chances of the Fed taking action at the end of the year. Affect of global economic turmoil is still not yet recognized and as a result the FOMC will wait for further data to confirm their view. Yellen has expressed in the past that shortfalls in inflation are due to temporary factors such as low oil and low import prices. It remains to be seen how temporary these factors are considering that oil prices and import prices are both driven lower by the stronger dollar which is set to rise with interest rates.
Corporations have been blaming the strength of the US dollar on earnings shortfalls. Companies who have used this justification include SAB Miler, Pepsi, and Yum Brands. Pepsi in particular says that 11% will be taken off of full year EPS as a result of dollar strength. Some analysts are not buying this rationale considering that the dollar index is still below it’s March/ April level and has been relatively firm with the euro and the yen. The affects of currency appreciation will largely be felt by corporations with high emerging markets exposure. HSBC notes that 1/3 of revenues are earned overseas but of that portion only 7% are earned in emerging markets. There has historically been no long term relationship between the S&P500 and the US dollar. Some sectors such as telecom and utilities are almost exclusively domestic. Others such as tech and energy earn as much as half of their revenues abroad.
European high yield bonds have outperformed the US counterparts. Although prices have fallen interest payments have exceeded capital losses. The US market has sold off more heavily in the last three months. Looking deeper into the discrepancy, the difference is that virtually no energy companies have issued debt in the European markets. On the other hand nearly 20% of the US high yield market is made up of energy companies which have been dragging down performance. Divergent monetary policy is also an important factor. With interest rates set to rise in the US bonds have been selling off. With quantitative easing going on in Europe this puts upward pressure on bond prices. The European market is smaller but has been growing since 2008.