Sunday, December 20, 2015

End of Year Drama in Financial Markets: The Global Macro Picture in a Few Charts

In the face of global economic weakness, the central banks of Europe and Japan have engaged in vigorous programs of monetary easing, while the U.S. central bank has cut back its program of quantitative easing.  That has been bullish for the U.S. dollar, as the chart of UUP depicts:

A number of emerging economies have currencies tied to the U.S. dollar, so that the dollar rise has created tighter financial conditions for them, even as those global economic conditions have weakened.  That has not been bullish for the relative performance of emerging market stocks, as the chart of EEM vs. SPY depicts:

With that global economic weakness and the tightening of economic conditions, commodity demand from China and related emerging economies has declined precipitously, as the chart of DBC depicts:

With the decline most notably in oil prices, fears of default among energy companies issuing high yield bonds have led to a sharp decline in the prices of high yield bond funds, as the chart of HYG depicts:

This past week, the Federal Reserve announced an interest rate hike and a path of future rate hikes.

Since that time, the U.S. dollar has risen; commodity prices have fallen; stocks have fallen; and high yield bond prices have fallen.  In short, the dynamics driving global macro markets have intensified and that is creating year-end drama in financial markets.  It also carries important implications for 2016, as emerging markets are going to need a large depreciation in their currencies to kickstart financial conditions.