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Pimco links Fed, China, commodity deflation & market concerns
Noting that scientist Ivan Pavlov trained dogs to salivate in anticipation of receiving a tasty reward, Pavlov’s experiments translate into the current market environment, a recent Pimco strategy note observed. Investors have become trained to react negatively simply at the anticipation of a Fed rate hike, and the Fed is accomplishing a task that hasn't been successfully executed in the postwar era, they note.
Pimco: Fed is eliciting typical Pavlovian response, causing markets to shudder at the thought of a rate hike
“In 2015, market volatility has been rooted in a phantom rate hike from the Federal Reserve, which throughout the year has been ringing a bell to warn markets that it is on the verge of raising interest rates for the first time since 2006,” Pimco’s market strategist Tony Crescenzi wrote in a note to investors. “Though it hasn’t happened, the Fed has elicited a typical Pavlovian response, causing markets to shudder at the thought and prompting a very significant chain of events that has rippled throughout global financial markets.”
Crescenzi says that the Fed’s much anticipated rate hike isn’t the cause of market volatility, but notes that it has been a catalyst. Crescenzi says the most significant fallout from “the Fed’s phantom rate hike” can be seen in China, connecting two of the primary performance drivers of negative stock market performance. China’s unexpected move to weaken its currency and improve its export sector in August spurred substantial market volatility highlighted by a plunge in global equities prices.
Pimco links Fed rate hike, China and commodity deflation
Linking nervous investors to concerns regarding the August 10 Chinese currency devaluation and a potential September Fed rate hike, Cresenzi says the strengthening U.S. dollar caused China’s currency, the yuan, to move higher on an inflation-adjusted basis, doing so at a time when its economy was weakening. “This is the opposite of what tends to happen and it is an undesirable outcome for a central bank seeking to stimulate economic growth by cutting interest rates…” he wrote.
Cresenzi noted the strengthening U.S. dollar along with “the anxious anticipation of a Fed rate hike by investors throughout the world sparked a cascade of events,” which are all inextricably linked. The Fed, China and the last leg of the troika of market concerns is the decline in commodity prices, which tend to fall when the dollar strengthens.
“That markets have moved so significantly on the prospect of a Fed rate hike exposes the fragility of the global financial system, which remains mired in a lengthy era of deleveraging,” he wrote. “It demonstrates the difficulty that central banks face in escaping crisis-era policies, including zero percent policy rates.”
Former Fed Chair Bernanke reminds Pimco that coming off zero has never been accomplished successfully in the post-war era
It is the zero interest rate trap that Cresenzi notes former Fed Chair