Stanford Brown TW3 – Fed Frets Over Debt

Market Wrap

Global Markets had another rollercoaster ride this week, ending in the black after comments from US Federal Reserve Chairman Jerome Powell that interest rates were just below the neutral rate (more on that below).

The week kicked off on a downbeat tone after tough talk on trade from Trump. In an interview with the Wall Street Journal, Trump indicated that he was likely to raise tariff rates on $200b USD of Chinese goods, remarking “I happen to be a tariff person because I’m a smart person, OK?”. Investors are hoping that Trump’s meeting with Chinese Premier Xi Jinping at this weekend’s G20 summit in Buenos Aires will result in a truce in the trade war.

One sentence from a speech given by Fed chief Jerome Powell sent global markets soaring during the week. Here it is: “Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy”. Investors perceived Powell’s comment that rates were “just below” neutral as an indication that fewer rate hikes are on the horizon than previously expected. The S&P 500 jumped more than 2% in response to the news, wiping out all of November’s losses.

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Source: The Wall Street Journal

Finance 101 – Monetary Policy

To understand what the neutral interest rate is, we need to revisit the basics of monetary policy. Most countries have a central bank (ours is called the Reserve Bank of Australia), which uses interest rates and other mechanisms to determine how much money is in the financial system. Monetary policy relates to the positions of a central bank, and has a range of implications for investors.

Monetary policy can be stimulatory (accelerates economic growth), contractionary (decelerates economic growth) or neutral (neither stimulates nor contracts economic growth). When a central bank lowers interest rates, borrowing money becomes cheaper and spending tends to increase. When a central bank raises interest rates, spending tends to decrease as borrowers have to pay more interest on their debt. In theory, a central bank can smooth out the economic cycle by providing stimulus during downturns and pulling in the reins when the economy is booming.

Unfortunately, economic theories usually don’t pan out in the real world. Many argue that central banks have made the economic cycle worse. For example, the boom in the American residential property market in the early 2000’s, which sowed the seeds for the Global Financial Crisis, was in large part thanks to the Americas’ central bank (the Federal Reserve) keeping interest rates too low in response to the bursting of the dot-com bubble and 9/11. Likewise, the enormous surge in Australian property prices is mostly thanks to the Reserve Bank of Australia keeping interest rates at historic lows, and we will see whether the current decline in prices will cause a recession.

For investors in shares and bonds, generally speaking lower interest rates are good for short term performance while higher interest rates are bad for short term performance. We’ll save the story of how interest rates affect long term returns for another day!

Fed Frets Over Debt

Investors celebrating Powell’s comments this week appear to have no concerns that the Fed’s caution is indicative of heightened risk in financial markets. The Federal Reserve released its first Financial Stability Report shortly after Powell’s speech, highlighting the rapid growth of corporate debt as a potential source of vulnerability for the American financial system.

Interest rates in America have been historically low since the Global Financial Crisis, making it cheap for borrowers to take on large debts. On the other hand, low interest rates have forced savers, pension funds and other conservative investors to invest in riskier debt (i.e. debt issued by less creditworthy borrowers) in order to earn a decent return. The result is that corporate bond spreads (i.e. the extra return investors require for taking extra risk) are near historic lows, leaving investors in corporate debt highly exposed to any financial downturn.

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Despite its concerns regarding corporate debt, the Fed was generally positive regarding the strength of the broader financial system. Household debt has risen in line with income growth, whilst banks do not have the funding issues that were major causes of the global financial crisis from 2007-2009.

How To Avoid Overspending During Christmas

A number of bargains were to be had during last week’s Black Friday sales (despite Australia not celebrating Thanksgiving). Counterintuitively, times of large sales are when we are most likely to overspend, with marketers exploiting well-known biases to dupe us into making purchases.

Retailers use short periods of heavy sales to trick consumers into making impulse purchases rather than taking time to make an informed decision. When the sales only last for a brief period, shoppers get a fear of missing out: “If I don’t buy it now, I’ll feel like an idiot for buying it full price” “If I don’t buy it now, it will run out of stock” “If I don’t buy it now, I’ll miss out on free shipping”, etc.

Many consumers justify a purchase purely because they think they’re getting a bargain. If you don’t know what the standard price for a product is, you can be tricked into making a purchase thinking you’ve found a bargain. For example, our young editor came across a website last week offering a range of online courses at (supposedly) heavily discounted prices. Vietnamese 101 and Data Science at a 94% discount? Sign me up! Unsurprisingly, one week later the prices haven’t changed, with Nic now proposing to write next week’s TW3 in Vietnamese or Python to justify his purchase.

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So how can we counter these sales tricks? Here are some tips from Professor Jane Brown of Northumbria University:

  1. Make a list of what you’re going to buy and stick to it
  2. Make a budget of how much you will spend
  3. Set up a separate savings account for your impulse purchases
  4. Research your products carefully (some shoppers can find great deals purely by using price comparison sites)

Cryptocurrency Collapse

On the subject of discounts, fans of cryptocurrencies can now buy their favourite coins at bargain prices!

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Best Photos of 2018

Whether you like Elephants, Eskimos or Elvis, National Geographic’s top 100 photos of 2018 has something for everyone!

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I guess our submission for photo of the year must have gotten lost in the mail!

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Who Am I?

A bottle of red wine is en route to Megan, who spotted a young Michael Hutchence last week! Last Thursday marked the 21st anniversary of his untimely passing. They will never tear us apart!

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But who is this young man?

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Pic of the Week

Don’t you hate that one friend who always flaunts their exotic holidays? Here’s NASA’s InSight Mars lander with its first selfie from the red planet. It took seven months for the lander to get to Mars, and was delayed even further after failing to declare to customs that it had fresh fruit in its carry-on luggage.

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Video of the Week

Why people have trust issues!

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Have a great weekend!

Jonathan Hoyle, CEO & Nicholas Stotz, Investment Analyst

Stanford Brown

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