The tragic events in Paris on Friday have not only raised the global risk levels of further terrorist actions, but will also produce behavioral changes geopolitically and locally. This will affect markets beginning now.
We are already seeing the pulling together of a more coordinated global action against ISIS by the western world. Europe, of course, may bear the brunt of change and would appear to be the most vulnerable to the impact of the increased risk levels on the broad economy, country politics, and societal reaction within the diverse elements of the population. Kim Wallace of RenMac made the observation this past weekend that 3% of the 7.3 billion people in the world are emigrating from developing countries to more developed environs. With the turmoil in the Middle East in particular, but also other closer areas, Europe, with a more open door policy—at least until now—is bearing the brunt of the disruptive emigration on its economies, its existing population and the social issues surrounding the clash of cultures.
In the meantime:
- Russia is holding back from supporting what is likely to be a western world coordinated effort around ISIS, and will likely be a continued troublemaker relative to its own perceived interests.
- The IMF staff is recommending the inclusion of the Renminbi in the basket of reserve currencies. The actual adoption or rejection occurs at the end of this month.
- Commodities, including oil, have taken another downturn.
- While US employment data looks reasonably strong, it certainly didn’t translate into strength in retailing.
- The technicians don’t see much cause for recovery in the markets, at least through the data that was available through last Friday.
- And, the probabilities regarding a Fed hike in December will likely move down.
There is much more that could be said regarding what has happened this past week and certainly opinions that could be expressed. I leave that to the op-ed contributors. It is hard enough trying to make sense about what this means for the markets. Let’s try to address some of the possibilities, starting with the effects on economies.
Almost all of these actions would tend to support a slowdown in activity in the euro region from a combination of the disruption caused by the terrorist action within Europe, the political dysfunction that may occur, and the actual reduction of incoming travel to the region. This is against a backdrop of the possibility that the decline in commodities is an indication of even slower global growth as opposed to simply an oversupply situation caused by the continued production of various hard commodities and oil as long as the operating economics provide cash flow to service debt and cover other costs. I have said this before, but it’s worth reiterating, that energy is a significant input cost to the extraction and refining of most hard commodities, as well as oil itself. As the breakeven drops, production can continue longer than one might expect. We recently discussed this point relative to the Bakken oil fields in North Dakota. We will need to look for other signals to determine whether this is a global growth problem or something more specific. The offset in Europe to the impact of the terrorist activity is the likelihood of continued, and possibly increased, QE or QE-like central banking activity as well as fiscal activity. In addition, the currencies of China and the US are likely to remain stronger than the euro as a result of the IMF action, and some signs of growth stability in China, combined with a possible flight of capital to the two large countries that are somewhat—I say somewhat—more isolated, with lower probability, from the possibility of terrorist action internally. Relatively speaking, these markets may do better for some period as a result of these flows and growth patterns than what we see from Europe. It specifically may hold down rates as money flows into US government securities. Ultimately, the euro currency weakness could begin to mollify that spread in performance.
So what does this say about the likelihood of a Fed move in December? I think that depends a lot on the November employment reports where the Fed will have another set of data before a decision is made. The October numbers were certainly robust as we have pointed out in some of our recent Altegris video and audio broadcasts. If there is actual evidence of a further global slowdown combined with weaker employment data—not our expectation—the Fed could delay. That puts them into next year with all of the uncertainties that entails. If the US numbers are good, combined with no significant deterioration globally, the odds are the Fed will pull the trigger and get started. The markets are to some extent reflecting this, although we will see what the Paris incidents do to the dollar, flows and, ultimately, market rates. As I have said, I don’t think December is a good time to change the rate picture—even modestly—while there are significant end-of-year activities around balance sheets and inventories of securities in the financial markets.
All of this reinforces our view that there will be increased dispersion within and among asset classes, combined with some financial accidents, away from a fluid geopolitical environment. Active management and less-correlated solutions are the likely better performers in the aforementioned economic climate that may be with us for some time to come. I don’t really have to ask, given recent events, for everyone to pay attention.