USA: Thoughts on the higher discount rate & Australia
Summary
We analyze this briefly against the backdrop of America's Economic Time® and then suggest how to make money off it. In particular, we look at the Australian dollar.Topics Covered
- The discount rate and the Economic Clock®
- Three investment implications
- How to make money off this idea
Background
1. The discount rate and the Economic Clock®
Readers know that we have interpreted our Clock wrongly from March - the middle of January; since then, our interpretation of America's Economic Time has been vindicated in markets.
In a nutshell, America's Economic Time remains characterized by an
- excess demand for money, and by an
- excess supply of goods.
At its simplest, by "excess demand for money" we mean that banks won't lend - to others, nor to each other. This is where the discount rate hike comes in. By making it 50 basis points costlier for banks to borrow from the Fed, it is hoped that banks will lend more directly to each other via the inter-bank market.
By an "excess supply of goods" we mean that with rising unemployment, any peaks and valleys in production - as well as in durable goods orders - can reflect only swings in the inventory cycle: end-demand in America's domestic market remains tepid, as the unemployment data underline.
2. Three investment implications
The first implication of the discount rate hike has to be that banks will begin lending more directly to each other. That should get the interbank market moving again. This is important as it may begin heralding greater willingness by banks to lend not only to each other, but to third parties, as well. Increased lending of this "third party" nature should help improve America's Economic Time from its current excess supply of goods to an excess demand for goods. But this will take a great deal of time - way past the mid-term elections this November.
The second investment implication has to be that the Fed sees some light at the end of the tunnel. In other words, it must feel that economy is at least beginning to "see the shore line" of more stable growth. That is why it is seeking to wean banks away from their over-reliance on credit from the Fed itself, trying instead to get banks to lend to each other again. Obversely: if the Fed felt that things were still awful and with no end in sight, it would not have weaned banks away from their reliance on the Fed. but again, my guess is that that "growth shore line" is very far away, way past the mid-terms this November.
Finally, that the dollar spiked suggests that markets feel that more rate hikes are on the way. I, for one, do not. I think that the key goal of the Fed was to wean banks off Fed credit - as opposed to heralding higher Fed Funds rates in the near future. Reason: the Economic Time remains tepid. Having said this, however, the fact that the Economic Time of Europe and of Japan is so rotten means that their rates will stay lower longer than America's. So a case could be made that the dollar firmed because of this improving relative growth differential.
What this adds-up to is that market volatility will continue. Markets will remain in the dark about whether the interbank market will revive and what the true Fed intentions regarding its discount rate hike really are. So market volatility has to increase. This spells more unwinding of carry trades ahead, and that,in turn, means an ever-stronger dollar.
3. How to Make Money Off This Idea
- Always consult your financial advisor first.
- Keep buying the dollar: rising volatility in markets means that carry trades will keep being unwound. On top of which continued economic mush in Europe means that the ECB cannot raise rates for a long time, making the Euro less attractive.
- Go long Australian dollar/Euro or Australian dollar/yen. With rate hikes expected in Australia, its currency's attractiveness will rise particularly against these two near-term weaklings.
