How Far Do You Trust the Fed?

US Federal Reserve logo on note

The ASX was smashed for the second time in a week yesterday. Once again, the US fell overnight, just as it had early in the week. And once again, Australia followed it down at the open. The ASX all ordinaries index dropped more than 1.7% in the first 15 minutes of trade.

The market recovered slightly, ending 0.96% down for the day.

It was much the same story for the rest of the world, just as it had been all week.

After the initial wave of falls on Monday, set off by US markets dropping the Friday before, the buyers came out in force. It had all been a healthy correction, the headlines told us. One that the market had to have. But nothing to really worry about.

An incredible buying opportunity.

That may still be true. But as bargain-hunters have learned time and again with every significant correction, just because a stock is cheap doesn’t mean it can’t get cheaper.

It was a truly nightmare week on the markets. But the big question, whether this is a correction or the start of a true crash, remains.

Investors have had it easy for a long time, now. Markets have, generally, been headed upward fairly smoothly. Even the current falls were triggered not by bad news, but good. Positive job numbers in the US set off investor fears that ultra-low interest rates would be wound back even more quickly than they had been. That was all it took for the Dow Jones to record its largest single-day points fall in history.

Whether you believe the falls will continue really comes down to your level of faith in central bankers.

If you trust the US Fed to be able to smoothly unwind its emergency low-interest rate policy without crashing a market bloated on low rate-driven investment, then you probably aren’t worried. There may be a few chaotic moments like we saw this week. But generally, things should remain fairly stable. Making corrections like this week’s a good time to buy.

If you don’t have that much faith in the Fed, you might see them as having painted themselves into a corner. With falls like this coming just on the fear that rates may rise a little faster than expected. Imagine what it might look like if they actually did.

But if the Fed doesn’t lift rates, they expose the market to another risk. That if a fresh crisis like the collapse of the sub-prime real estate market in 2008 were to come along, they would have no room to move. 

Interest rates are the only real tool the Fed has to respond to crisis. And if such an event were to be set off today, arguably the Fed wouldn’t have the interest rate ‘ammunition’ to deal with it.

Unable to lift rates without triggering a full-blown crisis. Unable to leave them low, for fear of a crisis from another source. It’s not an enviable position.

And as you’ve seen this week, where the US goes, the world follows. If this week’s falls continue, or if the Fed’s balancing act tilts over, the results will be felt globally.

It’s unlikely that China will be able to manufacture a second construction boom, to save Australia again.

If you find the idea that global markets are all riding on the abilities of a few central bankers terrifying, you’re not alone. Vern Gowdie, one of the editors over at our sister publication Markets & Money and occasional contributor here at Money Morning, has been flying the crash warning flag since long before this week’s volatility started. He’s still flying it today. To read why, click here.

This week in Money Morning

Anyone who has been paying attention to China knows they have a problem with food safety. Violations of safety standards, substitutions with cheaper, dangerous ingredients, falsified nutrition information. This isn’t a matter of taste. It endangers lives, and has often cost them. The scandals grab major headlines, but long-term nothing seems to change. Soon enough, another incident always rolls around.

Well, all that could be about to change. And it’s thanks to everyone’s favourite new tech trend, blockchain. To read how blockchain could end the fake food crises in China, click here.

The Aussie share market followed the US by falling hard early this week. On Tuesday Harje looked at a method of investing that can help prevent you from selling at the worst possible time. Especially as an emotive reaction to events like we saw this week.

Emotions like greed and fear can trick us into buying near market tops, and selling near market lows. To read an unexpected way to avoid this, check out Tuesday’s Money Morning here.

It’s not just share markets that fell this week. The volatility in cryptocurrencies continued. While many have recovered some of the ground they lost in early 2018, there’s a long way to go before they regain the lofty heights of December last year.

A large part of the problem is regulation. While it’s true that sensible regulation is important for cryptos, and a vital part of any move towards mainstream acceptance, 2018 has seen some of the worst kinds of regulation. Widespread crackdowns and bans on cryptocurrency have been threatened or put in place by several national governments, throwing out the good with the bad. To read about the latest of these, and where bitcoin may be headed next, you can find Wednesday’s Money Morning here.

Then as markets seemed to stabilise later in the week, Harje looked at one of the worst mistakes you can make in markets. One that many voices in the mainstream investment media drive their readers to make, again and again. It comes from a basic misunderstanding of risk. And of the factors that caused the sudden falls early this week. Read the details here.

US markets fell again overnight Thursday. And sure enough, Friday Australia time our markets followed suit. In Friday’s article Harje looked at how much farther markets could fall in the weeks and months to come. And he discussed when the right time is to fill your pockets with the right shares, while they’re cheap. Find out more in Friday’s Money Morning, here.

Regards,

Tyler Jefferson,
Editor, Money Weekend

Tyler Jefferson

Tyler Jefferson

Tyler Jefferson joined Port Phillip Publishing in 2012. With a background in publishing, he started out as part of the team working behind the scenes with your Editors to bring you Money Morning each day.
When he joined, Tyler was Port Phillip Publishing’s 12th employee. Today that number has grown to over 50, as more and more readers turn to Money Morning as their source for independent financial analysis and ideas.
Tyler still edits every article published in Money Morning and, as the Editor of the weekend edition, each Saturday he brings you an overview of the analysis from your Money Morning team that week — along with his own irreverent take on the most interesting news and opportunities for you.

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