In less than two weeks’ time, we will know if the Federal Reserve is going to raise its benchmark US interest rate for the first time since December last year.
That move had triggered a big correction in US stock markets and the biggest rally for gold and silver in 31 years. Will it be the same this time around?
Not if you have been following the wave of optimism in financial markets since the election of Donald Trump as the next US president. After a brief sell-off and surge in the gold price, the US dollar jumped in value and US stock markets moved to new record all-time highs, and gold prices fell back sharply.
The question is whether this will prove to be a short-term honeymoon for the president-elect, or a more meaningful rally of his richest supporters to the flag. The man of the hour himself is in little doubt.
During his election campaign, Mr Trump repeatedly said that he thought the US stock market was in a bubble. Perhaps this will prove to be one campaign promise that he is able to keep.
Certainly the astonishingly strong rally in the US dollar is signalling a clear and present danger. So is the surge in bond yields that has already caused a $1 trillion crash in the US bond market, the largest and most liquid global financial market.
Many times in past stock market bubbles, dollar strength has proven to be the hole below the waterline of the Titanic, with the water flooding into what is generally thought to be an unsinkable ship.
The rise of the dollar is anticipating the now very likely increase in interest rates from the Federal Reserve. What it could not do for political reasons before the election, the Fed now has every reason to do before president Trump enters the White House.
Before the election, the Fed would have risked a major financial upset that could have had political consequences.
Now it faces no such criticism and is more likely to be blamed for getting behind the curve with interest rate rises; after all, of the four interest rate rises promised for 2016, we have yet to see one.
Do interest rates rises not matter any more? Have the laws of economics been permanently suspended by the election of a pro-business president with big tax-cutting and spending plans?
The most sanguine judgment is that the financial markets are getting carried away with the Trump hype and are at best being premature in deciding that he will be successful in his objectives.
The more immediate issue is that higher interest rates have already propelled the dollar and treasury bond yields to levels that spell doom for export earnings, multinational profits, real estate values and the stock market.
Recessions tend to roll around every seven years or so in the US and the economy is overdue for one right now. That’s also how the US political cycle works: spending rises in an election year to boost the incumbents, and it falls in the following year when politicians are not buying votes.
So let us hypothecate that the Trump rally was just a brief honeymoon for financial markets and that the original premise about a recession to follow was not so very wide of the mark. What would this mean for investors in the UAE?
Clearly a strong dollar is not doing our open economy much good. It is bad for trade and tourism, so anything that reverses that is not so terrible, assuming that a crackup in US financial markets is bad for the dollar.
A weaker dollar would also boost commodity prices that have been in the doldrums for the past couple of years like oil, and that’s about the one reason I can think of to be optimistic about the oil price next year, apart from oil producers getting their act together.
However, would interest rates stay so high if US equity markets slumped? You only have to look at the record spread between US and German bond yields to wonder if this is sustainable even in the short term.
Surely a big upset in US financial markets would be greeted by money printing again and lower interest rates from the Fed.
This would be good for bond and gold prices as well as lifting equities. But then are we really looking to a “big plan” from president Trump’s new administration to sort things out. Will that work?
In the meantime, uncertainty rules and in that context current optimism looks bordering on madness. Wait for markets to move lower again before buying anything.
Peter Cooper has been a financial writer in the Gulf for two decades.
pf@thenational.ae
Follow us on Twitter @TheNationalPF