One Man’s Opinion: Would An Interest Rate Hike By The Fed In 2014 Be Calamitous?

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92835431There is too much optimism as markets go into 2014, and it’s really easy to get caught up in all the good news at this time of the year, said James Bevan, Chief Investment Officer at CCLA Investment Management.

Realistically, the fundamentals are very strong, the central banks very supportive and the companies are saying all the right things. The question is what might go wrong? Risk number one, of course, is the US as there is a broad expectation the economy is moving at a rate that is consistent with the Fed taking some money away from support but still delivering growth.

Now, if there is too much growth, the Fed may act much more aggressively, potentially raising interest rates ahead of expectations, which could be calamitous for the markets, James said.

Asked if there is a possibility of the Fed raising interest rates in 2014, James answered in affirmative. The perception the Federal Reserve has been buying $85 billion in assets every month is nonsense because in reality they have been buying at $94 billion a month for the first 11 months of last year. So, if the Fed genuinely shifts down to $75 billion, the reduction in liquidity in the global marketplace will be huge. So it’s unlikely they will cut it to $75 billion, but there is a clear intent to take support away, he noted.

When countered that the markets have reconciled with the fact that tapering is not equivalent to tightening, James said if the economy continues to chug ahead, the Federal Reserve will realize it’s not an issue of providing less support alone. Questions about normalizing interest rates will be raised because the developed economies have become markets and economies that are low interest-rate junkies; they are very dependent on high leverage.

The fundamental debt problem that took the developed economies to the edge of the abyss was never solved in the first place. If companies, on the other hand, get their teeth behind this recovery and begin to invest, that will be really bad news for earnings-per-share because companies will begin to build up excess capital  and investors will be worried about the extent of depreciation charges and the reduction in competitive positioning, he argued.

Asked if markets will rally in 2014, James said he’s expecting the S&P 500 to hit 1950, which means there’s a potential for considerable upside from the current levels. But it’s not just the US that might get it wrong, even China may post materially low growth in 2014.

After all, the Chinese plenum has said it wants long-term sustainable growth, which means China’s authorities will be prepared to see lower growth in the near-term in order to cement a much more solid platform of growth for the long term. That could be jolly bad news, he explained.

Asked if he’s worried about a possible credit crunch in China, James answered in affirmative. It’s very hard to reconcile international lending figures with China’s claims. Even Hong Kong banks say they lend more to China than China says it borrows in aggregate, which certainly doesn’t add up.

Then there’s politics in Europe; nobody believes at the moment the European Central Bank will do anything other than support recovery. However, markets forget that the ECB is desperately dependent on the Bundesbank and the Bundesbank is simply going to run out of cash next year due to the current terms of reference, he explained.

Asked if the ECB will initiate quantitative easing to weaken the euro, James said QE by the ECB is most likely as the European economy is way too weak, particularly the periphery which had all of the benefits, he concluded.

You can watch the video here.

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