Investment Outlook Brightens as US Economy Braces for New Reality

© AP Photo / Hasan Jamali, FileIn this Wednesday, June 8, 2011 file photo, sun sets behind an oil pump in the desert oil fields of Sakhir, Bahrain
In this Wednesday, June 8, 2011 file photo, sun sets behind an oil pump in the desert oil fields of Sakhir, Bahrain - Sputnik International
International oil deal and the ongoing selloff in US governmental bonds have resulted in expectations of an almost certain Fed rate hike on December 14, as well as higher US inflation, thus improving the investment appeal of non-financial sector, backed by President-elect Donald Trump’s fiscal stimulus plan.

Kristian Rouz –The yield of 10-year US Treasuries surpassed a two-year high on Monday as a massive rally in global oil prices spurred inflation expectations higher, resulting in higher investment appeal for the more volatile real economy assets, including those in manufacturing and non-financial services.

Alexander Novak, Minister of Energy of the Russian Federation, during the Bloomberg Teledebates Shifting Landscape Ushers In A New Era For Global Oil And Gas Markets held at the 2015 St. Petersburg International Economic Forum - Sputnik International
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Market participants are expecting a hike in Federal Reserve’s base borrowing costs this month: Fed fund future contracts have suggested a 97-percent probability of an increase in interest rates.

These recent developments are stemming from the investor outlook on the Trump teams’ economic agenda, coupled with the pickup in commodities, all pointing at the industrial renaissance across the advanced economies.

Investor selloff of fixed-income assets continued on Monday, led by the US debt, as the Fed hike expectations, higher oil prices, and President-elect Donald Trump’s commitment to provide fiscal stimulus to the economy have spurred the interest non-financial sector assets. Albeit a higher profitability of such assets has been effectively offset by significant market volatility in the past year and a half, investment capital in coming back to manufacturing and retail, energy and utilities, and several other segments of the non-financial sectors.

“It (the decline in US bond value) does seem to be oil-driven, but clearly the bearish sentiment around fixed income prevails,” Mitul Patel of Henderson Global Investors said.

A man rides a camel through the desert oil field and winter camping area of Sakhir, Bahrain, Sunday, Dec. 20, 2015 - Sputnik International
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Oil prices have gained more than 5pc after the world’s largest oil-producing nations concluded the deal to curb crude output. However, the higher inflation expectations stemming from the oil deal, would have only contributed to rife market volatility and economic uncertainty in the US.

Indeed, should the Trump administration increase budget spending, the new fiscal policy will require accelerated borrowing in the form of higher volume Treasury note issuance. The US bonds, having started their decline in value after Trump’s election last month, are poised to dip further, and the rising benchmark 10-year yield is pushing natural interest rates higher.

The Fed’s borrowing costs, however, are far below the 10-year yield, standing at 0.25-0.5pc compared to the latter above 2.5pc. The Fed will likely employ a faster pace of interest rate hikes next year, whilst there is little doubt that on December 14 the rates will go up 0.5-0.75pc. Meanwhile, Fed fund futures dynamics suggest a 65pc chance of additional hikes before June 2017.

"Their path is going to move up faster and a little sooner," Steve Rick of CUNA Mutual Group said.

According to data from the Commodity Futures Trading Commission, investor sentiment of US debt notes has been increasingly bearish last week, hitting  rock bottom recently, which suggests that the continued selloff would put additional upward pressure on natural interest rates.

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Meanwhile, oil, which is now heading for the $60/bbl threshold in London, is expected to propel US inflation above the Fed’s 2pc target this month, while the pickup in real economy investment and a resurgence in manufacturing would support further oil price gains into 2017. reflationary spiral is another reason for the Federal Reserve to tighten the monetary environment at an upbeat tempo.

There is, however, a significant downside to this Trump- and oil-motivated US economic resurgence. With the supply of Treasury bonds projected to increase by the yearend, a massive issuance of new Treasuries in 2017 will be required to finance Trump’s fiscal stimulus. This might might result in a critical decline in the value of the US debt. Subsequently, foreign holders of US debt might dump their stockpiles of Treasuries, pushing benchmark yields and natural US interest rates even higher.

Whether the US Fed will be able to keep up its pace of interest rate hikes amid such potential developments, is unclear. A major risk could be US inflation spiralling out of control, similar to that in 1979-1981, and high Fed funds rates could hurt American borrowers and propel delinquency rates to the sky. A very high level of US household indebtedness is a challenge to Trump’s economic planning – something he’s well aware of.

"It's like the baseball players — they go out and have a good season and they think it is going to happen again," Trump said in September. "That's what we're doing. We're living like we're going to have no interest because rates are so low."

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