What Markets Say About 2016
What will 2016 bring for the world economy? Financial markets are sending a mixed message: There's reason to believe that the U.S. will outperform other major developed nations, but also to be wary about the health of American companies.
With the U.S. Federal Reserve and other central banks still holding interest rates low to stimulate growth, one big question is which economies will expand fast enough to justify an increase. As of Wednesday, traders in futures markets were putting their money on the U.S.: They expected the three-month dollar deposit rate to reach 1.24 percent by December 2016, a gain of about 0.64 percentage point. That exceeds their forecasts for the euro area, the U.K. and Japan. Here's how that looks:
At the same time, though, markets for credit derivatives -- which provide a sort of insurance against defaults -- are displaying mounting concern about the finances of U.S. corporations. As of Wednesday, the cost of five-year insurance on $10 million in debt issued by a basket of investment-grade U.S. companies stood at almost $89,000, up more than $22,000 from a year earlier. That's a larger percentage increase than in Europe, Japan and the rest of Asia. Here's how that looks:
So how can the U.S. be stronger and shakier at the same time? One possibility is that markets actually don’t see potential interest-rate increases as a reflection of strength at all: Maybe traders think the Fed will go too far, hurting growth and triggering a wave of defaults. Another, more optimistic explanation is that they expect higher interest rates to weigh only on a subset of companies -- for example, those hit by low oil prices and those that borrowed too much to buy back their own stock -- without sinking the broader economy.
Either way, the mixed signals illustrate the complexity of the task facing the Fed. A robust U.S. expansion is crucial for the rest of the world, given decelerating growth in China and a painfully slow recovery in Europe. Yet the planet's largest economy is still showing signs of weakness, and may be unusually vulnerable to rate increases. As Bloomberg View has noted, this means the central bank will have to act cautiously, and be ready to change course if 2016 doesn't go according to plan.
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