Fed’s Unwinding of Stimulus Program Could Have Global Ripple Effects

Investors sometimes have short attention spans.
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Just a month ago, worried by the escalating tension between the U.S. and North Korea, the gold price was rising, hitting its highest level in over a year at $1,358 an ounce as the dollar weakened and tensions ratcheted up.
However, Trump’s United Nations speech threatening annihilation on North Korea failed to support the gold price, as investors took a cue from central bank announcements that the Fed intends to start unwinding its multi-trillion dollar balance sheet in October.
The Financial Times reports the prospects of higher interest rates make gold less attractive, since the metal provides no yield.
After peaking in early September, gold remains up 13% on the year. Silver prices are up 6% in the year-to-date. The Fed seems set on a rate hike by December, followed by probably two more next year.
Yet, the gold price is merely the most visible of many undercurrents caused by the Fed’s gradual withdrawal of liquidity as it unwinds its eight-year stimulus program.
Little attention has been given of the impact this gradual draining of liquidity will have on emerging markets.
Already, a few alarm bells are beginning to sound.

China’s Capital Flight

China is not alone in being exposed to the possibility of a liquidity crunch.
The Telegraph notes China suffered capital flight of $100 billion per month after the Fed tapered bond purchases and then began raising rates in 2015 (triggering a global stock market and commodity price slump early the next year).
With China’s five-year party congress meeting next month, the economy is being allowed to ride on the mini-boom engineered last year. Once that deadline passes, the party will have to tackle China’s massive debt pile if it is not to suffer greater ignominy, as borrowing costs rise over the next two years.
At over 300%, China’s total debt pile, estimated by the Institute for International Finance, could prove a massive drain if borrowing costs rise too fast and the economy slows too fast.

Commodity Prices

So far, commodity prices, with the exception of precious metals, have been driven almost purely on supply and demand indicators from China.
Iron ore has eased back as steel prices have eased in recent days. Aluminum has hit a new peak as smelters seem to be cutting back earlier than the anticipated shuttering for the onset of the winter heating period in November.
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The Outlook

In the short term, expect more of the same.
Investors may take longer to appreciate the risks Fed tightening will hold and much will still depend on the pace and degree.
But precious metals metals, at least, have taken note, and so should we all.

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