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When will Domestic Monetary Policy Change?

What will conclusions will be made from this week’s FOMC meeting?  Many are discussing about a possible bubble in technology stocks.  I think there is a bubble in sovereign debt yield.  Several weeks ago I commented there are 21 countries that have negative interest rates, countries that contribute significantly to global GDP.

Friday PIMCO expanded upon this negative interest rate environment stating “the real froth in markets can be found in the swelling pool of negative yielding government debt from Europe to Japan.”

PIMCO states in Europe alone since last September the amount of European bonds with negative yields [charging investors to own the debt] has tripled from about $1 trillion to $ 3 trillion.  This is unprecedented.

Bank America states the pool of negative yielding European debt is almost twice as big as the outstanding investment grade corporate debt in Europe and almost nine times as large as the European high yield market.

To write the incredibly obvious central bankers are trying to ignite inflation in an attempt to reflate.  If reflation occurs, the losses in European and Japanese debt could be astronomical.

What does this have to do with this week’s FOMC meeting?  Everything.  There is an intense debate as to when domestic monetary policy is changed.

In my view there is no amount of reassuring rhetoric by the FOMC that can prevent markets’ over reaction when benchmark interest rates start heading higher.  Several weeks ago the IMF forecasted a possible 100 bps increase in the 10-year when the Fed starts to change monetary policy.

Is this a reasonable forecast given where rates currently stand?  In 2013 the 10-year rose about 125 bps during the proverbial “taper tantrum.”

I vividly recall 1994 and 1999.  According to Bloomberg, the 10-year rose 203 bps in “quick order” as the Fed raised its benchmark rate by 250 bps.  In 1999, the 10-year rose almost 1.80%.

The IMF states a rise in the 10-year can be swift and violent if history is of any guide for the vast majority of the increase in yields in the time period discussed above occurred in about two months.

Wow!  What will be the reaction to European debt?

Many times I have opined the velocity of change is frightening, where the unexpected has occurred.

Commenting upon Friday’s market activity, markets were relatively quiet digesting the plethora of earnings reports.

This week’s economic calendar is heavy.  First quarter GDP is posted, as are various housing and manufacturing data points and several consumer confidence surveys.

Last night the foreign markets were up. London was up 0.30%, Paris up 0.59% and Frankfurt up 0.97%.  Japan was down 0.18%  and Hang Sang up 1.33%.

The Dow should open quiet.  The 10-year is off 2/32 to yield 1.92%.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.