Trying to make sense of the global stock market selloff that began on May 13?
Remember that old Wall Street saying, "Don't fight the Bank of Japan"? If you want to know what has rattled stock markets around the world and when you can expect it to end, study the Bank of Japan.
What's that? You thought the saying was "Don't fight the Fed"? How yesterday. Right now the Bank of Japan, not the
U.S. Federal Reserve, is the most important central bank in the world. It's the Bank of Japan that's calling the tune for the world's equity markets.
Slip-Sliding Away
Over the last week, you've heard all of the talking heads focus on the U.S. Federal Reserve in their effort to explain the selloff that began on May 13. The market decline, which reached a temporary crescendo with the 214-point tumble of the
Dow Jones Industrial Average on May 17, is a result of worries that U.S. inflation is in danger of spinning out of control and that the Federal Reserve will have to raise interest rates at its June meeting and beyond.
Core inflation -- that is, inflation without volatile food and energy prices -- hit an annual 2.3% in the April Consumer Price Index numbers reported on May 17. That's perilously close to the 2.5% inflation rate that many think is the top of the range that the Federal Reserve will tolerate. After those numbers came out, the odds of a June 29 interest rate hike, as indicated by prices in the fed funds futures market, climbed to 50% from 35%.
That's not a huge shift -- to 50/50 from a 35% chance. And you'd think that while the stock market wouldn't welcome another interest rate increase -- higher interest rates, which increase the attraction of alternative investments such as bonds, are never great for stocks -- it would have gotten used to them by now. A rate increase in June would be the 17th quarter-point hike since the Fed began raising short-term interest rates in June 2004. The stock market has proved itself perfectly capable of rallying while the Federal Reserve raises interest rates. Before this recent selloff, the Dow was up 12% since the Fed began raising interest rates from 1% on June 30, 2004.
It certainly wasn't enough to send the U.S. bond market into a swoon. Bonds actually rallied on some days when stocks were sinking. On May 18, for example, when the Dow Jones industrials fell 77 points and the
Nasdaq Composite fell to its lowest level since November 2005, the 10-year Treasury note actually climbed in price by 0.75%. The yield on the 10-year note, which moves in the opposite direction to prices, at 5.07% on May 18, was very little changed from where it stood at 5.12% on May 10, the day the Fed announced its latest hike in interest rates.
Jim Jubak
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