Home' Trinidad and Tobago Guardian : November 12th 2015 Contents BG14 COMMENTARY
BUSINESS GUARDIAN www.guardian.co.tt NOVEMBER 12 • 2015
Acouple weeks ago, a "data
dependent" US Fed hinted
at a possible interest rate
hike at their December 2015
meeting. If it were to occur,
it would be the first rate hike
in close to a decade.
Based on last week s jobs report in the US,
the probability of a December rate hike is now
pegged at 70 per cent up from just about 50
per cent, prior to the strong job growth in the
US.If the rate hike were to become more certain
over the coming months and, if it comes about
as expected, the discussion will shift from
stock to flow.
Stock is something that relates to a point
in time while flow relates to what is happening
over time. The key issue here is not so much
when the US Fed raises interest rates but the
pace at which they would pursue a rate hiking
programme going forward.
The same basic issue is relevant in the T&T
context as well. The Central Bank of T&T has
embarked on a series of increases to the repo
rate in an attempt to engineer a rising interest
rate environment in T&T.
Similarly, the Central Bank has also aggres-
sively stepped into the foreign exchange market
by selling US dollars to the banking system in
order to support the currency.
The common thread associated with all
these issues is the focus on stock rather than
flow. The media will highlight the event as
they happen and there is very little discussion
on, say, the expected target differential between
US and T&T interest rates or the pace of
foreign currency injections into the market.
Rather than the focus being on a 25-basis
point rate hike or a US$500 million injection
into the financial system, what is more impor-
tant is the extent, and over what duration, we
can expect to see such actions continue (if at
all recur) in the future.
There is a basic premise in behavioural eco-
nomics that people will not change their
actions unless they see that the measure is
going to be consistent as opposed to one-off.
To give a related but different example to
emphasise the point, three tax amnesties in
seven years has done very little to improve tax
compliance and collections in this country as
it provided no sense of a sustainable shift
towards improved tax collection. It is only a
more permanent change---increased focus by
the Board of Inland Revenue or the proposed
Revenue Authority---that will result in a change
in approach by the local taxpayer.
When we speak of flow the issue then is
the pace of rate hikes that is to follow the
expected Fed announcement in December.
There are many factors that will influence this
and no clear consensus as to what is likely to
happen during the course of next year. How
it all pans out is going to have a material effect
on T&T as the issue encompasses the strength
of the US dollar and, by extension, the strength
of the TT dollar.
Other issues relate to the fact that there is
an inverse correlation between the movement
of the US dollar and the price of commodities
such as oil. Further, the rate of change of inter-
est rates in the US and, ultimately, the level
will impact the rate at which interest rates in
T&T must move in order to manage the foreign
exchange relationship between the US and TT
Finally, the propensity for instability in
emerging market countries, as a result of
increases in US interest rates, must also be
considered in the mix as this can impact some
of T&T s trading partners outside of Caricom
and our push into extra-regional markets.
All in all, we need to pay close attention
and the fact that there are so many variables
at play---with many of these variables not yet
priced into the market---speaks to a fair amount
of volatility going forward.
In addition, appreciate that the US accom-
plished a record-low Fed Funds rate of one
per cent following the Dot Com crash and
mini-recession around 2000.
After approximately five years, at these low
rates and record levels of credit expansion,
the result when the Fed moved rates up to
more "normalised" levels, was the crash of
the US housing market and the eventual global
Now we are on the cusp of a rate hike after
carrying zero interest rates for twice the length
of time. It means we have almost a decade
during which price discovery for financial
assets were skewed, risk was mispriced because
there was no clear determination as to what
was the risk free rate and capital flows were
dominated by financial engineering as opposed
to real investment.
At the end of the last rate hike cycle came
a recession. That we move to a new rate hiking
cycle means the overall business cycle will be
back in play. If that business cycle leads to a
recession in the US over the next five years,
it would be coming at a time when we would
be hoping to recover from the effects of low
oil and gas prices in T&T as well as when our
economic diversification thrust should be
taking root. There are many permutations to
factor in as we plan the economy for the next
Goldman Sachs, in a report released after 77
per cent of the market capitalisation of the S&P
500 had released earnings, described the third
quarter performance as "adequate earnings, dis-
According to Fact Set with 444 companies in
the S&P 500 reporting as at last Friday, earnings
declined by 2.2 per cent. If the overall number
ends up negative, it will be the first back-to-
back quarters of earnings declines since 2009.
This is referred to as a growth recession in that
growth is still positive but the rate of growth is
In terms of valuation, the 12-month estimate
of earnings per share of the S&P 500 is $126.88
and putting the index at 2100 gives a price to
earnings multiple of 16.6. A P/E of 16.6 is above
the five- and 10-year average.
The questions for investors going forward is
whether a higher price to earnings multiple is
justified in the face of a slower pace of earning
growth. If, not, then the market is likely to trade
in a volatile fashion until the earnings picture
clears. Earnings growth, of course, depends on
There is some element of bifurcation as the
US economy seems on steady footing given the
suggestion that the US Fed will seek to hike rates.
The global economy, including the emerging
markets, are less so. We can gauge what is hap-
pening globally through the lens of company
According to Fact Set, for companies that
generate more than 50 per cent of sales inside
the US, the blended earnings growth rate is 4.8
per cent. While those that generate less than 50
per cent of sales inside the US, the blended earn-
ings decline is -10.6 per cent. This relationship
holds even when energy sector stocks are exclud-
ed.A slower rate of growth outside the US will,
ultimately, hinder the pace at which the US Fed
can increase rates. Starting with the week before
the Fed meeting in December the European Cen-
tral Bank is set to provide more monetary stimulus
to the European economy. That will push the
Euro down against the US dollar with expec-
tations of parity.
Weakness in other areas, especially in Japan
and the emerging markets, in general, is likely
to see more accommodative policies there as
well. That means there is likely to be a natural
strengthening of the US dollar outside of policies
defined by the US Fed.
Another point to consider is that employment
can very well be a lagging indictor and the move-
ment of the US Fed can be a catalyst in accel-
erating the end of the current business cycle.
Overall, I do not expect that the pace of rate
hikes by the US Fed will be very aggressive. Fur-
ther, I don t think they can get very far into a
rate hiking cycle before having to reverse course
The bottom line is: we solved a debt crisis
ten years ago by issuing more debt. Servicing
that debt will be near impossible in a rising inter-
est rate environment.
I suggest that we will be in a cycle of low
interest rates for years to come.
Ian Narine can be contacted via email at
Lower for longer
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