- Fiscal stimulus in Asian economies
- Jackson Hole symposium and possible interest rate hike in the US
Changes in selected stock indices and commodities:
Note: USA: S&P 500, Europe: BE 500 inx, Japan: Nikkei 225, Brazil: Ibovespa, Russia: RTS, India: NIFTY, China: Shanghai Composite, Africa+Middle East: GCC 200, South Africa: JSE TOP 40, Australia: ASX 300, Gold and Oil
August trading was in a quiet holiday spirit with no major exchange rate information. The major stock markets thus closed the month without significant changes.
Asian markets benefited from the support of the economy by the states. Japanese Prime Minister Abe unveiled a long-awaited USD 275 billion fiscal package to help the Japanese economy. In China, tax incentives are driving up car sales, which rose 23.3% year-on-year in July. The hunger for new cars is great, with car stocks in China now at 11-month lows. In addition, tax incentives, which were originally only supposed to last until the end of this year, are expected to be extended.
The German economy grew +1.8% year-on-year in the second quarter, a very respectable result. The year-on-year growth was mainly driven by traditionally strong German exports, which managed to offset slightly weaker-than-expected domestic consumption in the overall result.
Investors’ eyes were on the speech by US Fed Governor Jannet Yellen towards the end of the month. At a symposium in Jackson Hole, she praised the performance of the US economy and the condition of the labour market. On the other hand, inflation still remains below the 2% inflation target. The Governor’s speech did not hint at a possible interest rate hike. However, according to Deputy Governor Stanly Fischer, it is possible that US interest rates will rise twice before the end of the year. The overseas indices reacted negatively to this statement, as a rise in interest rates is bad exchange rate information for stock titles.
A fall in interest rates is good news for equities, while a rise in interest rates is negative exchange rate information. Why is this so? There are several ways that rising interest rates translate into stock prices, but one of the most fundamental and best understood is through corporate performance.
When interest rates are low, firms borrow capital more cheaply. After all, the price of money is interest, and the lower interest rates are, the cheaper and more available money is in the market. Large firms almost always work not only with their own capital, but also borrow foreign capital in order to make a higher profit on their own capital invested. Thus, if interest rates are low, then the interest costs the firm pays are also low and do little to reduce the firm’s profits. The return on equity is high because the cost of foreign capital burdens the firm little. Conversely, if interest rates rise, the cost interest the firm has to pay also rises and hence its profits fall. Lower profits then mean a lower return for shareholders, paid out in the form of dividends or ploughed back into the further development of the firm. In the long term, higher profits attract more investors and push the share price upwards, while lower profits (caused, for example, by the effect of higher interest rates) reduce the attractiveness of the shares.
Rule of thumb: ↑interest rates = ↑firm interest costs = ↓firm profitability = ↓stock price
Precisely because of the effect of interest rates on corporate performance and hence on stock prices, investors are watching closely the possibility of interest rate hikes in the US. On the other hand, it should be noted that there is a lot of exchange rate information in the capital markets (there are other influences) and so share prices can rise even if interest rates rise. For example, because the economy is doing well. However, it can be assumed that in such a case share prices would rise faster if interest rates were not rising at the same time as the economy.