«I think the Fed basically painted itself into a corner»: Art Cashin
Around the globe financial markets are in turmoil. Alarming news out of China and the crash in the oil market is causing angst among investors everywhere. In the United States, the S&P 500 (S&P 500 4'464.33 -0.22%) is down more than 8% since the beginning of the year. Art Cashin, director of floor operations for UBS (UBSG 14.13 -1.26%) at the New York Stock Exchange, thinks that the rate hike of the Federal Reserve is one of the main reasons for the sell-off in the stock market. The highly respected Wall Street veteran fears that America will fall into a recession if the Fed doesn’t change its course and lowers interest rates back to zero.
Mr. Cashin, the pressure on the financial markets is rising. How’s the mood on the trading floor of the New York Stock Exchange?
The mood is both concerning and frustrated. On Friday, we traded temporarily lower than we got during the August spike down. That is never a good indication and it is troublesome. Here in the US, there was some concern that the markets will be closed for a holiday on Monday whereas the exchanges in Europe and in Asia are going to be open. So a lot of investors were worried about the exposure they will have for this extra day.
You’re working on the floor of the stock exchange for almost six decades. During that time you have seen many difficult moments. How severe is the situation right now?
It is very similar to what you get before you slip into a crisis. Also (ALSN 273.00 -1.44%), it’s earnings season and because of that many corporate buybacks have to be paused during this period. That removes an important potential support for the market. Over the last year, companies buying back their own stock have put more money into the market than all of the public has. The stop of those buybacks is probably a reason why we’re seeing the rather sharp selling that has occurred.
A main source of concern is the sharp drop in oil prices. Both, WTI and Brent, closed below $30 on Friday. Why is this causing so much havoc on Wall Street?
Investors are concerned that many of the small and domestic producers here in the United States have money owned in the high yield market. So if oil prices continue to go lower they’re afraid that up to two thirds of those fracking companies may go into bankruptcy. They fear that through financial contagion those bankruptcies would then begin to spread into other areas of the financial markets.
Are there already signs of contagion?
Several market participants have been asked to put up more collateral to prepare for bad loans. Also, on Wednesday there were both rumors and indications that there was a good deal of forced selling going on. There were rumors that it could have been either a hedge fund or a sovereign wealth fund, maybe investors who are exposed to the oil prices. It could have been Saudi Arabia or Norway. Forced selling and margin calls are very hard to deal with because such an investor basically has no latitude. Positions must be sold at any price and that’s very difficult for the market.
Also, there is alarming news coming out of China. What’s the problem here?
On Friday, before trading started in New York, Chinese equity markets were down another 3,5% already overnight – and that is despite the best efforts of the Chinese government and the central bank to keep prices from destabilizing.
Then again, the US economy seems hardly to be related to China.
China is the second biggest economy in the world. The US may not sell much to China. But many of our economic partners like the countries in Europe do have big markets with China. There are other aspects to the China problem, too: The Chinese currency is relatively pegged to the US dollar.
What’s the problem with that?
When the Fed began raising interest rates and the dollar strengthened it made the Chinese currency go higher which put China at a disadvantage. So the Chinese began to try to find ways to slightly weaken their currency and that is disruptive throughout all the other currencies in the emerging markets and the small Asian economies. Back in 1997 when Thai baht broke everybody thought that won’t mean too much since the US doesn’t deal too much with Thailand. But in fact what happened was it rapidly spread through the financial industry and a great deal of money was lost. So investors are worried of seeing something like that happening again.
So you think the rate hike of the Federal Reserve is one of the main sources for all the turmoil?
The Chinese currency isn’t the only one that is under some stress. For instance, the Saudi Arabian currency is also partially pegged to the dollar. So you’re seeing many other nations beginning to suffer somewhat in reaction to the Fed move to begin raising rates.
The appreciation of the dollar is also putting pressure on the export sector in the United States. Manufacturing has slowed down significantly over the last months.
In its hundred year history the Fed had never before raised rates with the ISM index for the manufacturing sector below fifty which is showing that the manufacturing sector is in somewhat of a recession. I think the Fed basically painted itself into a corner. In September, because of the turmoil in the international markets, they were afraid to raise rates and they said: »We didn’t want to move with the markets destabilized.» Because of that they found some critics here in the US who said: »Hey, you’re the central bank of the United States and not the central bank of the world. Therefore, do worry about us and do what you think our economy requires. Don’t pay attention to other economies.» So when the December meeting came the Fed talked itself into a corner with no chance to change.
On the other hand, many economists are seeing encouraging signs in the US labor market. In December payroll employment rose by over 290’000 and beat expectations handily.
When you look closer into the numbers you see that 280’000 of those jobs were seasonal adjustments. In other words it wasn’t physical people standing there, it was an assumption by the Bureau of Labor Statistics. They said it was December and the weather normally is cold so they had to add on some people. And If you went over to the household survey you saw that 35% of the new jobs were people under the age of nineteen. In fact, only 3% of the jobs went to people in the prime category between the ages of 25 and 55. So the vast majority of the new jobs went to people under 24 and over 55. To me, that looked liked holiday hiring: people who make deliveries, wrap packages etc. These are not long lasting jobs. That’s why I think the next couple of payroll numbers will not show that kind of strength.
So was it a policy mistake to raise rates?
Yes, I thinks so. I believe we may be back at zero percent interest rates before we see one percent interest rates. I think the Fed will wind up having to do that to try to avoid a recession. Before they moved Christine Lagarde, the head of the IMF, told them they shouldn’t move. Larry Summers, the former secretary of the Treasury, told them they shouldn’t move. The Bank of International Settlements told them they shouldn’t move. But they insisted upon it and I think part of the turmoil that we are seeing now is indirectly connected with the Fed’s decision to go ahead.
But on the day the Fed raised rates for the first time since the financial crisis many investors applauded and stock prices rallied. Why has the mood soured?
The rate hike had to work its way through the system. Investors had to see what would happen to the Chinese currency and how the Chinese central bank and the Chinese government respond to what happened to their currency. Not a lot of people guessed that immediately when they saw that the Fed raised the rate. It’s now working through the system and it’s contributing to the turmoil that we’re experiencing.
Looking ahead, what’s going to happen next?
The bumpy ride is probably not over yet. I would remain very careful. I think efforts have to be made to stabilize the oil price. Investors have to review their risk exposure. So make sure you’re on guard.