Archive for month: July, 2013

This Week

This is an extremely busy week of potential macro-economic catalysts and for more color into what the Fed might do next.

First, there is an FOMC meeting Wednesday. This is an “old school”-type meeting, so don’t expect economic projections or a press conference.  There is no change expected to interest rates or the QE program. “Tapering” at this meeting would be a huge surprise, although most do expect the Fed to further attempt to “talk down” rates, as they have (successfully) been doing for the last three weeks.  In particular, Hilsenrath’s article in the WSJ Thursday implied the Fed will potentially extend its “forward guidance” on how long interest rates will stay low, or perhaps lower the “thresholds” that would warrant tightening (currently unemployment below 6.5% or inflation above 2.5%).  So, there is some form of “rhetorical” easing expected from this meeting.

Second, it’s jobs week (and I’m sure the Fed will have the numbers when they meet Wednesday, so their statement may give some clues about the jobs report).  As usual, we’ll get the ADP report Wednesday, weekly claims Thursday, and then the government report Friday.  Given weekly claims have remained relatively stationary for four months, no one is expecting this jobs number to deviate significantly from the past few months’ reports.

Third, we get the official ISM manufacturing reports for China (which includes the government report), and the EU and the U.S. on Wednesday night/Thursday morning.  These are more important for China and Europe, and investors will be looking for confirmation of the “flash” estimates we got last week.  Especially look at Europe, if the report stays above 50 (which signals expansion in the manufacturing sector)—we could see some more upside in European shares.

Fourth, there’s an ECB meeting Thursday morning.  The fact that the ECB relaxed collateral requirements at smaller commercial banks for access to ECB funds has some thinking that there could be some additional programs announced at this meeting. But no one expects interest rates to change.  The key will be the commentary on the EU economy (it should be a bit more upbeat) and the pledge that the ECB will remain extremely accommodative for a long time.

Fifth, we get the first look at Q2 GDP, and as I said last week, this number is going to be ugly.  Most are expecting between 0.0% and 1.0% GDP growth in the second quarter, but a negative number is not out of the question.  But, the market shouldn’t really react that much, because everyone is expecting growth to materialize in the second half of the year (and it must; otherwise stocks are expensive).

Finally, to end the week, personal income and expenditures will be released Friday after the jobs report, and that’s important because it contains “core PCE,” which is the Fed’s preferred measure of inflation.  Inflation is currently running too low, and that’s making some Fed officials nervous about “tapering” too soon, lest we get a whiff of deflation.  But, if core PCE starts ticking up, like CPI did earlier in July, then “tapering” will become more solidified, and it’ll be taken as marginally “hawkish” (i.e., bonds-negative, dollar-positive).

The Dollar Index and Treasuries both rallied for the first time this week on Wednesday, but the main catalyst wasn’t the better economic data (although that obviously helped).  Instead, the reports in the Washington Post and Huffington Post that Larry Summers appears to be the favorite to become the next Fed chairman weighed on Treasuries.

It was widely assumed, up until a few weeks ago, that Bernanke would be replaced by Fed Vice-Chairman Janet Yellen, who is considered an “ultra-dove” and would err on the side of being “more dovish” whether tapering was occurring or not.  Basically, she’s viewed as an extension of Bernanke.  Summers, if he gets the job, is relatively unknown with regard to his views on monetary policy—and it’s almost a certainty that he wouldn’t be as dovish as Yellen.  So, Summers becoming the favorite to replace Bernanke is, in a way, a bit of a “hawkish” event compared to current expectations. This was the real catalyst behind the Treasury sell-off and the dollar rally yesterday.

Treasuries sold off hard yesterday, as the 30-year note fell 0.65% thanks to the Summers articles and the better than expected economic data.  Rising yields remain the most fundamentally sound trend in the market today. The economy is rebounding; the Fed is turning “less dovish” both in practice and, it appears, in personnel (if Summers is nominated, which is a big “if”); and the job market is improving.  On the charts, it looks as through the 30-year Treasury has failed at the first major resistance, and I think the downtrend in bonds/rally in yields is back on after this three-week-long, counter-trend rally.

Bottom Line

Yesterday was a good reminder that, while the stock market may be comfortable with Fed “tapering” in September, the expected rise in interest rates needs to be “orderly,” otherwise we’ll see a repeat of the turmoil in June.

That said, this market (domestically and internationally) feels a bit “tired” and, like most things that are tired, the market is probably overreacting a bit to the uptick in yields yesterday and this morning.  But, the key will be the emerging markets.  If PCY and EMB start declining sharply again, that’s a sign this could be another bout of money flows out of emerging market like we saw in June, and that would be a negative for equities.

But, yesterday was another reminder that, while the market will continue to adjust to the idea of higher yields, the way to play that is to get exposure to higher yields (they are the constant here, not the market rallying).  So, I’d continue to look to do that methodically via ETF’s like TBF, TBT, SJB and allocations out of “bond proxy” sectors like utilities, REITs and telecom, and towards financials and more cyclical stocks.