Sevens Report 5.30.14

Sevens Report 5.30.14

Sevens Report 5.29.14

Sevens Report 5.29.14

Sevens Report 5.28.14

Sevens Report 5.28.14

Your Weekly Economic Cheat Sheet – 5.27.2014

Last Week

Last week was a good one for economic data, as global flash PMIs confirmed current market expectations (Chinese growth stabilizing, EU recovering slowly, U.S. recovery accelerating), and we got some welcome good news on domestic housing.

The global flash PMIs were the highlight of the week, and although there was some disappointment in European manufacturing data, largely the reports were better than expected.  Importantly, they helped reinforce that the pace of Chinese economic growth is stabilizing, Europe is seeing a slow recovery and growth in the U.S. is slowly accelerating.

Chinese flash manufacturing PMIs hit a five-month high at 49.7, just below the important 50 mark, and a lot of the details of the report were strong.  U.S. flash PMIs came in at 56.2 vs. expectations of 55.9, again implying that we are seeing a continued recovery form now that we’re past the winter-weather-imposed economic dip.

The one “miss” in these numbers was in Europe, where French PMIs disappointed, while German and EU manufacturing PMIs declined from April (and missed estimates).

On the headline that looks bad, but it’s really not.  First, everyone’s focus is on what the ECB will do a week from Thursday. So, in some respects, the slightly disappointing data are putting more pressure on the ECB to act (so, mildly bad news is good).  Second, in aggregate the PMIs for Germany and the EMU were “OK” (still comfortably above the 50 level), so importantly these weak numbers aren’t going to result in anyone changing their growth estimates for the EMU (which means the numbers aren’t really that bad for European stocks).

China and Europe remain two major areas of concern in the global economy, but the data last week further confirmed that we’re seeing positive incremental progress in both regions, which is a positive for global equities.

The other important data released last week were the existing home sales Thursday and new home sales Friday.  As you know, housing remains an area of concern for analysts and the Fed, as it hasn’t “bounced” from the winter dip like the rest of the economy.

Well, data last week implied that we may finally be seeing some sort of a “bounce” in housing, as April existing home sales rose month-over-month for the first time this year, while new home sales increased as well.

Those positive surprises helped stocks rally late in the week, because if we can get the housing recovery to start moving forward again, that will be an unanticipated tailwind on the U.S. economy (and a positive for equities).

Two reports won’t remove concern about housing, especially in this generally pessimistic environment, but these reports did help sentiment last week.

Finally, there were a bunch of Fed speakers last week and the release of the Fed minutes last Wednesday, but the bottom line is the outlook for Fed policy didn’t change at all (tapering ending in October/December, and first rate increases mid-2015).

Perhaps the most important Fed-related item from last week was Vice Chair William Dudley’s commentary about a Fed exit strategy. But there will be plenty of time to dissect that, as we’re still a ways off from the Fed even starting to exit all these programs.  But, as tapering and eventual rate increases draw near, expect the focus of the Fed analysis to shift to the exit strategy. For now, though, everything remains status quo.

This Week

There are several notable economic releases this week, but the truth is that, barring any major surprises, the market will be looking ahead to next week (ECB decision and May jobs report).  So, nothing this week should materially change the market’s outlook for the U.S. or global economy, again unless there’s a big surprise.

Revised Q1 GDP Thursday will likely be the most-watched number this week, as it’s likely we’ll see growth for Q1 revised into negative territory.  But, while that will be a much-publicized headline, again remember the market is much more focused on the pace of growth now than it was eight weeks ago.

April durable goods are released later this morning, while we get jobless claims and pending home sales Thursday.  Claims ticked up a bit last week so the market will be looking for a resumption of that downtrend, while pending home sales will be closely watched (and that’s probably the most important number this week, given the housing data last week).

It’s the same story in Europe, as there are several releases, but everyone is looking ahead to the ECB on June 5.  Japan is the one expectation, as there are multiple releases Thursday night.

This could move markets, as everyone is still trying to figure out how much the Japanese economy has slowed now that the sales tax increase has been in place for over a month.  That, obviously, will have a impact on when (and if) the Bank of Japan eases further.

Sevens Report 5.27.14

Sevens Report 5.27.14

Update on the U.S. Equity Market

The market was still frustratingly flat, but Thursday was a bit different than the previous days this week.  Monday and Wednesday weren’t as good as the averages implied, and Tuesday wasn’t as bad.

Thursday, however, was actually a bit better than the moves in the averages would make you believe because of two main reasons.

First, economic data (especially housing) was good, and at the end of the day the economy has to be the catalyst to power this market higher.

Second, the small caps and “momentum” sectors continued to rebound, with the Russell trading well and NBI and QNET trading with some strength for the first time in over six weeks.  It’s too early to call a bottom yet, but there’s no question the space (over this week) has traded better.

Bottom line is the fundamentals for this market remain largely static (although it’s looking more and more like the Ukraine situation may improve over the weekend, as Petro Poroshenko may win easily).  Despite that, sentiment remains very negative and, as a result, the short-term “pain trade” is likely higher. But again, I don’t expect any material rally above 1,900 in the S&P 500 without a rally in Treasury yields or further improvement in the economic data.

Dissecting the FOMC Minutes

Fed Minutes

There weren’t many surprises in the minutes, and they certainly didn’t change anyone’s outlook for Fed policy going forward. 

Regarding the economy, the Fed remained cautiously optimistic. Apparently, though, the lack of a housing rebound is catching some Fed officials’ attention, so housing remains a key area to watch (reports coming out today and tomorrow are important).  But, overall there appears large agreement that the economy was rebounding from a weather-induced slowdown in Q1. 

The other focus of the meeting was on the Fed’s exit strategy from QE.  I think that reflects two things:  First, it’s going to take a big negative shock to the economy to derail tapering of QE, and the outlook for Fed policy (end of QE in October/December, first rate increases mid-2015) is about as set in stone as the Fed outlook can be. 

Second, with the Fed policy outlook relatively “known,” the market’s focus is going to shift more to the specifics of the Fed’s “Exit Strategy” from QE.  And, yesterday’s minutes implied that the Fed doesn’t really know how it’s going to “normalize” policy and its balance sheet (i.e., raise rates while they own so many Treasuries). 

I suppose every plan begins with a conversation, and it seems that the FOMC has started the conversation about normalizing policy – now they just need to come up with a plan.  Assuming the economy stays level through the coming months, Fed exit policy is going to become a more-important topic for the markets. 

Know Where the (Fed) Exits Are

Current (and about to be ex) Fed Vice Chair William Dudley made some comments Tuesday about the Fed exit strategy that were generally viewed as “dovish.”  But, that interpretation is incorrect, and Dudley’s comments may be one reason we saw some bond weakness Tuesday and Wednesday.

The media focused on the fact that Dudley said the “equilibrium” interest rate (a rate that isn’t accommodative or too tight) might be lower going forward than it had been in the past (so say well below 4%).  There are many reasons for that but basically his main thesis is that the economy simply doesn’t have the growth potential it used to (due to demographics and other things). 

That is a “dovish” statement, but it’s not something new. 

Instead, the important part of Dudley’s speech had to do with the Fed exit strategy.  Dudley said he believes the Fed should continue to reinvest principal payments from its QE purchases into other bonds, even after it begins to raise rates (presumably this will soften the blow).  If that opinion reflects the consensus of the FOMC (and Dudley usually does) then that’s a change, as the Fed previously stated it would halt re-investment of QE purchases prior to raising rates.

Now, before your eyes glaze over, this is important because this change in policy may put more upward pressure on rates.

Here’s why: If the Fed stopped re-investing principal payments, that would remove artificial demand from the bond market, and bonds would decline/interest rates would rise faster than if the Fed was reinvesting.  So, not reinvesting principal is a mild form of tightening. 

If the Fed is going to continue to reinvest, though, then any tightening of policy the Fed wants to achieve will have to come solely from interest rate increases, because the rate increases will have to counter the re-investment of principal payments. 

Again, I know this is pretty boring stuff, but understanding Fed policy is key, especially with regard to the expected direction of rates.

Sevens Report 5.22.14

Sevens Report 5.22.14

USD/JPY Bounces Off Critical Support at 200 Day Moving Average

Yen

Sevens Report 5.21.14

Sevens Report 5.21.14