Archive for month: September, 2014

The Fed’s Perception Problem (and why it’s Hawkish)

If the FOMC does indeed become incrementally more “hawkish” today, it’ll likely be because of the growing fear among Fed officials that the market views the Fed as simply being too “dovish.”

We’ve heard several Fed presidents reference this, and last week there was a San Francisco Fed paper citing this potential problem.

And, the worry that the market doesn’t “believe” the Fed isn’t some general “feeling” – it’s actually backed up by hard data.

Fed Funds futures, which trade on the CME and can be accessed via this link, reflect the market consensus of where the Fed Funds rate will be at the end of each month.  And, simply put, the market is reflecting a much more dovish Fed than what FOMC members are stating.

The Fed Funds futures prices shows a much slower and more gradual increase in interest rates than the official Fed projections – plain and simple.  And, frankly, this type of discrepancy is significant.

And, it’s a problem for the Fed.

If the Fed isn’t being taken seriously (as a hawk) then that poses a potentially serious problem. While the Fed wants to start to restrain the risk-taking and the unbridled “chase for yield” it’s manufactured over the past several years, if the market doesn’t believe the Fed will actually raise rates, then the excessive risk-taking will continue—potentially resulting in bubbles.

Point being – there is some room here for the Fed to give the markets a bit of a “hawkish” dose of reality today – if not via the removal of “considerable time,” then via other means, including the “dots” as we described yesterday, or via Yellen’s press conference.

Point being, the propensity for the Fed to give us a “hawkish” surprise is rising. While that won’t guarantee the bond declines will continue in the near term, the simple fact is that the setup is for the Fed to, finally, be slightly more hawkish. That is, until the market, as reflected by Fed Fund futures, starts to believe rates will rise sooner than is currently the consensus.

Finally, I’ve mentioned frequently that the pace of the increase in rates is more important than the date rates start to rise.  You can monitor both via Fed Fund futures (or you can just let us do it … we’re watching it either way).  The way it works is you subtract Fed Fund futures from 100 to get the implied Fed Funds rate.  So, right now the market anticipates the first rate increase to occur in June 2015 – and if that changes tomorrow, one way or the other, Fed Funds futures will let us know.

Last Week

There were just two notable U.S. economic releases last week. Although neither was enough to force a change in the outlook for Fed policy, August retail sales were strong and incrementally viewed as increasing the chances for a hawkish statement change this week.  Outside of that, the most important thing that happened last week from a data standpoint was some soft Chinese data renewed some concerns about the pace of growth.

Starting with the U.S., though, the most important number last week was Friday’s retail sales report.  The headline met expectations (up +0.6% m/m) but it was a better report than that.

The key indicator of retail sales is the “control” group that excludes car purchases, gasoline purchases, building material purchases and food service. As such it gives the best read on true consumer spending.

The “control” group rose +0.4% in August, but more importantly the July number was revised higher from 0.1% to 0.4%, dismissing the concern that consumer spending had suddenly dropped off during the summer.

Does this number, by itself, mean the Fed will get more “hawkish” this week?  No, it doesn’t—but consumer spending was one of the more sluggish sectors of the economy, and incrementally it bolsters the argument for the “hawks” to remove “considerable time” from the statement. So, bottom line, the retail sales report doesn’t mean any expectations of actual Fed policy will change. But for this week’s statement, it was viewed as slightly more “hawkish.” (Silly as it is, these are the things we need to worry about in the age of ZIRP and QE.)

Internationally, European data was almost all second tier last week, although it was better than recent reports.  But, nothing last week changed the outlook for Europe (i.e., the continuation of a slow recovery).

There was a lot of Chinese data out last week, though, and generally it was disappointing. CPI and PPI were both below expectations (which is usually seen as a positive). But taken in the context of the soft import numbers two weeks ago, the lower inflation numbers furthered the concern that domestic demand in China is slowing.

Over the weekend, industrial production missed estimates (6.9% yoy vs. (E) 8.7%) while retail sales met.  There are some concerns re-emerging about the pace of growth in China, but it’ll take more disappointing data (specifically, a lot more disappointing data) before legitimate concerns about a potential “hard landing” take shape.

China is transforming its economy, and that’s going to produce periods of slower growth. But the Chinese central bank and administration remain committed to around 7%-7.5% annual GDP growth. As long as that’s the case, China shouldn’t be a major macro headwind (although it will weigh on emerging markets, which is a positive for EUM).

This Week

Obviously the FOMC meeting is the highlight this week, and the entire focus seems to be on whether the wording “considerable time” will be removed from the statement released at 2 p.m. Wednesday. Keep in mind, though, this is one of the meetings where we’ll get the Fed forecasts (the “dots”) and the Fed chair press conference.

I’ll preview it in Wednesday’s Report, but the bottom line is “considerable time” is the focus of the meeting. There is a definite fear the Fed will get very, very slightly more hawkish in tone (and given this Fed’s propensity to stay “dovish,” I’m worried the market may be a touch ahead of itself and we could see a “sell the rumor, buy the news” reaction).

Part of the reason the market expects this shift is because of the Chair’s press conference—the FOMC can remove “considerable time” from the statement and then she can refute that the Fed is getting more “hawkish” at the press conference.  If they don’t do it here, the next press conference isn’t until December.

Outside of the Fed, we get our first look at September economic data via the Empire State manufacturing survey (this morning) and Philly Fed (Thursday), and in all likelihood they’ll both show that manufacturing activity in their respective regions continues to grow at a good pace. (However, activity in those regions has gotten pretty hot, so don’t be surprised by a dip in the numbers –but on an absolute level, activity should stay brisk.)

The other notable domestic release is the August housing data, with housing starts Thursday. The market will be looking for confirmation that the acceleration in the rebound we saw in the July data is continuing.

Internationally it is a very quiet week in both Europe and Asia.  The German ZEW survey (out tomorrow) is probably the highlight. If the survey can surprise to the upside, this could help investor sentiment toward Europe as we approach the implementation of the ECB’s Targeted Long-Term Refinancing Operation (TLTRO) and private-market QE program (which starts in October).

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