The Economy: A Look Back and What’s Ahead

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Last Week

If economic data had been “Goldilocks” (meaning good, but not so good that the Fed would “taper” QE early) domestically during the past two months, then last week’s data was decidedly “anti-Goldilocks.” (It wasn’t bad enough to remove the prospects of tapering, but it wasn’t good enough to give people confidence the economy can keep growing if the Fed pulls back.)

Retail sales were basically flat last week, meeting low estimates.  The first look at August manufacturing data via the Empire State and Philly Fed reports showed continued expansion but at a slower pace than July.  Jobless claims fell to the lowest levels since October ’07, implying we’re seeing incremental improvement in the labor market, and the Consumer Price Index rose slightly. But it has been increasing for three consecutive months, which is helping to ease some fears about dis-inflation.

So, the latter two reports helped solidify the expectation of “tapering” being announced at the September Fed meeting. Meanwhile retail sales, Empire State manufacturing, Philly Fed, Industrial Production and Friday’s new home sales (which met expectations) basically showed an economy that’s still expanding, but at a slower pace than the previous few months.

Bottom line: The data rekindled the market’s primary fear that the Fed has to taper QE because of the potential negative side effects they risk by keeping it going, but that the economy isn’t strong enough to handle the rise in interest rates that will accompany the tapering of QE.  The economic data last week didn’t directly imply that’s what’s happening, but it certainly made people think about it. With the S&P 500 up 18% year-to-date, that’s a reason to de-risk a bit, which is what happened.

The opposite was true in Europe, as the data there almost universally showed the EU economy is indeed starting to turn, although many investors remain skeptical.  EU GDP turned positive thanks to strength in Germany and France, while the ZEW index, German industrial production, UK retail sales and labor market report were all better-than-expected.

So, from a rate-of-change perspective, last week implied that the EU economy is actually outperforming the U.S. economy. The data there implies an acceleration while the data here implies continued recovery, but at a stagnant pace—meaning, we may see continued outperformance from EU markets over the near term.

This Week

There isn’t a lot of data this week but what’s reported is important, and this is by far the most important week of the month from an economic and a WWFD (What Will the Fed Do) perspective.

The headline this week is the global flash PMIs from China (Wed night) and the EU and U.S. (Thursday morning).  International markets and basic materials have outperformed thanks to better economic data internationally, and this trend needs to continue for those markets to rally further.

The next most-watched event this week will be the FOMC minutes, as investors will parse the release for insight into whether tapering will be announced in September, October or December.  Right now the consensus remains on a September announcement, but that’s no sure thing.  Anything beyond September will probably be taken as peripherally “dovish” by the market. The important thing to keep in perspective here is that the Fed is tapering, whether it’s in September, October or December.

We get more housing data also this week in the form of existing and new home sales (Wednesday and Friday respectively).  The new home sales figure was “OK” and the market will welcome more signs that the housing recovery isn’t losing too much positive momentum in the face of higher mortgage rates.  It is very important for the market that housing doesn’t show signs of backtracking.

Finally, weekly jobless claims will be watched to see if the six-year low set last week sticks, or if there are some big revisions.  Regardless, the anecdotal evidence implies the job market is incrementally improving, and that supports the September taper argument.

Internationally, it’s quiet outside of the flash PMIs, as most of Europe will be on “holiday.”

This could be an important week with regard to resolving what’s expected of the Fed and specifically answering the question of whether or not we will see tapering announced in September.

One important thing to remember, though, as the week unfolds:  Good economic news is still good for the market, regardless of the very short-term reaction.  Better economic data is the only way this rally has legs over the medium and longer term—if the market sells off on good data, then that’s probably a place to nibble on the long side.

Worried About The Fed Killing the Rally? Here Are Four ETFs That Should Rise Whether The Fed Tapers QE or Not

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Is “Forward Guidance” Overvalued?

Whether the paper from the San Francisco Fed has any effect on Fed policy remains to be seen. But I think the conclusion that “forward guidance” is a more-effective policy tool than QE is incorrect, and I’m starting to get the impression that the academics at the Fed, and other central banks, are overvaluing “forward guidance.”

Last week, the Bank of England released “forward guidance” that said they would keep rates at or near 0% for the next several years.  The British pound reacted by doing exactly the opposite of what should happen—it rallied more than 1%.  The reason it rallied was because most investors think the BOE is too pessimistic on their economic projections, and that the economy will be doing much better over the coming years. At that point, the BOE would then have to abandon its “0% until 2016” policy stance or risk big inflation.

I think it’s the same thing with the Fed.  All of us have watched the Fed for a long time—and I can tell you their long-term forecasting abilities leave a lot to be desired.  So, beyond about 6 months or a year, I’m not sure how many people actually believe the Fed’s forecasts.  Does anyone think that, if the economy starts to accelerate and the 10-year yield moves through 3% and GDP growth accelerates, the Fed reiterating its promise to keep rates low until 2016 will have any legitimacy behind it?

I bring this up because if the Fed “tapers” QE and expects “forward guidance” to keep rates anchored, I think they risk letting the rise in interest rates accelerate, potentially significantly.  So, if this shift in policy focus does occur, I think it only strengthens the case for the inverse bond plays: the ProShares Short 20+ Year Treasury ETF (TBF), ProShares UltraShort 20+ Year Treasury ETF (TBT), iPath U.S. Treasury Steepener ETN (STPP) and ProShares Short High Yield ETF (SJB).

What’s Ahead Economically This Week.

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This week is a reverse of last week: Not a lot of international data, but an increase in domestic reports, although most of the releases are “second-tier” and are unlikely to have an effect on Fed policy going forward.

The highlight of the week is probably the Empire State Manufacturing and Philly Fed surveys Thursday. They are the first look at August economic data, and both surveys were leading indicators to the uptick in manufacturing activity nationally that we’ve seen over the past month. If they can keep positive momentum going, it’ll speak well for August economic data.

Retail sales are released Tuesday, and June’s sales numbers were one of the few disappointing economic reports we’ve had recently. That was furthered last week by some soft same-store sales reports and reduced earnings guidance from retailers. So, it’ll be important to see if the consumer bounced back in July. The consumer remains one of the areas of concern in the domestic economy, so the market will watch closely for any signs of a further pullback.

The latest round of housing data also kicks off Friday with housing starts, and as I said when recapping mortgage applications, it’ll be important for the market to see the housing data at least stay level from June or even tick a bit higher in July. Don’t underestimate how important housing is to the economy. If the housing data is disappointing over the next few weeks and shows the recovery may be slowing, that’s a reason to re-think levels of risk.

Internationally, China is quiet, and Europe is pretty slow too. EU industrial production (Tuesday) and flash GDP (Wednesday) are the highlights. But, barring some horrid number, neither should alter current sentiment toward the EU economy (which is that it’s stabilizing).

The Economy – A Look Back and A look Ahead

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Economics

Last Week

The economic data and central bank announcements last week were expected to help provide greater clarity on the three major questions in the market right now:  When will the Fed taper?  Is the European economy stabilizing? Is the slowing of China’s growth getting worse?

Despite almost universally better-than-expected economic data (the jobs report being the notable exception), what we got was more clarity on the latter two questions, but surprisingly more confusion on the outlook for Fed “tapering,” which is by far the most important topic in the markets right now.

In Europe, manufacturing PMIs rose back above 50 and largely the economic data signaled the EU economy is finally stabilizing.  In China, the data wasn’t any worse than expected, and Chinese officials were again saying they will defend economic growth as needed. So, bottom line was last week was good for both Europe and China and, with regard to Europe, the numbers point to continued potential outperformance.

Looking at the economic data domestically, last week was a good week and further implies that the economy is continuing to recover.  ISM Manufacturing PMI was a very strong number not only on the headline (which hit a multi-year high), but the details of the report were also strong. They further confirmed what we’ve been pointing out here for over a month: that the manufacturing sector of the economy is finally recovering, and this recovery is starting to accelerate.

Lost in the jobs report hysteria Friday was a strong personal income and outlays report, which showed consumer spending beat expectations for June. (The weak retail sales report of two weeks ago raised some concerns about the health of the consumer, so Friday’s report is helping alleviate those concerns, somewhat.)  Additionally, the “Core PCE Deflator,” which is the Fed’s preferred measure of inflation, ticked a bit higher. It shows year-over-year inflation at 1.3%, up from 1.0% in May, and core inflation up 1.2%, up from 1.1% in May.  This is important because if inflation ticking up, as it appears to be doing, then that is a good thing for the economy.

The one disappointment last week was, of course, the jobs report.  The report itself wasn’t particularly good in that, not only did the headline miss, but “leading indicators” of the jobs market were also surprisingly weak. Average hourly earnings and average workweeks were flat to down from the May report (both move higher ahead of jobs gains as employers increase current employees’ pay and hours before adding new employees).

For all the gnashing of teeth Friday morning, though, the miss itself wasn’t really all that bad (162K jobs added vs. (E) 185K) and I’d characterize it as a “ho-hum” report, not a “weak” report.

Finally, the biggest “event” of last week was the Fed meeting, and this is where things got confusing.

The Fed statement was “dovish” in that they lowered their commentary on economic growth, and also cautioned on low inflation and an uptick in mortgage rates, and the dovish message surprised markets.

Last week the economic data continued to show the economy is recovering, which would imply “tapering” is on schedule for September.  But, the Fed has thrown that into doubt with the newest statement. Bottom line is this: Despite the whiplash caused at the end of last week by a dovish Fed, strong data and then a ho-hum jobs report, the expectation remains for tapering of QE to start in September, although that’s not as concrete as it was this time last week.

This Week

Domestically it is very quiet this week.  The three things to watch are: non-manufacturing (service sector) PMIs this morning, the Mortgage Bankers Association’s purchase application data Wednesday morning, and jobless claims Thursday.  The MBA purchase applications will take on added importance because the Fed singled out higher mortgage rates last week as a potential headwind on the economy.  So, a weak purchase application number, one that further implies the housing recovery is losing steam, will be “dovish” … and not positive for stocks.  Finally, jobless claims hit a new, multi-year low last week, and if that trend can continue, it will help alleviate some of the concerns about the labor market raised by last week’s jobs report.

Internationally, it’s a much-busier week. Most importantly, we get the latest round of Chinese inflation and economic data Thursday night/Friday morning. Clearly, given concerns over Chinese economic growth and whispers of potential stimulus from Chinese officials, these numbers are important.  If Chinese growth can level off, that’s a big positive for risk assets.

In Europe, there will be a lot more insight into whether the EU economy is indeed stabilizing.  Composite PMIs and retail sales this morning—and UK and German industrial production tomorrow  and Wednesday—will be watched closely to see if economic data further improves.  The big event is the Bank of England’s “Inflation Report,” which will be issued Wednesday. This is important because the BOE will elaborate more on their use of “forward guidance” as a monetary policy tool to help keep interest rates low.  No one knows exactly what they will say, but the expectation is they will use forward guidance and, on balance, be dovish. This should be good for UK stocks.

Bottom line is it’s an important week for China and Europe, but domestically, with regard to the Fed, none of the data will change current shaky expectations of “tapering” in September—we will have to wait for the FOMC minutes for more color there.

Finally, keep this in mind:  The market is “OK” with tapering in September as long as the data stays good (which it is).  If “tapering” is delayed, it will be because of a weak economy or threat of deflation, and neither are good for stocks.  So, if tapering of QE is delayed, it  will not be bullish for equities.

Interest Rates Moving Higher Despite Dovish FOMC Statement – Here’s the Need To Know

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The FOMC meeting and statement generally met expectations, although on balance the statement was taken as slightly dovish (which shouldn’t surprise anyone).  There were four wording changes in the statement from June:

First, “Information received since the Federal Open Market Committee met in May suggests that economic activity has been expanding at a moderate pace” was changed to “Information received since the Federal Open Market Committee met in June suggests that economic activity expanded at a modest pace during the first half of the year.”

This represents a bit of a economic downgrade, likely reflecting the low GDP numbers for both Q1 and Q2 that were released yesterday morning.

Second, “and the housing sector has strengthened further, but fiscal policy is restraining economic growth” was changed to “the housing sector has been strengthening, but mortgage rates have risen somewhat and fiscal policy is restraining economic growth.” 

This language change obviously points out the Fed is not oblivious to the uptick in mortgage rates, and shows the Fed understands just how important a continued housing recovery is for the economy.

Third, “The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective” was changed to “The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.” This was no doubt added at the urging of Fed President Bullard, who dissented in the June meeting because the committee didn’t explicitly acknowledge the risks of currently low inflation.  Apparently his arguments carried more weight this month, which means that at least some on the Fed are getting a bit worried about stubbornly low inflation.

Finally, the committee “reaffirmed” that monetary policy will remain highly accommodative until long after QE ends. (“Reaffirmed” was likely added to pave the way for extension of the forward guidance at the September meeting when tapering will likely begin.)

Bottom Line

The statement was taken as dovish, but the Fed has been trying to “talk down” rates for nearly a month now, so I don’t know why this was so surprising.  With regard to WWFD (What Will the Fed Do) the bottom line remains it’s not a question of “if” the Fed will taper; it’s a question of “when” (September or December).  Either way, tapering is going to occur this year, and the marginal direction of policy for the Fed is toward less accommodation, which is ultimately dollar-bullish/bond-bearish. The Friday jobs report (and data this morning) just got even more important, too—if the jobs number is particularly weak or strong, look for violent reactions in bonds and currencies.

FOMC, Jobs and Economic Data – It’s a Busy Week, Here’s the Need to Know

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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).

Correction or Pause? Here’s The Indicator to Watch.

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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.

WWFD (What Will the Fed Do), Is Fed “Tapering” Still on Track?

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Last Week

Economic data wasn’t the main market driver last week, as earnings have taken center stage.  But, the data was mostly positive and the big takeaway from last week is that Fed “tapering” remains very much on schedule for September.

The first look at July manufacturing data was pretty encouraging, as the Empire State Manufacturing Survey, Philly Fed Manufacturing Index and industrial production all pointed to a continued recovery in the manufacturing sector—something that, if confirmed by this week’s national manufacturing flash PMIs, would be an economic positive.

Housing was also in focus last week, but the results were more mixed than the manufacturing data.  Positively, homebuilder sentiment hit a new high, reflecting the fact that homebuilders, so far, don’t think higher interest rates will hurt the market.  Housing starts, however, had a big headline drop, which spooked some investors. However, it’s important to note that drop came from the multi-family segment.  The more-important single-family segment was basically flat month-over-month, so the number wasn’t as bad as expected.  The takeaway is that the question of whether or not higher rates might slow the housing recovery remains very much unanswered.

The one definitive negative last week was the retail sales report, which missed expectations and implies, somewhat, that the consumer might be slowing spending.  Whether consumer spending can continue through tax increases, sequestration, etc. has been a concern for some time.  And, last week’s numbers, while not definitively saying the consumer is slowing, will keep the debate, and concern, alive.  Finally, jobless claims reversed their recent increase last week (the increase was mostly due to the July Fourth holiday skewing the data), so the jobs market continues to improve at about the same pace we saw last month (which is a positive).

Internationally, there was a lot of Chinese economic data last week. Given the concern about China’s economy, it was closely watched.  But, the result was relatively anticlimactic. The data largely met reduced expectations, and 7.5% growth remains a key number to watch.  The Chinese government said they still expect ‘13 GDP growth to be 7.5%, but most believe there’s downside risk to that number.  If expected GDP growth drops below 7.5% and moves toward 7%, that’ll be a headwind for commodities and global equities.  So, the situation in China remains precarious.

Again, the main takeaway from the data last week was that nothing was released that changed the current expectation of Fed “tapering” to begin in September.

This Week

The highlight of the week undoubtedly will be the global “flash” manufacturing PMIs released in China (Tuesday night) and Europe and the U.S. (Wednesday morning).  The international data will be more market-moving than the U.S. data. In particular, markets will be looking for:

1) Stabilization of the Chinese manufacturing sector  (so the PMI doesn’t fall much further than last month’s 48.3).

2) An uptick in growth in the EU manufacturing sector (so an uptick from last month’s 48.7).

If the data reflect both those events, it’ll be a tailwind for stocks and commodities, and vice-versa.

Looking domestically, housing and manufacturing continue to be the key areas of focus this week.  Given the uncertain nature about the housing recovery, existing home sales (today) and new home sales (Wednesday) will be closely watched for more color on whether higher rates are slowing the housing market.  In manufacturing, June durable goods are released, and are expected to give further insight as to whether we are seeing a growing recovery in manufacturing.

Finally, weekly unemployment claims will be monitored to make sure they “stick” at current low levels, and that the spike higher in early July was indeed a one-off July Fourth statistical aberration.

While the international PMIs this week are pretty important with regard to sentiment toward China and Europe, domestically the data is more anecdotal with regard to WWFD. Nothing on its own this week will likely alter the present course of Fed “tapering” unless there is a big negative surprise.

Boring But Important: ECB Relaxes Collateral Rules

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This news hit wires pretty quietly Thursday, but the ECB took action to help solve a major issue that is impeding the recovery in Europe.

One of the problems I and others have been discussing for some time in Europe is the inability for very cheap money (low interest rates) to get into the hands of so- called “SMEs,” or small to medium enterprises.  The idea was supposed to work like this:  The ECB lends money to banks at virtually 0%, and banks provide current loans (mortgages, inventory loans, etc.) as collateral for the funds.  The banks are paying virtually 0% for the money, and they can then turn and lend it to the SMEs (or the real economy) at a higher rate, and everyone wins:  The SMEs get fresh capital to invest and expand, the banks make a spread on the loans, and the ECB helps revive the EU economy.

Here’s what’s been happening instead: Cheap funds from the ECB have been staying on bank balance sheets. It’s not because of the “evil bankers”; it’s because a lot of the ECB’s new rules require greater capital ratios, and the ECB won’t accept certain types of loans as collateral for cash, which smaller commercial banks can then lend out to “SMEs,” which will hopefully stimulate the economy.  So, like most things fiscally speaking in Europe, it was a “one foot in, one foot out” approach, and that’s why it hasn’t worked.

Well, yesterday the ECB took two steps to help change that.  First, they relaxed some of the ratings requirements on certain loans that could be pledged as collateral for cash loans to these central banks.  Second, the ECB realized “haircuts” on asset-backed securities pledged as collateral for loans from the ECB to these commercial banks.

Previously, because asset-backed securities are deemed riskier, if I were a commercial bank and had a 100-million-euro loan from a car dealer secured by the inventory, I could pledge that to the ECB to get fresh capital to lend. But I wouldn’t get 100 million; I’d only get 75 million or 80 million, because the ECB imposed a “haircut” in the loan to insulate it from losses.  (I’m making up the numbers, but it illustrates the point.) Well, that “haircut” made it not worth it to me economically, so I didn’t do it.  Now, with haircuts on asset-backed securities reduced, this is a viable option, and it is one of the better ways to help get all this cheap money in the hands of SMEs (or the “real” economy) and break the capital logjam at the banks.

So, yesterday’s news was positive for two reasons:  First, it’ll help the EU economy.  Second, it implies the ECB is still working on ways to stimulate economic growth in the EU, and it will boost expectations that more plans may be announced at the ECB meeting in August.

Bottom line, though, this is a positive for, first, European banks and, second, the European economy.  And, it’s more of a tailwind on my “long” UK idea (ETF symbol EWU, the iShares MSCI United Kingdom Index).  While it doesn’t really affect the UK, it’s peripherally positive.

Missed Profiting from the Bond Market Selloff? Here’s Your Chance to Get In.

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The key here remains that the equity market continues to get more comfortable with the reality of “tapering.”  Keep in mind that the market broke from its highs almost two months ago on the Hilsenrath WSJ article that said the Fed was game planning its exit, so markets have been adjusting to this new Fed reality, sometimes violently, for 2 plus months.

So, as long as current expectations are generally met:  “Tapering” starting in September, QE ending in mid/early ‘14, then what will decide if this market moves to new highs or not is boring old economic data and earnings.  As long as rallies in bond yields and stocks are no longer mutually exclusive, as they have been since May, and emerging market bonds continue to stabilize (they don’t have to rally, they just have to not implode) then the path of least resistance for the market is higher, as long as the data is “ok”.

1650 is a key level in the S&P 500 and we’re going to open well above it this morning.  A strong close today and tomorrow could bring in momentum buyers off the sidelines and accelerate the rally into the end of the week, so that’s an important level to watch.

The analysis of the Fed minutes yesterday caused a bit of whiplash. Initially, the takeaway from the minutes was that they were “dovish,” and we saw stocks move higher and Treasuries rally/yields fall.

But, that interpretation was incorrect (as is often the case with initial interpretations of anything Fed-related). That’s why there is a popular trading axiom that states “the first move of the market after a Fed event is usually the wrong one.”

What the speed-reading programs and analysts didn’t see—in their “dovish” interpretation—was that, buried in the appendix, was this passage:

“Given their respective economic outlooks, all participants but one judged that it would be appropriate to continue purchasing both agency mortgage-backed securities and longer-term Treasury securities.

“About half of these participants indicated that it likely would be appropriate to end asset purchases late this year. Many other participants anticipated that it likely would be appropriate to continue purchases into 2014.” (Emphasis added).

Remember back to Ben Bernanke’s press conference after the Federal Open Market Committee statement.  What surprised the market was that Bernanke said the broad consensus of the Fed was that QE should end in mid-2014, which was earlier than the consensus thinking at that time. (Consensus was for QE to end in late ’14.)

Well, the “end date” of QE may be closer than “mid” 2014, depending on data, which is trending better since the last Fed meeting.

Of the 19 participants at the meeting, at least one leans toward QE ending immediately.  Of the remaining 18, “about half” thought QE should end later this year, presumably at the December meeting.

That’s another “hawkish” surprise, and we did see the effects of it when Treasuries sold off into the close and the Dollar Index pared some losses.  Now, does that mean QE will end in December?  Probably not, as Bernanke/Yellen and Dudley still dominate the Fed and they are doves.

But,  for all the gaming of the Fed, the takeaway here is that “tapering” remains very much on schedule, and it would appear that the risk is for QE ending sooner than current expectations, rather than later.

So, with regard to the market, the minutes only further reinforced the fact that interest rates are going higher as is the U.S. Dollar, unless economic data turns decidedly worse.  So, in my opinion, today’s Dollar Index decline and Treasury rally is doing nothing other than providing a great entry point to get exposure to the most powerful trends in the market:  Higher rates, which strengthens the bullish case for “short bond” plays like TBF, TBT, SJB, banks, etc.