Archive for category: Investing

FOMC Preview

Despite the official end of QE, this meeting should go generally according to plan, although there are 4 key areas where potential surprises are lurking. From a market standpoint, the FOMC is expected to be “dovish,” so most of the surprise risk is on the “hawkish” side (although it’s admittedly remote).

There are four keys to watch for in today’s FOMC announcement:

1. End of QE: Despite Fed President Bullard’s comments last week about potentially halting the tapering of QE due to global economic weakness, it is universally expected (and priced in) that the FOMC will end QE at this meeting. To say it would be a dovish shock if they did halt the taper would be an understatement.
2. Potential Removal of “Considerable Time”: This phrase and its potential removal was in focus at the September meeting. Basically, “considerable time” is thought to mean 6 months. So, if/when this phrase is removed from the statement, it’s anticipated that rate hikes will begin 6 months later. Given that it’s October, 6 months from now is March, which is earlier than current market expectations for rate “lift-off.” Expectation: “Considerable Time” will remain in the statement. Surprise Potential: Hawkish. If the phrase were removed, it would be a “hawkish” surprise with stocks, bonds and gold falling while the dollar rises.
3. Potential Removal of “Significant Underutilization of Labor Resources”: This is the other key phrase to watch. This refers to the slack in the labor market, and a removal of this phrase would imply a material upgrade to the jobs market. This would be “hawkish.” Expectation: The phrase stays or may be slightly modified—but not removed totally. Surprise Potential: Hawkish. If “significant underutilization of labor resources” is removed entirely, it’ll be a hawkish surprise with stocks, bonds and gold falling while the dollar rises.
4. Downgrade of Inflation: Starting in July, the FOMC basically upgraded its outlook on inflation, saying that it was moving toward its 2% goal and that downside risks to inflation had been diminished. But, given the recent drop in CPI, it’s possible the FOMC may re-insert some cautious language on inflation. It could say something like “inflation consistently below 2% poses a risk to economic performance, and the Committee will carefully monitor inflation going forward.” Expectation: It seems like the FOMC could re-insert cautious language about inflation. Surprise Potential: Dovish. This shouldn’t elicit too much of a market response, as we’ve already largely priced in a dovish meeting, but expect the dollar to sell off and bonds to rally (and stocks to rally modestly also) if the Fed again sounds cautious on the inflation front).

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Last Week

The market needed economic data last week to show that the global economy wasn’t as bad as markets had come to believe over the past month, and the data delivered.

On the growth and inflation fronts (the two main areas of concern for risk assets), data last week were solid if unspectacular (but helped correct sentiment, which had been getting almost exponentially worse each day).

The data started good last week as Chinese Q3 GDP was 7.3%, slightly under the 7.5% “target” but better than expected. And, importantly, it was comfortably above the 7% GDP “Maginot Line” that determines when concerns about Chinese growth become a significant headwind on risk assets.

But, the October flash manufacturing PMIs really helped calm nerves about the global recovery. Again, while not spectacular, they were definitely better than feared. At a 10K-foot level, the data last week showed the global economy is still recovering, and not contracting again, as expectations for German and Chinese PMIs were for both numbers to fall below 50 (signaling contraction) but both surprised to the upside.

The highlight was the German data (remember Germany is now “Ground Zero” for European economic worries. German manufacturing PMI rose 51.8 vs. (E) 49.5, while the Chinese data hung on, rising to 50.2 vs. (E) 49.9.

The broader EMU PMI was also a beat at 50.7 vs. 50.0 (but again showing expansion) while the U.S. number was a slight miss at 56.2 vs (E) 57.0—but the important thing is that, at an absolute level, activity in the manufacturing sector is still brisk.

Turning to inflation (and specifically worries about dis-inflation/deflation), the September CPI was also steady. Month-over-month CPI rose +0.1% vs. (E) 0.0%, and the year-over-year change in “core” CPI (which is the most important metric to watch) was unchanged from August at 1.7%. Again, while unspectacular, the data implied the dis-inflation threat in the U.S. isn’t increasing, which is a positive.

This Week

We get more important data on growth and inflation this week, but the most important event of the week will be the FOMC meeting Wednesday.

I’ll preview it as we get closer, but the almost universal expectation is for the FOMC to end QE (as expected). Where expectations differ, though, is what the statement will look like. Specifically, the big question is whether the Fed will remove the “significant time” statement or the “significant underutilization of resources,” thereby making the statement slightly more “hawkish.”

Given recent events with inflation and the global economy, the market is very interested to see if this has made the core of the FOMC more “dovish” or if they appear intent to stay the course. Given the rally in stocks, a slightly “dovish” statement has been priced in already.

After the Fed, the focus this week will be on inflation. The second most important event this week will be the October flash EU HICP, which comes Friday. Europe remains the major source of risk to global equities, and we need positive news on that front.

In the U.S. we also get an important inflation indicator Friday, via the “Core PCE Price Index” contained in the Personal Income and Outlays Report. The Core PCE Price Index is the Fed’s preferred measure of inflation, and for dis-inflation worries to recede further, we need to see the year-over-year number hold firm like in CPI.

Also, we get the quarterly Employment Cost Index Friday, which provided a big surprise to markets back in June when wage costs jumped higher. Remember, wage inflation begets broad inflation, so this will be watched to see if wage increases continued in Q3.

If those numbers are good, that will go a long way toward easing deflation worries in the EU and dis-inflation worries in the U.S.

From a growth standpoint, the first look at Q3 GDP comes Thursday, with expectations currently sitting just under 3.0%. Other than that we Durable Goods tomorrow and some more housing data (Pending Home Sales today, Case-Shiller tomorrow) and weekly jobless claims, which continue to hover at a near-15-year low.

Bottom line this week will be important from a Fed expectation and deflation/dis-inflation standpoint. If the Fed is dovish and the inflation numbers are steady, it will support a further rally in equities.

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What You Need to Know About the “Deflation” Threat

We are on the eve of another CPI report. As we look back over the last month, the surprise steep decline in the September CPI release was one of the catalysts that turned this market lower, as focus shifted squarely to dis-inflation and the stronger dollar.

But, it’s important to point out that what we have seen over the past two months in the U.S. was a commodity-led decline in inflation statistics … not full-scale deflation. For those of us who were in the business in 2008, we’ve seen what real deflation looks like (at least as close we ever want to get to it). Major indicators of monetary conditions, credit, economic activity, consumer spending, etc. are NOT showing dis-inflation. CPI is showing dis-inflation, mainly because of commodity prices.

Much has been made of the decline in the 5-year inflation break-evens (the difference in 5-year TIPS yields and 5-year Treasuries). Yes, it is true they have declined sharply. But, keep in mind TIPS are priced off of headline CPI – so as headline CPI drops (with oil and other commodity prices), then the attractiveness of TIPS also drops. Again, that’s because it is directly tied to headline CPI. Case in point, if you look at a chart of DBC (the commodity ETF), you’ll see it closely mirrors the drop in 5-year inflation expectations, and that’s not just a coincidence.

Two very reliable indicators of deflation (which I learned to follow during the ’08 crisis) are the adjusted monetary base and revolving consumer credit.

Adjusted monetary base is one of the most useful barometers of the stock of available money in the U.S. It’s accelerated to a new all-time high and is considerably higher than it was just a year ago, thanks to QE.

Revolving consumer credit (think credit card debt and other consumer-based lending) has exploded so far this year.

So, while things may change in the future, obviously, neither of these indicators are signaling we are seeing any sort of a deeper deflation threat.

PMIs are at multi-year highs. The six-month rolling average of payrolls is at multi-year highs. Durable goods, retail sales, housing prices, etc. are all fine. Weekly jobless claims hit an 14-year low last week.

Nothing in the economy that I can see is screaming dis-inflation, other than CPI and (potentially) the yield curve, which has flattened. But, I believe what’s going on in the bond market is a confluence of the short end selling off in anticipation of the Fed Funds hike next year (so short term rates go up), and the long end rallying as European money flows into Treasuries given their relative value (so long rates decline, flattening the yield curve). If we see a global deflation/depression, then obviously the U.S. won’t be immune, but my point here is to show the difference between real deflation, and commodity price-led dis-inflation.

Bottom line, there is a silver lining to this commodity-led dis-inflation, as it’s a positive for the U.S. consumer. And, over the next few days, we’re going to be laying out a case as to why we think a theme for the remainder of the year is the “return of the U.S. consumer” and why consumer-related stocks (finance companies and select retailers) can outperform if the broader market stabilizes.

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