Commodities Are 2% Higher This Week – Here’s Why the Rally Can Continue.

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Commodities were up big Tuesday (DBC up 1%) as worries over Syria resulted in big rallies in the precious metals and energy. Another piece of stronger-than-expected Chinese economic data (industrial profits were better than estimates) and a weaker U.S. dollar also helped push commodities higher, but really yesterday was all about Syria.

And, showing the benefits of diversification: Although commodities have lagged badly this year, I want to point out that while most major global stock markets are down around 2% so far this week, the commodity ETF DBC is up 2.3%, to a 4+ month high.

Since Syria was behind the moves in commodities, instead of recapping the moves in the energy and metals markets (energy, including oil, was up about 2.5% yesterday, while gold rallied 1.5% and silver 2%), it’s more useful to explain exactly why Syria matters, and whether it’s going to be an ongoing positive for the commodity markets.

First, we’ve got to think about Syria in the context of everything else going on in North Africa and the Middle East.  Egypt, which continues to teeter, has been pushed to the back burner, but the debate about whether to suspend U.S. aid is still ongoing.  If the U.S. suspends aid, that’s a serious blow to the military-controlled government.  The Saudis, the world’s No. 2 oil producer, have expressed support for the military rulers, so if the U.S. does suspend aid, we can assume the Saudis will be none too pleased.

Now let’s move on to Syria, where we are considering a military strike.  The Russians, the world’s No. 1 oil exporter, support Syrian President Bashar al-Assad’s regime. It’s very safe to say that they will be upset by any U.S. military strike, as they want to see the current administration stay in place.  And, the Syrian conflict has further cooled already-frosty U.S./Russian relations. (Russian Deputy Prime Minister Dmitry Rogozin said on Twitter yesterday that “the West behaves toward the Islamic world like a monkey with a grenade.”)

So, there are two situations where U.S. interests seem, potentially, at odds with the world’s two largest oil producers.  Point being, while it’s unlikely that either situation will escalate too much further (even if we strike Syria it’s likely to be very limited, which will result in Russian criticism in the press but little else), the potential fallout, if either one does escalate significantly, is serious with regard to the world’s immediate energy needs.  That is why Syria, a country of approximately 145K bbls/day of oil production, is causing so much consternation right now.

WTI crude yesterday broke through resistance at $108/bbl and hit a new high for the year, as geo-political premium is pumped into the contract.  Gold also rallied through resistance at $1,400/oz. and silver traded through the $24.43 level, breaking a downtrend in place since last fall.

The rules of technical trading say that we should buy gold, silver and oil here, as they’ve broken through resistance and made new multi-month highs.  But, I have a very hard time buying anything when an extraneous event like Syrian military conflict is behind the move. That’s because in reality we’re just guessing, as we’ve got no edge or insight as to when and how the U.S. will strike Syria, and what the reaction will be.  And, guessing with no discernible edge in this business inevitably leads you into trouble.

So, if you’re long commodities and made the good buy back in June and July, I think you enjoy this rally. However, just realize it’s fickle and that, if the global macro backdrop settles down, we’ll see WTI and gold give back yesterday’s gains.

But, more importantly, looking beyond Syria, I believe both gold and oil are seeing the environment get more-bullish for the remainder of the year. If we see continued progress in the global economy, expect consistently higher prices once all this Syria turmoil settles down.

And, I think the commodity space in general, while a bit overbought, continues to offer an attractive place for incremental capital and potential outperformance between now and the end of the year.  If you’re not long commodities already, though, I’d be inclined to wait for a pullback before getting broad commodity exposure via DBC or a similar ETF.

The Economy: A Look Back and What’s Ahead

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Last Week

Economic data last week was largely supportive of the current market trends (improvement in global economic growth & tapering of QE in the U.S. to begin this fall). But the one glaring exception was Friday’s new home sales report, which implies higher mortgage rates are indeed acting as a headwind on the housing recovery.

FOMC minutes from the August meeting was the most-watched item last week, although they failed to provide any insight into when the Fed might taper QE or how they might do it (size of the taper and split between Treasuries or mortgage-backed securities).  The minutes showed a divided Fed that lacks consensus on every aspect of tapering QE … other than the fact that they all agree QE does need to be tapered starting this fall.

The bottom line from the Fed minutes (and the outlook for Fed policy) is that the market “consensus” (and I use that term lightly because it’s not a big majority that see tapering in September) is that the Fed will announce a small tapering ($10 billion-$15 billion) to start in October and it will occur entirely in Treasury purchases. That represents a slightly more “dovish” outlook than we had going into the meeting (the expectation for a September taper was a bit higher, and the amount of tapering was expected to be around $20 billion).  But, the key is that tapering is still on schedule for later this year.

The second big release last week was the flash global PMIs, and they were universally better than expected.  Importantly, China’s flash manufacturing PMI got back above 50 for the first time since April, and Germany and the EU’s flash PMIs beat estimates.  This data further implies we’re seeing a stabilization of global economic growth, which should continue to benefit European and Chinese markets.

Finally, housing was in focus last week, and here’s where an otherwise good week of data hit a speed bump.

Existing home sales for July largely met expectations, but the new home sales data released Friday was a big miss. Not only did the headline badly miss, but we also saw a revision of negative 64K to the prior three months’ sales data.

While this report doesn’t show the housing recovery has stalled, this report has to make investors and the Fed nervous that higher mortgage rates are indeed acting as a headwind on the recovery. And if the housing data continues to appear to be getting soft, we could see an even smaller “taper” in September than currently expected.

This Week

Although there are numerous releases this week, the data is largely “second-tier” and unless it’s horrid, it shouldn’t really change current Fed expectations.

Revised 2Q GDP is released Wednesday, and there aren’t expected to be any major positive or negative revisions from the 1.7% annual rate that was announced at the preliminary look back in July.

Personal income and outlays is the second most important report this week, but not because of the headline data.  Instead, the core Personal Consumption Expenditure price index, which is the Fed’s favorite measure of inflation, is contained in the report. Markets will be looking to see if we get any uptick in that price index, which would imply we are seeing the seeds of inflation.

Given last Friday’s report, housing also remains in focus this week as we wrap up the July housing data.  Pending home sales is released Wednesday, and this will be a more closely watched report than usual given last Friday’s New Home Sales miss.

Is This Decline a Buying Opportunity? Here’s The Key Indicator To Watch.

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India Is Now the Center of the EM Crisis—Watch EPI & ICN as They’ll Bottom First.

The turmoil in India seems to be asserting itself as the tail wagging the emerging-market dog.  The relentless declines in the rupee have been a problem for months, but the acceleration recently has stoked concerns that we may see a full-blown capital flight out of India.  That’s a pretty big concern, because while it is an emerging market, India is also one of the 10 largest economies in the world. A current-account or balance-of-payments crisis in India would have significant ripples across the globe.

Already a problem, the situation in India has been made worse by recent “flip-flopping” by the Reserve Bank of India.  Several weeks ago, the RBI took measures to tighten liquidity and push up interest rates in an effort to stem the slide in the rupee.  Well, it didn’t work, and yesterday the RBI reversed course and provided liquidity to the market (effectively pushing borrowing costs lower) after they realized that the higher rates they manufactured several weeks ago were putting stress on Indian banks and risking a further economic slowdown.

Basically, the market is losing confidence in the RBI. It is becoming clear that they don’t know what they want to do:  hold up the rupee or help support economic growth in the short term.

Bottom line is the rupee is making new lows vs. the dollar almost every day, and it’s becoming more volatile (it moved more than 3% from peak to trough yesterday) as the RBI flails about.

This sounds a bit odd, but I don’t think markets can rally until we get calm in the emerging currency and bond markets, and I don’t think we can get calm in the emerging currency and bond markets until India stabilizes. So, that puts the WisdomTree India Earnings Fund (EPI) and the WisdomTree Indian Rupee Fund (ICN) at the top of our watch list, just above the PowerShares Emerging Markets Sovereign Debt Portfolio (PCY) and the iShares JPMorgan USD Emerging Markets Bond Fund (EMB).

Bottom Line

If you’re looking for a reason to be a bull, there were some anecdotal positives yesterday, but nothing much changed.  If interest rates can slow their ascent and emerging markets can behave (they don’t really have to rally) then, like we saw in July, this market can rally.

But, the bottom line is the global market continues the process of adjusting to the beginnings of a policy change from the Fed, and it’s an adjustment process that will take time and have its share of hiccups.  Although I think the burden of proof remains with the equity bears, I’d be cautious about adding any additional long exposure other than to European equities (EWU, EIRL) so far on this dip.

I will again point out that the much-easier way to make money from the new reality of higher interest rates is by getting positive exposure to higher rates (TBF, TBT, STPP), not by analyzing each and every tick of an equity market in August that is very thinly traded.

Heres’s Why The Plunge in the Indian Rupee Matters To You

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In May and June, when markets initially declined on the prospects of Fed tapering, I pointed out to my clients two very important things we all needed to keep in mind as the market started to adjust to the reality of higher interest rates in the future.

First, it’s the pace of the rise in interest rates that’s important, not the absolute level.  So, the stock market can rally along with interest rates, as long as the pace of the rise in interest rates isn’t too fast.

Second, emerging-market debt is now the “leading edge” of any potential market turmoil, as that sector has replaced Europe as the “weakest link” in the global financial system.  Stable emerging debt markets are a pre-requisite for any sustainable rally in stocks.

With that in mind, after we saw an initial shock in May/early June, the pace of the increase in interest rates leveled off, and emerging-market debt stabilized—which allowed the stock market rally to new all-time highs.

But, over the last week, emerging debt markets have quietly begun to break down again as the pace of the rise in interest rates here in the U.S. has quickened substantially. (The 10-year yield went from a low of 2.55% last Monday to a high of 2.899% yesterday.)

In reaction to that acceleration, emerging-market bonds—as measured by the PowerShares Emerging Markets Sovereign Debt ETF (PCY) and the iShares JPMorgan USD Emerging Bond Fund (EMB)—have declined sharply, and are now dangerously close to breaking down.

As a refresher, I’ve included an excerpt from the June 12 Report that explains why emerging-market debt poses a potentially significant risk to the market (below):

Why The Plunge In the South African Rand Matters to You (June 12th 7:00’s Report).

“Away from the yen, the other focus in the currency markets was on the implosion we’re seeing in emerging-market currencies.  The Indian rupee hit another all-time low vs. the dollar. The Brazilian real and South African rand hit four-year lows vs. the dollar, and even strong currencies like the Mexican peso got hit yesterday. 

“The reason for the weakness is this:  Since the Fed went to 0% interest rates and round after round of QE, investors have moved into higher-yielding emerging-market currencies over the past few years. 

“Now with the Fed potentially ‘tapering’ and interest rates in the U.S. rising, investors are reversing the trade. They no longer need to take the risk of being in emerging markets, as rates are rising here at home. 

“That’s causing the currencies of those emerging-market countries to drop as investors sell their bonds and reconvert those investments back into dollars.  Basically, ‘doomsayers’ are saying the world’s major central banks, led by the Fed, have created a bubble in emerging-market credit, and now it’s popping.

“The question I’m sure you’re asking right now is ‘Why the hell do I care about emerging-market credit?’  Well, you care because, as these currencies and bonds plunge, it’s causing losses in the leveraged hedge funds that have put the trade on. That’s causing them to liquidate other holdings to cover the losses (like stocks and gold, for instance). 

“Point being, you should care for the same reason everyone should have cared when the mortgage-backed security markets started blowing up in ‘07, ‘08 and eventually led to the takedown of Bear, Lehman, etc.  I’m not saying it’s the same thing here at all—but it’s the leverage and the huge declines that are making people nervous. 

“So, while it’s not a disaster yet, this unwind out of emerging-market debt and currencies is having an effect on all asset classes.  It’s not anywhere near 1998-style proportions yet (the emerging-market debt crisis), but it is unnerving investors, and weighing on other risk assets.  Bottom line is watch PCY and EMB, the two emerging-market bond ETFs. Emerging-market bonds need to stabilize in order for equity markets to calm down a bit.”

Bottom Line

The market dynamic may have changed a bit Monday, and for the worse.  The acceleration in the rise in interest rates is causing another round of turmoil in the emerging markets. And, as stated, a stable EM debt market is a requirement for any rally in the global equity markets.  If emerging-market bonds can’t stabilize at these levels and they take another leg lower, then stocks are going to follow them down, regardless of the positive economic momentum in Europe China, etc.

My optimism on equities has been consistently hedged with the statement “if the macro environment stays relatively clear.”  Well, an emerging-market currency/debt crisis doesn’t constitute a “relatively clear” macro horizon, so emerging markets need to stabilize before equities can resume their rally.

Keep an eye on PCY and EMB—if they break down to new lows, that’s a sign to get defensive with regard to domestic and international equity exposure.

I wouldn’t sell yet as EM bonds haven’t made new lows, and keep in mind the EM inspired dip in June turned out to be a buying opportunity.  But, this is a potential game changer if we get a sustained move lower in the emerging markets, so I’d certainly get a plan together about just how I want to de-risk if EM bonds break down further.

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).