We’ve talked a lot about the set ups for big moves in Japanese and German stocks, as these major stock markets have lagged the recovery in the U.S.
Many have yet to come to the realization that a higher growth, healthier U.S. economy is good for everyone — starting with developed marketeconomies. And it unquestionably applies to emerging market economies, despite the fears of trade constraints.
A trillion dollars of U.S. money to be repatriated, has the dollar on a run that will likely end with USDJPY dramatically higher, and the euro dramatically lower (maybe all-time lows of 0.83 cents, before it’s said and done). This is wildly stimulative for those economies, and inflation producing for two spots in the world that have been staring down the abyss of deflation.
This currency effect, along with the higher U.S. growth effect on German and Japanese stocks will put the stock markets in these countries into aggressive catch up mode. I think the acceleration started this week.
As I said last week, Japanese stocks still haven’t yet taken out the 2015 highs. Nor have German stocks, though both made up significant ground this week. Yen hedged Nikkei was up 4.5% this week. The euro hedged Dax was up 7.6%.
What about U.S. stocks? It’s not too late. As I’ve said, it’s just getting started.
We’ve talked quite a bit about the simple fundamental and technical reasons stocks are climbing and still have a lot of upside ahead, but it’s worth reiterating. The long-term trajectory of stocks still has a large gap to close to restore the lost gains of the past nine-plus years, from the 2007 pre-crisis highs. And from a valuation standpoint, stocks are still quite cheap relative to ultra-low interest rate environments. Add to that, a boost in growth will make the stock market even cheaper. As the “E” in the P/E goes up, the ratio goes down. It all argues for much higher stocks. All we’ve needed is a catalyst. And now we have it. It’s the Trump effect.
But it has little to do with blindly assuming a perfect presidential run. It has everything to do with a policy sea change, in a world that has been starving (desperately needing) radical structural change to promote growth.
Not only is this catch up time for foreign stocks. But it’s catch up time for the average investor. The outlook for a sustainable and higher growth economy, along with investor and business-friendly policies is setting the table for an era of solid wealth creation, in a world that has been stagnant for too long. That stagnation has put both pension funds and individual retirement accounts in mathematically dire situations when projecting out retirement benefits. So while some folks with limited perspective continue to ask if it’s too late to get off of the sidelines and into stocks, the reality is, it’s the perfect time. For help, follow me and look over my shoulder as I follow the world’s best investors into their best stocks. Our portfolio is up more than 27% this year. You can join me here and get positioned for a big 2017.
On Friday, we looked at five key charts that showed the technical breakout in stocks, interest rates, the dollar and crude oil.
All of these longer term charts argue for much higher levels to come. Remember, the big event remaining for the year is the December 14th Fed meeting. A rate hike won’t move the needle. It’s well expected at this stage. But the projections on the path of interest rates that they will release, following the meeting, will be important. As I said Friday, “as long as Yellen and company don’t panic, overestimate the inflation outlook and telegraph a more aggressive rate path next year, the year should end on a very positive note.”
On that note, today we had a number of Fed members out chattering about rates and where things are headed. Did they start building expectations for a more aggressive rate path in 2017, because of the Trump effect? Or, did they stick to the new strategy of promoting a view that underestimates the outlook for the economy and, therefore, the rate path (a strategy that was suggested by former Fed Chair Bernanke)?
The former is what Bernanke criticized the Fed as doing late last year, which he argued was an impediment to growth, as people took the cue and started positioning for a rate environment that would choke off the recovery. The latter is what he suggested they should move to (and have moved to), sending an ultra accommodative signal, and a willingness to be behind the curve on inflation — letting the economy run hot for a while (i.e. they won’t impede the progress of recovery by tightening money).
So how did the Fed speakers today weigh in, relative to this positioning?
First, it should be said that Bernanke also recently criticized the Fed for the cacophony of chatter from Fed members between meetings. He said it was confusing and disruptive to the overall Fed communications.
So we had three speakers today. New York Fed President William Dudley spoke in New York, St. Louis Fed President James Bullard spoke in Phoenix, and Chicago Fed President Charles Evans speaks in Chicago. Did they have a game plan today to promote a more consistent message, or was it a more of the disruptive noise we’ve heard in the past?
Fortunately, they were on message. Only Dudley and Bullard are voting members. Both had comments today that spanned from cautious to outright dovish. Dudley, the Vice Chair, wasn’t taking a proactive view on the impact of fiscal stimulus — he promoted a wait and see view, while keeping the tone cautionary. Bullard, a Fed member that is often swaying with the wind, said he envisioned ONE rate hike through 2019. That would mean, one in December, and done until 2019. That’s an amazing statement, and one that completely (and purposely) ignores any influence of what may come from the new pro-growth policies.
This is all good news for stocks and the momentum in markets. The Fed seems to be disciplined in its strategy to stay out of the way of the positive momentum that has developed. And that only helps their cause. With that, if today’s chatter is a guide, we should see a very modest view in the economic projections that will come on December 14th. That should keep the stock market on track for a strong close into the end of the year.
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Tomorrow we get the last jobs report of the year. And unlike the other 11 this year, this one doesn’t have the same buzz surrounding it, even though we have a big Fed meeting coming in just two weeks.
Why? It’s no longer a Fed-driven (monetary policy-driven) world. The switch has been flipped. With the Trump presidency bringing structural change and fiscal stimulus to the table; the markets, the economy, sentiment that has hinged so tightly to each data point has become far less fragile.
Earlier in the week, I talked about the inflationary effect of an OPEC cut. That’s continuing to reflect in the interest rate market. The 10 year yield ran up to just shy of 2.50% today. On a relative basis, it’s a huge move. Given where it has traveled from, it looks like an incredibly dramatic and even a destabilizing move. But on an absolute basis, a 2.5% interest rate on lending your money for 10 years is peanuts (i.e. it remains a highly attractive borrowing environment).
And if we step back and consider where we were last December, when the Fed made its first move on rates, the market had priced in the rate hike, and stood at 2.25% going into the decision. Following the Fed’s move, the bond markets started expressing the view that the Fed had made a mistake in its projection that the economy could withstand four hikes over the subsequent 12 months. That’s what they were telegraphing. And for that, the bond market began telegraphing chances of a Fed-induced recession.
Given the events of the past month, and the outlook for a more pro-growth environment for next year, the message that the bond market is sending is simply a perfectly priced in 25 basis point hike by the Fed this month, into an economy that can withstand it. Imagine that.
The fact that the jobs numbers and the Fed are becoming a smaller piece of the market narrative is very positive. In fact, I would argue there hasn’t been a jobs report, with a Fed meeting nearby, that has been less scrutinized in eight years.
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Yesterday I talked about how an OPEC cut on oil production would/should accelerate the Fed’s plan for interest rate hikes next year.
Interestingly, the former Fed Chair himself, Ben Bernanke, wrote a post today on the internet talking about the Fed’s rate path and its quarterly projections (which we looked at yesterday).
Like his post in August, where he interpreted a shift in the Fed’s communications strategy for us, the media, which is always following the latest shiny object, didn’t pick up on it then, didn’t pick up on his message about the Bank of Japan’s actions in September, and has barely reported on his new post today (to this point).
When Bernanke speaks, for anyone that cares about the direction of markets, interest rates and the economy — we should all be listening.
Let’s talk about some of the nuggets Bernanke has offered in recent months, to those that are listening, through simple blog posts. And then we’ll look at what he said today.
Remember, this is the man with the most intimate knowledge of where the world has been over the past decade, what it’s vulnerable to, and what the probable outcomes look like for the global economy. He advises one of the biggest hedge funds in the world, the biggest bond fund in the world and one of the most important central banks in the world (the BOJ), and clearly still has a lot of influence at the Fed.
Back in August he wrote a piece criticizing the Fed for being too optimistic in its projections for the path of interest rates. He said that the Fed’s forward guidance of the past two years has led to a tightening in financial conditions, which has led to weaker growth, lower market interest rates and lower inflation. In plain English, consumers and businesses start playing defense if they think rates are on course to be dramatically higher, and that leads to lower inflation and lower growth. The opposite of the Fed’s desired outcome.
With that, Bernanke thought they should be taking the opposite approach, and suggested it may already be underway at the Fed (i.e. they should underestimate future growth and the rate path, and therefore possibly stimulate economic activity with that message).
It just so happens that Yellen has been speaking from this script ever since. They’ve ratcheted down expectations of the rate path, and in her more recent comments she’s said the Fed should let the economy run hot (to give it some momentum without bridling it with higher rates).
Then in September, after the BOJ surprised with some new wrinkles in their QE plan, Bernanke wrote a post emphasizing the importance of their new target of a zero yield on their 10 year government bond. The media and markets gave the BOJ’s move little attention. It was as if Bernanke was acting as the communications director for the BOJ.
He posted that day saying that the BOJ’s new policy moves were effectively a bigger QE program. Instead of telling us the size of purchase, they’re telling us the price on which they will either or buy or sell to maintain. He said, if the market decides to dump Japanese government bonds, the BOJ could end up buying more (maybe a lot more) than their current 80 trillion yen a year.
Bernanke also called the move to peg rates, a stealth monetary financing of government spending (which can be a stealth debt monetization). The market has indeed pushed bond prices lower since, which has pushed yields back above zero, and as Bernanke suggested, the BOJ is now in unlimited QE mode (buying unlimited amounts of bonds as long as the 10 year yield remains above a zero interest rate). That’s two for two for Bernanke interpreting for us, what looks like a complicated policy environment.
So what did he talk about today? Today he criticized Fed members for sending confusing messages about monetary policy through their frequent speeches and interviews that take place between Fed meetings. But most importantly, he seemed to be setting the table for another 180 from the Fed on their economic projections at their December meeting.
Remember, they went from forecasting four hikes for 2016, to dialing it back dramatically just three months into the year. Now, with the backdrop for a $1 trillion fiscal stimulus package finally coming down the pike, to relieve monetary policy, the outlook has changed for markets, and likely the Fed as well.
With that, Bernanke seems to be trying to give everyone a little heads up, to reduce the shock that may come from seeing a Fed path, in it’s coming December projections, that may/will likely show expectations of more aggressive rate hikes next year — perhaps projecting four hikes again for the year ahead (as they did into the close of last year).
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In my November 2 note (here), I talked about three big changes this year that have been underemphasized by Wall Street and the financial media, but have changed the outlook for the global economy and global markets.
Among them was Japan’s latest policy move, which licensed them to do unlimited QE.
In September they announced that they would peg the Japanese 10 year government bond yield at ZERO. At that time, rates were deeply into negative territory. In that respect, it was actually a removal of monetary stimulus in the near term — the opposite of the what the market was hoping for, though few seemed to understand the concept.
I talked about it earlier this month as an opportunity for the BOJ to do unlimited QE, and in a way that would allow them to keep stimulating the economy even as growth and inflation started moving well in their direction.
With this in mind, the Trump effect has sent U.S. yields on a tear higher. That move has served to pull global interest rates higher too — and that includes Japanese rates.
You can see in this chart, the 10 year in Japan is now positive, as of this week.
With this, the BOJ came in this week and made it known that they were a buyer of Japanese government bonds, in an unlimited amount (i.e. they are willing to buy however much necessary to push yields back down to zero).
Though the market seems to be a little confused by this, certainly the media is. This is a big deal. I talked about this in my daily note the day after the BOJ’s move in September. And the Fed’s Bernanke even posted his opinion/interpretation of the move. Still, not many woke up to it.
What’s happening now is the materialization of the major stimulative policy they launched in September. This has green lighted the short yen trade/long Japanese equity trade again. It should drive another massive devaluation of the yen, and a huge runup in Japanese stocks (which I don’t think ends until it sees the all-time highs of ’89 — much, much higher).
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As we discussed on Friday, the dominant theme last week was the big run-up in global yields. This week, we have four central banks queued up to decide on rates/monetary policy.
With that, let’s take a look at the key economic measures that have been dictating the rate path or, rather, the emergency policy initiatives of the past seven years. Do the data still justify the policies?
First up tonight is Australia. The RBA was among the last to slash rates when the global economic crisis was unraveling. They cut from 7.25% down to a floor of just 3% (while other key central banks were slashing down to zero). And because China was quick to jump on the depressed commodities market in 2009, gobbling up cheap commodities, commodities bounced back aggressively. And the outlook on the commodity-centric Australian economy bounced back too. Australia actually avoided official recession even at the depths of the global economic crisis. With that, the RBA was quick to reverse the rate cuts, heading back up to 4.75%. But the world soon realized that emerging market economies could survive in a vacuum. They (including China) relied on consumers from the developed world, which were sucking wind for the foreseeable future.
The RBA had to, again, slash rates to respond to another downward spiral in commodities market, and a plummet in their economy. Rates are now at just 1.5% – well below their initial cuts in the early stages of the crisis.
But the Australian economy is now growing at 3.3% annualized. The best growth in four years. But inflation remains very low at 1.7%. Doesn’t sound bad, right? The August data was running fairly close to these numbers, and the RBA CUT rates in August – maybe another misstep.
The Bank of Japan is tonight. Remember, last month the BOJ, in a surprising move, announced they would peg the 10 year yield at zero percent. That has been the driving force behind the swing in global market interest rates. At one point this summer $12 trillion worth of negative yielding government bonds. The negative yield pool has been shrinking since. Japan has possibly become the catalyst to finally turn the global bond market. But pegging the rate at zero should also serve as an anchor for global bond yields (restricting the extent of the rise in yields). That should, importantly, keep U.S. consumer rates in check (mortgages, auto loans, credit card rates, etc.). Also, importantly, the BOJ’s policy move is beginning to put downward pressure on the yen again, which the BOJ needs much lower — and upward pressure on Japanese stocks, which the BOJ needs much higher.
With that, the Fed is next on the agenda for the week. The Fed has been laying the groundwork for a December rate hike (number two in their hiking campaign). As we know, the unemployment rate is well into the Fed’s approval zone (around 5%). Plus, we’ve just gotten a GDP number of 2.9% annualized (long run average is just above 3%). But the Fed’s favorite inflation gauge is still running below 2% (its target) — but not much (it’s 1.7%). Janet Yellen has all but told us that they will make another small move in December. But she’s told us that she wants to let the economy run hot — so we shouldn’t expect a brisk pace of hikes next year, even if data continues to improve.
Finally, the Bank of England comes Thursday. They cut rates and launched another round of QE in August, in response to economic softness/threat following the Brexit vote. There were rumors over the weekend that Mark Carney, the head of the BOE, was being pushed out of office. But that was quelled today with news that he has re-upped to stay on through 2019. The UK economy showed better than expected growth in the third quarter, at 2.3%. And inflation data earlier in the month came in hotter than expected, though still low. But inflation expectations have jumped to 2.5%. With rates at ¼ point and QE in process, and data going the right direction, the bottom in monetary policy is probably in.
So the world was clearly facing deflationary threats early in the year, which wasn’t helped by the crashing price of oil. But the central banks this week, given the data picture, should be telling us that the ship is turning. And with that, we should see more hawkish leaning views on the outlook for global central bank policies and the global rate environment.
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Remember, up to mid 2015, there were reasons to be optimistic about the outlook for the global economic recovery. The U.S. economy was improving. With the job market hitting targets, the Fed was preparing the world for the first rate hike, to begin moving away from emergency policies. The BOJ was keeping its promises of going full bore into an aggressive easing program which had driven the yen much lower, and stocks much higher, which was beginning to reflect in the economic data. And the European Central Bank had finally started an aggressive easing program to deal with deflationary malaise in the European economy. Better data plus continued aggressive global stimulus was reason to believe better times ahead.
But then came a jolt to markets by the Chinese making an about face on their currency (from strengthening to weakening). That created question marks about the health of China. Were things there worse than people think? And is China beginning to respond with a mass currency devaluation? That shook markets and confidence. And then we had the oil price bust early this year. That threatened mass industry defaults, and a spread to the global financial system. That shook markets and confidence. And, of course, we’ve had the surprising vote from the UK to leave the European Union (Brexit). That shook markets and confidence.
In this environment, stocks (especially U.S. stocks) are a key barometer of confidence. And it becomes self-reinforcing. When confidence shakes, stocks go lower. When stocks go lower, confidence wanes more. Weak confidence starts reflecting in weaker economic data. Weaker economic data pushes stocks lower. And the circle continues.
With this said, for much of the year, there has been speculation of another recession coming. The interest rate market had been pricing in a deflation forever story, with $12 trillion worth of global government bonds in negative yield territory at one point this past summer.
And despite the fact that the intensity of the macro concerns has abated, the fall back in the interest rate market was still sending a very cautionary signal to markets. That caution signal looks like it’s lifting. U.S. 10 year yields look like a run back above 2% is coming soon. And most importantly, the yield on German 10 year bunds (another key global benchmark interest rate) has been on a tear, exiting negative yield territory this week and running up to levels not seen since the day of the Brexit vote.
This move higher in rates, from record low levels, should be good for confidence, good for the economic outlook, and therefore good for stocks (as it removes the another cautionary cloud over sentiment).
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Last week we talked about the set up for a move in global bond yields. And we discussed the case for why the bond market may have had it very wrong (i.e. rates have been too low, pricing in way too pessimistic a view on the current environment).
Well, today rates have finally started to remind people of how quickly things can change. The U.S. 10 year yield finally broke above the tough 1.80% level and is now trading 1.85%. German yields have now swung from negative territory just three days ago, to POSITIVE 19 basis points at the highs today. Importantly, German yields are now ABOVE pre-Brexit levels.
Still, we’re approaching a second Fed rate hike and U.S. yields are almost 1/2 point lower than where they traded just following the Fed’s first hike in December of last year. As for German rates (another key benchmark for world markets), we found with the Fed in its three iterations of QE, that QE made market rates go UP not down, as people began pricing in a better outlook. That’s yet to happen in Germany. The 10 year yield was closer to 40 basis points when they formally kicked off QE – still above current levels.
But remember this chart we looked at last week.
In the white box, you can see the screaming run-up in yields last year. The rates markets had a massive position squeeze which sent ten–year German bond yields from 5 basis points (near zero) to 106 basis points in less than two months — a 20x move. U.S. ten–year yields (the purple line in the chart below) moved from 1.72% to 2.49% almost in lock–step.
This time around, as we discussed last week, let’s hope a rise in rates is orderly and not messy. Another sharp rise in market rates like we had last year would destabilize global markets (including the very important U.S. housing market).
But the buffer this time around should be the Bank of Japan. Remember, the Bank of Japan, just last month announced they would peg the Japanese 10 year yield at zero. Even with the divergent monetary policies in Europe and Japan relative to the U.S. (central bank rate paths going in opposite directions), the spread between U.S. rates and European and Japanese rates should stay tame. That means that Japan’s new policy of keeping their 10 year yield at zero will/should prevent a run away U.S. interest rate market – at least until there is a big upgrade in the expectation in U.S. growth. On that note, we get a U.S. GDP reading tomorrow.
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Yesterday we talked about the two big central bank events in focus today. Given that the Bank of Japan had an unusual opportunity to decide on policy before the Fed (first at bat this week), I thought the BOJ could steal the show.
Indeed, the BOJ acted. The Fed stood pat. But thus far, the market response has been fairly muted – not exactly a show stealing response. But as we’ve discussed, two key hammers for the BOJ in achieving a turnaround in inflation and the Japanese economy are: 1) a weaker yen, and 2) higher Japanese stocks.
Their latest tweaks should help swing those hammers.
Bernanke wrote a blog post today with his analysis on the moves in Japan. Given he’s met with/advised the BOJ over the past few months, everyone should be perking up to hear his reaction.
Let’s talk about the moves from the BOJ …
One might think that the easy, winning headline for the BOJ (to influence stocks and the yen) would be an increase in the size of its QE program. They kicked off in 2013 announcing purchases of 60 for 70 trillion yen ($800 billion) a year. They upped the ante to 80 trillion yen in October of 2014. On that October announcement, Japanese stocks took off and the yen plunged – two highly desirable outcomes for the BOJ.
But all central bank credibility is in jeopardy at this stage in the global economic recovery. Going back to the well of bigger asset purchases could be dangerous if the market votes heavily against it by buying yen and selling Japanese stocks. After all, following three years of big asset purchases, the BOJ has failed to reach its inflation and economic objectives.
They didn’t take that road (the explicit bigger QE headline). Instead, the BOJ had two big tweaks to its program. First, they announced that they want to control the 10-year government bond yield. They want to peg it at zero.
What does this accomplish? Bernanke says this is effectively QE. Instead of telling us the size of purchase, they’re telling us the price on which they will either or buy or sell to maintain. If the market decides to dump JGB’s, the BOJ could end up buying more (maybe a lot more) than their current 80 trillion yen a year. Bernanke also calls the move to peg rates, a stealth monetary financing of government spending (which can be a stealth debt monetization).
Secondly, the BOJ said today that they want to overshoot their 2% inflation target, which Bernanke argues allows them to execute on their plans until inflation is sustainable.
It all looks like a massive devaluation of the yen scenario plays well with these policy moves in Japan, both as a response to these policies, and a complement to these policies (self-reinforcing). Though the initial response in the currency markets has been a stronger yen.
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We have two big central bank meetings this week–BOJ and the Fed. With that, as we head into the week, let’s look at a key chart.
This chart is from a St. Louis Fed blog post last year. The inflation data, however, is all up-to-date. The Fed says “the chart above shows eight series that receive a lot of attention in the context of policy.”
So according to this chart, last year, as the Fed was building into its first rate hike to move away from emergency level rates and policies, the inflation data was looking soft. The Fed was telegraphing, clearly, a September hike, though six of the eight inflation measures in the chart above were running south of their target of 2% in the middle of last year. The headline inflation number for September, their preferred date of a hike, was zero!
Of course, after markets went haywire following China’s currency devaluation in August of last year, the Fed balked and stood pat. When things calmed, in December, they made their move. And at the same meeting, they projected to hike FOUR times this year. So far it hasn’t happened. It’s been a one and done.
Moreover, as of March of this year, they took two of those projected hikes off the table, and guided lower on growth, lower on inflation and a lower rate trajectory into the future. I would argue removing two hikes from guidance was effectively easing.
But if we look at the chart above, where inflation stands now relative to the middle of last year, when they were all “bulled-up” on rates, the story doesn’t jive. By all of the inflation measures, the economy is clearly running hotter (a relative term). Five of the eight inflation measures are running ABOVE the Fed’s 2% target (the horizontal black line in the chart). Yet, aside from a few Fed hawks that have been out trying to build expectations for a rate move soon, on balance, the messaging from the Fed has been mixed at best, if not dovish.
The Bernanke-led Fed relied heavily on communication (i.e. massaging sentiment and perception) to orchestrate the recovery, but the Fed, under Yellen, has been a communications disaster.
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