As we discussed yesterday, the minutes from the most recent Fed meeting (which was still under Yellen) gave us some clues about the tone of a Powell-led Fed. They acknowledged the lift they expected from fiscal policy, which we didn’t hear all of last year, despite the clear telegraphing of it from the Trump administration. Powell was Trump appointed. And it looks like the Fed messaging will now reflect that.
This is from his prepared remarks today:
“The economic outlook remains strong. The robust job market should continue to support growth in household incomes and consumer spending, solid economic growth among our trading partners should lead to further gains in U.S. exports, and upbeat business sentiment and strong sales growth will likely continue to boost business investment. Moreover, fiscal policy is becoming more stimulative. In this environment, we anticipate that inflation on a 12-month basis will move up this year and stabilize around the FOMC’s 2 percent objective over the medium term. Wages should increase at a faster pace as well.”
So he’s bullish on economic output, wage growth and therefore, inflation. That’s bullish for rates. And, for the moment, what’s bullish for rates is bearish for stocks.
Oddly, on the same day Powell had his first testimony to Congress, the two former Fed chairs (Bernanke and Yellen) thought it was acceptable to host a chat about monetary policy this afternoon at the Brookings Institute.
It looked a bit like a partisan counter-punch. The same two former Fed Chairs that were, not long ago, begging Congress for fiscal stimulus to take some of the burden off of monetary policy, continue to (now) criticize the move. In fact, in Powell’s statement, he called the lack of fiscal response from Congress in past years, a headwind: “some of the headwinds the U.S. economy faced in previous years have turned into tailwinds: In particular, fiscal policy has become more stimulative.”
The takeaway from our first look at Powell: He doesn’t sound like a guy that will risk choking off the benefits of fiscal stimulus with overly aggressive “normalization” of monetary policy. That’s good.
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With a Fed decision queued up for tomorrow, let’s take a look at how the rates picture has evolved this year.
The Fed has continued to act like speculators, placing bets on the prospects of fiscal stimulus and hotter growth. And they’ve proven not to be very good.
Remember, they finally kicked off their rate “normalization” plan in December of 2015. With things relatively stable globally, the slow U.S. recovery still on path, and with U.S. stocks near the record highs, they pulled the trigger on a 25 basis point hike in late 2015. And they projected at that time to hike another four times over the coming year (2016).
Stocks proceeded to slide by 13% over the next month. Market interest rates (the 10 year yield) went down, not up, following the hike — and not by a little, but by a lot. The 10 year yield fell from 2.33% to 1.53% over the next two months. And by April, the Fed walked back on their big promises for a tightening campaign. And the messaging began turning dark. The Fed went from talking about four hikes in a year, to talking about the prospects of going to negative interest rates.
That was until the U.S. elections. Suddenly, the outlook for the global economy changed, with the idea that big fiscal stimulus could be coming. So without any data justification for changing gears (for an institution that constantly beats the drum of “data dependence”), the Fed went right back to its hawkish mantra/ tightening game plan.
With that, they hit the reset button in December, and went back to the old game plan. They hiked in December. They told us more were coming this year. And, so far, they’ve hiked in March and June.
Below is how the interest rate market has responded. Rates have gone lower after each hike. Just in the past couple of days have, however, we returned to levels (and slightly above) where we stood going into the June hike.
But if you believe in the growing prospects of policy execution, which we’ve been discussing, you have to think this behavior in market rates (going lower) are coming to an end (i.e. higher rates).
As I said, the Hurricanes represented a crisis that May Be The Turning Point For Trump. This was an opportunity for the President to show leadership in a time people were looking for leadership. And it was a chance for the public perception to begin to shift. And it did. The bottom was marked in Trump pessimism. And much needed policy execution has been kickstarted by the need for Congress to come together to get the debt ceiling raised and hurricane aid approved. And I suspect that Trump’s address to the U.N. today will add further support to this building momentum of sentiment turnaround for the administration. With this, I would expect to hear a hawkish Fed tomorrow.
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With some global stock barometers hitting new highs this morning, there is one spot that might benefit the most from this recently coordinated central bank promotion of a higher interest environment to come. It’s Japanese stocks.
First, a little background: Remember, in early 2016, the BOJ shocked markets when it cut its benchmark rate below zero. Counter to their desires, it shook global markets, including Japanese stocks (which they desperately wanted and needed higher). And it sent capital flowing into the yen (somewhat as a flight to safety), driving the value of the yen higher and undoing a lot of the work the BOJ had done through the first three years of its QE program. And that move to negative territory by Japan sent global yields on a mass slide.
By June, $12 trillion worth of global government bond yields were negative. That put borrowers in position to earn money by borrowing (mainly you are paying governments to park money in the “safety” of government bonds).
The move to negative yields, sponsored by Japan (the world’s third largest economy), began souring global sentiment and building in a mindset that a deflationary spiral was coming and may not be leaving, ever—for example, the world was Japan.
And then the second piece of the move by Japan came in September. It was a very important move, but widely under-valued by the media and Wall Street. It was a move that countered the negative rate mistake.
By pegging its ten-year yield at zero, Japan put a floor under global yields and opened itself to the opportunity to doing unlimited QE. They had the license to buy JGBs in unlimited amounts to maintain its zero target, in a scenario where Japan’s ten-year bond yield rises above zero. And that has been the case since the election.
The upward pressure on global interest rates since the election has put Japan in the unlimited QE zone — gobbling up JGBs to push yields back down toward zero — constantly leaning against the tide of upward pressure. That became exacerbated late last month when Draghi tipped that QE had done the job there and implied that a Fed-like normalization was in the future.
So, with the Bank of Japan fighting a tide of upward pressure on yields with unlimited QE, it should serve as a booster rocket for Japanese stocks, which still sit below the 2015 highs, and are about half of all-time record highs — even as its major economic counterparts are trading at or near all-time record highs.
Over the past week, I’ve talked about the potential for disruption in what has been very smooth sailing for financial markets (led by stocks). While the picture has grown increasingly murkier, markets had been pricing in the exact opposite – which makes things even more vulnerable to a shakeout of the weak hands.
With that, it looked like we are indeed working on a correction in stocks. But it’s not just because stocks are down. It’s because we have some very important technical developments across key markets. The Trump trend has been broken.
Let’s take a look at the charts …
The above chart is the S&P 500. We looked at a break in the futures market last week. Today we get a big break in the cash market. This trendline represents the nice 45 degree climb in stocks since election night on November 8th. We have a clean break today.
Stocks ran up on the prospects that Trumponomics can end the decade long malaise in, not just the U.S. economy, but the global economy too. With that, the money that has been parked in U.S. Treasuries begins to leave. Moreover, any speculators that were betting the U.S. would follow the world into negative rate territory run for the exit doors. That sends Treasury bond prices lower and yields higher (as you can see in the chart above). So today, we also get a break of this “Trump trend” in rates as well (the yellow line). Remember, this is after the Fed’s rate hike last week — rates are moving lower, not higher.
Next up, gold …
I talked about gold yesterday — as being the clearest trade (higher) in an increasingly murkier picture for global financial markets. You can see in the chart above, gold is now knocking on the door of a break in this post-election Trump trend.
Remember, we’ve talked about the buy-the-rumor sell-the-fact phenomenon in markets. The beginning of the Trump trend in stocks started on election night (buying “the rumor” in anticipation of pro-growth policies). The top in stocks came the day following the President’s speech to the joint sessions of Congress (selling “the fact”, entering the “show me” phase).
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We had a heavy event calendar last week for markets, with the Fed, BOJ and BOE meetings. And then we had the anticipation of the G-20 Finance Minister’s meeting as we headed into the weekend.
As I said to open the week last week, markets were pricing in a world without disruptions. But disruptions looked likely. Still, the week came and went and stocks were little changed on the week, but yields came in lower (despite the Fed’s third rate hike) and the dollar came in lower (again, despite the Fed’s third rate hike).
Is that a signal?
Maybe. But as we discussed on Friday, the divergence between market rates and the rate the Fed sets is part central bank-driven Treasury buying (from those still entrenched in QE — Japan, Europe), and part market speculation that higher rates are threatening to the economy, and therefore traders sell short term Treasuries (rates go higher) and buy longer term Treasuries (rates go lower). With that, the Fed has been ratcheting the Fed Funds rate higher, now three times, but the 10 year government bond yield is doing nothing.
As for the dollar, if your currency has been weak, no one wanted to head into a G-20 Finance Ministers meeting and sit across the table from the new Treasury Secretary under the Trump administration (Mnuchin) and be drawn into the fray of currency manipulation claims. With that, the dollar weakened across the board last week.
All told, we had little disruption last week, but things continue to look vulnerable this week. Today we have the FBI Director testifying before Congress and acknowledging an open investigation of Trump associates contacts with Russia during the election. Fed officials have already been out in full force today make a confusing Fed picture even more confusing. And it sounds like the UK will officially notify the EU on March 29 that they will exit.
With all of the above in mind, and given the growth policies from the Trump administration still have little visibility on “when” they might get things done, the picture for markets has become muddied.
This all makes stocks vulnerable to a correction, though dips should be met with a lot of buying interest. Perhaps the clearest trade in this picture that’s become more confusing to read, is gold.
Gold jumped on the Fed rate hike last week, and Yellen’s more hawkish tone on inflation. If she’s right, gold goes higher. If she’s wrong, and the Fed has made a big mistake by hiking three times in a world that still can’t sustain much growth or inflation, gold probably goes higher on the Fed’s self-inflicted wounds to the economy.
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With the Fed’s third rate hike this week in the post-financial crisis era, let’s take a look at how market rates have reponded.
Here’s a chart of the U.S. 10 year government bond yield.
On December 16, 2015, the Fed moved for the first time. The 10-year traded up to 2.33% that day and didn’t see that level again for 11-months. Despite the fact that the Fed forecasted four hikes over the next twelve months, the bond market wasn’t buying it. A month later, the fall in oil prices turned into a crash. And the 10 year yield printed a new record low at 1.32%, just under the crisis lows.
On December 14, 2016, the Fed made the second move. This was after they had spent the better part of the last nine months walking back on what they thought would be their 2016 hiking campaign. The difference? Trump was elected the new President and he was already fueling confidence from talk of big, bold fiscal stimulus. The Fed’s big hiking campaign was placed back on the table. The high in yields the day the Fed made hike #2 was 2.58%. The next day it put in a top at 2.64% that we have not seen since.
And, of course, this past week, we’ve had hike #3. The 10 year yield traded up to 2.60% that day (Wednesday) and we haven’t seen it since, despite the fact that the Fed has continued to tell us another couple of hikes this year, and that the economy is doing well, expect about three hikes a year through 2018. Yields go out at 2.50% today.
So why aren’t market rates screaming? The 10 year yield should be 3.5%+ by now. And consumer rates should be surging. Is it the Bank of Japan, the European Central Bank and China buying our Treasuries, keeping a cap on yields? Is it that the market doesn’t believe it and thus the yield curve is flattening (which would project recession)? Probably a bit of both. The important point is that the Fed absolutely cannot do what they are doing if they think they will push the 10 year yield up to 3.5%+, and fast.
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Following the Fed yesterday, we heard from the Bank of Japan overnight, and the Bank of England this morning. As for Europe, we heard from the ECB last week.
Coming into this week we’ve had this ongoing dynamic, for quite some time, of the Fed going one way on rates (up) and everyone else going the other way (cutting rates, QE, etc.).
That’s been good for the dollar, as global capital tends to flow toward areas with rising interest rates and better growth prospects. That combination tends to mean a rising currency and rising investment values. What really determines those flows though, is the perception of how that policy spread, between countries, may change. Most recently, that perceived change in the spread has been in favor of it growing, i.e. Fed policy tighter or at least stable, while other spots of the world considering even easier on monetary policy.
That divergence in policy has been bad for currencies like the euro, the pound and the yen. But that hit to the currency is part of the recipe. It promotes higher asset prices, better exports and growth. And as Bernanke says, QE tends to make stocks go up, which helps.
Still, those stocks have lagged the strength in U.S. stocks. With that, over the past six months or so, I’ve talked about the opportunities in European and Japanese stocks for a catch up trade.
While U.S. stocks have continued to set new record highs, stocks in Europe and Japan have yet to regain the highs of 2015 — when the global economy was knocked off course, first by slowing China and a surprise currency devaluation, and later by a crash in oil prices.
With that, if you think Trumponomics marked the end of the decade long deleveraging period (post-financial crisis), and that the Fed is signaling that by ending emergency level monetary policy, then the rest of the world should follow. That means the next move in Europe, Japan, the UK will be toward normalization, not toward more emergency policies.
That means the expectations on the policy gap narrows. With that, we may have seen the bottom in the euro. If negative interest rates and an election cycle that has parties that are outright promising to destroy the euro can’t push it to parity, what can? If it can’t go lower, it will go higher.
And if the euro has bottomed and the next move for the central bank in Europe is tapering, the first step toward ending emergency policies, then this stock market in Europe looks the most intriguing for a big catch up trade – still about 20% off of the 2015 highs and well below the pre-crisis all time highs.
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As we head into the Fed tomorrow, stocks have fallen back a bit today.
Yesterday we looked at the nice 45 degree climb in stocks since Election Day. And the big trendline that looked vulnerable to any disruption in the optimism that has led to that climb. That line gave way today, as you can see.
The run up, of course, was on the optimism about a pro-growth government, coming in after a decade of underwhelming growth. The dead top in stocks took place the day after President Trump’s first speech before the joint sessions of Congress. There is a phenomenon in markets where things can run up as people “buy the rumor/news” and then sell-off as people “sell the fact.”
It’s a reflection of investors pricing new information in anticipation of an event, and then selling into the event on the notion that the market has already valued the new information. It looks like that phenomenon may be transpiring in stocks here, especially given that the timeline of tax reform and infrastructure spending looks, now, to be a longer timeline than was anticipated early on.
And as we discussed yesterday, it happens to come at a time where some disruptive events are lining up this week: from a Fed rate hike, to Dutch elections, to Brexit, to G20 protectionist rhetoric.
Stocks are up 6% year-to-date, still in the first quarter. That’s an aggressive run for the broad stock market, and we’re now probably seeing the early days of the first dip, on the first spell of profit taking.
What about oil? Oil and stocks traded tick for tick for the better part of last year, first when oil crashed to the mid-$20s, and then when oil proceeded to double from the mid-$20s. Over the past few days, oil has fallen out of it’s roughly $50-$55 range of the Trump era. Is it a drag on stocks and another potential disrupter? I don’t think so. Oil became a risk to stocks and the global economy last year because it was beginning to trigger bankruptcies in the American shale industry, and was on pace to spread to banks, oil producing countries and the global financial system. We now have an OPEC production cut under the belt and a highly influential oil man, Tillerson, running the State Department. With that, oil has been very stable in recent months, relative to the past three years. It should stay that way – until demand effects of fiscal policy start to show up, which should be very bullish for oil.
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This week will be a huge week for markets. Stocks continue to hover around record highs. Rates (the 10 year yield) sit at the highest level in three years.
This snapshot alone suggests a world that continues to believe that pro-growth policies “trump” all of the risks ahead. At the very least, it’s pricing in a world without disruptions. But disruptions look likely.
Here’s a look at stocks as we enter the week. Still in a 45 degree uptrend since the election.
But if we take a longer term look, this trendline looks pretty vulnerable to any surprise.
Let’s take a look at the disruptions risks:
There was a chance that the official execution of Brexit may have come as soon as tomorrow — the UK leaving the European Union by triggering Article 50 of the Treaty of Lisbon. That looks unlikely now, but could come in the coming weeks. To this point the Bank of England has done a good job of responding and promoting stability which has led to financial markets pricing in an optimistic outcome.
We have the Fed on Wednesday. They will hike for the third time in the post-financial crisis era. We don’t know at what point higher interest rates, in this environment, might choke off growth that is coming from the fiscal side.
This next chart looks like rates might run to 3% on the 10-year. That would do a number on housing, IF tax reform and an infrastructure spend out of the White House come later than originally anticipated (which is the way it looks).
We also have the Bank of Japan and Bank of England meeting on rates this week. Let’s hope they have a very boring, staying the path, message. That would mean extremely stimulative policies for the foreseeable future 1) in the case of Japan, to continue to promote global liquidity and anchor global yields, and 2) in the case of the UK, to continue to promote stability in the face of uncertainty surrounding Brexit.
Keep this in mind: The Bank of Japan’s big QE launch in 2013 is a huge reason the Fed was able to end QE in the first place, and start its path of normalization. The BOJ launched in April of 2013. Bernanke telegraphed “tapering” a month later. The Fed officially ended tapering on October 29, 2014. Stocks fell 10% into that official ending of Fed QE. On October 31, 2014 (two days later), the BOJ surprised the world with bigger, bolder QE (a QE2). Stocks rallied.
Finally, to end the week, we have a G-20 finance ministers meeting. This is where all of the trade and dollar rhetoric from the new administration will be front and center. So the news/event outlook looks like some waves should be ahead. But any dip in stocks would be a great buying opportunity.
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It’s jobs week. Thanks to 1) Trump’s reminder to the country in his address to Congress last week that big economic stimulus was coming, and 2) Yellen’s remarks last week that all but promised a rate hike this month, the market is about as close to fully pricing in a rate hike as possible for March 15.
The last data point for everyone to obsess about going into next week’s Fed meeting will be this Friday’s jobs report.
But as I’ve said for quite a while, the jobs data has been good enough in the Fed’s eyes for quite some time. Nonetheless, they’ve had many, many balks along the path of normalizing rates over the past couple of years. Here’s a look at a chart of the benchmark payrolls data we’ll be seeing Friday.
You can see in this chart, the twelve-month moving average is 195k. The three-month moving average is 182k. The six-month moving average is 182k. This is all fairly consistent with historical/pre-crisis levels.
So the numbers have been solid for quite some time, even meeting and exceeding the Fed’s targets, especially when it comes to the unemployment rate (4.7% last). However, when the Fed’s targets have been met, the Fed has moved the goal posts. When those goal posts were then exceeded, the Fed found new excuses to justify their decisions to avoid the path of aggressive hikes/normalization of rates that they had guided.
Among those excuses: When jobs were trending at 200k and unemployment breached 5%, the Fed started to acknowledge underemployment. Then the lack of wage growth became the focus. Then it was macro issues. To name a few: It’s been soft Chinese economic data, a Chinese currency move, Russian geopolitical tensions, collapsing oil prices, Brexit and weak productivity.
And just prior to the election last year, the Fed became, confusingly, less optimistic about the U.S. economic outlook, which was the justification to ratchet down the aggressive projected path for rates.
I suspected last year, when they did this that they were making a strategic pivot, to set expectations for a much easier path for rates, in hopes to keep people spending, borrowing and investing — instead of promoting a tighter path, which proved for the better part of two years (prior to the election) to create the opposite effect.
Remember, Bernanke (the former Fed Chair) even wrote a public piece on this last August, criticizing the Fed for being too optimistic in its projections for the path of interest rates. By showing the market/the world an expectation that rates will be dramatically higher in the coming months, quarters and years, Bernanke argued in his post that this “guidance” has had the opposite of the desired effect – it’s softened the economy.
A month later, in September, in Yellen’s post-FOMC press conference, she said this in response to why they didn’t raise rates: “the decision not to raise rates today and to wait for some further evidence that we’re continuing on this course is largely based on the judgment that we’re not seeing evidence that the economy is overheating.” Safe to argue, the economy isn’t overheating, still.
Again, as I said on Friday, the only difference between now and then, is the prospects of major fiscal stimulus, which is precisely what the Fed claims to be ignoring/leaving out of their forecasts – a believe it when I see it approach, allegedly.
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With a Fed decision queued up for 
With some global stock barometers hitting new highs this morning, there is one spot that might benefit the most from this recently coordinated central bank promotion of a higher interest environment to come. It’s Japanese stocks.
It’s jobs week. Thanks to 1) Trump’s reminder to the country in his address to Congress last week that big economic stimulus was coming, and 2) Yellen’s remarks last week that all but promised a rate hike this month, the market is about as close to fully pricing in a rate hike as possible for March 15.