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Wednesday, March 18, 2015

Not Patient But No Hurry

Financial Review

Not Patient But No Hurry

DOW + 227 = 18,076
SPX + 25 = 2099
NAS + 45 = 4982
10 YR YLD – .11 = 1.95%
OIL + 1.25 = 44.71
GOLD + 18.30 = 1166.90
SILV + .36 = 15.99

Today is Fed decision day. The Federal Reserve released a policy statement along with quarterly economic projections followed by a Janet Yellen news conference. In the statement, the Fed removed the phrase about being “patient” regarding an interest rate increase, which might seem like bad news for Wall Street; except, they came up with new language which sounds like they will be …, well, patient about increasing interest rates.

Here is the new language: The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term. 
So, now we are looking for “further improvement in the labor market” and reasonable confidence” about inflation.

If this sounds like so much word play, well it is; but the bottom line is that they did not make a firm commitment to raising rates in June, and it could be quite some time until we see interest rates rise. Wall Street liked it and went from a triple digit loss to a triple digit gain.

Maybe Wall Street shouldn’t be so happy. The flip side of the interpretation is that there is still way too much slack in the labor force and we are dealing with disinflation and maybe even deflation. Throw in weak economic data and add a dash of a very strong dollar and aggressive monetary policy from the Bank of Japan and the European Central Bank which may already be having an effect similar to a rate increase by cutting into US exports. And you are looking at Fed monetary policy that has painted itself into a dovish corner. Or maybe we can just chalk it up to bad winter weather and a temporary drop in oil prices; whatever, Wall Street seems to love uncertainty when it comes to raising rates.

The Fed’s economic forecasts see the economy growing 2.3% to 2.7% in 2015, below its prior target of 2.5% to 3%. Nor does the Fed see the U.S. growing more than 2.7% in 2016 or 2017, even with the unemployment expected to fall to as low as 4.8% from its current 5.5% level. And then converting that economic forecast into a dot plot chart, shows interest rates going from zero to  0.625% by the end of the year, down from an earlier projection of 1.125% by the end of 2015.

After the Fed issued the statement, Janet Yellen held a news conference. She said that even though the Fed removed the word patience, they will be patient. Other highlights of the news conference: Yellen says productivity has been “disappointingly low.” She said that equity valuations “appear on the high side but not outside of historical ranges,” and she had no comment of specific sectors, such as biotech. She said the Fed hasn’t made a decision about when to reduce its balance sheet. She also said the Fed can’t change the “brazen” behavior at some of the banks it supervises; which seems like a strange thing for a regulator to admit. And regarding the specifics about just how much improvement the Fed would need to see in the labor market and how confident they would need to be about inflation, well, that was all a little vague but Yellen says the Fed will know it when they see it.

For now, the Fed has opened the door for a rate hike but they don’t appear to be in a hurry to cross the threshold.

Oil extended losses earlier today, and then turned higher following the Fed announcement. Late yesterday the American Petroleum Institute said its data showed U.S. crude stockpiles rose by a massive 10.5 million barrels in the week ended March 13. That was more than double market expectations. This morning the EIA reported that stockpiles rose by 9.6 million barrels to 458 million barrels last week; that’s a new record, and storage has been surging for 10 consecutive weeks. Oil prices have been falling since mid-2014, but the decline stalled in February, raising expectations that prices had bottomed out. But Nymex oil has lost roughly 15% month to date as production has surged despite lower prices; even if we haven’t seen a corresponding drop in retail prices yet; always a little lag in lowering prices at the pump.

Prices are low, storage is filling up, and oil-drilling rigs are being idled at an unprecedented rate. But the U.S. oil boom hasn’t slowed yet.  Global oil demand marches higher each and every year by nearly a million barrels per day. Inventories aren’t likely to max out, there is still room in the storage tanks; but even the possibility of that happening is adding pressure to an oversupplied oil market.

Supply and demand have both been freakishly in tandem for the last 15 years; each up by the same million barrels. Global demand is right around 93 million barrels a day; so just a swing of a few million barrels per day can swing the price from $40 a barrel to $120 a barrel. So, we will see domestic production growth slow, probably sooner rather than later. OPEC is expected to cut production in June. So, the thinking, including Fed forecasts, is that oil prices will rise again, with all the attendant implications for the economy.

There is something that could change the equation for oil price volatility – renewable energy. The cost of solar cells has fallen 75% over the last six years. Meanwhile, fuel efficiency has been improving. Renewable energy doesn’t have to replace oil in order to put a thumb down on global energy prices. It merely needs to become the “swing producer,” what the US became in the past half-decade thanks to the fracking boom, the additional source of supply that tips the balance.

Oil prices may go lower, but at some point the price movement will swing and probably move higher, which would encourage some oil producers to tap wells that are being idled today, but higher oil prices will also encourage more renewable supplies. Eventually, all these wild swings in energy prices will give way to stable, predictable energy, but not just yet.

Greece frustrated its main creditors yesterday by refusing to update euro zone peers on its reform progress at a scheduled teleconference, insisting that the discussions should be escalated to tomorrow’s EU summit. Prime Minister Alex Tsipras hopes to unlock funds from the country’s $254 billion bailout package. Greece faces about $2.1 billion in debt payments on Friday. Athens is likely to run out of cash by the end of the month. The IMF says Greece is its most “unhelpful client ever.” This is all pointing to a possible Greek exit from the Eurozone.

And it is a safe bet that the ECB has been calculating the possibility of a Greek Exit. Greece has about € 320 billion in debt. You would have to think an exit would mean default. And you might wonder why Greece would default when there was already a bailout, two bailouts actually. In the first bailout, the ECB allowed European nations and banks to dump sovereign bonds onto the ECB balance sheet in exchange for cash. In the second bailout, the ECB dumped Greek bonds onto banks, mainly French and German banks. About 80% of the bailout money went to Greek bondholders, not to the Greek economy. So, the earlier bailouts were about giving money to banks that were using Greek bonds as collateral to meet capital reserve requirements. It had almost nothing to do with helping Greece.

So, if Greece defaults, what are the implications? Well Greek debt amounts to about 2% of Europe’s GDP. Why not take a hit and give Greece a fresh start with a square deal that has them make much smaller payments with a haircut for the bondholders? And the most likely answer is that the Troika – the ECB, and the IMF, and the Euro Monetary Union – don’t care a flip about Greece. The fear is that if Greece gets a deal, then Spain and Italy and Portugal and maybe even France will want a deal; and then you are talking about € 3 trillion in sovereign debt, which in turn has been used as collateral for something like € 100 trillion in various derivatives deals. So, the Troika can’t afford a Greek default and they can’t afford a precedent of leniency; which means the preferred approach is to take a hard line to force the Greeks into a bad deal, again.

Just one little problem, now, it is obvious that it is a bad deal. The Greek voters voted against more austerity and more bad deal. Other Europeans see what is happening to Greece and they don’t’ want the same deal. Violent protests hit the streets of the German city of Frankfurt today, as anti-austerity protesters rallied against the opening of a new $1.4 billion building for the European Central Bank.

Premera Blue Cross, which sells health insurance in the northwestern US, said information on 11 million people may have been exposed in a cyberattack uncovered six weeks ago. Hackers may have accessed information including names, Social Security numbers, bank accounts and medical information. The company says it discovered the breach on Jan. 29, said notified the FBI, and is sending letters to affected individuals.

Facebook is updating its PC and mobile Messenger apps to allow users to send cash to each other. Once users link a Visa or MasterCard debit card to their Messenger account, they will be able to send their friends money for free by tapping a dollar sign in the chat box. Some are now speculating that WhatsApp will also join rival messaging platforms to support payments.

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