Don’t Fight the FedSinclair Noe May 18, 2016
DOW – 3 = 17,526
SPX + 0.42 = 2047
NAS + 23 = 4739
10 Y + .12 = 1.88%
OIL – .12 = 48.19
GOLD – 20.80 = 1259.00
There’s an old saying “don’t fight the Fed.” The Fed has indicated that if the data points to a rate hike, they would be prepared to hike rates in June. The markets have not reflected the Fed’s position.
The CME’s Fed Watch tool, which uses fed fund futures trading levels to determine the likelihood of a hike at each meeting, indicates that a better than 50 percent chance of a move doesn’t happen until the December FOMC session. Within the past week, futures trading indicated almost zero chance of an increase in June.
Yesterday, Atlanta Fed President Dennis Lockhart and San Francisco Fed President John Williams agreed that up to three rate hikes this year “seemed reasonable,” while Dallas President Robert Kaplan said he would call for a rate rise in June or July.
Today, the Fed released minutes from the April FOMC meeting. June is definitely on the table. The minutes indicated that members of the Federal Open Market Committee were worried that markets were underestimating the possibility of an early rate hike. Fed officials sought to correct this misconception, by spelling out what they need to see to raise rates in June. They expect to see continued improvement in the labor market.
The April jobs report was weak, and it was published after the FOMC meeting, but it wasn’t like the labor pool has dried up; the economy is still creating jobs and the unemployment rate is still low. Inflation continues to show signs of life, as evidenced by yesterday’s CPI report, which was stronger than expected. The broader economy had a rough first quarter, but it is perking up in the spring.
The domestic outlook was further enhanced by significant improvements in US and international financial conditions. The global risks are still out there. Japan and Europe are still weakened economies. One question mark on the international stage is the June 23 referendum on the UK exit from the Euro Union. That is a very big question mark.
So, the Fed did not take an unequivocal hawkish stance in the minutes, but they have largely abandoned the dovish position. In anticipation of the release, traders had started to reprice the probability of a Fed hike. According to CME Group, prices for futures contracts on the Fed’s benchmark overnight lending rate implied that investors saw a 34 percent chance of a rate increase next month, up from 19 percent shortly before the release of the minutes.
This was reflected in the upward move in yields on 2-year Treasuries, the maturity most sensitive to Fed action, the probability rise indicated by the Fed funds futures, or the flattening of the yield curve, led by the front end and to an extent not seen since December 2007. This repricing accelerated into the afternoon, with large yield spikes, particularly for 2-year and 5-year Treasuries. And to punctuate the point, the Dollar Index closed up, just a whisker above 95, the biggest jump for the dollar in 6 months, which in turn put the brakes on the recent rally in oil.
It is clear that Fed monetary policy has been a major source of support for the markets. And as the Fed moves further away from its Zero Interest Rate Policy, you have to wonder what catalyst can push the markets higher from these levels.
Japan’s economy dodged a recession last quarter as gains in government and consumer spending compensated for a slide in business investment. Gross domestic product expanded by an annualized 1.7%, exceeding all forecasts and recording the nation’s fastest pace of growth in a year. Prime Minister Shinzo Abe is widely expected to announce new fiscal stimulus during the G7 Summit this month as part of his “Abenomics 2.0” program.
Iran’s oil exports are set to surge in May, climbing nearly 60% from a year ago, with European shipments recovering to about half of pre-sanction levels, according to Reuters. This shows that Tehran is regaining market share at a faster pace than analysts had projected as it battles with Saudi Arabia for customers by lowering its prices. April loadings at 2.3-million barrels per day were around 15% higher than the International Energy Agency estimated earlier this month.
Goldman Sachs has downgraded its outlook on equities to “neutral” over the next 12 months, saying there’s no particular reason to own them. In a research note to clients, Goldman analysts wrote: “Until we see sustained signals of growth recovery, we do not feel comfortable taking equity risk, particularly as valuations are near peak levels.” Goldman also upgraded commodities to “neutral” on a three-month basis, stayed “overweight” on credit over both 3- and 12-month horizons, and remained “underweight” on bonds.
The Chair of the Securities and Exchange Commission says cyber-security is the biggest risk facing the financial system. Banks around the world have been rattled by an $81 million cyber theft from the Bangladesh central bank that was funneled through SWIFT, a member-owned industry cooperative that handles the bulk of cross-border payment instructions between banks.
SEC Chair Mary Jo White says some major exchanges, dark pools and clearing houses did not have cyber policies in place that matched the sort of risks they faced. Cyber security experts said her remarks represented the SEC’s strongest warning to date of the threat posed by hackers.
The U.S. Senate passed legislation that would allow families of Sept. 11 victims to sue Saudi Arabia’s government for damages. The “Justice Against Sponsors of Terrorism Act,” or JASTA, passed the Senate by unanimous voice vote. If it became law, JASTA would remove the sovereign immunity, preventing lawsuits against governments, for countries found to be involved in terrorist attacks on U.S. soil.
More than 4 million U.S. workers will become newly eligible for overtime pay under rules issued today. Under the new rules, the annual salary threshold at which companies can deny overtime pay will be doubled from $23,660 to nearly $47,500. That would make 4.2 million more salaried workers eligible for overtime pay. Hourly workers would continue to be mostly guaranteed overtime.
The United States has ramped up import duties on Chinese steel makers by 522%, accusing Beijing of anti-competitive behavior by selling steel below cost. Last year, U.S. Steel, AK Steel, ArcelorMittal, Nucor and Steel Dynamics, all filed a complaint to the International Trade Commission, alleging foreign companies were selling steel at unfairly low prices. The industry claims it has had to lay off 12,000 workers as a result of the unfair competition.
Google introduced its answer to Amazon’s Alexa virtual assistant along with new messaging and virtual reality products at its annual developer conference today, doubling down on artificial intelligence and machine learning as the keys to its future.
The new offerings include Google Assistant, a virtual personal assistant, along with the tabletop speaker appliance Google Home; plus, Allo, a new messaging service that will compete with Facebook’s WhatsApp and Messenger products and feature a chatbot powered by the Google Assistant; plus, a new virtual reality platform called Daydream designed to work with the Android mobile operating system.
Google Assistant can search the internet and adjust your schedule, and it can use images and other information to provide more intuitive results. For Google Home, the Google Assistant merges with Chromecast and smart home devices to control televisions, thermostats and other products. Google did not offer a specific release date or pricing for Google Home, saying only that it will be available later this year.
Target reported a lower-than-expected increase in quarterly sales at established stores and gave a cautious outlook for the current period, citing volatile weather and weaker demand for electronics and groceries. Shares of the company, which also reported slower digital sales growth, fell more than 9 percent in early trading.
Home improvement chain Lowe’s followed larger rival Home Depot in reporting better-than-expected quarterly sales as strength in the U.S. housing market and favorable weather led to strong demand for building and home renovation products. Results from the home improvement chains stand in stark contrast to grim quarterly sales reports from retailers such as Macy’s and Target, as consumer spending shifts away from apparel and accessories to big-ticket items including cars and homes.
San Francisco is set to become the first U.S. city to require health warnings on advertisements for soda and other sugar-added drinks after the beverage industry failed to get a court order to stop it. The law goes into effect July 25 and will require that billboards and other public advertisements include the language, “WARNING: Drinking beverages with added sugar(s) contributes to obesity, diabetes, and tooth decay.”
GrubHub shares hit a 2-month low yesterday, after Amazon announced it would expand restaurant delivery service into New York and Dallas. The offering is free with Prime membership and promises no markups from online menus. Where’s the profit? According to the NY Post, Amazon is reportedly charging restaurants 27.5% of each delivery order, compared to the 12-24% charged by GrubHub and Seamless, which merged in 2013.
Fedex has declared its recommended all-cash public offer for TNT Express unconditional, with all requirements having been satisfied or waived. Settlement will take place in one week.
Peabody Energy has won final bankruptcy-court approval for an $800M financing package after lenders made concessions to appease creditors. Peabody said final approval on the Chapter 11 financial arrangements ensures the company can continue operating as usual while it works through a load of debt that it can’t support given the declines in coal demand and prices.