No Harm In Waiting For A Fed Increase

Financial Review

First Do No Harm

Sinclair Noe — September 17, 2015

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

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DOW – 65 = 16,674
SPX – 5 = 1990
NAS + 4 = 4893
10 YR YLD – .08 = 2.22%
OIL – .25 = 46.90
GOLD + 11.80 = 1132.00
SILV + .21 = 15.24

The Fed will raise rates someday, just not today. The FOMC issued their statement today, and they left interest rates unchanged, again. The biggest change in the wording dealt with international markets, saying: “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”

The statement also included this new line: “The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced, but is monitoring developments abroad.” You may recall that China was also frequently referenced in the Beige Book published a couple of weeks ago in preparation for this FOMC meeting.

The Fed also released their economic projections and they seem to be forecasting more of the same: GDP just over 2% for 2015, the unemployment rate finishing the year at 5%, inflation still significantly short of their target, and the outlook for a rate hike before the end of the year. But don’t bet on it; this Fed might never get off the Schneid. There will be growing pressure for a rate hike, if only to avoid the perception that the Fed is weak, or the idea of a Yellen put, or the view that market volatility is enough to stay the Fed’s decision again.

And the Fed’s decision to wait raises concerns about global economic weakness. Slowing growth in China has rippled across the world, hitting commodity-producing countries hard. The MSCI Emerging Markets Index, which captures stock markets in nations such as Brazil, Chile, Egypt and China, is down 14 percent this year. Just how bad is the situation in the emerging markets? And is it about to get worse?

The statement from the Fed also featured the first dissenter, Richmond Fed President Jeffrey Lacker was gung ho for a 25 basis point increase. And in the economic projections, known as the “dot plot”, which include forecasts of where each policymaker thinks the Fed should have its policy rate at the end of a given period, there’s one remarkable outlier in the projections.

For the first time ever, one monetary policymaker thinks the U.S. needs to move to negative interest rates until at least the end of 2016 to achieve full employment and get inflation back to 2 percent. That was probably the parting shot of outgoing Minneapolis Federal Reserve Bank President Narayana Kocherlakota. Beyond that one vote for negative rates, most of the dots point to higher rates by the end of the year. And there is a good chance that might happen, if only to prove they can.

The decision to leave rates unchanged doesn’t mean much; remember we’re talking about one-quarter of one percent. The Fed hasn’t chosen to resolve the doubts about whether its monetary tools can raise rates without causing upheaval in the banking system. But it has also chosen not to create new uncertainty over whether a rate hike is a one-off or a signal of more to come. Even so, forecasts show policymakers predicted that the Fed’s benchmark rate would rise gradually, reaching 2.6 percent by the end of 2017. In June, they predicted that the rate would reach 2.9 percent by then.

Futures traders are pricing in a 21 percent probability the central bank increases it target range in October, a 49 percent chance by the December meeting and a 56 percent likelihood by January. Treasuries rallied, pushing yields lower; while the dollar tumbled to a three-week low; stocks wobbled then slipped – there is bound to be some concern that slowing global growth could hamper the domestic economy.

There was some speculation that if the Fed didn’t raise rates today, they would at least come out with a hawkish statement, reaffirming their intent to raise rates soon – but that didn’t happen. And so this is being interpreted as a very dovish statement from the Fed. It might also be giving us some insight into the Yellen-led Fed. Greenspan or Bernanke probably would have hiked rates, right or wrong. And I thought Yellen would be a bit more hawkish, just to be assertive. That was not the case. Yellen appears more cautious, but that doesn’t mean she made a mistake.

There is more danger in hiking rates prematurely than in waiting. The Fed may think inflation is transitory but for now, it certainly isn’t a problem – no harm in waiting. The Labor market has been improving but there is still plenty of slack; a stronger labor market might attract some discouraged workers to try again; a stronger labor market might result in push on stagnant wages – no harm in waiting.

If the Fed raises rates, no borrower will feel the pain more acutely than the federal government, the nation’s largest borrower; and fiscal policy has been irresponsible at best; the Fed couldn’t feel confident raising rates with the prospect of a federal government shutdown in less than 2 weeks – no harm in waiting.

The housing market has finally shown signs of life, but many markets, like Phoenix, still haven’t fully recovered; a Fed rate hike would almost certainly result in higher mortgage rates – no harm in waiting. A Fed increase might have prompted investors to pull money out of emerging, damaging their economies, and hurting their abilities to buy goods from developed countries – no harm in waiting.

The problem for the Fed is that any action they take will take time to work; steering the economy one way or the other is like trying to steer a huge ship, not a small sports car; there is lag time before the effects of policy are felt. And there might never be a perfect time to change policy. If they don’t get to it by the December, next year we move into an election year, which means there will be political implications thrown into the mix.

There was other economic news today. The number of Americans getting laid off from their jobs remains near the lowest level in decades. New applications for U.S. unemployment benefits fell by 11,000 to 264,000 in the seven days ended Sept. 12. This is the lowest level of claims since mid-July, when claims fell to 255,000, the lowest level since September 1974.

Construction of new homes slowed down over the past two months. Housing starts fell 3% to an annual rate of 1.13 million units in August. Starts in July were revised down sharply to a decline of 4.1% to an annual rate of 1.16 million units from the prior estimate of a 0.2% gain to 1.21 million.

The U.S. current account deficit narrowed to a preliminary $109 billion in the second quarter, or 2.5% of gross domestic product, from a revised $118 billion.

The Philadelphia Fed manufacturing index took a surprise turn into negative territory in September, falling to negative 6 from positive 8.3 in August.

Copper prices rose to two-month highs in early Asian trading on worries about supply disruptions due to a powerful earthquake off the coast of Chile – the world’s largest copper producer. The magnitude 8.3 quake shook buildings in the capital Santiago and generated tsunami warnings from New Zealand to California. Five people are now known to have died, and one million residents have been evacuated from Chilean coastal areas.

French media giant Altice has confirmed it will buy Cablevision for an enterprise value of $17.7B, or $34.90/share in cash (a 22% premium to Wednesday’s closing price). Together both operators represent the fourth-largest cable operation in the U.S. market.

General Motors has agreed to pay $900 million and sign a deferred-prosecution agreement to end a U.S. government investigation into its handling of an ignition-switch defect linked to 124 deaths. The deal means GM will be charged criminally with hiding the defect from regulators and defrauding consumers, however, the charges will be put on hold while the automaker fulfills the terms of its settlement. Individuals are also not expected to be charged in the criminal suit.

Australia’s antitrust regulator has deferred a decision again on Royal Dutch Shell’s proposed $70 billion takeover of BG Group, this time until Nov. 12, warning the deal could raise prices and cut the supply of natural gas to consumers on the east coast of Australia. The takeover has already been cleared by the European Commission, U.S. and Brazilian antitrust authorities, but still needs approvals from Australia’s Foreign Investment Review Board and China to go ahead.

Saying the deal was unlikely to hurt competition, the Justice Department has granted antitrust clearance to Expedia’s $1.3 billion takeover of rival Orbitz Worldwide. The department had investigated how the merger might affect the commissions Expedia and Orbitz negotiate with airlines, car rental companies and hotels and explored new charges to consumers.

Northrop Grumman  announced a new $4 billion share repurchase program. The defense contractor had previously approved a $3 billion program last December.

Sony said China censorship rules are hurting sales of its PlayStation 4 video game console, even though a ban on foreign-made gaming consoles was lifted last year.

KKR‘s Samson Resources filed for Chapter 11 bankruptcy protection, as the oil and gas producer hands control over to its lenders. Samson was bought four years ago by a group led by KKR for $7.2 billion.

Back from the dead? Google seems to have resurrected its troubled Glass connected eyewear project, now called Project Aura, by hiring engineers and software developers from Amazon. Aura will remain within Google rather than Alphabet to collaborate more closely with advanced technology efforts and develop other wearables. Google stopped selling the initial $1,500 version of Glass to consumers in January following waning interest, criticism over its price and privacy concerns.

Financial Review

Not Patient But No Hurry

Sinclair Noe — March 18, 2015

 

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

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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.