Fed Chair Janet Yellen’s speech at 5 p.m. may help investors understand what circumstances the Fed needs to see if it is to move ahead with a rate increase this year — and whether continued market volatility, including the selloff in global equities in the past week, is an obstacle to a 2015 liftoff.
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We Still Aren’t Sure What Will Cause Janet Yellen to Pull the Trigger The central bank is facing a communications problem.
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The Fed Open Mouth Committee Roils Markets
The Fed’s stately building seems to have been replaced by a modern Tower of Babel with various speakers’ dissonant voices causing great uncertainty in the financial markets.
Gavyn Davies: A catch-22 for the Fed
(…) Mainly because of the rising dollar, the FCI [Financial Conditions Index] has identified a tightening of 200 basis points since last year, and 90 basis points since June 2015. It has actually tightened slightly since last week’s FOMC meeting. Although forward short-term interest rates have dropped by about 10-15 basis points, this has been more than offset by a stronger dollar and weaker equities.
According to Goldman Sachs, the tightening seen in the FCI has already resulted in a reduction in US GDP growth of 0.5 per cent (year on year); and this drag will increase to 0.8 per cent by 2015 Q4. This could explain why the US activity growth rate has fallen recently, according to the Fulcrum “nowcast” models, from 2.5 per cent in July to 1.7 per cent now.
Furthermore, Goldman Sachs calculates that the very recent tightening in the FCI would have the same effect as three quarter-point increases in the federal funds rate. As a result, they conclude that the current stance of the FCI is tighter than optimal, given the normal relationship with the Fed’s objectives for inflation and unemployment. That seems to be Mr Dudley’s view as well.
There is, however, a catch-22 with any attempt to use the FCI as a guide to setting monetary policy. Eventually, if the Fed really does want to tighten policy, it will have to follow through with its threat, or else the markets will undo the rise in the FCI as they realise that the Fed is bluffing. This is a game of chicken, a game with no unique equilibrium.
So how will this infuriating game end? If we are to believe their interest rate projections, a majority on the FOMC wants to press ahead with gradual rates rises, starting this year, regardless of the FCI. In the medium term, this might turn out to be the appropriate path for short-term interest rates. But, for now, given recent events in China, that seems optimistic to the markets. A collision is therefore developing between the Fed’s reluctance to recognise downside economic risks and what the markets want to hear.
Until the majority on the FOMC starts paying more attention to the large tightening in the FCI, the economy may weaken further. That is what the markets are worried about.
FYI, the Atlanta Fed GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2015 is 1.5% on September 17, having been inching up since mid-August.
U.S. Core Inflation Not Immune to Falling Gas Prices
Economists tend to view core inflation metrics as more valuable gauges of price pressures, as the exclusion of food and energy prices make them less volatile than their headline counterparts. Still, those components can influence the core trend through indirect channels. This is particularly true for energy prices, with energy-sensitive production and transportation costs often factored into the final prices paid by consumers. The continuing drop in prices at the pump could steal momentum from an otherwise improving core inflation trend — and at a critical juncture for monetary policy makers no less.
(…) Gas prices have a distinct seasonality, and based on the average over the past 10 years, prices typically decline an additional 13 percent from September through year-end. That means there is a strong possibility that prices could head further toward $2.00 per gallon around year-end.
The correlation between rates of change in retail gasoline prices and core inflation illustrate the substantial second-order effects from the former to the latter. This is demonstrated in the accompanying figure. (Note that moving averages are used to reduce noise.) As it takes time for these effects to percolate through to final prices, the gas price trend leads core inflation by several months.
The correlation between the adjusted moving averages for gas and core CPI is an impressive 70 percent. For the core PCE deflator, it is a lesser, albeit still significant, 45 percent. That suggests there is a distinct possibility that low and falling gasoline prices could nudge core inflation lower through year-end and into early 2016. A simple linear regression of the series suggests that core CPI could drift from 1.8 percent in July and August down toward 1.6 percent in the first quarter of next year. The implication is less compelling for the core PCE deflator given the lower correlation coefficient.
Nonetheless, a similar regression suggests this series will remain near the current level of 1.3 percent into the new year.
While there are many other factors at play with core inflation — including rental pressures, currency effects and a tightening labor market — knock-on effects from cheap energy prices appear poised to at least partly offset an emerging upward bias in the coming months. Policy makers have repeatedly indicated that they would be willing to look beyond transitory factors as they assess the appropriate timing for policy normalization. But if core inflation appears to have stalled, the case for liftoff will be more difficult.
The latest Markit manufacturing PMI survey shows that prices of manufactured goods are now deflating in the U.S.
From the same survey, I find this chart intriguing. U.S. new export orders have climbed back above 50 in the face of a strengthening dollar.
Volkswagen could pose bigger threat to German economy than Greek crisis The Volkswagen emissions scandal has rocked Germany’s business and political establishment and analysts warn the crisis at the car maker could develop into the biggest threat to Europe’s largest economy.
Volkswagen is the biggest of Germany’s car makers and one of the country’s largest employers, with more than 270,000 jobs in its home country and even more working for suppliers. (…)
“If Volkswagen’s sales were to plunge in North America in the coming months, this would not only have an impact on the company, but on the German economy as a whole,” he added.
Volkswagen sold nearly 600,000 cars in the United States last year, around 6 percent of its 9.5 million global sales. (…)
In 2014, roughly 775,000 people worked in the German automobile sector. This is nearly two percent of the whole workforce. (…)
In addition, automobiles and car parts are Germany’s most successful export — the sector sold goods worth more than 200 billion euros ($225 billion) to customers abroad in 2014, accounting for nearly a fifth of total German exports. (…)
Disinflation washes up in Vietnam Nation once known for hyperinflation joins the 0% brigade
(…) Consumer price inflation in Vietnam, whose multi-zero banknotes are testament to years of hyperinflation, fell short of market forecasts for a rise of 0.8 per cent in September. The zero reading was the lowest in almost 10 years of data. (…)
After China devalued the renminbi on August 11, Vietnam responded by widening the trading band for the dong, twice, from 1 per cent to 3 per cent, to allow the currency to fall and support exports. The currency has since lost 3 per cent to 22,486 per dollar.
Nguyen Bich Lam, head of the General Statistics Office, said those moves should lift CPI by 0.7 per cent by year-end. He said Vietnam should aim for 5-8 per cent inflation to support growth.
The fall in inflation is mostly a result of the drop in oil prices. Prices in the transport category were down 13.1 per cent over 12 months. But food prices were also down 1.8 per cent and housing and construction material prices were down 1.7 per cent.
Debt Relief Snarls Market for Student Loans Federal programs designed to ease the burden of college loans are causing snarls in the bond market and raising concerns that banks may soon ratchet back lending.
The programs, which let struggling borrowers scale back their repayments, have made student loans more affordable at a time when millions of Americans are falling behind on their student debts. (…)
Credit rating firms Moody’s Investors Service Inc. and Fitch Ratings Inc. have collectively placed more than $36 billion worth of bonds backed by student loans on watch for a possible downgrade, warning it is increasingly likely that borrowers won’t pay their loans off in full by their original due dates and that bonds backed by those loans could end up in default.
The result is that investors are demanding better prices in the esoteric but crucial market where banks raise capital by selling or repackaging their loans. (…)
Moody’s is expected to make a decision on whether to downgrade the bonds as early as November. (…)
As of June, there were $371 billion of FFELP loans outstanding, according to the Education Department. Overall, there are $1.27 trillion of outstanding student loans, 93% of which are federally backed, according to MeasureOne, a San Francisco-based firm that tracks the student loan market. (…)
Moody’s has put $34 billion of these bonds on watch for a downgrade this year through June. Since then, Navient’s shares have tumbled about 35%.
Navient was the largest buyer of FFELP student loans last year, purchasing $11.3 billion of these loans from banks and other institutions, according to the company. Wells Fargo& Co., the second-largest private student loan originator by volume, sold $8.5 billion of FFELP loans to Navient late last year. (…)
J.P. Morgan Chase & Co. had more than $4.5 billion of the federal student loans on its books as of June, according to bank filings, with some $500 million in delinquency or default. A bank spokeswoman said it has no plans to sell these loans at this time. SunTrust Banks held $4.4 billion of these loans as of June. A bank spokesman declined to comment on future plans for its loan holdings.
Fracking Firms That Drove Oil Boom Struggle to Survive A wave of bankruptcies and closures is sweeping across the oil patch, and dozens of the mostly small, privately owned hydraulic-fracturing companies that help oil-and-gas explorers drill and frack wells are at risk.
Most of the companies that help oil-and-gas explorers drill and frack wells are small, privately owned and just a few years old. They are part of a flood of new entrants in the energy business—one that is drying up as oil prices languish below $50 a barrel. (…)
At least five frackers have filed for bankruptcy, stopped fracking, or shut their doors altogether, according to consulting firm IHS Energy. Other analysts say that number may be higher, and they expect many more companies to follow suit or consolidate in a merger frenzy.
Energy analysts at Wells Fargo & Co. say as much as half of the available fracking capacity in the U.S. is sitting idle. (…)
So far this year, the amount of fracking work has fallen about 40% from a year earlier, and the price of a frack job has fallen 35%, according to Spears & Associates, a consulting firm for oil-service companies. (…)
Gasoline Volume Sales
Because the sales data are highly volatile with some obvious seasonality, we’ve added a 12-month moving average (MA) to give a clearer indication of the long-term trends. The latest 12-month MA is 6.1% below the all-time high set in August 2005 but off the -8.9% interim low set in August 2014.
The 6.1% drop highlighted is from the 2005 peak. I am more interested in the more recent trend which is clearly up. The recent monthly data circled in red are well above anything seen since 2010.
SENTIMENT WATCH
Louise Yamada: Major Sell Signals on All Indices
“We’ve been progressively more cautious and this month we became even more cautious…because we have major monthly sell signals in place for all of the indices… [H]istorically if we look back we got one of these monthly sell signals in January of 2008 and in June of 2000 so we tend to take them rather seriously. The next thing we are waiting for is a crossover of the monthly moving averages and we use a 10-month and a 20-month moving average, which would be a monthly death cross if you will. Everybody is talking about that…and the New York Stock Exchange just this week has been the first one to register that cross under of the 10-month moving average under the 20-month so that death cross is in place for one of the indices. I think that things are becoming much more fragile.”
“There’s a good possibility that we see a 20% decline, which is defined as a bear market or slightly more than that. Whether it’s cyclical or structural has yet to be determined but for instance if the S&P, which is already down around 10%, were to come down another 10% you’d take it right back to 1600, which, ironically, is the breakout point through the 2000 and 2008 peaks, which was broken through on the upside in 2013. So a pullback to that breakout level would be a perfectly normal cyclical bear market in what presumably would be an ongoing bull market, just as we saw cyclical bear markets in the course of the 1982-2000 bull market.”
“[T]his is the first time that a continuation of easing, so to speak, was greeted by disappointment in the market… Whenever the Fed offers liquidity the markets tend to go up and interestingly here they’ve maintained some sort of liquidity by not tightening…and that’s been greeted negatively for the first time I think.”
“We have some monthly sell signals on a variety of the international markets and we’re watching carefully to see whether that begins to spread to the rest of the ones that have been looking good. Japan had been looking good. Germany had been looking good. India had been looking good. But if we start to see that we’re losing that leadership and getting sell signals for those major markets joining a lot of the other emerging nations, we would be raising our antenna a little bit more. I think that’s definitely part of what was on Yellen’s mind the other day.” (…)
“I have no problem staying in cash. Preservation of capital…this is not a good environment in which to initiate positions. I think you really need to wait and see where the dust settles. We have an enormous number of stocks that are down already 20-80%. The larger declines are obviously in the energy area and once you’ve had that kind of decline you’re not going to go to new highs anytime soon. And that’s a fair amount of S&P capitalization weight that’s damaged and when you have that kind of damage it’s going to take time before one is going to benefit on a sustainable basis by being involved.”
“I would wait until we have evidence that all of these sell signals are false, which I don’t think we are going to get. But the point is, time will tell. We would need to see the advance-decline line move to a new high; we’d need to see these monthly sell signals reverse, which could happen in a period of 3-4 months as it did in 2011 even though you had almost a 20% decline there for the S&P and the Dow but these signals are not only in place but the momentum is declining which did not happen in 2011…so I think we are looking at something a little bit more serious in this environment.”
Goldman Says Copper Bear Market to Last Years as Gluts Build
Copper will slump as the U.S. Federal Reserve starts to raise interest rates, demand growth stalls in China and stockpiles surge, according to Goldman Sachs Group Inc., which stood by a year-end forecast that signals the biggest annual drop since the globalfinancial crisis.
Prices will probably drop to $4,800 a metric ton by the end of December and $4,500 at the end of next year, analysts including Max Layton and Jeffery Currie wrote in a report. The metal traded at $5,080 at 7:44 a.m. in London. A drop to Goldman’s end-2015 target implies a full-year retreat of 24 percent, the most since the 54 percent plunge in 2008.
“We see a long list of potential catalysts for copper’s next major move lower,” Layton, Currie and Yubin Fu wrote in the note received on Thursday. Of particular importance for copper has been the weakness in China, which points to a hard landing for commodities demand during 2015, they said. (…)
There will be about 530,000 tons more global supply than demand in 2016, Goldman said, paring its estimate from about 670,000 tons. The worldwide surplus was seen at 566,000 tons in 2017, 626,000 tons in 2018 and 657,000 tons in 2019, it said. (…)
Global stockpiles were seen increasing by as much as 1 million tons between November and March, Goldman said in the report, which was titled ‘Copper’s bear cycle still has years to run.’ Holdings in LME-tracked warehouses stood 327,175 tons as of Wednesday, according to bourse data. (…)
Oh Canada! Four in 10 Americans Want Wall on Northern Border