Larry Summers Helps Clarify the Future Path of Fed Policy

Wardwell’s Weekly Market Report

Observations on Events and the Capital Markets – Week Ended September 13, 2013

  • Kerry inadvertently averts a war; the long-term implications are unknowable
  • Low growth, low inflation—the new Goldilocks?
  • A few consumer clouds on the horizon
  • Larry Summers helps clarify the future path of Fed policy

Kerry Inadvertently Averts a War
Last Monday, at a London press conference, U.S. Secretary of State John Kerry responded to a reporter’s question about what might avoid a military move against Syria by ad-libbing that Assad could give up his chemical weapons. As you probably know, Russia promptly endorsed the idea and Assad promptly agreed. The long-term implications of this development are unknowable; what matters now is that the risk of a U.S strike declined sharply last Monday. Over the most recent weekend, the U.S. and Russia have apparently agreed on key details, further reducing the probability of an attack.

  • Bonds returns were modestly positive as ten-year Treasury yields fell 4 basis points (bps) to 2.90% and the 10-year TIP yield fell 7 bps to 0.80%.
  • Equities rallied strongly led by the MSCI Japan Index (+3%) followed closely by MSCI Emerging Market Index (+2.5%), the S&P 500 (+2%), and MSCI Europe Index (+1.5%). Within the S&P 500, Industrials (notably capital goods) and Consumer Discretionary (notably media) led; Energy and Information Technology lagged.
  • Commodities: Oil was down 2%; gold was down 5%.

Low Growth, Low Inflation — The New Goldilocks?
August “core” inflation (excluding food and energy) was 1.4% y/y (year over year). Inflation including food and energy was 1.2% y/y.

  • August retail sales rose less than expected. Still, they’re up 4.8% y/y. Other reports for the week:
  • Company inventories rose modestly; inventory/sales ratios remain low: inventories are under control.
  • Import prices were flat in August; they’re down 0.4% y/y.
  • Export prices are down 1.1% y/y, reflecting a 5.7% decline in agriculture prices (from a better harvest).

A Few Consumer Clouds on the Horizon
Consumer borrowing (consumer credit) ticked up (people are borrowing a bit more to support spending) it’s growing at about a 6% annual rate. The concern is that incomes are growing more slowly, so the debt/income ratio is rising as well (it’s up from 21.5% in mid-2010 to 23% now). This is not sustainable indefinitely.

  • Consumer confidence surveys (University of Michigan) have been a bit weaker recently.
  • Home mortgage applications declined modestly. Refinancing applications fell 20% week/week; since May, they’re down by two thirds.

Larry Summers Helps Clarify the Future Path of Fed Policy

Sunday night’s news services said that Larry Summers had withdrawn his candidacy for Fed chairman. Snark warning: Summers wasn’t supposed to be a candidate because this wasn’t supposed to be a campaign. The President was supposed to nominate someone and Summers shouldn’t turn down something he hasn’t been offered. It’s all very unseemly.

Under the circumstances, it’s highly likely Obama will now nominate Janet Yellen for Fed chairman. Yellen, who is widely respected and viewed as eminently qualified to chair the Fed (she’s currently Vice-Chairman), is a person who doesn’t gain headlines. She’s generally viewed as a “dove” within the Fed and a supporter of QE (quantitative easing). By building near-unanimity for his broad policy outlook, Chairman Bernanke has essentially bound the Fed to a course of action.

If the Fed were a sailing ship, I’d say the course has been laid in, the helmsman has been given his instructions, and now captain Bernanke can turn the deck over to the first officer and retire below.

Data Sources: The Wall Street Journal, Financial Times, Bloomberg.

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