Federal Reserve Puts the Fear of a 2013 QE Taper Back on the Table

Wardwell’s Weekly Market Report

Observations on the Capital Markets – Week Ended November 1, 2013

  • QE taper back on the table.
  • Last week in the capital markets: The market rethinks its Fed and ECB forecasts
  • Good news for homeowners, less good for home-buyers
  • Progress on the deficit
  • What I learned about Obamacare this week (that you probably didn’t see on TV)

The Federal Reserve put the fear of a 2013 QE taper back on the table. Bonds sold off and the dollar rallied. There was no change in policy, but there was a change in wording of its statement that suggested a December or January taper of Quantitative Easing (QE) might occur. Both the September and October statements said “The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall”…but in September, it had continued by saying, “but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market.” The dropping of that phrase (when many were apparently expecting the Fed to cite the negative impact of the government shutdown), along with stronger manufacturing data, led to rising T-bond yields and a U.S. dollar rally.

Last week in the capital markets: The market rethinks its Fed and ECB forecasts

  • Bonds: The 10-year Treasury yield rose 12 basis points (bps) on the week to 2.65%; the 10-year Treasury Inflation Protected (TIP) yield rose 16bps to 0.50%. The Barclays Aggregate Bond Index was down roughly 0.4%.
  • Equities: The S&P 500 was up 0.1% for the week. Within the S&P 500’s sectors, Telecoms and Consumer Staples led while Financials and Materials lagged. For the MSCI regional indices, Europe was up about the same, but Emerging Markets was best, up just over 1%; Japan rose roughly 0.6% (all from the perspective of a U.S. dollar-based investor.)
  • Commodities: Gold and oil were each down 3% for the week; oil fell below $95 for the first time since June, reflecting both higher inventories and expectation of tighter Fed policy.
  • Currencies: The prospect that the Fed might begin tapering sooner and that the ECB might consider cutting rates led to a sharp rally in the dollar. The dollar gained about 2.3% against the Euro and 1.5% against the Yen; it rallied against most EM currencies including, for a change, the Chinese Yuan.

Good news for homeowners, less good for home-buyers

  • The S&P/Case/Shiller home price index was up 0.9% month-over-month (m/m) and 12.8% year-over-year y/y in August (the data is based on a 3-month moving average and released with a long lag) . . .the largest y/y gain since February 2006. Prices rose in all 20 cities tracked by the survey. Las Vegas (+29% y/y) and san Francisco (+25% y/y) have been the hottest markets; New York (+3.5% y/y) is the laggard.
  • August pending home sales (purchase & sale contracts on existing homes) fell 5.6% m/m and 1.2% y/y. Realtors cited both the government shutdown and high prices as causes.
  • The Q3 national apartment vacancy rate fell to 4.2%, its lowest level since 2001. The average U.S. effective rent is up 3% y/y. The homeowner (houses, not apartments) vacancy rate will be released 11/5; in Q2, it was at 1.9%, a cycle low, down from 2.9% in 2008.

The U.S. consumer appears to be OK

  • The U.S. Census Bureau’s preliminary report showed September retail sales down 0.1% m/m (up 0.4% excluding autos, which can be volatile), but still up 3.2% y/y.
  • October vehicle sales came in at a 15.2 million units annual unit rate, in line with September’s 15.3 rate. Sales of light trucks and cars were each 7.6 million units for the year.
  • The Conference Board Consumer Confidence index fell from 80.2 to 71.2 – ugly…but it covered the period of the government shutdown. Daily surveys suggest confidence has partially (but not fully) recovered since then . . . the Obamacare website troubles and notices that insurance policies are being cancelled are new drags.

Progress on the deficit

  • The fiscal year (FY) 2013 federal deficit was $680B, down from $1,089 in FY12. That was a fiscal austerity drag of almost 2% of GDP. In the past 4 years, the deficit has been cut from 10.3% of GDP to 4.4%. The Congressional Budget Office projects (baseline forecast) that the deficit will fall to 3.3% of GDP next year.

What I learned about Obamacare this week (that you probably didn’t see on TV)

  • The Affordable Care Act imposes penalties on people who fail to buy health insurance, but the law prohibits the IRS from filing a lien against a taxpayer’s assets or seizing them to collect the penalty, although it can deduct the penalty from a tax refund.
  • Comment: my core objection to the law has always been that it’s a massive wealth transfer from the young to the old: it overcharges young (and healthy) people to subsidize benefits for the elderly (and sick . . . though I find this element less objectionable). If young and healthy people don’t sign up, the system will collapse because of “adverse selection”—because the law mandates “guaranteed issue,” there’s no need to buy insurance until you’re really sick, so young people don’t need to buy it if the penalty is cheaper than the insurance…and if the IRS can’t enforce the penalty…

Next week:

  • Third Quarter GDP (flash estimate) . . . will probably come in at 2-2.5%. Also non-manufacturing ISM, leading economic indicators, labor productivity, manufacturing orders.
  • Labor market data: monthly employment report (probably distorted by the shutdown), weekly jobless claims (probably the first week of clean data in a while)
  • Consumer data: personal income, outlays, consumer sentiment, and credit (borrowing)
  • Eurozone industrial production

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

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