New Fed Papers Foreshadow a Dovish Fed Policy Under Yellen

Wardwell’s Weekly Market Report

Observations on the Capital Markets – Week Ended November 8, 2013

  • New Fed papers foreshadow a dovish Fed policy under Yellen
  • The market rethought its Fed and ECB forecasts
  • Q3 “advance” GDP growth was above consensus
  • Other U.S. economic news was generally positive . . .
  • . . . But scared consumers didn’t borrow or spend
  • Watching Europe, China and Japan

New Fed Papers Foreshadow a Dovish Fed Policy Under Yellen
Two new Fed papers presented at the International Monetary Fund (IMF) argue for prompt lobbying for continued aggressive monetary policy, but suggest prompt tapering of quantitative easing (QE) and more emphasis on forward guidance. The assumption is that these papers would not have been released if Janet Yellen intended to push policy in a different direction . . . and they reinforce the message of papers released at Jackson Hole this summer, suggesting that QE wasn’t acting as effective economic stimulus.

The Market Rethought its Fed and ECB Forecasts

  • Currencies: The European Central Bank (ECB) rate cut and the prospect of a Fed taper lifted the dollar about 1% against the euro and many emerging market currencies; it rose roughly 0.3% against the Yen.
  • Bonds: The 10-year U.S. Treasury returned roughly -1% as its yield (which had dipped below 2.5% just before the Fed met) rose 12 basis points (bps) on the week to 2.77%; the 10-year TIP yield rose 9bps to 0.59%. The Agg was down roughly 0.5%; the BoA Merrill Lynch High Yield Index was down roughly 0.4% as its OAS rose 7bps to 438. Foreign sovereign bond markets were generally quiet.
  • Equities: The S&P 500 Index was volatile, but managed to end the week up 0.6%. Roughly 90% of S&P 500 companies have reported earnings. There were few upside revenue surprises outside the energy patch. Cost control still drives margins. The MSCI Europe Index was roughly flat; MSCI Japan was down roughly 0.6%. MSCI Emerging Markets (EM) was down about 2% (as in the May “taper panic”, EM currencies and stocks have been hit hardest as markets rethink likely Fed policy).
  • Commodities: Gold was down roughly 1.5% for the week and oil ended the week roughly flat.

Q3 “Advance” U.S. GDP Growth Was Above Consensus
Inventory growth accounted for 0.8% (so ex-inventories, growth would have been only around 2.0%). Bears talk about the risk of a Q4 reversal, but good harvests are boosting inventories: real non-farm inventories rose at only a 3.2% annual rate – not too high. The Institute for Supply Management (ISM) indexes and Commerce Department inventory reports don’t show signs of an inventory buildup.

Personal consumption expenditures rose at only a 1.5% rate quarter over quarter (q/q), but incomes rose faster. Q3 personal income rose incrementally as well, and over 20% was saved . . . a higher savings rate (greater ability to spend in the future) is good.

Other U.S. Economic News was Generally Positive . . .

  • The non-manufacturing (service) Purchasing Managers Index (PMI) rose, though the new orders component eased slightly. Factory orders were somewhat disappointing; excluding transportation. The global composite PMI rose to 55.5% in October . . . a plus for the U.S.
  • Core PCE inflation is 1.2% y/y. Headline is 0.9% y/y.
  • Gasoline prices are falling to/through their lowest prices of this year.
  • US labor market data was better than expected. The unemployment rate edged up to 7.3%, as the government shutdown rippled through the household survey, which showed employment falling 735k. (Recall: the 800k furloughed federal workers didn’t show up in the payroll survey but do show up in the household survey.

. . . But Scared Consumers Didn’t Borrow or Spend

  • The University of Michigan consumer confidence survey declined again in late October, instead of bouncing after the government shutdown ended.
  • The Fed’s Senior Loan Officer Opinion Survey showed lending standards being eased…but weak demand is keeping loan growth down.
  • Household formation has dropped sharply in the past six months.
  • Purchase mortgage applications fell.

Watching Developments in Europe, China and Japan

In Europe: The European Central Bank (ECB) cut rates sooner than expected, dropping its target rate from 0.5% to 0.25%. Perhaps more importantly, it strengthened its forward guidance on interest rates (no hike before the second quarter of 2015) and commitment to ample bank liquidity provisions. At the press conference, ECB President, Mario Draghi, warned of the risk of prolonged low inflation (Euro Zone inflation fell to 0.7% y/y in October) and reiterated a pledge to keep rates low for an extended period of time to counter deflation risks.

Economic data was generally upbeat – notably German factory orders and UK industrial production. The European Commission lowered its 2014 EU GDP forecast from 1.2% to 1.1%. Ireland passed its final “Troika” (ECB, IMF, and European Commission) review; it will begin issuing debt again in 2014.

In China: Data was generally upbeat as well. Premier Li said 7.2% growth will be needed to create 10 million jobs a year.

In Japan: The non-manufacturing PMI rose to 55.3, its highest level since the data series started in 2007. Signs that the government may be moving ahead with structural reform (the “third arrow” in Abenomics)…plans to cut tariffs on imports and cutting farm subsidies.

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

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