Treasury Secretary to Emerging Markets: Get Your Fiscal House in Order

Observations on the Capital Markets – Week Ended February 21, 2014

The Congressional Budget Office (CBO) stirred the pot again by saying raising the minimum wage would cost jobs, causing a rare public rebuke from The White House.

The G-20 met for two days in Sidney and agreed on enacting policies to, over the next five years, boost collective GDP by two percentage points compared to GDP under current policies. U.S. Treasury Secretary Jack Lew said President Obama will ask for a new stimulus package including things like infrastructure projects to create good middle-class jobs.

The capital markets last week were calm, even as economic data pointed in both directions. Housing market data was disappointing, blamed largely on weather, while inflation remained well-behaved low but with no apparent threat of deflation.

Janet Yellen appears to have hit a home run in terms of building her “brand” and credibility. This may be the most important development of the week. FOMC minutes suggest Fed policy may be becoming less predictable. Fed minutes showed that there were champions of virtually every policy option and no apparent consensus on anything. This suggests policy decisions might truly become data-dependent, even if there is a bias to predictability and stability. As was the case while waiting for the Fed to begin tapering, markets might focus inordinately on forest, not the trees: on the pace of tapering ($10 billion at this meeting or not?). This might increase market volatility.

Next week holds a lot of data reporting, but not enough to confirm/disprove the “weather” hypothesis. Very much on the radar now: Ukraine and Thailand.

Last week’s U.S. economic data pointed in both directions

  • The Empire State (NY) manufacturing index fell from 12.5 to 4.5 (slower growth). New orders dipped into negative territory.
  • The Philly Fed index fell from 9.4 to -6.3 (contraction) on weak new orders.
  • The Markit flash manufacturing PMI jumped to 56.7 on strong new orders.
  • The LEI (index of leading economic indicators) rose 0.3% in January a good reading.
  • Initial unemployment claims were 335K…fine.

The housing market data was disappointing: it’s more than just weather

  • The average 30-year conforming mortgage rate rose 5 bps to 4.50%.
  • January existing home sales were down 5.1% month over month (m/m). They’re also down 5.1% year over year (y/y).
  • Mortgage applications fell 6% week/week (they’re down 17% y/y).
  • The NAHB homebuilders’ (confidence) index crashed, dropping 10 points to 46 (below 50 = bad)
  • January housing starts fell to an 880k annual rate; permits came in at a 937k rate. Starts were weak in the South…where the weather was unusually bad.

Mortgages Apps Down

Inflation remains well-behaved…low but with no apparent threat of deflation

  • CPI inflation—both headline and core—was 1.6% y/y January.
  • The PPI rose 1.2% y/y; core PPI rose 1.3%.

The CBO stirs the pot again by saying raising the minimum wage costs jobs

  • A CBO report estimated that raising the minimum wage to $10.10 would result in 16.5 million workers getting a raise but 0.5 million jobs being lost. As with its analysis of the impact of the Affordable Care Act last week, this stirred a duel of talking heads.

Next week: a lot of data, but not enough to confirm/disprove the “weather” hypothesis

  • Economy: Chicago, Dallas, Kansas City, and Richmond Fed district surveys, Chicago PMI, Markit services PMI
  • Employment: unemployment claims
  • Housing and homebuilding: new home sales, pending existing home sales (P&S agreements), FHFA and Case-Shiller house price indexes.
  • The second (of three) estimate of Q4 GDP growth comes out…it’s expected to be revised down from the 2.7% flash estimate.

The G-20 met for two days in Sidney and agreed on the language of a communique

  • This cycle’s host is Australia, a natural resource exporter which benefits from stronger global growth…and it’s using its time in the leadership role to promote that agenda.
  • In the communique, countries endorsed the objective of enacting policies to, over the next five years, boost collective GDP by two percentage points compared to GDP under current policies.
  • There were no specifics beyond this: “To achieve this we will take concrete actions across the G20, including to increase investment, lift employment and participation, enhance trade and promote competition, in addition to macroeconomic policies.” Countries are expected/supposed to bring growth-enhancing plans to the November G20 meeting.
  • An IMF report prepared for the meeting suggested strategies such as market reforms to increase competition and improve the business environment, reforms to increase labor market participation, and infrastructure investment.
  • U.S. Treasury Secretary Jack Lew said President Obama will ask for a new stimulus package including things like infrastructure projects to create good middle-class jobs.

The G-20 can’t compel the Fed to think of the emerging markets when it tapers…but Yellen comes across as caring

  • The official communique said: “All our central banks maintain their commitment that monetary policy settings will continue to be carefully calibrated and clearly communicated, in the context of ongoing exchange of information and being mindful of impacts on the global economy.” Nicely worded, signifying nothing.
  • U.S. Treasury Secretary Jack Lew used plainer language: “Emerging markets need to take steps of their own to get their fiscal house in order and put structural reforms in place.” His German and Japanese counterparts made similar statements: Germany’s Schaeuble said emerging countries first had to do their own homework, while Japan’s Taro Aso said “It is important for emerging economies to correct these things by making their own efforts.”
  • Janet Yellen was generally off-camera and out of the spotlight, and she made no public promises, but left behind her a trail of officials who seemed to think she was listening attentively and sympathetically to them and their concerns. As was the case in her Congressional hearings, she appears to have hit a home run in terms of building her “brand” and credibility. This may be the most important development of the week.

The FOMC minutes suggest Fed policy may be becoming less predictable

  • The Fed’s intention to end QE this year while keeping the Fed Funds rate low is clear, but the path is unclear. The “market” would have liked clearer guidance; the Fed knew this, and chose not to give it.
  • The minutes showed that there were champions of virtually every policy option and no apparent consensus on anything.
  • This suggests policy decisions might truly become data-dependent, even if there is a bias to predictability and stability.
  • As was the case while waiting for the Fed to begin tapering, markets might focus inordinately on forest, not the trees: on the pace of tapering ($10 billion at this meeting or not?). This might increase market volatility.
  • Also, as noted earlier, the more data-dependent the Fed is (and the more policy options it is seriously considering), the less credible (and thus effective) forward guidance becomes.

Also very much on the radar: Ukraine and Thailand

  • A truce between protestors and government forces in the Ukraine broke down; the death toll rose. President Obama said “We hold the Ukrainian government primarily responsible” and warned that ‘there will be consequences if people step over the line.” Subsequently, the Ukrainian President fled the capital. Right now, I think it’s technically correct to say that the country is in a state of anarchy (no government). This invites radicals to overstep and (especially with the Olympics over) Russia to step in forcefully to protect citizens and property.
  • Violence is rising in Thailand as protesters seek to paralyze Bangkok and topple a government they perceive as bankrupting the country via unaffordable (but popular with rural voters) income transfer policies (most notably subsidies to rice farmers).

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

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About Sam Wardwell

Sam Wardwell, CFA, is Senior Vice President and Investment Strategist at Pioneer Investments. He joined Pioneer in 2003.
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