Yellen More Dovish? Don’t be Fooled.

Observations on the Capital Markets – Week Ended April 4, 2014

Fed Chair Yellen sounded very dovish in Monday’s speech, emphasizing that markets should expect extraordinary policy accommodation for some time, given the slack in the labor market. She broke with precedent by citing anecdotes (this from a person who has perhaps overused the words “data dependent”). She did not repeat the “six-month” guesstimate of how soon after QE ended Fed funds would start rising, but she didn’t “walk it back” either, or give any guidance suggesting anything more dovish than the Fed statement.

My take: she demonstrated empathy without making any promises or commitments. She’s a very good politician (as well as a very good Fed Governor).

In Europe, the European Central Bank (ECB) left policy unchanged but gave very dovish guidance. The set-up line was “We are resolute in our determination to maintain a high degree of monetary accommodation and to act swiftly if required.”

The punch line was (later that same paragraph), “The Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation.”

The word “unanimous” was important, suggesting ECB president Draghi has built a consensus to act forcefully. It is also significant that the trigger is not deflation: it is inflation not promptly rising.

The drop in inflation to 0.5% year over year in last week’s report might reflect seasonal factors, but the level is probably low enough to trigger ECB action if it doesn’t rebound quickly. Elsewhere, the statement said “we will monitor developments very closely.” In the past, the words “very closely” often preceded a policy move at the next meeting.

U.S. economic data was generally upbeat.

  • Perhaps making up for demand suppressed by cold weather, light vehicle sales rose to a 16.3 million seasonally adjusted annual rate (saar), the highest level since February 2007.

Blog Auto Sales in March

  • The ISM manufacturing Purchasing Managers Index (PMI) rose to 53.7; Markit manufacturing PMI is at 55.5. In each case, the details were encouraging. (above 50 indicates expansion)
  • The ISM Services PMI rose to 53.1; Markit’s came in at 53.5.
  • Construction spending ticked up month over month (m/m), and is up about 9% y/y.
  • Factory orders ticked up m/m, but are effectively flat y/y.
  • The February trade deficit was a bit wider than expected.
  • The Chicago-area PMI faded, but is still at 55.9.
  • The Milwaukee PMI rose from 48.6 to 56.0.
  • The Dallas Fed manufacturing survey rose to a very solid 4.9.

Labor market data was encouraging—especially the length of the workweek.

  • According to the Challenger Layoff Report, the total number of job cuts in the first quarter was the lowest since 1995.
  • Initial Unemployment Claims ticked up to 326K . . . no concern.
  • Friday’s “establishment survey” jobs report showed employment rising by 192k in March. That might have been a bit below expectations, but revisions to January and February added another 37,000 . . . for a total effective gain of 229,000.
  • The “household survey” jobs report had employment rising by 476k. The unemployment rate was unchanged at 6.7% because the workforce rose 503k as the labor force participation rate rose from 63.0% to 63.2%.
  • Perhaps most importantly, the length of the average workweek rebounded to 34.5 hours, signaling that the sharp drop (to 34.2) we saw in the past few months was mostly, if not entirely, a weather effect.
  • Average hourly earnings ticked down by $.01/hour . . . no concern: they had jumped $.09/hour last month (weather-related noise). The trend remains solid: the 12-month change (2.1%) is intact and remains comfortably above the inflation.
  • A minor milestone: private sector employment has now passed pre-recession highs (gov’t employment is still down).

Comment: I didn’t see anything in the jobs report that would explain Friday’s stock market sell-off . . . other forces were more important.

Don’t bet on QE from the ECB.

  • The statement (the punch line) included the phrase “within its mandate.” The ECB’s mandate effectively precludes it from engaging in Japanese- or US-style QE: monetizing government debt/deficits is prohibited. The Bundesbank and German Constitutional Court represent strong institutional barriers against “pushing the envelope” in this direction. Instead, don’t be surprised to see the ECB move to a zero or even negative interest rate target to push the FX value of the Euro down.
  • Draghi ended his statement by calling on governments to continue to shrink deficits and debt:GDP ratios and pursue structural reform…the ECB continues to follow a policy of “tough love” toward politicians…no “enabling behavior.

Eurozone: the (painfully slow) recovery continues.

  • Q4 GDP was revised downward from +0.3% q/q +0.2%; y/y remains +0.5%.
  • Markit’s Eurozone services (52.2) and manufacturing (53.0) PMIs ticked down but the first quarter data were still the best readings in three years.
  • The EZ unemployment rate was flat at 11.9%.
  • German factory orders ticked up m/m; they’re up 6% y/y.
  • Eurozone flash CPI was up 0.5% y/y, the lowest rate since December 2009. Core (ex-energy, food, alcohol and tobacco) was up 0.8% y/y.

Ukraine update: a quiet week last week doesn’t mean the situation is quieting down.

  • The Ukraine situation appeared quiet through Friday. Over the weekend, though, pro-Russian groups occupied government buildings in several eastern regional capitals, calling for Crimean-style referendums on seceding from Ukraine and joining Russia.

Comment: This path is one I foresaw as Putin’s likely next move. He doesn’t have to be the overt aggressor. If the Ukraine government cracks down on these demonstrations, it will give him an excuse to “protect” ethnic Russians.

China: still slowing

  • The official China Non-Manufacturing PMI ticked down while the HSBC China Services PMI ticked up. Both are above 50 but trending down. HSBC’s China Manufacturing index fell to 48.0.
  • The government unveiled a stimulus package including additional spending on railways and low income housing and tax relief for small businesses.
  • The Japanese sales (VAT) tax hike took effect. Negative Q2 GDP growth is the consensus expectation.
  • The Bank of Japan meets next week. Some expect it to increase QE to help offset the drag from the tax increase.

Quick notes on other political and economic news.

  • Elections in Afghanistan took place (relatively peacefully) Saturday; turnout was reasonably high. It appears a run-off between the top 2 candidates will be necessary (assuming no candidate gets 50%).
  • Voting in Indian national elections begins this week…and will last all month.
  • In France, Hollande’s Socialist party suffered large setbacks in local elections, leading him to name a new Prime Minister.
  • The Brazilian central bank, fighting stagflation, raised rates. The Indian and Australian central banks didn’t change policy.

Last week in the capital markets: a Friday U.S. stock market sell-off after a solid jobs report puts a damper on an otherwise good week.

  • Equities: The US lagged global markets as the MSCI indices for Europe, Japan, and Emerging Markets were all up 1-2% last week. The S&P 500 returned 0.4%, having been up over 2% mid-week. Within the S&P 500, cyclically-sensitive groups generally rose while “momentum” stocks and groups—notably social media—sold off. The Industrials (+1.5%) sector led, while the Information Technology sector (down 0.7%) was the biggest loser: no other sector posted a negative return.
  • Bonds: Bond yields rose on good economic data early in the week before settling back to end the week largely unchanged. The 10-year Treasury yield rose 1 bp to 2.74%; the 10-year TIP yield rose 1 bp to 0.61%. The yield spread of the BoAML High Yield Index declined from 373 to 364, another new cycle low, before ending the week at 368. Eurozone bond markets were well-behaved as well: peripheral spreads narrowed further on Draghi/ECB statements.
  • Commodities: Oil was down about 0.5%; gold was up a couple of dollars.
  • Currencies: The dollar gained about 0.5% against the Yen and against the Euro. The Chinese Yuan ended the week roughly flat.

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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