The Fed Keeps a Watchful Eye as U.S. Economy Continues to Improve

The Fed’s “Beige Book” painted a beige—or is it Goldilocks?—picture of the economy, as most districts reported economic activity growing at a modest/moderate pace, employment generally rising, and wage pressures still generally well-contained. Nothing suggested cause for the Fed to change its plans or guidance.

  • Indeed, in her speech last week, Fed Chairwoman Janet Yellen said that she thinks the U.S. is at least 2 years away (maybe more) from reaching full employment and that inflation pressures remain subdued, so tightening policy any time soon would probably be premature.
  • With that said, her speech wasn’t all that dovish. She didn’t make new promises or push the envelope; rather, she reiterated that Fed policy remains data-dependent and the Fed “must always be prepared to respond” to rising inflation.
  • Somewhat worryingly (for those who worry about these things), she stressed the mandate of maximizing employment and acknowledged the responsibility to constrain inflation, but made no mention of preventing asset price bubbles in things like stocks, houses, or things that yield 5%.

Business and Consumer Activity Rebounding
Early in the week, the Empire State (NY Fed) survey disappointed, slipping from 5.6 to 1.3 on weak new orders. Later in the week, the Philadelphia (Mid-Atlantic) Fed index surprised on the upside, rising from 9.0 to 16.6 on strong new orders. The market’s reaction suggests Philadelphia trumps New York.

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‘No Brakes’ on U.S. Growth – But Are Americans on Board?

IMF Bullish on U.S. Economy – Americans Remain Cautious
“There are no brakes on U.S. growth,” said the IMF’s chief economist, “It’s an economy that is fundamentally robust.” The latest International Monetary Fund (IMF) forecast is for 3.6% global GDP in 2014. The U.S. is expected to grow 2.8%, the Eurozone 1.2%, Japan 1.4% and the UK 2.9%.

Indeed, U.S. labor market data signaled ongoing strength, as unemployment claims fell to 300k, the biggest week/week drop in 10 years and the lowest weekly number since May 2007. Seasonal factors (Easter) and normal data volatility may be at work, but it’s still a low number. The February JOLTs report was fine, considering the weather: the number of job openings and hires rose, the number of terminations was flat. The number of job openings is the highest since January 2008.

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Where Should Interest Rates Really Be? Applying the Taylor Rule to the World’s Central Banks.

The Taylor Rule is a formula widely used by central banks to determine how interest rates should change based on inflation, output, economic conditions and other factors. Since the start of the Great Financial Crisis in 2008, the world’s “G4” central banks – U.S., Japan, UK, and Europe have injected over $5 trillion of liquidity into the global economy. The U.S. Federal Reserve began “tapering” in December 2013, starting the process of exiting its quantitative easing program designed to keep rates low, stimulate borrowing and promote investing. Amidst signs that the global economic recovery is broadening and becoming more sustainable, market attention has begun to shift to whether less overall monetary accommodation is needed.

We applied the Taylor Rule to test the monetary policy stance of the G-4 central banks – testing each of them individually and making the results available below and conclude that policy for all but the Eurozone is too accommodative and that central bankers may have to respond more swiftly than many expect. Continue reading

U.S. Economic Outlook is Sound

We believe U.S. economic data supports sound conditions for the economy in 2014, with no major imbalances appearing. Some figures, weaker than expected in the first weeks of the year, are mainly the result of exceptional weather conditions. The transition towards a self-sustained recovery is supported by strengthening internal demand, driven by recovering capital expenditure and household consumption. We expect to see mixed signals coming from economic activity indicators and labor market as the economy normalizes, but we do not expect the trend in the main drivers of growth to be derailed.

Our growth estimates for 2014:

  • U.S. GDP growth of 2.8%.
  • Personal consumption estimated to grow at a moderate pace and then accelerate in the second half of the year.
  • Inflation expected to remain below 2% but step up gradually during the year.
  • Non-Residential Investments to accelerate in the second half of the year, giving momentum to acceleration in capital expenditures.
  • The Fed will continue to taper its bond buying program which will be effectively wound down by the end of 2014 if its current economic projections hold.

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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). Continue reading

The Fed Doesn’t Surprise, but the Market Reacts Anyway.

As expected, quantitative easing (QE) was tapered another $10 billion last week and the Fed dropped its earlier guidance that it might start raising the Fed Funds rate when unemployment is 6.5% (confirming that it will wait longer than that, since we’re almost at 6.5%).

The U.S. stock market sold off sharply on this news (even though the outcome was widely expected), then rallied the next day.  Some observers think it was computer algorithms that (seeing unexpected hawkishness) triggered the selling; the dip was a buying opportunity.  The bond market moved to price in a stronger economy and faster pace of Fed Fund rate hikes.

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China’s Currency Drop. What it Means for China and the World’s Markets.

China’s currency, the renminbi, depreciated 1.4% in February 2014, essentially tying the record for the largest monthly drop since the Chinese government’s “peg” policy officially ended in 2005. This jump raised the question of whether or not the renminbi has come to some turning point or just another road bump before resuming a 9-year modest bull rally. We believe the recent depreciation of China’s renminbi is government-engineered and potentially signals a change in China’s exchange rate policy.

In 2013, the renminbi (abbreviation CNY), also called the yuan, was among the top 5 best performing emerging market currencies to appreciate against the U.S. dollar (USD), rising 2.9%. The seeming one-way trend in the currency, and, more importantly, the widening interest rate differentials between China’s onshore version of its currency (CNY) and its offshore version (CNH) has led to capital inflows domestically and from offshore investors.

China's Renminbi Sharp Decline Continue reading

Will the World and the Markets (Passively) Accept Russia’s Actions?

Having bloodlessly consolidated his control of Crimea, Russian President Vladimir Putin announced he hoped there would be no shooting (e.g. military response to the invasion). Most markets rallied, regaining the ground they’d lost when the invasion occurred.

There won’t be a NATO military response: pushing the Russians out is effectively impossible in practical terms. (How the Ukrainians themselves will act is uncertain. As one analyst put it, “The only question now is whether the new Ukrainian government will accept the loss of Crimea quietly or try to retaliate against Russian speakers in Ukraine – offering Putin a pretext for invasion, and thereby precipitating an all-out civil war.”)

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March – In Like a Lion? Not as Far as The Economy is Concerned

Last week’s U.S. economic data was again on the soft side, but we still can’t rule out bad weather as the cause. New factory orders for durable goods were down 1% month over month (m/m) in January but up 4.6% year over year (y/y). Excluding the volatile transportation segment, they were up 1.1% m/m and 1.2% y/y. This is consistent with bad weather superimposed on a slowly-growing economy – no big surprise. In other data:

  • The Markit flash services PMI fell from 56.7 to 52.7 . . . still above 50.
  • The Chicago Fed’s National Activity Index fell to  - 0.39
  • The (local-focus) Chicago-area PMI was strong, at 59.8.
  • The Kansas City Fed index came in at +4, even after citing weather as a headwind.
  • The Richmond Fed index fell to -6 . . . details were weak . . . weather is blamed.
  • The Dallas Fed’s February Manufacturing Outlook Survey showed general business activity, at 0.3, barely in positive (slow-growth) territory. However, factory activity was notably strong, rising for the tenth month in a row.
  • Initial unemployment claims rose to 348k – the high end of the recent range.

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What Has Abenomics Achieved?

Pioneer Investments’ Head of Global Asset Allocation Research, Monica Defend, assesses the progress of Abenomics – the series of economic reforms implemented by the government of Prime Minister Shinzo Abe – and discusses her outlook for the Japanese market.

What has the new policy course known as Abenomics achieved and what is yet to be done?
Japan managed to exit a long stagnation, also marked by deflation, thanks to aggressive monetary expansion. That was probably the easy part of Abenomics, as it got a major implicit endorsement from the U.S. Federal Reserve; Japan’s quantitative easing accounted for an even larger part of GDP than the U.S. version, but had the Fed not led the way with quantitative easing, we have legitimate doubts that it would have been as effective.

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