“More compelling!” No, “Less Compelling!” It’s the battle of the data as the Federal Reserve heads off to its Jackson Hole retreat to think about interest rates
If you’re old enough to remember, today’s comments from the Federal Reserve at the annual retreat conducted by the Kansas City Fed in Jackson Hole will remind you of those Miller Lite adds where one gang of retired athletes yelled “More flavor” at another group that yelled “Less filling.”
Only today it’s Fed members yelling “More compelling” and “Less compelling” at each other over the potential for an initial interest rate increase when the central bank’s Open Market Committee meets on September 17. On Wednesday New York Fed President William Dudley helped push the market toward higher by saying that recent market turbulence had made the case for a September interest rate increase “less compelling.” Today Fed vice chairman Stanley Fisch said reports on the U.S. economy had been “impressive” and “the economy is returning to normal.”
And then Fischer, in an interview with CNBC balanced between the two positions:
“I think it’s early to tell, the change in the circumstances which began with the Chinese devaluation is relatively new and we’re still watching how it unfolds. I wouldn’t want to go ahead and decide right now what the case is, more compelling, less compelling.” (Fischer will make an official appearance tomorrow on a panel at the conference.)
No wonder that U.S. stocks are meandering aimlessly with a slight downward bias today
Would you want to be ahead of potential news on the Fed’s thinking tomorrow—even if the likelihood of any significant news is relatively small?
Complicating the situation are comments from James Bullard, President of the St. Louis Fed, suggesting that the central bank could pass on a September decision but give itself the option of moving in October by adding a press conference to the agenda that day. Many traders had decided that the Federal Reserve wouldn’t act in October because the central bank doesn’t like to move on interest rates at meetings without a scheduled press conference that would let it explain its thinking.
Odds of a decision at the October 28 meeting had climbed to 47% from 40% on Thursday. Meanwhile odds of a September increase have recovered to 38% after having dropped to 28% after the big down day in Shanghai on Monday.
The next important data point will be the jobs number for August scheduled to be reported on Friday, September 4. A strong read on the creation of new jobs—200,000 or more—would raise the odds for a September increase. Economists are currently forecasting a 220,000 gain.
To me the idea of adding a press conference and putting October on the schedule suggests a way for the Fed to split the difference between moving in September without convincing data and seeming indecisive by waiting until December.
Meanwhile, as of the close today, the Standard & Poor’s 500 stock index was ahead 0.06% 0.06% and the Dow Jones Industrial Average was off 0.07%. (By the way, the photo today is of the Andes in Chile. I didn’t have a photo of the Tetons.)
On revision second quarter U.S. GDP revised up to 3.7% from 2.3%–and U.S. stocks are off and running
Back on August 22 I posted that it looked like second quarter U.S. GDP growth would get revised upwards in a release scheduled for today, August 27. The initial estimate of 2.3% annualized growth could get revised upwards by as much as a full percentage point, I wrote.
Boy, was I wrong. Second quarter growth was revised upwards today to an 3.7% annualized rate, an increase of 1.4 percentage points from the prior estimate. None of the economists surveyed by Bloomberg forecast that big a revision. In addition, contracts to purchase previously owned homes climbed in July for the sixth time in the last seven months.
On the good news, U.S. stocks climbed with the Standard & Poor’s 500 up by 2.43 at the close and the Dow Jones Industrial Average ahead by 2.27%. (It didn’t hurt that China’s markets staged a big rally overnight, with the Shanghai Composite climbing 5.34%. That gave U.S. stocks plenty of upward momentum at the open.
So far, at least, I haven’t seen any comments suggesting that the higher than expected 3.7% growth rate might be strong enough to put a September interest rate increase back on the table. The consensus, which I don’t agree with, is that that ship has sailed.
One reason that I’m hearing today for thinking that this stronger than expected growth won’t lead the Fed to act in September is the fragility of the financial markets. Analysts raising that point aren’t gesturing at the Chinese equity markets but at the U.S. credit markets. The spread between the yields on high-yield bonds and Treasuries has expanded to 600 basis points (or 6 percentage points) as investors ramp up their anxiety about rising defaults, especially in the energy sector. Even taking out energy high yield bonds, also known as junk bonds, the spread to Treasuries is 100 basis points higher than a year ago. Does the Federal Reserve want to raise interest rates, they ask, when the debt markets are looking so shaky—at least in the high yield sector?
Volatility, which had spiked hard earlier in the weak, continued to fall with the Chicago Board Options Exchange Volatility Index, the VIX, declining today by another 9.2% to 27.52 after a 14% drop the day before. That’s quite a reversal from the charge in volatility that saw the VIX climb to its highest level since October 2011.
What is now a two-day rally in U.S. stocks put the S&P 500 on a path to its strongest back-to-back advance of the six-year bull market.
Today on my paid JubakAM.com site I crawl out on a limb to look at when and where we might see an actual bottom in Shanghai and U.S. markets. Seemed like a good time to do that given the big rally in U.S. stocks today and the upcoming Jackson Hole conference that’s likely to generate some fireworks about the timing of a Federal Reserve interest rate increase.
Looking at the long base-building that Shanghai put in from 2012 to August 2014 to set up the current rally, I conclude that we could still see another 25% to the downside in this market. I would be willing, on a risk/reward basis, however, to start putting money to work in China after another 12% or so decline. The market doesn’t have to go back to that base.
In the case of the U.S. markets I conclude that today’s bounce after six down days is a sign of a bottoming process but that the process is likely to stretch into September. I also note four stocks that I’d like to buy when that process is further along.
Just thought I’d let you know what I’m working on at JubakAM.com–I think there’s some value to you in passing on the direction of my thinking about this market on that site. Hope so anyway.
And, of course, there’s an ulterior motive: If you decide that you’d like more detail on those posts, I’m hoping that you’ll subscribe to my site at JubakAM.com for $199 a year. (By the way, you can get a full refund during the first seven days if you change your mind for any reason.)
Is a September interest rate increase from the Fed really off the table? The consensus believes it is
The consensus now says that the Federal Reserve won’t raise interest rates—for the first time since 2006—when it’s Open Market Committee meets on September 17.
On August 18, the Fed funds futures market pointed to an almost 50/50 chance (48%) of a September move in interest rates off the current zero rate that has held since 2008.
On August 25, the odds had fallen to just 28%. And markets were giving an increase in 2015 at all just a 50/50 chance. That was down from 73% on August 18.
The consensus vote is now for an initial rate increase in March 2016 (72%).
That’s what a renewed bear market in Chinese equities, a continued meltdown in emerging market stocks and currencies, and the fall of U.S. indexes into a technical (10% decline) correction will do to sentiment.
The markets—and in this case I think that means the big players on Wall Street—have decided that the Fed won’t risk adding to market turmoil by increasing interest rates in September.
There are good reasons to think that the current consensus is wrong. Wall Street may be voting its own hopes rather than coolly calculating the odds.
Why do I think the consensus might be wrong?
- The Chinese meltdown hasn’t significantly weakened the U.S. economy—and the strength of the U.S. economy, particularly the strength of the U.S. labor market—is the single biggest feature in the Fed’s calculations. Today government numbers showed, for example, that orders for capital goods, the stuff that companies use to make stuff, rose in July by the most in more than a year. Orders for all durable goods—that’s stuff that’s meant to last for more than three years–climbed by 2%. That was stronger than any forecast by any economist surveyed by Bloomberg. And there’s a very good chance that on next revision GDP growth for the second quarter will get a big upward revision.
- The Fed would really like to disabuse the stock market of its belief that every time markets flag the central bank will ride to the rescue. A strong belief that the Fed (and other central banks) will shower the markets with cheap cash whenever they get into trouble is a key market belief from the years following the Global Financial Crisis. The Fed would like to eat away at that certainty—because the central bank sees it as a key element in creating asset bubbles.
- If not now, when? It’s not like the problems in the Chinese economy and financial system or the weakness in emerging market economies and currencies will end in just a few weeks. What is supposed to change that will make raising interest rates “better” in March?
- We’re only talking about 25 basis points (100 basis points equals one percentage point) in any initial interest rate increase. Much of that has already been anticipated by the markets. And an interest rate increase of that size off of a base near 0% isn’t going to change conditions very much
- The Fed has so thoroughly signaled a September or at least a 2015 interest rate increase that Janet Yellen and crew at the Fed may well feel the central bank’s credibility is at stake.
That’s not to say there aren’t reasons to believe the Fed will stay its hand—at least for September. Emerging markets and their currencies are indeed very fragile after China’s devaluation of the yuan. Countries such as Brazil and Turkey and Russia don’t need even 25 basis points in extra inducement for money to flow into dollars and out of the real, lira, and ruble. And we know that the current global financial market is so nervous that even a minor move—like a 4.5% devaluation of the yuan versus the dollar—can have huge unexpected effects.
The best near-term indicator of the Fed’s intentions is likely to be Federal Reserve vice-chairman Stanley Fischer ‘s Saturday appearance on a panel at the Kansas City Fed’s annual Jackson Hole conference. (Fischer, as of the current schedule, will be the senior Fed figure present since chair Janet Yellen isn’t scheduled to attend. Speculate all you want about what that means. European Central Bank president Mario Draghi is, so far, scheduled to be absent as well.)
If Fischer focuses on the strength in the U.S. economy and, in particular, on the solid gains in the U.S. labor market, it will be read as an endorsement of a September increase. Comments that indicate the Fed sees current dollar strength and low oil prices as “transitory” will also be seen as signs that the Fed is leaning toward a September move.
In the current very sensitive market, Fischer comments that point to a September increase could well set off another round of losses in emerging markets and China in the days after the Jackson Hole conference. I remain convinced, however, that in the longer run putting in place the first interest rate increase of a very modest 25 basis points is likely to help stabilize global markets. Putting the increase in the books and observing that global markets and currencies haven’t collapsed would be a very positive step toward stabilizing these financial markets.
Worth following Fischer’s comments at Jackson Hole? You bet.
At end of the day U.S. markets decide the risk of the plunge continuing in China tomorrow is just too great
On the evidence of the last hour of trading today on Wall Street, U.S. traders and investors just don’t trust China’s markets not to blow up tomorrow.
U.S. stocks had staged a rally for most of the day after the People’s Bank of China cut lending interest rates, reducing the amount that banks have to keep in reserves against loans, and injected cash into the financial system. The move came after the markets in Shanghai and Shenzhen had closed. Without that news from China central bank the Shanghai Composite closed down 7.63% and the Shenzhen Composite was lower by 7.09%. But global markets cheered the effort to increase growth in the Chinese economy. In Europe the French CAC 40 index closed up 4.02% and the German DAX was ahead 4.97%.
In the U.S. the Dow Jones Industrial average was up 1.54% as of 2 p.m. New York time and the Standard & Poor’s 500 stock index was ahead 1.38%.
And then the bottom fell out of U.S. markets. The Dow, which had been ahead to 16,168 at 2:55 p.m. in New York moved relentlessly lower to close at 15,666, down 1.29% for the day. The S&P 500, which had been up at 1926 at 2:55, fell to 1868 at the close, down 1.35% for the day.
What were U.S. markets afraid of at the end of trading?
It would have been logical to assume that tomorrow when Chinese markets get a chance to react to the moves by the People’s Bank, they’ll join in the early rally today in global markets. (That goes for Tokyo too, where the Nikkei 225 closed down by 3.90% ahead of the news from the People’s Bank.)
But, hey, these are the Chinese markets we’re talking about and Chinese traders and investors have their own idiosyncratic take on the financial world. Remember that the immediate cause of the most recent stage of the sell off in Chinese stocks is a belief that the Chinese government was backing off its program to directly buy stocks in order to support prices. After spending an estimated $200 billion buying shares, it sure looked like the Chinese government threw in the towel yesterday when, faced with a another big hit to stocks, the government didn’t intervene.
That was a huge disappointment and fed into today’s 7.63% drop in Shanghai.
The People’s Bank’s intervention to support economic growth will feed into stocks eventually—if it results in higher growth—but it doesn’t do anything for stocks today. It will be “interesting” to see if Shanghai and Shenzhen decide that the central bank’s efforts to help the economy in general are—from a stock price point of view—too little and too delayed.
Global markets, however, have been more worried about how a further slowdown in China’s economic growth would hurt their own exports to China. So they were relieved by the central bank’s move. That’s one reason that export-oriented economies in the EuroZone such as Germany, the Netherlands, and Finland all gained more than 4% today.
And the move by the People’s Bank to support economic growth in China added to commodity prices today. As of 3 p.m. New York time U.S. benchmark West Texas Intermediate crude was up 1.08% and Brent benchmark crude was ahead 0.54%.
But—and this is a really important “but”—you’ll notice how extremely modest the gains in those commodity prices were (both oil benchmarks finished up today) and how U.S. stock markets got less enthusiastic later in the day. Earlier the S&P had been up 2.9%–more than twice its 2 p.m. gain and far ahead of its eventual close in negative territory.
Even at their most optimistic today, U.S. markets weren’t totally convinced that Shanghai and Shenzhen wouldn’t do something “nutty” when they open tomorrow (tonight New York time.) Apparently at the end of trading today New York investors decided that the risk of a negative Chinese reaction was just too great and they sold “just in case.”
Not that there aren’t good reasons to worry about the effects of the moves by the People’s Bank. U.S. stock and global commodity markets reacted with less than run-away enthusiasm even earlier today because first, they wonder if the actions by the People’s Bank will work, and second, because they recognize that in some ways the bank’s efforts will make some problems in the Chinese economy worse.
As dramatic as the move by the People’s Bank was supposed to seem, it wasn’t actually all that large—25 basis points is as incremental as you can get. If China’s economic slowdown is as deep-seated as I suspect it is, 25 basis points isn’t going to make much of a difference and it’s certainly not going to restore confidence. (In other words more interest rate cuts to come.)
And a reduction in interest rates is going to require the People’s Bank to intervene more forcefully in the currency markets if the central bank is to have any hope of keeping the devaluation of the yuan within the bounds that it set when it first devalued the currency. Estimates are that the central bank has spent about $200 billion to support the currency. (Add that to the $200 billion spent directly to buy stocks and we’re starting to talk real money.) After letting the yuan fall 4.5% against the dollar in the days after the August 11 devaluation announcement, the central bank has been buying yuan to keep the currency essentially pegged to the dollar. Besides its expense—even to China $200 billion isn’t nothing—that effort has put an extra $200 billion into the financial system. With stocks in a retreat, it looks like the money is going into the real estate sector again where it could re-inflate a real estate bubble that the People’s Bank has worked so hard to deflate. (At the moment China’s very low inflation rate gives the central bank plenty of room to operate before it needs to worry about inflation. But plenty of room isn’t the same as “all the room in the world.” An increase in inflation because of all the cash injected into the economy would severely cut into the bank’s operating freedom.)
Tomorrow should be interesting–again. I don’t think we’ve seen the last of China’s bear market.