Call it “Whatever it takes” II.
Today, European Central Bank President Mario Draghi said that the EuroZone central bank “will do what we must to raise inflation as quickly as possible.”
I don’t expect that this promise, made in a speech in Frankfurt, will have the same electric effect as “Whatever it takes” I in July 2012. That promise reversed a plunging euro, pulled the bonds of Spain and Italy back from the brink, and set the stage for a significant recovery in the prices of euro assets.
This time I think the likely market reaction will be positive—that is the euro will move lower as the bank wants (it closed at $1.0656 down 0.68% against the dollar today) and financial assets will move higher (the German DAX is up 0.31% today)—the move will be much more modest. The likely actions from the bank are relatively modest in contrast to past proposals and the problems the central bank faces have proven to be very resistant to the bank’s solutions to date.
After today’s remarks by Draghi pretty much everyone has concluded that the bank will move at its December 3 meeting—even though hardline members of the bank’s board of governors such as Germany’s Jens Weidmann are saying no changes are needed now. The bank’s inflation target of 2% remains a distant dream with the current inflation rate in the EuroZone at just 0.1%.
The policy menu in front of the bank includes an expansion of the current program of bond buying from 60 billion euros a month to 80 billion or so; an extension of the life of the program beyond the current September 2016 limit, and a further drop in the bank deposit rate. In normal times the central bank pays a modest rate of interest on money that banks leave on deposit over night. These days the central bank charges banks that leave their money overnight 0.2%. It’s just about certain that the European Central Bank will take that negative deposit rate even lower to, say a negative 0.3%. Bond yields across the EuroZone are already falling even further into negative territory in anticipation of the central bank’s move. The yield on 2-year German government bonds fell to a record low of a negative 0.389% today.
There is a good possibility that rather than choosing from this policy menu the European Central Bank will implement all of these items. That would still fall well short of a “shock and awe” response to the current mix of extremely low inflation and tepid growth, but at this point it might be the best the European Central Bank can do.
Inflation in China at the consumer level rose in October at just a 1.3% rate year over year. That, the National Bureau of Statistics said on Monday, was the lowest rate since May and well below the 1.6% rate in September. Economists had expected an increase of 1.5
A truckload of implications (or at least five) follows from this number.
First, combined with the disappointing showing on exports and imports in data released over the weekend, it reinforces forecasts of slow growth in the global economy. The fear of slow global growth has led to another day of declines in emerging markets. The iShares MSCI Emerging Markets Index ETF (EEM) was down another 0.38% on Monday.
Second, with inflation in China so low, the People’s Bank of China is relatively free to cut interest rates, reduce bank reserve requirements, and otherwise stimulate growth in the Chinese economy. I think the Chinese markets will start to anticipate some or all of those measures in fairly short order. (Think possible short-term rally.)
Third, with low or no inflation in the global economy, there isn’t anything that I can see that stands in the way of a stronger U.S. dollar. (The U.S. dollar, in fact, hit a six-month high against the euro on November 9).
Fourth, with a stronger dollar and lower global growth expect weaker commodity prices. Oil was up slightly today as of 3 p.m. in New York time after days of decline but copper was down 0.47%.
Fifth, a stronger dollar means more cash flowing into dollar assets, which is likely to damp increases in U.S. interest rates when/if the Federal Reserve moves. The yield on the 10-year U.S. Treasury held steady on Monday at 2.31%.
Yesterday’s report showing that core Consumer Price inflation rose 0.2% in September to an annual rate of 1.9% for the 12 months through September has had almost no effect on the market’s belief that the Federal Reserve won’t raise interest rates until 2016. (Core CPI takes out the effect of volatile energy and food prices that are included in the headline CPI. Headline CPI was unchanged on a 12-month basis in September.) The odds of a December initial interest rate increase have fallen to just 27%, according to Bloomberg. A rate increase at the Fed’s October 28th meeting is essentially off the board at just 6%. (An October move has always been a long shot since that meeting doesn’t include a press conference and the Fed prefers to announce policy changes at meetings with a press conference.)
Which strikes me as kind of strange. At 1.9% the annual core inflation rate isn’t all that far below the 2% target that the Fed has set for inflation. (Do note, however that the Fed doesn’t follow the Consumer Price Index to measure inflation. Instead it uses a measure called Personal Consumption Expenditures and we won’t have the September read on this index until the very end of October.)
The approach to that 2% target is significant since the Fed knows all about lags and momentum in the economy. If your target for inflation is 2%, you don’t wait until inflation is at 2% before tapping the brakes because momentum will carry inflation beyond your 2% target.
The financial markets right now are convinced that economic growth is slowing so that inflation won’t move through that 1.9% figure and bust through the 2% target. The Chinese economy continues to show signs of slowing with the latest report showing a 5.9% year over year drop in wholesale Producer Prices. The U.S. September retail sales report showed just a 0.1% gain against expectations for a 0.2% increase. The biggest retailer in the U.S. lowered guidance for sales. The Atlanta Fed’s GDPNOW Tracker estimates third quarter GDP growth at just 0.9% after a 3.9% growth rate in the second quarter. And manufacturing showed weakness in the most recent Federal Reserve Beige Book survey of regional economic activity.
We know that the Federal Reserve is currently deeply divided with one faction wanting to raise interest rates in December before inflation gains any more momentum. The other faction wants to put off an increase until 2016 out of fear that a move in 2015 would slow the U.S. economy.
The 1.9% gain in core CPI inflation certainly strengthens the case of the “move in 2015” group. An increase in PCE inflation measure for September would increase fears of moving too late by waiting until 2016.
A move up in the September PCE is certainly likely to lead some money out of the current crowded trade built on assuming a 2016 initial increase. I’d watch out for signs that the market has decided that its current positioning is too optimistic. Look for a stronger dollar, weakening commodity prices (especially for gold) and a retrace of some of the gains in emerging markets as signs that the market is looking to reduce its exposure to the “no move until 2016” position.
Food commodity prices are soaring. The Federal Reserve may not care since the core inflation number it watches takes food and energy prices out of the calculation. But commodity traders do. And so does your wallet, I’ll bet.
Ahead of tomorrow’s meeting of the Federal Reserve’s interest-rate-setting Open Market Committee, the Bureau of Labor Statistics today, March 18, reported a miniscule 0.1% increase in the core inflation rate in February. On an annual basis, core inflation is up just 1.6%. That’s well short of the Fed’s 2.5% target. The very low rate of inflation is one more reason to think that the Fed will hold its course at tomorrow’s meeting with another $10 billion reduction in what was once a program to buy $85 billion a month in Treasuries and mortgage-backed securities and a pledge to keep short-term rates at their current low 0%-0. 25% range deep into 2015.
But for those of us who live in the real world—as opposed to the Fed’s world where energy and food prices don’t count in calculating inflation—the inflation trend is a little ominous. Food prices climbed 0.5% in February, the fastest monthly increase since September 2011. Prices for meat, poultry, eggs, and fish climbed 1.2% in the month.
The price increases don’t stop with those food items. Coffee prices are up 70% thanks to unseasonably dry weather in Brazil. An epidemic of pig virus has sent pork prices up 40%. Wheat is up on the crisis in the Ukraine and on extreme cold in the United States. Dairy prices are up on rising demand from China.
And current weather may not be the end of the problem. Read more
It looks like another group of gold traders and investors has thrown in the towel today. Yesterday on news that the Federal Reserve would taper its $85 billion in monthly asset purchases to $75 billion gold fell below $1,200 an ounce to a five-month low.
Today gold (February 14 futures on the Comex) has dropped another 3.2% (as of 2:30 p.m. New York time) or $39.20 an ounce to $1195.30.
It sure looks like some traders, who had been holding onto their gold positions in the hope that the price of gold would climb on news either that the Fed had decided not to taper or that the taper would be very modest, are selling today. The logic to being long gold ahead of the Fed’s decision was that the market would see either a no-taper or small-taper decision as likely to produce inflation—which would lead to an advance in gold prices. With the price of gold dropping on what was indeed a very modest taper, this argument for holding gold is done, cooked, out of here.
Selling does look like the best decision in the short term since the downward trend in gold—with futures down 36% from the September 11 record of $1,923.70—is still in place. And it’s not clear where it stops. I’m hearing $1,000 an ounce frequently but I don’t know if that’s based on anything other than $1,000 being a nice round number. Certainly markets have a tendency to defend round numbers—such as $1,000 an ounce—but that doesn’t mean they always successfully defend them.
In the long term, however, the picture looks very different with the supply of gold falling. Read more