Are stocks suddenly rooting for a rate hike?

28 Sep 2015 | Author: | No comments yet »

Central banks haven’t lost their mojo.

While she reiterated last week that the Fed expects inflation to gradually rise back near 2 per cent, long- and short-term market forecasts for price gains have plunged to their lowest levels since 2009.It’s been a rough stretch of trading days since that fateful Federal Reserve meeting, with the S&P 500 SPX, -0.05% closing lower in six of the last seven sessions.In Australasia, Japan’s key quarterly Bank of Japan (BoJ) Tankan survey (Thursday) will be reported along with last month’s retail sales, household spending and unemployment.

Global equities are down more than 10 percent from their peak in June, the largest fall since 2011, leading investors to question the ability of central banks to protect downside and push markets higher. That’s even though oil prices have rebounded almost 20 per cent since late last month. “We’ve had so many years of accommodative policy, I think the market is losing faith in the Fed,” said Priya Misra, the head of global interest-rate strategy in New York at TD Securities, one of the 22 primary dealers that trade with the central bank. “You’re not really seeing the impact of policy end up in inflation.” Falling energy prices have contributed to keeping inflation low, a trend that should be transitory, according to Yellen. The index is down by more than 6% this quarter as the final days wind down, putting it on track to be the worst quarter since 2011, when the S&P shed 14%, according to Michael O’Rourke of Jones Trading. “The [Fed’s] transparency policy serves as an open window to view central bankers who lack clarity, consistency and conviction,” he says. “Endlessly easy policy has undermined the Fed’s credibility for years, but so has the lack of consistency between the policy maker’s words and actions.” James Grant, the man behind our call of the day (see below), is a bit more critical in his assessment of Janet Yellen and the Fed. “Helicopter money” may be the next thing, he says, as we continue to skip and whistle “in the age of magical thinking.” Magic aside, the bears have the upper hand in this market. But while markets have reacted badly to the notion that central banks have lost their mojo, we believe investors are underestimating central bank capacity to influence markets.

Most people think it’s a good thing if prices are rising more slowly (dis-inflation), or even falling (deflation), as that stretches the buying power of a paycheck whose growth has too often been stagnant in recent decades. But she cited another force behind cooling inflation — the stronger dollar, which depresses import prices, as shown in a chart accompanying her speech. “They’re utilising a monetary policy that’s not designed to influence what’s going on right now,” said Jack McIntyre, a portfolio manager with Brandywine Global Investment Management, which oversees $67 billion in Philadelphia. In the press conference following the Fed’s Sept. 17 decision to hold its benchmark rate near zero, where it’s been since 2008, “she talked a lot about global, external influences, and that’s going to take some time to resolve itself,” McIntyre said. First, these phenomena are often driven by persistent weakness on the demand side of the economy, leading to slow growth and a high unemployment rate, something that has been a big problem in advanced economies, including our own, in recent years (energy price movements, conversely, are often driven by supply changes). Yellen said Thursday that declining demand for inflation compensation, as measured by the difference between yields on inflation-linked Treasuries and those on nominal securities, may indicate that traders have very low inflation forecasts. “Although the evidence, on balance, suggests that inflation expectations are well anchored at present, policymakers would be unwise to take this situation for granted,” she said in her remarks.

If you went away in May — and are still a sucker for such trends — then it’s time to start thinking about buying again (see “the chart”). “Once the sellers exhaust themselves, buyers will creep back in and then drop the #$@# anvil of absolute death onto their faces. However, the ‘piece de resistance’ will be this Friday’s U.S. employment figures release (NFP +202k and +5.1%), as investors will be looking for clues on when the Federal Reserve will finally get to kick start its rate normalization policy.

Second, lower inflation means higher real interest rates, which can slow growth (the real rate is the nominal rate minus the inflation rate, so less inflation means a higher real rate). Traders’ bets following the Fed decision indicate they see interest rates only rising to 0.71 per cent by the end of 2016, about half as high as the median forecast from Fed policymakers. China still can trim its one-year official interest rate, making debt servicing easier, and lower its reserve requirement ratio, permitting banks to lend more. Third, because debt is usually set in nominal terms, inflation that is too low prolongs the deleveraging cycle (higher inflation erodes nominal debt burdens more quickly), another big drag on demand.

Yellen keeping the door ajar for interest rate hikes this year, capital markets continue to look for improvements in the U.S. employment landscape, together with any signs of stability in the slowing Chinese economy to be convinced that a rate increase remains on the table before year-end. In the euro zone, European Central Bank President Mario Draghi has been explicit in his willingness to unveil bigger monetary policy guns, saying on Sept. 3 that “the size, composition and duration” of quantitative easing could all be enlarged.

That’s all there is to it.” Monday blues are infecting the market early, with futures on the Dow YMZ5, -0.62% and the S&P ESZ5, -0.63% dressed in red. We consider it likely that the Bank of Japan’s asset purchase program, running at 80 trillion yen ($663 billion) annually, will be increased in response to low inflation readings. Since about 2009, according to a detailed new analysis by Fed Chair Janet Yellen, the Fed has been missing its 2 percent inflation target to the downside, as the figure below (from Yellen’s paper; that’s her title, not mine) reveals.

In China, the benefits of measures — such as increased fiscal spending, recent cuts to reserve-ratio requirements, and credit-asset securitization schemes — are still working their way through the economy. The final GDP print was raised to +3.9% from +3.7% in the preliminary reading and +2.3% in the advance data, with the additional strength coming from the services component of consumer spending. Second, contrary to what is by far the most dominant theory of inflation dynamics, it’s increasingly missing its target as the labor market is tightening up. At the heart of economists’ theory on what drives inflation is the negative relationship between slack — the under-utilization of resources, including labor — and inflation.

The channel by which this should work, and has worked to various degrees in the past, is that as the demand for labor, products, services, etc., increases to the point where it approaches or surpasses the supply, inflation will begin to rise. In 2013, slack explained about half a percentage point of the downside miss, but now, given that according to the metrics, the economy is just about at full employment, slack is allegedly playing a negligible role. Alcoa AA, -1.20% says it will split into two publicly traded companies, one “upstream” and the other “value-add”, with completion in the second half of next year.

However, in the medium term, there are fears in the market that a more conservative “speaker” may use the upcoming debt ceiling issue to force a governmental shutdown in late Q4. The latter just means that because the dollar has appreciated in value relative to the currencies of those with whom we trade, we can buy more of their goods for at lower prices. German prosecutors have opened a fraud investigation into former CEO Martin Winterkorn, while Audi has revealed that 2.1 million of its vehicles have the emissions-rigging software installed. Lagarde effectively flagged a downgrade to global growth, calling the +3.3% 2015 GDP objective set three-months ago no longer “realistic.” She said developing economies’ growth is picking up, however, emerging markets are slowing at a faster pace.

Nexstar NXST, -2.56% has made a bid to buy local-television station owner Media General MEG, -1.59% The proposal values Media General at about $1.85 billion, but the deal is worth $4.1 billion when debt is included. Recent weeks have been one such time, with equities falling and bonds offering less support than we would normally expect under conditions of heightened risk aversion.

U.S.-listed shares in SABMiller SBMRY, +0.81% are nudging up in premarket trade after a report that Anheuser-Busch InBev BUD, +2.48% has decided to bid $106 billion to take over its beermaking rival. Yet such periods do not last indefinitely, which is why we believe diversification — both across regions and in terms of asset classes — is important. Exchange rate dynamics are a function of relative global growth rates, plans of other central banks, and in some periods, currency manipulation by trading partners trying to boost their trade surpluses at the expense of our trade deficits.

President Barack Obama is slated to hold talks with Indian Prime Minister Narendra Modi today, as the two men look to strengthen the relationship between their respective countries in the face of an increasingly assertive China. Overnight, published reports indicate that Chinese industrial profits contracted by their largest amount in a number of years, with the Stats Bureau blaming rising input costs and the decline in the yuan. Commentary by Mark Haefele, global chief investment officer at UBS Wealth Management, overseeing the investment strategy for $2 trillion in invested assets. In Europe, separatists in the wealthy Catalonia region claimed victory the weekend in an election they believe will lead to their independence from Spain. But the actual jobless rate is biased down right now for reasons explained here, and second, no one knows the level of the unemployment rate associated with full employment.

That’s not as farfetched as it sounds, according to James Grant, founder and editor of “Grant’s Interest Rate Observer.” He says we’re in a “never-ending, circular process” that will eventually lead to some pretty unconventional ideas. “I dare to say that we have not yet seen the most radical brainwaves of the mandarins running our central banks,” Grant said in an interview with Finanz und Wirtschaft. Yellen took some of his heat, as well. “If a difficult decision needs to be taken, a person who’s so anxious or so much of an impulsive risk minimizer is perhaps not the best qualified to take sometimes a leap into the dark,” he wrote.

If it were to raise interest rates, something it’s intent on doing before the year’s out, that would presumably lead to more slack and strengthen the dollar further, both of which push the wrong way, i.e., toward lower inflation. And Callum Thomas, investment strategist at AMP Capital, tweeted this friendly reminder. $47.5 million — that’s how much “Hotel Transylvania 2” brought in over the weekend to set a September opening record, despite a lukewarm reception from critics. “We challenge the tech industry to do far more for those most marginalized, those trapped in poverty, and those beyond or on the edge of the network.” — Bono, or Facebook’s Mark Zuckerberg, in a New York Times shared byline over the weekend urging global connectivity for everyone.

But while Yellen’s carefully drawn evidence helps us solve one mystery, it brings us no closer to the much bigger one: How does one logically get from her revealing account of the missed target to her stated desire to raise rates before the year ends?

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