FMX | Connect – www.fmxconnect.com - (Reported 9/22/2010)
Breakfast with Dave: The FOMC Fix
Excerpt from MARKET MUSINGS & DATA DECIPHERING
WHILE YOU WERE SLEEPING
There is a slightly more negative tone in global equity markets to start off the day with Europe down across the board (CDS spreads are widening rather materially in Portugal, Ireland and Spain) but the action was rather mixed to slightly positive in Asia – the Nikkei was down for the second day in a row (-0.4% to 9,566). It’s never that bad when the Kospi can manage to eke out a 0.3% gain (the MSCI Asia Pac index actually did inch up to a 5-month high today). As John Mauldin likes to point out, emerging markets, which had actually shown some decoupling signs in the opening quarters of the Great Recession in the U.S.A. and are showing even more signs of doing so this cycle (Emerging Asia is on track for 9.2% GDP growth this year versus 2.6% in the “advanced” country economies).
This is additionally good news for the commodity complex given the voracious appetite for raw materials coming out of Asia. The dollar is softer today in the aftermath of the “dovish” wording from the Fed – trading down to a five-month low against the euro, a two-year low against the Australian dollar, a 29-month
low against the Swiss franc, a 30-month low versus the South African rand – and get this – a 13-year low against the Thai baht and Malaysian Ringgit! Yet another reason to favour those things priced in depreciating greenbacks – like gold which is up another six bucks an ounce today after yesterday’s 10 dollar rally – $1,300/oz is in sight, nine months after breaking above $1,200 for the very first time. In other words, a steady but sure secular bull market in bullion. Copper, oil, wheat and rubber have all followed suit this morning.
On the political front, a new Bloomberg poll found that over three-quarters of U.S. investors view President Obama as “anti-business” – and we shall see who he chooses as Larry Summers’ replacement as his economics team falls by the wayside. With respect to the failure of White House economic policies to turn things around (we don’t accept that the grading should be done on the premise that “oh, well, things would have been worse without all the government incursion and intervention” – isn’t the jobless rate supposed to be at 7% by now?), we received this little ditty yesterday from a reader on the West Coastthat resonated with us:
Dave,
You pointed out that FDR worked out the WPA at lunch one day and put Americans to work, paying them to build the Golden Gate Bridge, while Obama is mailing Americans 99 weeks of unemployment checks—the modern soup line. Well, it’s worse than that. Think about it: FDR borrowed that money, mostly from Americans, and sent it to American workers who bought American goods. Today Obama is borrowing money from China and sending it to Americans entitled to 99 weeks of no-work-pay, I mean unemployment insurance, and they are taking it over to Wal-Mart and sending it to Chinese workers. Go figure….
Well put.
Now what exactly was behind the market reaction to the FOMC press release yesterday? The Fed reminded the stock market that the economy is fundamentally weak and downgraded its capex outlook. Check the wording. Bonds like the heightened prospect of more bond buying and the reference to deflation. Gold sees more money printing ahead – and hence the slide in the greenback. So if anyone needed any evidence of how deflation is good for bonds and bullion, yesterday’s price action was a case in point. The deflation risks are great for safe income strategies and here we have the 10-year T-note yield (rallying again in the wee hours of the morning – coming off a four-day winning streak, by the way) to 2.54% after touching 2.8% following the recent post-ISM selloff – and just a handful of basis points from heading back to the closing low of 2.47%. The 5-year note at 1.28% is back at the lows and the 41 basis point yield on the 2-year note is a modern-day low as well. At the same time, it is the Fed’s reflationary fight against deflationary risks that makes gold so alluring – ultra-low short-term rates means ultra-low gold leasing rates (now at a mere 41 bps for three-month terms). We see on our Bloomberg News screen that the folks at Mitsubishi UFJ Asset Management are calling for a 1.75% yield on the 10-year T-note – and who would know better about deflation and how to profit from it than the Japanese? They’ve only had two decades of experience dealing with it.
On the data front, we saw Eurozone July orders weaker than expected at -2.4% MoM (consensus was -1.6%). With the positive economic impact from the early year euro strength now moving into reverse, the bloom is clearly off the rose across the pond as the latest data points out of Europe have been listless to say
the least.
POST-FOMC MEETING REVIEW
Well, all we can really say is that the late-afternoon reversal in equities and the huge rally in the Treasury market may well have been a turning point. We shall see soon enough. The stock market can really only rally so much just because double-dip risks or the perception of these risks have subsided. In an FOMC press statement that contained many nuances compared to the last one, what did not change was this …
“Information received since the Federal Open Market Committee met in August indicates that the pace of recovery in output and employment has slowed in recent months.”
This is what the Fed said in the last go-around to describe the macro backdrop between June 23rd and August 10th. And then, apparently, things have “slowed” further ever since.
On June 23rd, the S&P 500 was sitting at 1092. Then on August 10th, it was 1121. And on September 23rd it closed at 1140. So things have “slowed” doubly over the past three months and yet the equity market has managed to rally 5%.
The Fed did not downgrade its already downbeat economic forecast, but it did cut back on its constructive view on capex – citing that “business spending on
equipment and software is rising,” but added “ though less rapidly than earlier in the year”.
Even though the Fed acknowledged that the banks were not tightening their credit scoring as much as before (“bank lending has continued to contract, but
at a reduced rate in recent months), the Fed was much more straightforward in its pledge to embark on another round of quantitative easing if conditions warranted (likely through asset purchases). For example, back in July, this is what the press release had to say on the matter:
“The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.”
Yesterday, it had this to say:
“The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.”
So the Fed is now prepared to take more easing action even though bank lending is not contracting at the same rate is was months ago. What gives? What gives is that the Fed acknowledged that deflation is the number-one risk going forward and it is prepared to fight it tooth and nail. The fact that bonds rallied is testament to the view that before inflation does rear its ugly head, it will likely take years, and along the way a whole lot of Treasury note buying by the
central bank. To wit:
“Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to
promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate. “
That is a lot more direct than the August reference to “measures of underlying inflation have trended lower in recent quarters and, with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time”.
There were so many subtle changes in the press statement that few mentioned that the Fed stuck with “extended period” to describe how long the funds rate will remain near the floor (tough to believe it was just six months ago that market participants were debating when this phrase was going to be deleted) and the fact that Tom Hoenig dissented for the 6th meeting in a row didn’t even elicit a yawn.
David A. Rosenberg
Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 8919
Source: Market Musings & Data Deciphering
http://www.fmxconnect.com/
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