April 3. The Fed joins the fray in fx wars
The Nikkei is down 15% ytd and was down 3.5% Friday. We’ll come back to that in a minute.
The big news this week was Yellen’s speech Tuesday, which reinforced the idea of gradual/glacial rate hikes, with the overarching theme that the central bank can and will do whatever it deems necessary to counter any adverse shocks. Yellen also cites the role of the bond market in transmitting the Fed’s policy goals:
Financial market participants appear to recognize the FOMC’s data-dependent approach because incoming data surprises typically induce changes in market expectations about the likely future path of policy, resulting in movements in bond yields that act to buffer the economy from shocks. This mechanism serves as an important “automatic stabilizer” for the economy. …In addition, the public’s expectation that the Fed will respond to economic disturbances in a predictable manner to reduce or offset their potential harmful effects means that the public is apt to react less adversely to such shocks–a response which serves to stabilize the expectations underpinning hiring and spending decisions.
That last part is a pretty big claim, implying that the public has such faith in the Fed’s steering that hiring and spending decisions needn’t deviate due to disturbances or changes in incoming data, because the maternal Fed will keep us safe. It’s almost a bit contradictory: Traders will adjust interest rates immediately in response to news, but Main Street doesn’t have to do anything differently. We’ll see if the FOMC minutes which are released on Wednesday shed additional light on these ideas.
It appears as though the Fed has become more interested in expanding its sphere of influence to global asset prices, and the transmission vehicle of choice is the US dollar. Clearly, the dovish press conference at the March 16 FOMC weakened the dollar, thus supporting commodity prices, emerging markets, credit, and US equities. Last week’s speech cemented (some of) those goals. Indeed, stocks and the dollar took their marching orders, with the dollar index closing at its lowest level since the start of Q4, and stocks threatening new highs. However, the commodity complex hears the beat of a different drummer. For example, both oil and copper made their highs 2 days after the FOMC, but this week closed at the lows, significantly below levels associated the dovish Fed conference on March 16. I would also note that junk bond funds are below mid-March levels.
There are also mixed messages coming out of official data. Friday’s employment report was solid. However, the employment sub-indices in both Service and Mfg ISM are in notable downtrends. As mentioned last week, Service employment went from over 58 at the end of last year to 49.7 last month. Friday’s Mfg employment was only 48.1. In the past six years there have only been three lower readings in manufacturing, and those have all been within the past six months. On Tuesday we will get the new Service ISM data for March. It should bounce, but the divergence is clear. A piece from JPM suggests that jobs are growing faster than the economy, which implies that productivity is falling, with negative implications for corporate earnings. All things considered, the jobs picture in the US has been good, but the easy gains have already occurred.
So what are the signals from the interest rate markets? Market based measures of inflation spiked lower in February and have had decent bounces. The 5y5y Inflation Swap forward is up about 30 bps from the low of 180 in Feb, and the ten yr note to tip spread is up 43 bps from Feb’s low of 120. In spite of the strong employment report, bond yields closed much lower on the week with fives down 14.5 to 1.24% and tens down 10 bps to 1.79%. Over the past 2 ½ years the five year note has ranged between 110 and 180 (having started this year at the upper end of that range), now it’s much closer to the bottom in spite of the round trip in stocks (back to unchanged on the year). The curve, having steepened immediately after Yellen’s speech, gave back those gains Friday. For example, 2/10 was 102.6 at the end of last week, went to 107 by Wednesday, but closed back at 103. So while some measures of inflation have firmed, in general the market is taking more of a weak growth, reach for yield, no inflation posture in the short term. The peak one-year Eurodollar calendar spread is June’16/June’17 at 27 bps, suggesting just one hike this year. Red/green, green/blue, and blue/gold pack spreads are all within ½ bp of each other at 25, 25.5 and 25.125.
Back to Japan. A client summed up the week by saying they’re keeping the financial plates spinning. Doug Noland’s commentary was entitled “Another Coin in the Fuse Box.” Everything’s done as a last gasp effort to prop up the financial architecture. There have been a lot of references to central banks running out of ammo. No where is that clearer than in Japan, and the Fed is making it harder on both the BoJ and ECB to manufacture inflation. The yen closed at its highest level of the week, near the highest of the past year and a quarter. As noted at the outset of this missive, the Nikkei is down 15% ytd. This week’s tankan report was abysmal. All of the hyper-stimulative efforts in Japan are falling flat. Why should markets believe the Fed only has to reach deeper into the toolkit to “fix” things? Indeed, by pushing the USD lower, the Fed is likely harming export dependent economies like Germany and Japan, and is certainly adding to pressures on banks and other financial institutions in both countries. Global linkages thus create feedback problems for US banks.
In terms of the economy, one of the bright spots had been auto sales, buttressed by low finance rates and incentives, cheap gas, and payments being stretched out further and further. From BBG: “All three U.S. automakers posted sales gains that missed analysts’ estimates in March, while Japan’s Toyota Motor Corp. reported a surprise decline. The annualized rate adjusted for seasonal trends fell to 16.6 million, the lowest in 13 months, according to researcher Autodata Corp. The average analyst estimate was for a pace of 17.3 million, up from 17.1 million last March. …Changes in the way consumers are buying vehicles suggest more people are stretching payments out to make them more affordable. There was an increase in March in the number of people buying cars with six-year loans.” The peak level of 18 million units is fading into the rearview mirror.
It’s a fairly light news week in the US. Labor market conditions and Factory Orders on Monday. Trade and Service ISM Tuesday. Fed Minutes on Wednesday. Fed’s Rosengren speaks on cybersecurity Monday. The Bangladeshis will probably pay special attention to that one, having seen $100 million vanish from their account at the Fed last month due to a breach.
