Sept 6, 2015. Does the Fed want to re-live the 1997/98 Asian crisis?
THEMES:
- Employment report, something for everyone
- USD strength against all EM; Fed hikes into that environment?
- China. Sell reserves or devalue. My money’s on the latter
- Risk aversion
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Again from Fischer’s CNBC Jackson Hole interview, “WE’D BE ADJUSTING THE KNOB SLIGHTLY AND WILL PROBABLY WAIT AWHILE BEFORE DOING SOMETHING ELSE.
-There’s something for everyone in the employment report. Headline number was only 173k, bad, but the previous number was revised up 30k to 245k, good. The rate was just 5.1, good, but the labor force participation rate was 62.6, bad. Average hourly earnings were +0.3, good, but QoQ Unit Labor Costs in Wednesday’s data were -1.4%, bad.
All in all, the Fed still seems to be on course for a hike, perhaps in September or, in my opinion, a greater likelihood in October. In either event, the trajectory of rate increases is likely to be gradual, as Fischer apparently emphasized to a group at the G20. Certainly, the market has bought into the idea of graduality (is that a word?) as can be seen in Eurodollar calendars. The peak one-year calendar had been bouncing around ¾% to 7/8% all year, (though it started the year near 100bp). More recently it seemed anchored at 75 bps, and now can barely stay above 5/8%. EDH6/EDH7 declined by 7.5 bps this week to just 65.5, signaling between 2 and 3 hikes per year. Low implied vol in interest rate futures – even in the face of significant equity market turbulence – is another factor that reinforces the idea of little movement by the Fed.
In terms of timing of the first hike, in my opinion it’s just as likely to occur in January of next year as it is in September. Here is the problem with a move in 11 days. No matter which EM currency one looks at vs USD, they are either at or near new lows. In Asia, one can look at Indonesian Rupiah (IDR), the Indian Rupee (INR), Malay Ringgit, (MYR) Thai Baht (THB), Korean Won (KRW). Same with Turkish Lira (TRY) and S Afr Rand (ZAR). Same with Brazil (BRL), Mexican Peso (MXN). Same with Canada and Aussie. The Brazilian real has lost about 45% of its value this year, Aussie’s down 16%, Copper 25%. Equity markets are shaky at best. Many Fed members love to talk the hiking talk, but when it comes right down to it, do you really think they want to face down a firestorm of political criticism if stocks plunge and emerging markets crumble based on an initial hike? Does the Fed want the blame for a replay of the 1997/98 Asian crisis? By the way, these adverse market moves may occur no matter what the Fed does, so why should the Fischer stand up and take that bullet? I say Fischer, not Yellen, because for all practical purposes he is the Fed chair. He’s the one out front discussing and forming Fed policy.
It’s more about China now than the US anyway. The G20 gave China a pass on its fx devaluation. But without further weakening the currency, China is spending reserves, supposedly $60-80 billion per month. As Doug Noland of the Credit Bubble Bulletin says, “How long will Chinese officials tolerate spending international reserves to allow “money” to exit China at top dollar?” Even with the drawdown in reserves in the form of treasury selling, US rates are falling. The idea that China will be selling into a black illiquid hole and drive US long end rates up is simply not occurring. What we’re more likely to see is a controlled devaluation of the currency.
Of course, China is taking other steps to help its economy. (Reuters) – Finance Minister Lou Jiwei said that central government spending will rise 10 percent this year, more than the 7 percent growth budgeted at the start of the year, according to a statement late Saturday on the People’s Bank of China website. China will raise dividend payments from designated state-owned enterprises to make up for any shortfalls. http://www.reuters.com/article/2015/09/06/us-g20-china-economy-idUSKCN0R604T20150906
Grand Keynesian fiscal measures in China to boost internal consumption and (mal)investment are more of a threat to US treasury bond values than reserve sales. Reserve sales and devaluation both admit to a weak, disinflationary global economy. US treasury prices do not go down in that environment, unless temporarily. This week’s auctions of 3’s, 10’s and 30’s in the absence of economic data will be the litmus configuration as to whether the US bond rally is true or fake.
Much of the demand for bonds is wrapped up in total portfolio allocation. This was a week when we heard about “Risk Parity Funds” exacerbating selling pressure, (being compared to “Portfolio Insurance” of the late 1980’s). Calstrs is reportedly looking at “Risk Mitigating Strategies”. Bill Gross says short term corporates may be the best chance to eke out returns. A WSJ headline Sunday morning says, “Pensions roll back return targets” noting that assumed returns of 7.5 to 8.0% aren’t happening (not exactly news). Some of the ‘strategies’ might have fancy names, but the theme is clear: pare risk and preserve capital. A change in the aggregate allocation decision, even at the margin, can further undermine support for equities.
