The UK's Monetary Policy Committee today announced their first interest rate cut in seven years, lowering the benchmark rate to a record low of 0.25%. The rate cut came as no surprise to markets worldwide, and the MPC vote was 9-0 in favor of the cuts. What did surprise some, however, was a £170 Billion stimulus that will be introduced via the purchase of Gilts (UK government backed bonds similar to US Treasury Bonds), the purchase of corporate bonds, and a new bank lending program. That portion of the stimulus package was not expected to coincide with the interest rate cuts.
The FTSE responded positively to the news, finishing the day up 1.56% although the Pound dropped 1.5% versus the US Dollar and 1.3% versus the Euro. US markets responded with a yawn, finishing the day flat. The US 10-Year Treasury Yield, however, dropped 2.58% to 1.51.
BoE Governor Mark Carney sounded a pessimistic note in his presentation, stating, “We took these steps because the economic outlook has changed markedly. Indicators have all fallen sharply, in most cases to levels last seen in
the financial crisis, and in some cases to all-time lows." That's a bit troubling, given the lengthy duration anticipated for the actual Brexit events to unfold. With the benchmark rate now down to an extreme low, there is very little additional room for the BoE to maneuver should the British economy slow further.
Surprisingly, the MPC signaled the potential for a further rate cut, although Carney assured reporters that the central bank had no intention of bringing rates into negative territory. That they would consider - and even signal - that rates could drop to near zero, however, indicates the level of concern the committee has over the economic prospects during the Brexit transition.
The fallout from the Brexit vote has manifested more slowly than critics had forecast, but - at least in the UK - it is starting to be felt. Consumer Confidence is dropping dramatically, and the industrial outlook is starting to decline as well. The forecast for the UK GDP is now down to 0.8% for 2017, and the Central Bank foresees a strong decline in corporate investment and in the housing markets. The Pound's weakness is certainly hurting UK imports, and that is having a marked effect on growth potential over the next 18 months. That import price pressure is expected to have an impact on inflation in 2017, with the central bank forecasting inflation to hit their 2% target in the fourth quarter of 2017 and exceed it throughout 2018.
What all this signals is a period of weakness, uncertainty, and potential market instability in the UK that will likely last through 2018. With the ECB taking a bit of a "wait and see" attitude mingled with a healthy dose of skepticism a couple of weeks ago, the likelihood of continental fallout is extremely high. US 10-Year Treasury yields have declined steadily since December, 2015, and are now sitting at the lows last seen in August, 2012. That represents a significant flight to safety, and with US equities sitting near all-time highs, it's reasonable to conclude that the heavy demand on US treasury bonds is coming from overseas.
There is a limit to how long the US can remain immune to economic weakness in the UK and the EU. The strong US dollar is having a severe impact on US exports, and that, in turn has a serious impact on US companies that are heavily exposed to Europe. This is evident in the behavior of the S&P 500 where demand has fallen off over the past few weeks, and the market has gone essentially flat since it reached a record high in mid-July. With GDP growth down dramatically in Europe, the UK, and the US, prospects for a global recession are mounting as we transition from a tumultuous US presidential election to the uncertainty of a prolonged Brexit negotiation and execution.
Earnings season in the US is almost over, and there is not another FOMC announcement before September 21. So now we turn our attention to tomorrow's jobs report. The pattern in the market right now is not encouraging, so the key economic reports over the next few business days may well set the tone for the remainder of August.
Happy Trading
Showing posts with label monetary policy. Show all posts
Showing posts with label monetary policy. Show all posts
Thursday, August 04, 2016
Thursday, July 28, 2016
FOMC Holds Rates Steady; Details Economic Progress
As expected yesterday, the US Federal Opens Market Committee (FOMC) held interest rates steady with the target range between 0.25% and 0.50%. One sign of the weakening of the Fed's resolve at maintaining the status quo, however, came with Esther L. George's dissenting vote. As noted in the formal announcement, the traditionally hawkish George preferred to increase the federal funds rate to 0.50% to 0.75%. She was outvoted 9-1.
The language and tone of the announcement demonstrated a subtle shift towards a tightening policy, however. Respective to the Fed mandate of maintaining full employment, they said, "Information received since the Federal Open Market Committee met in June indicates that the labor market strengthened and that economic activity has been expanding at a moderate rate. Job gains were strong in June following weak growth in May."
Given the very robust jobs report in June, that position is not surprising. Indeed, the standard unemployment level has been sustained below 5% for several months, although it's equally important to note that over 94 million Americans are now unemployed - the highest number since the Labor Force Participation Rate has been maintained.
If the job market were the only factor under consideration, there's little doubt that the Fed would be moving to raise interest rates. The stumbling block continues to be inflation. The all-items CPI for urban consumers is 1%. The FOMC target, however, is 2%, and there's little indication that inflation will reach that target in the short term. They acknowledged that yesterday, saying, "Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further."
They did not define "medium term" in this context, however Janet Yellen defined it in 2009, saying, "From macroanalysis, I consider short term as referring to less than, say, a year or two, medium term as ranging from around two to six years, and long term as anything beyond around six." Read into that what you will, since the ultimate question will be whether or not the Fed will raise interest rates before inflation reaches the 2% target. If that target is not anticipated for at least another two years, then we've a long ways to go before we see any monetary tightening.
The June announcements were rife with caution, citing potentially permanent "headwinds" and some rather dire forecasts regarding the global economy. This month's announcement shows a complete reversal of those ominous undertones. "Near-term risks to the economic outlook have diminished. The Committee continues to closely monitor inflation indicators and global economic and financial developments."
What they classified as "near-term risks" was not expounded upon, however it's reasonable to assume that they are referencing the unknown impacts of Brexit, a strong US dollar, and the prospect of recession in Europe. While the Brexit impact is certainly moved out into the distant future - at least 2019 or beyond, even if the UK invokes Article 50 next year - and Europe appears to have inched ever so slightly away from recession, I find it hard to dismiss the impact the strong US dollar is having and will continue to have for the foreseeable future. It's doubtful, however, that the dollar alone will be enough to stay the Fed's hand.
Interestingly, the markets appeared to treat the FOMC release with a yawn. The Nasdaq Composite was up both yesterday and today, and the S&P 500, while down a hair yesterday, recovered it today to continue it's horizontal correction without giving or gaining any ground.
Equally interesting, the Fed Fund Futures still show only an 18% chance of a rate hike in September, and the chance of a December hike dropped to 36.8%. In fact, you have to go all the way out to June 2017 before the chance of an increase even reaches 40%. Clearly, the market is factoring in very low interest rates for at least the next year. The 10-year Treasury Yield is still declining, dropping to 1.52% today, which would be another possible indication that rates will continue low for some time. (It's also a further indication of a flight to safety, which is a warning of potentially troubled times ahead in the equities markets.)
The Fed summed up a very dovish posture once again, stating, "The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run." That view, however, is not consistent with the "dot plot," an estimation of where FOMC members view interest rates over the next several years. A solid base of participants forecast one additional rate hike in 2016, however the strongest dot concentration shows two rate hikes, presumably in September and December with the average rate falling between 0.75% and 1% by year end.
The next FOMC meeting is September 21st, so we have almost 8-weeks before the next rate decision is expected. A lot can happen in 8-weeks, and there will be two more major economic data points available to the Fed before that decision is warranted. What we as traders need to watch, however, is the potential for good economic news to become bad for the market. A very strong jobs report, or a healthy uptick in inflation could signal that there is a greater potential for a September rate hike. That would send stocks tumbling once again, hence the good news is bad phenomenon. Exercise caution around major data releases since the reaction will be somewhat unpredictable for the time being.
With regards to monetary policy, we now turn our attention to the Bank of England and next Thursday's Monetary Policy Committee announcement. Stay tuned.
Happy Trading.
The language and tone of the announcement demonstrated a subtle shift towards a tightening policy, however. Respective to the Fed mandate of maintaining full employment, they said, "Information received since the Federal Open Market Committee met in June indicates that the labor market strengthened and that economic activity has been expanding at a moderate rate. Job gains were strong in June following weak growth in May."
Given the very robust jobs report in June, that position is not surprising. Indeed, the standard unemployment level has been sustained below 5% for several months, although it's equally important to note that over 94 million Americans are now unemployed - the highest number since the Labor Force Participation Rate has been maintained.
If the job market were the only factor under consideration, there's little doubt that the Fed would be moving to raise interest rates. The stumbling block continues to be inflation. The all-items CPI for urban consumers is 1%. The FOMC target, however, is 2%, and there's little indication that inflation will reach that target in the short term. They acknowledged that yesterday, saying, "Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further."
They did not define "medium term" in this context, however Janet Yellen defined it in 2009, saying, "From macroanalysis, I consider short term as referring to less than, say, a year or two, medium term as ranging from around two to six years, and long term as anything beyond around six." Read into that what you will, since the ultimate question will be whether or not the Fed will raise interest rates before inflation reaches the 2% target. If that target is not anticipated for at least another two years, then we've a long ways to go before we see any monetary tightening.
The June announcements were rife with caution, citing potentially permanent "headwinds" and some rather dire forecasts regarding the global economy. This month's announcement shows a complete reversal of those ominous undertones. "Near-term risks to the economic outlook have diminished. The Committee continues to closely monitor inflation indicators and global economic and financial developments."
What they classified as "near-term risks" was not expounded upon, however it's reasonable to assume that they are referencing the unknown impacts of Brexit, a strong US dollar, and the prospect of recession in Europe. While the Brexit impact is certainly moved out into the distant future - at least 2019 or beyond, even if the UK invokes Article 50 next year - and Europe appears to have inched ever so slightly away from recession, I find it hard to dismiss the impact the strong US dollar is having and will continue to have for the foreseeable future. It's doubtful, however, that the dollar alone will be enough to stay the Fed's hand.
Interestingly, the markets appeared to treat the FOMC release with a yawn. The Nasdaq Composite was up both yesterday and today, and the S&P 500, while down a hair yesterday, recovered it today to continue it's horizontal correction without giving or gaining any ground.
Equally interesting, the Fed Fund Futures still show only an 18% chance of a rate hike in September, and the chance of a December hike dropped to 36.8%. In fact, you have to go all the way out to June 2017 before the chance of an increase even reaches 40%. Clearly, the market is factoring in very low interest rates for at least the next year. The 10-year Treasury Yield is still declining, dropping to 1.52% today, which would be another possible indication that rates will continue low for some time. (It's also a further indication of a flight to safety, which is a warning of potentially troubled times ahead in the equities markets.)
The Fed summed up a very dovish posture once again, stating, "The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run." That view, however, is not consistent with the "dot plot," an estimation of where FOMC members view interest rates over the next several years. A solid base of participants forecast one additional rate hike in 2016, however the strongest dot concentration shows two rate hikes, presumably in September and December with the average rate falling between 0.75% and 1% by year end.
The next FOMC meeting is September 21st, so we have almost 8-weeks before the next rate decision is expected. A lot can happen in 8-weeks, and there will be two more major economic data points available to the Fed before that decision is warranted. What we as traders need to watch, however, is the potential for good economic news to become bad for the market. A very strong jobs report, or a healthy uptick in inflation could signal that there is a greater potential for a September rate hike. That would send stocks tumbling once again, hence the good news is bad phenomenon. Exercise caution around major data releases since the reaction will be somewhat unpredictable for the time being.
With regards to monetary policy, we now turn our attention to the Bank of England and next Thursday's Monetary Policy Committee announcement. Stay tuned.
Happy Trading.
Thursday, July 14, 2016
Bank of England Holds Rates Steady; Signals August Stimulus
Despite market estimates of an 80% chance for a rate cut today, the Bank of England held rates steady at 0.5%. With new Prime Minister Theresa May signaling a slow and cautious path towards Brexit and also signaling an invocation of Article 50 no earlier than 2017, the central bank's delay in lowering interest rates makes sense.
Only 2 1/2 weeks have passed since the Brexit vote, and that is an insufficient amount of time to gather enough data to make an informed projection on the economic climate for the next six to twelve months. The MPC (Monetary Policy Committee) next meets on August 4th, giving them additional time to gauge the reaction and potential impact.
Additionally, despite the immediate reaction worldwide on June 24 and 27, markets in the UK and around the world have since stabilized and, in fact, rebounded significantly. In the Forex market, the British Pound did indeed take a significant hit against both the Euro and the US Dollar, however the currencies have since stabilized albeit at the lower levels experienced immediately following the vote.
Given the slight trade imbalance the UK currently experiences, that overall drop in the Pound is actually very good for their exports. It provides an immediate boost to UK-based corporations and, in that context, is a nice stimulus without the Central Bank taking any actions at all. Coupled with that, initial fears that companies would seek to relocate out of the UK have since abated. To that point, JP Morgan Chase CEO Jamie Dimon specified in today's earnings call that he had no intention of leaving the UK despite rumors to that effect on June 24th. Following the initial shock of the vote, we now see other companies taking a step away from the ledge, realizing that the new dynamic offers tremendous opportunity, not peril.
What the Bank of England has done by standing pat is afforded themselves some options later in the year should the British economy weaken to the point where a stimulus in the form of a rate cut becomes necessary. Lowering that key rate today would have left the Central Bank with no room left to move as the UK approaches what will certainly be a period of uncertainty after they invoke Article 50. Remember, the BoE already provided a significant stimulus on July 5th when they eased capital requirements for commercial banks, effectively providing a £150 Billion short-term stimulus.
The change in capital requirements on 5 July was seen as a direct attempt to prevent a repeat of the 2008 crisis in which banks ceased lending. Whether or not that move is sufficient only time will tell, however as of today the signal is that the MPC is thus far satisfied with the short-term results.
Today's decision underscores a strengthening in the overall financial stability of the UK and stands in stark contrast to some dire warnings issued by Governor of the Bank of England Mark Carney just a week ago: “The number of vulnerable households could increase due to a tougher economic outlook and a potential tightening of credit conditions. In particular there is growing evidence that uncertainty about the referendum has delayed major economic decisions, such as business investment, construction and housing market activity. The UK has entered a period of uncertainty and significant economic adjustment." The wording is particularly harsh coming from such a prominent member.
There's no word as to what measures the Committee are considering in August, however according to officials there was significant discussion of it in today's meeting: “Most members of the committee expect monetary policy to be loosened in August. The committee discussed various easing options and combinations thereof. The exact extent of any additional stimulus measures will be based on the committee’s updated forecast, and their composition will take account of any interactions with the financial system.”
The August 4th meeting comes only a week after the US Federal Opens Markets Committee (FOMC) meets. Fed Chair Janet Yellen typically addresses the economic environment in Europe and the UK in her post-meeting announcement, so it will be worth listening to that release for clues as to any action the Bank of England may feel necessary. Given the interrelationships between the various central banks and the global impact each of their decisions have, it would be a mistake to focus only on the MPC for guidance as to what the future economic environment may entail.
Also of interest is the next European Central Bank (ECB) meeting, scheduled for 21 July. Again, listening to Mario Draghi's perspective will add further insight. It's likely that, between the ECB and FOMC, we should have a fair idea of the direction the Bank of England may take on August 4th.
Happy Trading.
Only 2 1/2 weeks have passed since the Brexit vote, and that is an insufficient amount of time to gather enough data to make an informed projection on the economic climate for the next six to twelve months. The MPC (Monetary Policy Committee) next meets on August 4th, giving them additional time to gauge the reaction and potential impact.
Additionally, despite the immediate reaction worldwide on June 24 and 27, markets in the UK and around the world have since stabilized and, in fact, rebounded significantly. In the Forex market, the British Pound did indeed take a significant hit against both the Euro and the US Dollar, however the currencies have since stabilized albeit at the lower levels experienced immediately following the vote.
Given the slight trade imbalance the UK currently experiences, that overall drop in the Pound is actually very good for their exports. It provides an immediate boost to UK-based corporations and, in that context, is a nice stimulus without the Central Bank taking any actions at all. Coupled with that, initial fears that companies would seek to relocate out of the UK have since abated. To that point, JP Morgan Chase CEO Jamie Dimon specified in today's earnings call that he had no intention of leaving the UK despite rumors to that effect on June 24th. Following the initial shock of the vote, we now see other companies taking a step away from the ledge, realizing that the new dynamic offers tremendous opportunity, not peril.
What the Bank of England has done by standing pat is afforded themselves some options later in the year should the British economy weaken to the point where a stimulus in the form of a rate cut becomes necessary. Lowering that key rate today would have left the Central Bank with no room left to move as the UK approaches what will certainly be a period of uncertainty after they invoke Article 50. Remember, the BoE already provided a significant stimulus on July 5th when they eased capital requirements for commercial banks, effectively providing a £150 Billion short-term stimulus.
The change in capital requirements on 5 July was seen as a direct attempt to prevent a repeat of the 2008 crisis in which banks ceased lending. Whether or not that move is sufficient only time will tell, however as of today the signal is that the MPC is thus far satisfied with the short-term results.
Today's decision underscores a strengthening in the overall financial stability of the UK and stands in stark contrast to some dire warnings issued by Governor of the Bank of England Mark Carney just a week ago: “The number of vulnerable households could increase due to a tougher economic outlook and a potential tightening of credit conditions. In particular there is growing evidence that uncertainty about the referendum has delayed major economic decisions, such as business investment, construction and housing market activity. The UK has entered a period of uncertainty and significant economic adjustment." The wording is particularly harsh coming from such a prominent member.
There's no word as to what measures the Committee are considering in August, however according to officials there was significant discussion of it in today's meeting: “Most members of the committee expect monetary policy to be loosened in August. The committee discussed various easing options and combinations thereof. The exact extent of any additional stimulus measures will be based on the committee’s updated forecast, and their composition will take account of any interactions with the financial system.”
The August 4th meeting comes only a week after the US Federal Opens Markets Committee (FOMC) meets. Fed Chair Janet Yellen typically addresses the economic environment in Europe and the UK in her post-meeting announcement, so it will be worth listening to that release for clues as to any action the Bank of England may feel necessary. Given the interrelationships between the various central banks and the global impact each of their decisions have, it would be a mistake to focus only on the MPC for guidance as to what the future economic environment may entail.
Also of interest is the next European Central Bank (ECB) meeting, scheduled for 21 July. Again, listening to Mario Draghi's perspective will add further insight. It's likely that, between the ECB and FOMC, we should have a fair idea of the direction the Bank of England may take on August 4th.
Happy Trading.
Thursday, July 07, 2016
Market Focus is on Tomorrow's Jobs Report
The Bureau of Labor Statistics will release the June 2016 Employment Situation report (popularly called the "Jobs Report") at 8:30 AM EDT tomorrow. It's one of the most closely watched releases each month, and its trends have a significant impact on the Fed's monetary policy. As you may recall, the May report issued last month stunned the financial world, showing a dismal increase of just 38,000 jobs in the Non-farm Payroll category. When teamed with Brexit, the Italian banking crisis, and increased fears of recession in Europe - all factors Fed Chair Janet Yellen termed "headwinds" - the May report pushed any prospects of another Fed rates hike out into the distant future. The futures market is currently projecting a near 0% chance of a rate hike in September, although it starts to climb ever-so-slightly in the fourth quarter.
Analysts do not expect such a dismal jobs report tomorrow, although the projections of 175,000 on the optimistic side to as low as 140,000 on the pessimistic side are still well under the levels needed to sustain economic growth. The street is also expecting a slight rise in unemployment from 4.7% to 4.8%, and the expectation for hourly average earnings is an increase of 0.2%.
The June report, however, is being closely watched more as a harbinger of the economic outlook for the next twelve months. Some analysts are now placing the risk of recession at 30% for the next year. Given the turmoil in Europe and the impact that contagion can have in the States, I would categorize that 30% as very optimistic. Even Janet Yellen, in the cryptic fashion typical of a Fed Chair, expressed concern last month: “Is the markedly reduced pace of hiring in April and May a harbinger of a persistent slowdown in the broader economy? Or will monthly payroll gains move up toward the solid pace they maintained earlier this year and in 2015?” If, indeed, we see another month of anemic growth, prospects for recession will spike dramatically.
There's one important factor that will not manifest in this report, and that is the effect of Brexit on the US jobs market. The data for the Employment Situations report closed on June 12, well before the UK vote to leave the European Union. That vote sent shock waves through the world markets, including here in the States, and most companies are adjusting their capital plans to account for it. Financial firms in particular are adjusting to the reality of prolonged low interest rates heading into 2017, and most companies with heavy European exposure are still trying to assess what the vote means for them and what adjustments they'll need to make in their 2017 capital plans. Whenever there's uncertainty of that nature, companies become reluctant to add to their workforce. None of this, however, will be reflected in this month's release.
The final data points that will be most interesting concern the Labor Force Participation Rate. You've seen me write time and again that, in my view, this is the most accurate measure of the true employment picture, and the numbers released on June 3 were horrendous. The rate dropped to 62.6%, setting an all-time record of 94,708,000 Americans out of work. Analysts are expecting the rate to drop even lower in tomorrow's release.
What the report will mean for trading tomorrow is anybody's guess. I've long since stopped trying to predict how the market will react to pre-open releases, especially when you have to factor in the contradictory effects of bad news being good for interest rate projections, but bad for future growth projections. I've learned over the years to sit back on release days and let the market sort itself out over the first 30-60 minutes of trading. Tomorrow will be no exception.
Analysts do not expect such a dismal jobs report tomorrow, although the projections of 175,000 on the optimistic side to as low as 140,000 on the pessimistic side are still well under the levels needed to sustain economic growth. The street is also expecting a slight rise in unemployment from 4.7% to 4.8%, and the expectation for hourly average earnings is an increase of 0.2%.
The June report, however, is being closely watched more as a harbinger of the economic outlook for the next twelve months. Some analysts are now placing the risk of recession at 30% for the next year. Given the turmoil in Europe and the impact that contagion can have in the States, I would categorize that 30% as very optimistic. Even Janet Yellen, in the cryptic fashion typical of a Fed Chair, expressed concern last month: “Is the markedly reduced pace of hiring in April and May a harbinger of a persistent slowdown in the broader economy? Or will monthly payroll gains move up toward the solid pace they maintained earlier this year and in 2015?” If, indeed, we see another month of anemic growth, prospects for recession will spike dramatically.
There's one important factor that will not manifest in this report, and that is the effect of Brexit on the US jobs market. The data for the Employment Situations report closed on June 12, well before the UK vote to leave the European Union. That vote sent shock waves through the world markets, including here in the States, and most companies are adjusting their capital plans to account for it. Financial firms in particular are adjusting to the reality of prolonged low interest rates heading into 2017, and most companies with heavy European exposure are still trying to assess what the vote means for them and what adjustments they'll need to make in their 2017 capital plans. Whenever there's uncertainty of that nature, companies become reluctant to add to their workforce. None of this, however, will be reflected in this month's release.
The final data points that will be most interesting concern the Labor Force Participation Rate. You've seen me write time and again that, in my view, this is the most accurate measure of the true employment picture, and the numbers released on June 3 were horrendous. The rate dropped to 62.6%, setting an all-time record of 94,708,000 Americans out of work. Analysts are expecting the rate to drop even lower in tomorrow's release.
What the report will mean for trading tomorrow is anybody's guess. I've long since stopped trying to predict how the market will react to pre-open releases, especially when you have to factor in the contradictory effects of bad news being good for interest rate projections, but bad for future growth projections. I've learned over the years to sit back on release days and let the market sort itself out over the first 30-60 minutes of trading. Tomorrow will be no exception.
Subscribe to:
Posts
(
Atom
)
