Economic Update. October 2016

Transcription

1 Economic Update October 2016

2 Imagine a world October 12, 2016 Heading into September stock traders were worried about the Fed meeting, the first presidential debate, and the dreary historical performance of the stock market in September. Bond traders were hoping stock traders were right to be worried, and bond yields would fall again after a modest rise in August. But those fears of a bad September for stocks were not realized. The Fed meeting was uneventful, and the debate outcome was a positive surprise for stock traders. Both markets ended the dangerous month almost unchanged. October was started off with some much better economic data and one big surprise on the political front. Stocks have yet to make a big move, as the election outcome is still in doubt. Bond yields are higher, not on the economy or the election, but on what is happening in foreign bond markets. It seems like everything is in a holding pattern until after the election. In this month s commentary I will take a quick look at economic developments and the latest developments at central banks. These things matter in the longer-term, but nothing matters in the short-term except getting past November 8. Economic doomsayers have to wait The economic data since the last report has not lived down to what the economic bear camp is wishing for. The last jobs report wasn t a barnburner, but it was good enough. The payroll gain of 156k was in line with expectations and in line with what should happen as the labor market tightens. The two weak spots from the August jobs report, hourly wages and hours worked, both healed in September with rebounds in both. Continued jobs report like this one will do the job of keeping the economy on track. While the jobs report was a bit of a bore, other data wasn t. The bears growled in early September with the ISM manufacturing index and the ISM non-manufacturing index were both much weaker than expected. They pounced on these as certain signs the economy was heading south. The growls fell silent when the latest data was released. Economists were looking for modest rebounds, but both indexes not only recovered what was lost in September but added several points to boot.

3 The good news didn t stop there. While Factory Orders is typically a highly volatile, unreliable indicator, there is one component in the data release that economists and others do pay attention to. That component is the core capital goods component, a proxy for business spending. Business spending has been the weakest sector of the economy for almost two years, but that component had reported two surprisingly good increases in June and July. Economists were expecting orders to retreat in August, but capital orders surged by.9%. Score another one for the economy. The next surprise was auto sales for September. Sales were expected to post a rate of 17.2 million units annualized, but sales jumped to 17.8 million. The bears tried to muddy the waters by pointing out the heavy discounting and rebates offered by auto makers, but they need to look at their calendars as well as history. Auto makers always offer big discounts and rebates in September as they try to move out one model year to make room for the next. There wasn t a bad report for the U.S. economy to be had over the past month, and that goes for global economic data as well. Economic data out of Europe and the UK has surprised economists to the upside, especially in the case of the UK. Even the latest inflation data from Europe has turned higher. It s far too early to say the economy has turned higher in Europe, but the deaths of the economies of the UK and Europe have been greatly exaggerated. Getting the message? In last month s Longer-term Commentary I had an extensive rant on the policies of global central banks and the damage they have done and will continue to do if they advance down the same path. I doubt that many of them read my commentary. Actually, I am 100% certain that none of them did. But we did hear faint noises that perhaps some of them are recognizing the limits of what they can do and are beginning to worry about the unintended consequences of what they have already done. Let s start with the Fed. While the Fed did nothing in September and Janet Yellen indicated she has no intention of seriously considering any move until December, the FOMC vote to maintain the unchanged policy recorded three dissenting voters who were ready to move. While three of twelve votes is a small minority vote, it is high by Fed voting standards. But what I have been encouraged by lately is how many Fed officials are openly expressing concerns about the penalty they have imposed on savers and pensions and about the potential that the bond market could be vulnerable to a painful selloff. These are just words at this time, but at least the conversation is happening.

4 The Bank of Japan, at its September meeting, pleased the bond market by pledging to keep all rates low but switched the focus to lowering short-term rates to steepen the yield curve. The BOJ also did not pledge to buy specified amounts of longer-term securities. While bond traders cheered the message, they may have also missed the point. The BOJ tacitly admitted that noholds-barred buying of securities wasn t working, and it was time to experiment with something new. Now, on to Europe and the UK. Bloomberg posted a story that several sources at the ECB said the ECB was likely to start tapering securities purchases beginning in March of next year. The program expires in March, but Draghi had already promised an extension of the 80 billion euro per month buying program. If the Bloomberg story is correct, the program will be extended but in a tapered down form. The ECB issued a tepid denial, but Bloomberg stood by its story. In the UK, the new Prime Minister called for the Bank of England to reduce its ramped up securities buying program. The Bank of England hit the panic button immediately after the Brexit vote and dramatically ramped up the existing program. PM May said the program was dangerous for the capital markets. Bank of England officials did not directly respond to May, but British newspapers are reporting that BOE officials were in fact already looking to reduce the program. What does all of this mean? It could mean nothing. Central bankers have occasionally expressed concerns in the past about unintended consequences of their policies, only to cower in the corner the minute the markets have a hiccup. They are still slaves to the markets until they prove otherwise. Still, I will take some encouragement. It could mean a lot. There will be no sudden reversals in policies, but even backward baby steps will impact the markets. Longer-term rates in Japan and Germany are about 20 basis points higher than just a couple of months ago. That doesn t sound like much, but it s a big hit to principal when the base is negative rates. Just think about how much zero coupon bonds move on small rate changes. U.S. longer term rates are up about 40 basis points from the July historic lows. The moves in rates so far have been modest and controlled, but that could change if the overlyleveraged bullish bond trading community decides to de-leverage. But first things first. The dark, smelly air around the election must be cleared out.

5 Wrestlemania! I wrote this in a recent daily comment: The campaign has four more agonizing weeks to go, and who knows if there are more October surprises in store? The final debate will be next Wednesday. I wish we could mount a campaign to cancel the debate, but I guess it s too late. In lieu of cancellation of the debate, let s at least agree this is not an actual debate. It s mudwrestling. I apologize to mud wrestling fans out there. Mud wrestling is more dignified and less harmful than this election has been. America is divided on many things, but I think there is one thing that at least 99% of Americans can agree on. We just want this to be over. This has been bad. Just when you think the election couldn t sink lower, they find a way dig even deeper. The latest debacle was of course the Trump tape. While everyone had been waiting for the October surprise as promised by WikiLeaks founder Julian Assange to potentially hurt Clinton, the real surprise was for Trump. While Trump is trailing badly at this point, you can t take anything for granted in this election. There could be more October bombshells ahead, and you just don t know upon whose head they will land. Stock traders have wisely not yet embraced a surefire Clinton victory. This could be a long four weeks. As a reminder, this is not a political statement on my part. I m just reporting how stock traders react to uncertainty. There is no great love for Clinton on Wall Street, but there is great fear of the unknown and unpredictable. And Trump is the embodiment of unpredictable. Imagine a world Imagine a world in which we don t have to worry about a presidential election. Fortunately, that dream will come true in four weeks. The markets will do whatever they do on the results and then put the results aside and move on. Imagine a world in which the economic data continues to be solid. I think that dream will come true as well. There is no reason to expect the economy here or elsewhere to simply rollover. There are risks ahead in 2017, but the risks are no greater than they have been for the last fiveplus years. Imagine a world in which interest rates align with the economy. This dream will still be on hold for some time to come, but there are just as many, if not more, reasons for optimism as pessimism. If that dream also comes true, what would this imaginary world look like? Given the current level of inflation and economic performance, the absolute lowest for fed funds would be 2%. Historically, that would represent an easy money policy. Looking back over decades of data, the 10-year note yield would be 4% or higher. Again historically, the 10-year yield has been roughly 200 basis points over the rate of inflation. This is my imaginary world where everything makes sense again. Perhaps it s a dream too big, but I don t see it that way. I believe it s possible. Of course, I also once believed in the Tooth Fairy and Santa Claus.