Posts tagged Federal Reserve
Not long now

Too many themes have caught my attention recently, so I’ll stick with some points on markets this week, leaving my more discursive thoughts for later. I think two things currently are serving to make sure that markets resemble deer caught in the headlights. For starters, Mr. Trump’s Twitter feed is keeping everyone on edge, whether they like it not. Markets clearly are moving as he tweets—no matter how crazy the statements—and to the extent that the president is using his executive powers to affect policy, he is liable to announce it on Twitter, even if he does decide not to go ahead. This makes Trump’s twitter feed a bit like nonfarm payrolls. Everyone knows that it is a lagging indicator, that it is heavily revised, and notoriously volatile due to seasonal adjustment and sampling issues. Still, knowing the headline in advance can make you a lot of money. In short; traders have to stay alert to Mr. Trump’s volatile ramblings. Secondly, markets are waiting for the decisions by the Fed and the ECB later this month. Further easing is all but guaranteed from both central banks, but expectations are elevated, increasing the risk of a disappointment. In any case, it is fair to say that whatever they actually do this month, the guidance from messieurs Powell and Draghi will be just as important as the actual actions taken by the FOMC and ECB.

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Front-running Easy Money

In a nutshell, this is what my models are telling at the moment: the three-month stock-to-bond ratios in the U.S. and Europe have soared, indicating that equities should lose momentum in Q2 at the expense of a further decline in bond yields. That said, the three-month ratios currently are boosted by base effects from the plunge in equities at the end of last year. They’ll roll over almost no matter what happens next. Moreover, the six-month return ratios are still favourable for further outperformance of stocks relative to fixed income. Looking beyond relative returns, my equity valuation models indicate that the upside in U.S. and EM equities is now limited through Q2 and Q3, but they are teasing with the probability of outperformance in Europe. Finally, my fixed income models are emitting grave warnings for the long bond bulls, a message only counterbalanced by the fact that speculators remain net short across both 2y and 10y futures. This mixed message from my home-cooked asset allocation models is complemented by a mixed message from the economy. The majority of global growth indicators still warn of weaker momentum, but markets trade at the margin of these data, and the green shoots have been clear enough recently. Chinese money supply and PMIs showed tentative signs of a pick-up at the end of Q1, a boost reinforced by data last week revealing that total social financing jumped 10.7% y/y in March.

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Doves on Parade

My main job on these pages is to  distil the market Narrative™ for my readers, and recent events have made this week’s missive a layup. The debate on whether to fire, and how to arm, the fiscal bazooka has continued, and now monetary policymakers have joined the party. For a while, it seemed as if the world’s biggest central banks were sleepwalking into coordinated tightening, or in the case of the PBoC, failing altogether in the attempt to counter a sustained cyclical slowdown. To the extent that the Q4 chaos in equities was investors’ vote on this strategy, they should consider their message received. In Japan, signs of wage growth briefly alerted markets to the prospect that the JGB market would be un-frozen by further loosening of the yield-curve-control. But the truth is that Kuroda-san is stuck. With global headline inflation pressures now easing, manufacturing and exports struggling, and the looming consumption tax, the BOJ isn’t going anywhere fast; zero rates and (modest) balance sheet expansion will continue as far as the eye can see.  In Frankfurt, the ECB recently downgraded its assessment of the economy—the convoluted shift from “broadly balanced” to “downside” risks—and expectations are building that the TLTROs will be extended, or even renewed and expanded.

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Making sense of it all

I think that I am on record somewhere for saying that I would sell everything if the 2s5 inverted. Well, it just did—by a slender margin of 2bp—and for that reason alone, I should have a view. It isn’t easy, though, to add something that hasn’t already been added by the cacophony of comments on the back of recent gyrations in U.S. bonds. If a falling tree in an empty forest doesn’t make a sound, does a yield curve inversion matter if everyone has been talking about it for a year? As it happens, the tree does make a sound, and the yield curve inversion does matter, though not for the reason that you might think.  Rick Reider, CIO of the investment manager Blackrock, is a smooth operator, and he delivers the goods in a few tweets. The significance of a yield curve inversion is not about its ability to predict a recession in the U.S., or elsewhere—more about that in a bit—but about the following three points. First, the Fed has some questions to answer; second, an inverted yield is as much a statement of markets’ perception of the Fed’s neutral/terminal rate as it is about its ability to forewarn about a recession, and third; bonds are finally offering a bit of protection for balanced portfolios. This week, I’ll go through each of these points in turn. 

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