2016/09/12 Commentary: So What Just Happened?

2016/09/12 Commentary: So What Just Happened?

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COMMENTARY (Non-Video): Monday, September 12, 2016

So What Just Happened?

Essentially, Goldilocks just got mugged by the Fed hawks. In yet another display of the Fed’s rampant ‘normalcy bias’, since the Jackson Hole Hawk-fest the Fed’s minions have continued to beat the drum on as many as two more rate hikes this year. For more on this pernicious syndrome see our December 16^th Fed’s ‘Normalcy Bias’ Continues post and previous analysis. And just like in what now appear to be major misguided projections from back on that first rate hike in almost a decade (see December 16^th on that), the Fed’s Eric Rosengren could not help himself on Friday from making another of the incredibly distorted anticipatory observations that was way too hawkish for equities.

As noted in Friday morning’s Quick Update: Creature of Expectations post, he went so far as to say that NOT hiking might cut the recovery short(??) How the central bank not hiking rates would shorten recovery is beyond us in current circumstances. Of course, as usual this was related to the Fed’s ‘normalcy bias’ insofar as it is only a risk if you believe the lack of a hike now will require aggressive rate hikes later. That could only be due to major acceleration of economic growth. Also of course, this is still part of the Federal Reserve fantasy that everything is back to normal waiting to explode soon.

For all manner of reasons (see last Wednesday’s Goldie’s Back! post) this is just another manifestation of that Fed ‘normalcy bias’. In fact, not much more than 2 hours after Rosengren’s speech in an interview with CNBC’s Steve Liesman, Fed Governor Daniel Tarullo said that in spite of some temporary asset and commodities price gains at times we are not in that kind of economy. This reinforces our long-held view that central bankers have gone from ‘inscrutable’ (in the good old days) to ‘insufferable’. And much will come down to the Fed’s dovish Ms. Brainard’s speech today, the surprise announcement of which on Friday added to the pressure on the equities (more on that below.)

Yet the hawkish Fed minions aren’t going to let silly things like two weeks of serial weak economic data get in the way of their attempt to convince everyone that things are back to ‘normal’ and at risk strengthening much further. Consider the litany of woes that is the US economic data since the Jackson Hole Policy Symposium. While we have already reviewed quite a few of these as they were released, a summary review to understand why the equities are taking such exception to the Fed’s continued hawkishness is in order…

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NOTE: Back on the evening of December 8^th we posted our major Extended Perspective Commentary. That reviews a broad array of factors to consider Will 2016 be 2007 Redux? For many who believe that the US economy is really strengthening and can once again lead the rest of the world to more extensive recoveries, this may seem a bit odd.

Yet there are combined factors from many areas we have been focused on since the early part of last year which are less than constructive for the global economy and equity markets. We suggest a read if you have not done so already.

We pointed out in December in the face of another likely Santa Claus Rally this was not an actionable view during the year-end equities rally. Yet it was (and remains) important background to utilize into 2016. This is much like our major late 2006 perspective on Smooth Rebalancing? …or… The Crash of ‘07? In that instance the economic factors built up, but the actual crash was deferred into 2008. It is starting to feel this one may be deferred as well.  

▪ First of all we need to allow that the Fed has been repeatedly wrong-footed by the economic data because its ‘normalcy bias’ leaves it wanting to see a more robust recovery in every short-term burst of improved news. And it was once again one of those periods leading into the Jackson Hole Symposium that left its minions feeling comfortable with renewed hawkish views. In this instance that even included the typically more circumspect Chair Yellen.

However, it didn’t take long after Jackson Hole for the data to weaken again, and do so in a troubling pervasive manner. Yet the Fed communication remained very hawkish even as key indicators refuted their opinion. Also keep in mind weaker US data is complemented (if one can call it that) by on balance still weak European and Asian data.

Coming back in after Janet Yellen’s more hawkish than usual views at Jackson Hole on Friday August 26^th, Monday saw a much weaker than expected Dallas Fed Manufacturing Index even if Tuesday’s Consumer Confidence was stronger. On Wednesday, the much weaker than expected Chicago PMI was released to finish the month of August.

September got off to a bad start with a much weaker than expected ISM Manufacturing Index (dropping surprisingly back below 50.0 from 52.6 the previous month.) Yet, that left economic bulls still pointing to the following Tuesday’s release of ISM Non-Manufacturing as the real key to the modern US economy. On Friday, September 2^nd the US Employment report was also a disappointment with only a 151,000 Nonfarm Payrolls increase, and (as importantly) monthly Hourly Earnings slipping back down to a measly 0.10% gain.

The latter is an indication of the quality of the jobs being created. The entire report should have been a real ‘Goldilocks’ affair in the context of restraining the Fed. BUT NO!! The Fed minions having the data point out that they were yet again wrong on their strong US economic view wasn’t going to deter them from talking up the economy and rates!

So we continue into last week, with the possibility they might have actually been right to ignore the weak post-Jackson Hole data. After Monday’s Labor Day holiday what do we see on Tuesday but a really weak ISM Non-Manufacturing Index (a drop to 51.4 from 55.5), and a US Labor Market Conditions Index Change that was supposed to be down from 1.3 to 0.0, yet was -0.7 instead. The ISM Services figure is important in confirming the ISM Manufacturing weakness, and the Labor Market Conditions Index is one of the key indicators the Fed allegedly watches closely in its economic and inflation assessment.

In fact, the weakness of those indications was part of the market calculus that saw the equities and govvies rally together on Tuesday and hold up on Wednesday. There was some consideration the cumulative weak data might be a restraint on the Fed. While there was little US economic data last Wednesday and Thursday there was the ECB meeting and press conference.

And as we pointed out in our early Friday Quick Update: Creature of Expectations, the old adage “the market is a creature of expectations” seemed to be at work again out of Thursday into Friday morning. There was an expectation of more extensive QE from Mario Draghi and the ECB on Thursday. It didn’t happen. And with more hawkish missives on the way from the Fed’s minions Friday morning (like the Rosengren comments noted above), the equities expectations shifted into preparing for more of the Fed’s hawkish ‘normalcy bias’ rhetoric in spite of the recent serial weak data.

The Coup de Grâce

And this would seem to be the straw that broke the camel’s back (or more appropriately in this case the bull’s back.) Yet, even at that the weakness of the early Friday break was still orderly into the key lower supports, like the September S&P 500 future 2,155 area. Then came the coup de grâce: the surprise announcement that Fed Governor Lael Brainard would be delivering a previously unannounced speech on Monday at The Chicago Council on Global Affairs knocked the equities below that support.

This is important, and was very disconcerting for the equities for two reasons. The first is that much like Mr. Rosengren in times previous, Ms. Brainard is among the Fed’s most committed doves. And if she is going to shift her rate increase perspective, Monday is a very critical horizon. It is one day prior to the Fed’s self-imposed “quiet period” prior to the major (projections revisions and press conference) FOMC meeting on September 20^th & 21^st. Another nebulous, counterproductive communication from the Fed! Insufferable!

What was not a surprise is that it let concerns over what Ms. Brainard might say fester through the balance of Friday afternoon. That caused the September S&P 500 future to drop through the next nominal 2,141.50 support (the August 2^nd trading low) below the 2,155 area. As we pointed out in Friday morning’s post (and previous), the next more prominent supports below 2,155 not reached when it bottomed at 2,141.50 on August 2^nd  are the 2,120 and 2,105-00 congestion areas. Not a huge surprise that it finished Friday around the 2,123 area after it cracked 2,155, and the lower support was neared in overnight electronic trading this morning.

We’ve Been Here Before

As dramatic as it looks whenever equities experience one of these short-term meltdowns, this is a recurring phenomenon based on that sustained Fed ‘normalcy’ bias. It occurs when the ostensibly most powerful, or at least ‘leading’, central bank in the world demonstrates a definitive penchant for NOT appreciating the real state of the US and world economy. When the lead-in to the Fed’s ‘quiet period’ prior to the next major meeting leaves the distinct impression that it might very likely hike rates into a weakening fundamental picture, why wouldn’t the equities take fright?

Yet, in spite of that there are times when the markets begin to question just what the Fed might, or might not, do under current conditions. Think back to last September. This is from our early September 18^th (one day after the major FOMC ‘non action):

“The FOMC did not just hold steady… It also provided a very downbeat assessment of not just the global economy but also the horizon for the Fed to see its inflaiton target hit… not until 2018!? Whatever discussion the Fed now provides on the potential for rates to rise this year versus waiting until 2016, there are other questions which come to mind.”

And so there we were, with a Fed that was supposed to hike, yet had a very downbeat view on the global economy restraining it. The result of it holding steady at the still lowest rates ever yet providing such a negative view was the S&P 500 lead contract future (just rolling over to December 2015 contract on the September 17^th day of the meeting) failing from its retest of the low 2,000 area it had failed in mid-August (after the FOMC on the 19^th.)

The break extended down to a 1,861 trading low at the end of September due to the same sort of weak economic data we are seeing at present. Then it began rebounding right at the end of the month, even before the October 2^nd very weak US Employment report. That it was already bottoming prior to that signaled the psychological change: the news was bad enough that the market participants realized the Fed was almost assuredly NOT going to raise rates in October in spite of its governors continued tough talk.

And so the equities churned their way higher in spite of continued weakish economic data after the weak US Employment report (which was not surprisingly revised higher in both subsequent reports.) And it ultimately pushed definitively back above that low 2,000 area into mid-October, even before the Fed indeed held back on raising rates at the next October 27^th-28^th FOMC meeting.   

The January Debacle

And consider for a moment the January equities debacle in the wake of the FOMC’s mid-December first rate hike in almost a decade. There’s an object lesson for the Fed… and the rest of us. We need to allow that this was exacerbated by the suddenly weaker view of China and emerging market economies. All the same, the Fed tightening up a bit in December gave the wrong signal to an equity market driven by the chase for yield in a risk-on world where the classic ‘safe’ yield alternatives are not providing a return.

That sharp selloff also ended not much below the August-September lows, back into the low-1,800 area. Once again there was some comfort from the fact that the extended equities weakness had bolstered the govvies (and sent yields lower) in a clear sign that higher yields were not sustainable regardless of the ‘normalcy bias’ that afflicted a Fed still trying to convince everyone the economy was on the verge of accelerated growth. Also once again the US equities recovered all the way back above the key 2,000 area once again as well.  

Structural Reform

And not much has changed in that regard. Until there are structural reforms we (among others) have highlighted as the only path to the return of robust growth are in place, forget about whatever the central banks are proposing or attempting. It’s pure folderol.

And that includes the current consideration that the central banks reaching the (very distended) end of the massive accommodation line (i.e. low rates and QE) means fiscal stimulus is the way to revive economies. Balderdash!! We’ve seen occasional major fiscal stimulus attempts, and they haven’t been any more effective than the Central bank accommodation at restoring robust growth.

As noted in last Wednesday’s Goldie’s Back!, “…US Treasury Secretary Jack Lew was crowing about the US winning the ‘austerity’ versus ‘fiscal stimulus’ debate is more so troubling than encouraging. Without the necessary structural reforms neither the massive central bank accommodation nor occasional fiscal stimuli of the past seven years have managed to restore strong growth.”

There was also a bit more on the importance of structural reform that the political class has singularly failed to deliver in that post. We encourage anyone who has not already read it to take a look.

But there was an even more succinct and meaningful insight on how important structural reform (including both tax and regulatory policies) is to any chance of a recovery in a chat on CNBC Friday morning. This was not with a central banker (most of whom refuse to push the political class) or an academic economic analyst. It was from a very prominent and well-informed businessman who needs to deal with these factors in the real world:

Waste Management CEO David Steiner, who was a guest host on Friday morning’s CNBC Squawk Box. As the head of a firm who needs to deal with regulations all of the time, and who has solid real economy views on what drives investment, his comments in just one of the clips from his sojourn as guest host are worth viewing. 

Right from the beginning he notes it is all about tax policy and regulatory policy. And he goes on to say, “…jobs follow business investment.” Also right on target that he notes, “Interest rates are important, but they are not what we sit and worry about running a business.” This should be required viewing for all members of the US Congress and other developed economy legislatures. He says in so many words that “…tax policy and regulatory policy would help the economy eminently more than anything having to do with interest rates.” It is a truly striking three minutes for anyone who bothers to watch.

FT Editor Warns

And even though they did not specify the structural reform aspect of low global economic growth, the Financial Times’ lead FT Weekend editorial was also very instructive on The mistake the Federal Reserve should avoid. (The link is to the post at FT.com and likely requires an FT subscription.)

It begins by also pointing out the additional stress created by last Friday’s impromptu announcement of Ms. Brainard speaking today. Yet they are finally coming around to a view that is consistent with our assessment that the Fed could appear misguided. “An increase in borrowing costs now would also confirm suspicions that the Fed is working with substantially the wrong model of monetary policy in mind, and bring the prospect of further unwarranted rises in the near term.”

Well said. Further… “The argument that raising rates now gives the central bank more room to cut in the future has it precisely backwards. (Our underline.) Keeping policy loose now reduces the probability that the central bank will have to try to ease further later on, only to find it has run out of tools.” Also well said. And with conditions still more suspect than the Fed will allow, the title of the editorial makes clear the well-informed folks at the Financial Times are not afraid to characterize any near term Fed tightening as a mistake.

So What Now?

As in all circumstances of this type it is important to keep the broader Evolutionary Trend View in mind. While we will provide the full Market Observations in the lower section below after today’s US Close, considering how the US equities are acting in the context of the key technical trend levels is the most important aspect for now. It is even more important than the weak performance of the government bond markets. Even though there is some concern about the govvies in the context of a potential FOMC hike next week, the govvies tend to be fine if the economic data remains weak. In fact, they are classically bolstered by any extensive equities weakness.

EQUITIES

▪ September S&P 500 future expires this Thursday, with the December contract trading approximately $7.00 lower. So any of the lead contract levels we note for the September contract need to be assessed in the context of the lower pricing of the December contract against those levels being important into late this week.

With the September S&P 500 future below the weekly Oscillator threshold that was up to 2,175-80 last week, all of the lower areas such as 2,155 already vigorously tested over the previous couple of weeks remained important. As noted again early Friday morning, next support below was not until the early August 2,141.50 trading low (also weekly MA-13.)

That weakness never quite reached the more prominent 2,120 trading high and much heftier 2,105-00 congestion areas from throughout 2015 and Spring of this year. The September contract has now neared it (with the December contract trading down into it.) That said, there is a good deal of ‘internal’ congestion below it in the 2,070 area. That would be the Tolerance of the 2,105-00 support. Much below it the market is well back into the broad lower trading range, and in that case we suspect a drop back to the low 2,000 area (or even lower levels) would become much more likely.

GOVVIES

▪ The September T-note future had been swinging around the same sort of technical levels as the June contract of late. That alone is very interesting, because the appetite for locked in yields even at these low levels indicates an overall flight to safety. In the case of the June expiration the typical half-point to full-point discount in the second month September future near expiration didn’t exist. In fact, the September contract was trading at a slight premium to the June contract prior to the latter’s expiration.

That is the sort very atypical of ‘flight to safety’ premium that continues to keep yields low in spite of the current more typical discounts in the second months.

It weakness below the 132-00 area has only progressed to near the interim 131-00 support. That shows quite a bit of resilience in light of the extreme weakness of the equities; it is probably also driven by that equities weakness. While the September contract does not expire until Wednesday the 21^st (that’s right, FOMC announcement day), it is important to note the full point discount in the December contract. Even so, at least so far that only leaves the December contract closer to the more prominent 130-00/129-16 support. Pending whether further US and global economic data remains as weak as recent indication, it is likely the govvies (Europe as well) will be alright.  

FOREIGN EXCHANGE

▪ The same sort of anomalies between the equities and govvies also goes for the foreign exchange, where the US Dollar Index is only back up near the top of the interim over-under .9500-50 congestion after being temporarily below the .9460 UP Break once again. After being the more active area after Jackson Hole, this looks a bit more subdued compared to the equities and govvies over the past couple of days. We suspect this is also a response to the Fed’s normalcy bias in the face of serial weak economic data in the US this week. As such, we refer back to the Market Observations in the lower section of Wednesday morning’s Commentary Goldie’s Back! post. In spite of the recent modest recovery of the US dollar, not much has changed in this area since last Wednesday.

Extended Trend Assessment is available below.

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