Days like Wednesday are the ones that remind investors why the Federal Reserve is what it is, and how some believe the other world central banks cannot compete, even as some expect the European Central Bank and Bank of Japan (to an extent) to take up the slack the Fed will leave behind when it ends quantitative easing in the next weeks and prepares for its first interest-rate hike some time in the third quarter.
The odds on that hike, by the way, shifted late Wednesday after the Fed’s minutes showed there was concern about moving policy too quickly. It’s the pace of increases that worries the Fed, not the idea of doing it at all. The Fed is likely to push rates to about 50 basis points either in July or September (the market is betting on September now, the Fed is probably thinking July), but it’s important to keep in mind that the monetary policy committee is not going to then start doing the one-move-per-meeting thing they did in the last rate-hiking cycle back in the Pre-Cambrian Era.
Just when the market thought it was out, it got pulled back in. The Federal Reserve will release its minutes later in the day that details what it was thinking during its most recent September policy meeting, but of late, the markets have been of a mind that the expectations for higher rates ought to be tempered a bit.
On Tuesday, New York Fed head William Dudley suggested in remarks that the chances of economic growth in the long-run coming in faster than anticipated is a fantasy that people should get shut of – and so that helped take down the market and not ironically contributed to a further decline in the five-year/five-year forward spread that serves as one of the market’s best barometers of inflation expectations.
Beware of companies tying their fortunes to one company – something both the debt and equity holders of GTAT Advanced Technologies learned painfully on Monday, when the company filed for bankruptcy. While it’s nice to look ahead at the rest of the world, the mechanics behind some of the selling is so severe that it’s worth delving into just a little bit here.
For the uninitiated, shares of this company’s stock had taken off in the last 12 months as investors grew excited over the possibility that its sapphire glass would be used in Apple applications – it even built a facility in Arizona dedicated pretty much for this. But as with everything, fine print matters, and Monday, it mattered to the tune of an unbelievable 92 percent drop in shares, the kind of thing usually seen only in stocks that trade on over-the-counter exchanges, or, well, names like Bear Stearns.
The preparation for tighter U.S. monetary policy is showing up in markets in a number of areas, most notably through the appreciation of the dollar which has a greater affect on GDP growth than people sometimes realize. Rising strength in the greenback, which would be expected to continue given the dovish monetary policies being pursued in Europe and Japan, turns into notable weakness in a number of U.S. sectors tied to exports like autos and energy.
Citigroup’s William Lee dives into this by pointing out that substantial rallies in the dollar have the power to brake GDP in a way that Fed tightening even doesn’t, saying GDP growth could decline by a percentage point if the rapid move in the dollar continues through early 2015.
As Abraham Simpson would put it, “that’s a job report you can set your watch to.” Overall growth came in a bit better than expected, with job growth at 248,000 and the unemployment rate dipping to 5.9 percent. There’s no wage growth, of course, because, well, it’s kind of an ongoing situation now, and the U-6 rate of underemployment fell to 11.8 percent, which is also overall strong news.
The market’s initial reaction is telling – bond markets are selling off, with more pain in the five to – and 10-year area of the curve, reflecting expectations for higher rates before long but not so much that you can really point to something that will derail economic growth. With futures higher, the thinking right now is that the market will manage to close out the week with a somewhat better tenor than it did coming into the week.
One day before the key jobs report that will likely paint yet another muddled picture of the current economic state, it’s the bond market that’s gotten more dynamic and interesting than the other asset classes out there. Treasuries are seeing a safe-haven bid on the back of Ebola and protests in Hong Kong, along with a comparison to the still-falling yields in the euro zone. High yield securities are seeing their spreads widen out in a way that’s commensurate with previous pullbacks that have later manifested into notable corrections in the stock market (and given the Russell 2000 hit that 10 percent threshold on Wednesday, the answer is yes, this is something to keep watching), and so that’s yet another bit to watch for as well.
Some of it can be explained by the sudden departure of a certain fixed income manager in California from the firm he founded a million or so years ago. And while there’s a heavy temptation to emulate Bill Gross here by somehow speaking this column out loud as if my rabbit had penned it, we’ll be content to note that the Treasury market’s selling pretty well snapped back in a couple of days.
One of the day’s biggest indicators will be monthly auto sales figures, at a time when the major U.S. automakers are seeing notable weakness in their equity prices. We’re waiting on insights from General Motors as they hold an analyst day and after Ford warned that its profits would fall short of expectations for 2014 and 2015 thanks to bigger recall costs in North America and bigger losses in South America and Russia. It’s tempting to go after the world weakness – be it Brazil, Russia, Germany or what-have-you – as that which ails the likes of a big automaker like Ford, and certainly the lackluster demand there isn’t going to help anybody.
But Ford in 2013 still counted 58 percent of its sales from the United States (Russia is de minimus now, not even warranting a percentage amount in its line items on its segment breakout). Germany accounts for about 6 percent, so there’s that – but still, U.S. Fifty-eight percent. Ford full-size pickups. Big margins, y’know? So the Detroit team (and investors) are looking for any kind of weakness there, anything that supports the idea that sales incentives are doing for car sales what the Fed has done for the bond market (that is, provide lots of financing) and whether transaction prices are rising or not.
Plenty of cross-currents to be aware of in the markets right now – many of which are pretty confusing and relate countervailing messages when it comes to where equities and other risky assets are headed. Stocks were heavy at the open on Monday and slowly got better throughout the day but energy stocks remained under pressure. The expectation of more unrest in Hong Kong certainly has contributed to the jitters, but the U.S. is a pretty resilient economy regardless of outside forces so it’s while it’s easy to blame China broadly, it’s hard to apply too much of a causation (probably why equities recovered throughout the day).
The bond market might be the better signal for the worries in equities. Last week speculators increased their short position in two-year notes to their longest since 2007, and asset managers hold their biggest short position in five-year notes since 2011; taken together that’s a clear sign of bearishness in the front end of the curve, reflecting expectations for a flattened yield curve as part of higher rates across the board. With the dollar continuing to strengthen, there’s a bearish sense in the air when it comes to U.S. central bank policy, and that’s something that again threatens to undermine equities — witness the weakness again in energy names.
These days things are all about canaries in coal mines – be it the small-cap names, the energy stocks, emerging markets or a handful of other important sectors that people hold up as a precursor to some sort of “big bad” event that comes down the line (and by big bad we mean like a boss level kind of thing, like Bowser from Super Mario Bros).
That said a correction wouldn’t be out of line right now – the market has gotten used to rolling corrections through a number of sectors throughout the year, and right now, it’s energy’s turn to take it on the chin, with stocks like Valero, Noble Energy, Ensco and Diamond Offshore among the worst performers in the S&P through September. They’ve been hit by a combination of factors – the dollar’s strength has sapped the price of oil dramatically in the last several weeks, and the ongoing fascination with the fracking boom has investors all a-buzz about the onshore drillers, so that’s hurt the offshore names (funny how that is).
The idea of increased political risk when it comes to the U.S. markets has been mined before, and it’s true that the uncertainty that surrounds debates such as the renewal of the Export-Import Bank’s charter and the growing expectation that Republicans, should they take power in November in the Senate, could force another confrontation over the debt ceiling. That said, political risk in the U.S. isn’t anything when compared with Brazil as the largest South American economy gears up for its presidential election, a contest between current president Dilma Rousseff and environmentalist Marina Silva, who until last month wasn’t even running (she was the vice presidential candidate for her party, whose original candidate was killed in a plane crash).
It’s an understatement to say the markets aren’t a fan of Rousseff, who hasn’t been able to bring the country out of its current economic rut – in fact, a chart of the Bovespa stock market makes it an easy one to pick out pivot points in the election race. In a two-week stretch following the death of Eduardo Campos, the Bovespa jumped more than 11 percent as investors started to see Silva as the candidate more likely to take out Rousseff (the other candidate, Aecio Neves, has seen his support slowly erode as Silva emerged as a popular choice).