Macro myopia on tapering and a preview of the week’s highlights
The solid US jobs report that saw the world’s largest economy add a little more than 200k net new jobs and the unemployment rate fall three tenths of a percent to 7.0%, even with the participation rate ticking up got some chins wagging about that the Federal Reserve tapering at its next FOMC meeting on December 17-18.
Even the usually astute Financial Times jumped all over the story with its page three story “US jobs boost raises speculation on Fed taper”. Not once in the article did the reporters note that US bond yields actually slipped after the jobs report or that the dollar fell. The speculation that it refers to was not found in price, but in one economist it cited.
Those inclined to the Fed tapering in December seem myopic. The employment was not the only economic report that was released before the weekend. The US also reported that the Fed’s preferred measure of inflation, the deflator for core personal consumption expenditures, which slipped to 1.1%, the slowest pace in more than 2.5 years. The FT thought this was worth a single paragraph it is report on the prospects of tapering.
The Financial Times did not see fit, though, to even recognize in passing, the fiscal uncertainty that hangs over the market. Recall that the lack of fiscal clarity influenced the Fed’s decision not to taper in September. Although December 13 is a self-imposed deadline for an agreement, the heightened tensions, especially in the aftermath of the Senate Democrats parliamentary maneuver that allows the filibuster to over ridden on presidential appointments with a simple majority, and the usual brinkmanship tactics warns that a final deal may be elusive until closer to the next legislative deadline in mid-January.
Nor do most observers take seriously the institutional interests of the Federal Reserve. We have argued that the seven person Board of Governors is going to see significant changes in the months ahead. The Fed’s forward guidance that is to replace QE as the main policy tool will be more credible if issued by the next Fed chairman not the soon-to-leave current chairman. Yellen-led tapering will build her (and the new Fed’s) credibility and help correct perceptions that she is a super-dove. The macro-economic impact of waiting a month or two before reducing asset purchases by $10 bln or $15 bln is minor at best.
More importantly, investors appear to be accepting the Fed’s argument in a way that it had not done so previously: tapering is not tightening. The US 2-year yield was above 50 bp in early September as many expected tapering. It was more than halved and now is near 30 bp, despite ideas that tapering could be imminent.
The German 2-year yield fell to 5 bp in early November as many took seriously the possibility that the ECB could soon adopt a negative deposit rate. As ECB officials played down the risk of deflation and the a negative deposit rate seemed remote, the German 2-year yield jumped and was near 25 bp before the weekend (settling near 22 bp). This saw the 2-year interest rate spread, which the euro-dollar exchange rate is sensitive to, fall below 9 bp to stand near the lowest levels since last February.
The 10-year interest rate differential between the US and Germany rose above 100 bp. This is near the highest since before the crisis. Yet, it offered the dollar little support. The euro finished at its best level since the end of October and appears poised to re-challenge the $1.3830 2-year high set on October 25.
This analysis helps explain why the US dollar is not rallying on good economic news and why an uptick in retail sales, the economic highlight of the week, may not lend the greenback much support. Separately, the flow of funds report on Monday is likely to show a new record high household wealth; completely recouping the sharp drop triggered by the crisis. Sharp gains in equity prices and more modest gain real estate have been experienced, but the holdings are highly concentrated.
Europe reports industrial production figures. A strong German report is possible, despite the weakness in orders data before the weekend. Survey data suggests a re-acceleration of the German economy in Q4. To be sure, it is not the poor growth prospects that incite the ECB to act, but the disinflationary forces, the increased volatility of short-term interest rates as excess liquidity evaporates, and small and medium sized businesses remain locked out from finance. Separately, the industrial dispute in a large refinery in Scotland warns of potential disappointment with the UK’s figures.
Sweden reports November CPI figures and this is the last important report ahead of the Dec 17 Riksbank meeting. Poor economic data has fanned speculation of a rate cut, though the market seems a bit divided, with some looking for the central bank to stand pat until early next year.
The Swiss National Bank and the Reserve Bank of New Zealand meet this week. Neither is likely to change policy. The latter is expected to hike rates toward the end of Q1 14. The former is likely to reaffirm its CHF1.20 floor for the euro and a 0-0.25% target for 3-month LIBOR.
Japan is expected to report a current account surplus in October after a seasonally adjusted deficit in September early Monday in Tokyo. It will also report revisions to Q3 GDP. These revisions are likely to be to the downside and quarterly annualized growth is expected to slow to 1.6% from the initial estimate of 1.9%, and down from 3.8% in Q2. More important will be the Oct machinery orders later in the week which will shed insight into capex in Q4.
Australia reports Oct employment data in the middle of the week. The consensus calls for a 10k increase after a 1.1k increase in September. This understates the Sept weakness as nearly 28k full time positions were lost. The Oct unemployment rate may tick up to 5.7% from 5.6%.
China reports a host of data this week, including CPI early Monday, industrial production, new lending and retail sales. Although there a number of factors behind the rise in Chinese bond yields, which as we noted, has become a more worrisome development for Chinese officials, can be largely accounted for by the rise in inflation. The risk is for another rise to 3.3% from 3.2%, which would be the highest since April 2012.
Over the weekend, China reported a much larger than expected trade surplus. The $33.8 bln Nov surplus is the biggest since Jan 2009. Exports jumped. The 12.7% (year-over-year) increase was more than twice the rise reported in Oct. Imports slumped. The 5.3% increase is the smallest since June. It compares with a 7.6% increase in Oct and consensus expectations for a 7% increase.
The PBOC said recently that there was no longer a need to accumulate reserves. Some observers took this to mean that it would no longer do so and that this was negative for US Treasuries. We are less sanguine. . The combination of the trade surplus coupled with severe limits on the yuan and capital flows means that it will still be accumulating reserves.
Finally there were two other notable developments over the weekend. First, after much consternation, a World Trade Agreement was struck. Critics will complain that the agreement is not ideal, as if any agreement is. On balance, officials will embrace it in anticipation of boosting world trade and refrain from making the good an enemy of the perfect.
Second South Korea has announced an expansion of its air defense identification zone, which will now overall China’s newly declared zone. The immediate market impact may be minimal, but the escalation of tensions as the year winds down is troublesome. The animosity between Japan and South Korea seems to be preventing a coordinated response. This absence works in China’s interest.