A daily bond market chronicle
This is a long piece from Merrill on a variety of topics. I thought the most noteworthy was the information on holiday sales. In the aftermath of Black Friday Merrill’s tracking model of Bank America customer spending patterns had indicated a less than festive consumer but data for the full month reveals softness but not to the extent of earlier reports.
Via Bank America Merrill Lynch Research:
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I received this an hour ago which is a little late. It is from a fully paid up subscriber across the pond:
Fed: Hearing there’s a think tank piece on the Fed…
Fed: Hearing there’s a think tank piece on the Fed, which is similar to comments from WSJ’s Hilsenrath earlier. Apparently, it says the Fed will use the word ‘patient’ to help carry policy through until the year end, before it looks at whether to raise rates or not. Original not seen
Via Stephen Stanley at Amherst Pierpont Securities:
There have been a handful of developments since yesterday that individually are not Earth-moving but cumulatively merit a quick note.
First, Jon Hilsenrath has an above-the-fold p.1 article in the Wall Street Journal today on the Fed. The headline and first paragraph suggest pretty firmly that the FOMC will be taking “considerable time” out of the statement next week. The remainder of the article is much less definitive and the main evidence cited is the Dudley and Fischer comments from a week ago, counterbalanced to some degree by Lockhart’s more dovish quotes from yesterday. It wasn’t that long ago that an article like this, especially given the timing, could be taken as gospel, i.e. a direct leak from the Fed leadership. However, standard operating procedures at the Fed have clearly changed over the past couple of years, and the steady stream of Fed leaks to favored media outlets has dried up. This is an improvement for everyone except for Jon and the erstwhile leak conduits, as the days of shadowy “Fed sources” were not good for the credibility and transparency of the Fed. Having said all of that, we should be mindful that Jon has become a very good Fed watcher and generally does a nice job of reading the tea leaves, even if he is no longer a mouthpiece for the Fed leadership. I happen to agree with Jon that “considerable time” will come out next week, but, as he said, there will be a pretty active debate and the outcome is far from a done deal.
The Manpower quarterly Employment Outlook Survey for Q1 was released overnight and showed a third straight quarterly uptick. The net +16 reading is the best since early 2008, and firms in every region of the country expect hiring to accelerate. This gauge spent most of the 2003-2007 jobs expansion in the vicinity of +20, so the latest reading is not quite back to full health but we are getting pretty close.
Finally, the NFIB Small Business survey jumped by 2 points to 98.1, the best reading since February 2007, though it is still below levels associated with healthy expansions in the past. As the report points out, the improvement in November came entirely from “soft” indicators, i.e. expectations for business conditions and expectations for future sales volumes. In contrast, the “hard” components, job creation plans, plans for capital outlays, job openings, and inventory investment plans, collectively contributed a marginal negative to the composite gauge. Bill Dunkelberg, the chief economist of the NFIB, attributed the improvement to the election results, which would have given the business community reason for optimism at the margin. I tend to agree with his interpretation. The outlook for general business conditions surged by 16 points in November to the highest level since November 2010, the last time the small business lobby’s favored politicians performed well in an election. That earlier jump proved short-lived, so it remains to be seen whether November’s improvement is sustainable. It is noteworthy that expected sales volumes jumped by 5 points in November while actual sales changes slipped further into negative territory. Elsewhere, employment changes (actual and planned) remained modest, but the proportion of firms reporting that they were unable to fill a job opening held at 24%, a level that exceeds readings seen in the 2004-05 period. Compensation gains (actual and planned) were reported to be widening (yet another straw in the wind on the wage front), while price increases became less prevalent. Capital spending remains a sore spot, as both actual and planned investments were less prevalent than at any time from 1993 to 2007.
Circling back to the beginning and the political spin with regard to the improvement in the headline gauge, if there was any doubt where small businesses point the finger for their caution, 23% cite taxes and 22% cite government regulations and red tape as their most important problem, nearly double the next most pressing issue. It is no coincidence in my view that the year in which there has been no government shutdown or debt ceiling drama and no tax changes is the one when hiring strengthened and the economy found a somewhat firmer footing. Nonetheless, households and businesses are still unsure whether we will ever get income tax reform (corporate and/or individual), whether the long-term fiscal situation will ever be brought back to a sustainable footing, and, while they have now been steady for 18 months, tax rates on investment income are still far higher than they were before the fiscal cliff deal. And then there is the other part of the twin terrors: the regulatory situation. Obamacare employer mandates are due to kick in next year and, now that Congress promises to be more hostile to its agenda, the Administration is gearing up for an aggressive campaign of regulatory edicts, most of which will undoubtedly prove unpopular to the small business community. As the NFIB survey has shown for years, this fiscal/regulatory headwind is very real and, while it has abated somewhat this year, it remains mighty stiff.
I am in end of year holiday mode and will be posting less here for awhile. Most of what I post will be that which I can cut and paste.
This is an interesting article via Thehill.com on the impact of falling commodity prices and the stronger dollar on FOMC policy.
Via TheHill.com:
December 09, 2014, 07:30 am
The Fed ignores external developments at its peril
By Desmond Lachman, contributor
One has to wonder whether the Federal Reserve is paying sufficient attention to external developments in gauging the likely course for U.S. inflation. There appears to be a growing chorus of Fed officials intimating that the Fed will start raising interest rates by the middle of 2015, if not sooner. And they do so at a time when there are at least two major external developments that would suggest that the U.S. could see a marked deceleration in headline consumer price inflation over the next few months. Indeed, it is not difficult to envisage that those external developments could cause consumer price inflation to decelerate toward zero by the end of 2015, which could raise anew fears of U.S deflation.
The first external development is the recent collapse in international oil prices. Over the past six months, oil prices have fallen by 35 percent from around $100 a barrel to $65 a barrel. A rule of thumb commonly used in gauging the impact of oil price movements on the U.S. economy is that a sustained $10 a barrel decline in oil prices boosts U.S. gross domestic product (GDP) by 0.2 percentage points while it shaves 0.4 percentage points off U.S. consumer price inflation. On that basis, one would presume that if the recent $35 a barrel decline in oil prices is sustained, U.S. consumer inflation in 2015 would be around 1.4 percentage points lower than it would otherwise have been.
Considering the present state of global oversupply of energy and of Saudi Arabia’s reluctance to play its past role as swing energy producer, it would not seem unreasonable to expect that international oil prices will remain at their present low levels for an extended period of time. Indeed, one could envisage a situation where international oil prices might decline even further, especially if the global economic recovery were to continue losing steam.
The second major external development that could drag U.S. inflation lower is global exchange rate movements. Since the launch of Abenomics in Japan at the beginning of 2013, the Japanese yen has depreciated by around 40 percent against the dollar. It did so as the Bank of Japan (BOJ) embarked on a highly aggressive round of quantitative easing to end Japan’s many years of deflation. Judging by the BOJ’s recent decision to ramp up its quantitative easing program further to a level that in relative terms far exceeds the Fed’s past actions in this field, one could see the Japanese yen continuing to depreciate in 2015.
Judging by Europe’s poor economic performance and by its slow drift toward outright deflation, it has to be only a matter of time before the European Central Bank (ECB) begins buying sovereign bonds. The ECB has already announced that it intends to expand its balance sheet by 1 trillion euros over the next two years. In anticipation of such action, the euro has already depreciated by more than 10 percent against the U.S. dollar, to its lowest level in the past two years. Judging by past experience, one must expect a further significant weakening in the euro once the ECB actually begins its sovereign bond-buying program to meet its balance sheet expansion objective.
The depreciation of the Japanese yen and the euro has already resulted in a significant relative strengthening in the U.S. dollar that is bound to have a meaningful impact on the U.S. economic outlook. Indeed, over the past year, the U.S. dollar has now appreciated by more than 10 percent in nominal effective terms. Moreover, there is every prospect that it will appreciate further in the year to come, considering that the U.S. economy appears to be strengthening at the same time that the Japanese and European economies continue to struggle.
In gauging the impact of dollar movements on the U.S. economy, a rule of thumb that is often used is that a 10 percent appreciation of the U.S. dollar can shave 0.5 percentage points off GDP growth and at the same time reduce inflation by 0.5 percent. For this reason, it is not difficult to envisage that any further appreciation of the U.S. dollar, coupled with continued weakness in international oil prices, could very well cause U.S. headline inflation to decline toward zero by end-2015.
In normal times, the Fed is justified in making its policy decisions without too much regard to external developments. However, as underlined by the recent sharp decline in international oil prices and the very sharp decline in the Japanese yen, these are far from normal times. In gauging the likely course of the U.S. economy and of inflation over the next year, the Fed would be ignoring those external developments at its peril.
Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.
Via Merrill Lynch Research:
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Via Jon Hilsenrath at the WSJ:
Federal Reserve officials are seriously considering an important shift in tone at their policy meeting next week: dropping an assurance that short-term interest rates will stay near zero for a “considerable time” as they look more confidently toward rate increases around the middle of next year.
Senior officials have hinted lately that they’re looking at dropping this closely watched interest-rate signal, which many market participants take as a sign rates won’t go up for at least six months.
“It’s clearer that we’re closer to getting rid of that than we were a few months ago,” Fed Vice Chairman Stanley Fischer said in an interview with The Wall Street Journal last week. New York Fed President William Dudley has avoided using the “considerable time” phrase in recent speeches and instead said the Fed should be “patient” before raising rates.
There will be a robust debate among officials on the issue at the Dec. 16-17 policy meeting, and a decision hasn’t been made. Atlanta Fed President Dennis Lockhart told reporters at an event Monday that he was “not in a rush to drop” the “considerable time” phrase. He wants to be more certain the economy is strong enough to bear rate increases before moving.
A self-imposed Fed media blackout starts Tuesday and officials will begin a week of discussions and preparation. Chairwoman Janet Yellen typically confers privately with other officials to take stock of their views during this period.
The big challenge Fed officials face at next week’s meeting is communicating the prospect of rate increases without locking themselves into a timetable or severely unsettling markets. A key decision is when to remove the “considerable time” pledge in their policy statement, which has been in the Fed statement since March.
If Fed officials do scrap the pledge, it would be an important milestone in their long-running effort to nurse the U.S. economy back to health with cheap credit. The central bank has held short-term interest rates near zero since December 2008, far longer than many officials expected when they pushed them there during the financial crisis. The Fed hasn’t started a series of interest-rate increases in a decade.
“The decision [to raise rates], when it comes, will be historic,” Mr. Lockhart said.
The Fed has already taken steps toward pulling back from its easy-money efforts. In October, it ended a bond-buying program, known as quantitative easing, that was meant to spur growth.
While many Fed officials believe the economy will be strong enough by the middle of next year for them to move their benchmark short-term rate higher, there have been some contradictory signals that are tugging the Fed in two directions. Consistent gains in hiring and declines in unemployment suggest the labor market is getting closer to a state Fed officials call “full employment,” in which slack is gone and no longer holding back wage growth. Moreover, growth appears to have accelerated a bit.
At the same time, a stronger dollar and falling commodities prices—including the sharp decline in oil prices—are putting downward pressure on inflation.
Strong growth calls for the Fed to move toward rate increases but low or falling inflation calls for officials to hold off on raising rates.
Many officials believe that downward pressure on inflation is temporary and the pace of price increases will eventually rise toward the Fed’s 2% target. They also see lower oil prices giving the economy a boost.
Moreover, many want to start raising interest rates before the economy gets to full employment and are thus sticking with their projection that rates will begin to rise around June. “Market expectations that liftoff will occur around mid-2015 seem reasonable to me,” Mr. Dudley said last week. Mr. Lockhart, a bit more cautious, said Monday that he projected the first rate increases for mid-2015 or later.
Fed officials have several tactical issues to consider that could prompt them to shift their rate assurance now, while they’re still taking measure of the economy’s strength. Ms. Yellen has a news conference after the policy meeting ends Dec. 17 to explain the central bank’s decision. The Fed doesn’t have another news conference scheduled until March. If officials wait to change the words until then, the market could take it as a signal officials are pushing off planned rate increases until the second half of next year.
At the same time, they don’t want to appear to be locked into moving at midyear or to suggest rate hikes are coming earlier.
Mr. Dudley—a part of Ms. Yellen’s inner circle of advisers—has suggested recently that the Fed could replace the assurance of low rates for a considerable time by stating more vaguely that it expects to be patient before moving. Such a move would be an attempt to build a long runway for rate hikes that would give officials room to shift strategy as their forecasts evolve.
The Fed took this approach the last time it was trying to engineer a liftoff from low rates, in 2004, when Alan Greenspan was Fed chairman. In January of that year the Fed dropped an assurance rates would stay low for a “considerable period” and said it would be patient before raising rates. It dropped the patient phrase that May and in June raised rates from 1% to 1.25%. Officials seem likely to emphasize, if they adopt that phrasing, that it wouldn’t guarantee a repeat of the exact 2004 timetable. Instead, they have been saying for months the exact timing will depend on how the economy performs.
“We don’t want to surprise markets,” Mr. Fischer said in the interview at the WSJ CEO Council gathering. “On the other hand we can’t give precise estimates about dates that we don’t know.”
Plenty could go wrong with the Fed’s plans. Repeatedly in this slow recovery, officials have set out to wind down their easy-money policies, only to ramp them up again. The Fed twice ended its bond-buying program and then restarted it.
In April 2012, six of 17 officials said they expected to raise rise before the end of 2013 and another seven said they expected rate increases before the end of 2014. Instead they pushed rate increases off when the economy failed to accelerate as expected.
A sharp downdraft of inflation or global growth could scuttle their plans again. Indeed, the Fed’s rate considerations come as many other major central banks—including the European Central Bank, the Bank of Japan and the People’s Bank of China—are easing credit conditions in response to slow global growth.
At the same time, a rapid descent of unemployment in the next couple of months or sharp increase in hiring could lead them to accelerate their plan.
Some internal simulations of the U.S. economy used by Fed staff suggest the Fed should have already have started raising rates in the final months of 2014. To avoid derailing a vulnerable recovery until they’re confident it can bear higher rates, officials have been willing to wait.
CRT Capital survey clients each month regarding trading strategies post the labor report. Here is the result of this months survey.
Via CRT Capital:
** RESULTS!! CRT, PRE-NON FARM PAYROLL SURVEY, DEC 2014 ***
With a solid response rate this month, the takeaway from our pre-NFP survey was a lot of sidelined players with just a modestly bullish bias. Cutting to the chase, when asked what they would do if the market rallied post NFP, we had 36% keen to sell strength which is average, as is the 51% doing nothing. 14% said they’d buy strength, a tad more than normal but hardly outstanding which reveals no great need to chase prices.
When asked what they would do if the market fell, we got an agnostic response. 49% said they would do nothing, well over the 40% norm. Only 8% planned to sell into weakness — the average is 14% — giving a buyers-to-sellers skew of 36%, upper-end of the range, but below last month’s 42%. When asked about the next move in 5-yr yields 41% said higher vs. a 45% norm, 40% said lower vs. a 35% norm, and 19% didn’t know against a 19% average.
Here’s where it gets more interesting. Our Special Questions focused on the upcoming FOMC meeting and the “considerable time” language. We opened with a somewhat leading question that assumed the language is removed — and only got about 15% responding that the language stays. As for what replaces “considerable time”, we got very few specific phrases but the most common response was ‘more data dependent’ or not directly replace – but rather just drop it all together.
As for the response in the curve, FLATTER was the decided theme. 98% saw 5s/30s curve an average of 9 bp flatter, 98% saw 2s/10s flatter by an average of 12 bp and 93% saw 10s/30s flatter by an average of 10 bp. There were more unchanged or don’t know responses for 10s/30s — but that isn’t really a shock. What was more surprising was just how close the responses to our second special question were. We asked if YoY CPI is under 1.5% will the Fed hike anyway and 56% said they would — whereas the balance (44%) believed the Fed would refrain.
The dirty details follow below.
* Post-Payrolls, And Market Trades HIGHER in price: 14% BUY, in line with 12% norm. 35% SELL, slightly under the 36% average and 51% DO NOTHING, right at the 51% average.
* Post-Payrolls, And Market Trades LOWER in price: 8% SELLING vs. 14% norm. 44% BUY, below the 46% average — least selling of weakness since July. 49% DO NOTHING, above the 40% average. The buyers-minus-sellers skew comes to 36%, middle of the range.
* Next 15bps in 5-year Rates: 41% say higher, vs. an average of 45%. 40% say lower vs. a norm of 35%. 19% don’t know vs. the norm of 19%.
SPECIAL QUESTIONS:
1) a) What does the Fed replace “considerable time” with? Very few exact phrases were offered, but the most common response was ‘more data dependent’ or not specifically replaced – but rather just dropped.
b) What happens to the 5s/30s curve – 98% say flatter by an average of 9 bp.
c) What happens to the 2s/10s curve – 98% say flatter by an average of 12 bp.
d) What happens to the 10s/30s curve – 93% say flatter by an average of 10 bp.
2) All things being equal, if headline YoY CPI is under 1.5% at the moment the Fed is considering its first-hike, will they raise rates anyway or refrain? A slight majority think the Fed hikes anyway at 56%
Blogging has taken a back seat to life yesterday and today and that will continue for a bit. So blogging posts are likely to be sparse for a few days.
I do not know if this is reflected in the markets but Bloomberg is carrying this story:
Saudi Arabia Cuts All Jan. Oil Prices to U.S., Asia
2014-12-04 12:02:22.598 GMT
By Andrew Cinko
Dec. 4 (Bloomberg) — Saudi Arabia lowers Jan. Arab light
oil price to Asia; Saudi Aramco cuts Jan. Arab light oil Asia
OSP to $2 discount.
One dealer reports central bank selling of very short coupons and very short sovereign and supra paper.