Tuesday, March 3, 2015

March April 2015 Outlook: Award Season

TradeTheNews.com March April 2015 Outlook: Award Season
Tue, 03 Mar 2015 14:25 PM EST

In the spirit of Hollywood's self-congratulatory award season, let's start with a pat on our own back for what we got right in our January-February outlook. The ECB did indeed step up the timetable for its Quantitative Easing program, announcing the go ahead in January. The risk-on appetite generated by the new plate of QE, however, was initially tempered by the demands of the newly elected leftist government in Greece. As predicted, after a brief flirtation with brinkmanship, the Syriza Party leadership sobered up to the realities of governing and accepted a deal to keep Greece in the euro zone. In Eastern Europe, President Putin played at peace maker again, as we suspected he might, but the result of reaffirming the Minsk accord is as yet inconclusive. Also as expected, China took another swing at stimulus, which could be just the beginning as the nation reshapes its economy toward a more sustainable long term growth model. And finally, the strengthened dollar crimped Q4 results for a number of US multinationals, and oil prices have found a near term bottom, which has helped ease forex volatility in the last few weeks.

Over the next two month period the path of four crucial economic issues will become clearer. First down the red carpet, the oil market will tip its hand, either recovering some ground in a sign of growth returning or hitting fresh lows if new demand does not materialize amid continued high output. The latter seems more likely at this point as Saudi King Abdullah finally succumbed to old age, but his new oil policy lives on - Saudi is unwilling to act as the swing producer anymore, weighing heavily on oil prices and dragging down global inflation with it. Second is that issue of weak inflation, which most policy experts believe will avoid morphing into a deflationary spiral once low oil prices start to exert a stimulative effect. The third issue is how impactful the latest round of global stimulus will be as Europe and Asia add more logs to the fire, and to what extent smaller central banks will be forced to play a supporting role. Lastly, by April we should have more clarity on when the Fed plans to finally start dismantling its extraordinary stimulus machine.

Dark Horse Upsets

Just like award ceremonies, not every outcome in the market is predictable. There have been some genuine surprises in the last few months that could set up a counterproductive current in 2015. The monumental easing programs of the world's biggest central banks have recently pushed smaller national banks to new policy extremes. The shocking move by the Swiss National Bank to abandon its tightly defended floor in the franc against the euro seemed to open the floodgates for other smaller central banks enlist in the currency war. After the SNB move, central bankers from Singapore to Australia to Israel surprised markets by cutting already low rates, and some, like Sweden, joined the Swiss in experimenting with negative rates. As pressure builds on policy makers to address declining inflation, sliding commodity prices, and softening growth expectations such moves may become more commonplace, if not the norm. And now that the Swiss, who are more dependent on the banking sector than anyone, have resorted to negative rates, more central banks may find this course necessary to prompt commercial banks to channel their money into investments that will stimulate the economy. The downside is that if such aggressive and unprecedented monetary policy moves do not yield demonstrable results, it could erode trust in the global central bank monetary regime that won some praise for averting a Great Depression in 2008.

The Early Favorites

For market prognosticators, the show gets off to a quick start in early March. The first week of the month will be highlighted by an ECB policy meeting detailing the launch of its quantitative easing program. Meanwhile in China, leaders will gather to do the accounting of last year's reform efforts and slowing growth and set new targets, and in the US banks will see their statutory stress test results aired in public.

China's Q4 GDP report confirmed that the PRC's economic growth has fallen to its slowest pace in 24 years, and missed the official annual target (7.5% for 2014) for the first time since 1998. The leadership is now expected to further reduce its growth goal to around 7% for this year, an announcement that will come at the spring party plenum in early March. There are even some predictions that amidst the very public anti-corruption and reform campaign that has been waged over the last year, Beijing may take this moment to deemphasize the numerical GDP target as it strives to improve the qualitative shape of its growth. This means aiming to reduce its dependence on credit-fueled investment and government spending, and putting more emphasis on spurring domestic consumer consumption. Indeed some progress on this front shone through in the latest GDP data which indicated that consumption accounted 51.2% of 2014 growth, a full three percentage point higher than the prior year.

China's policy makers are still worried about slower growth, however, as evidenced by the PBoC cutting rates twice in the last three months, while the government has promised to continue its official "proactive" fiscal policy stance which has been in place since the inception of the 2008 financial crisis. The latest 25 basis point cut went into effect on March 1 and some analysts expect more rate cuts in the months ahead, though that would belie the central bank's assertions that it is only "fine tuning" its policy. On the fiscal side, Premier Li has made it known that the government will step up the magnitude of its proactive policy, including plans to give tax breaks to small businesses. All told, these drops of new stimulus add up to substantive support for the economy and would suggest that Chinese policy makers are ready and willing to do more if the need is there.

The PBoC's European counterpart has not been shy about providing more accommodation. Final details of the new ECB quantitative easing program will be discussed at the central bank's March 5 policy meeting. In January, the ECB announced an expanded asset purchase program of €60 billion per month, about what was expected including the roll up of the existing ABS and covered bond programs. Surprisingly, instead of setting a specific overall size or duration for the program, the ECB left the program open ended, stating it will continue until the central bank observes a sustained adjustment in path of inflation.

Stimulus junkies took delight in this indefinite end point which some analysts already see stretching well past the September 2016 cut-off date that had been expected. However, the latest press coverage indicates that this estimated end date could be realistic after all. According to reports, thanks to the positive reaction to the QE announcement, the ECB's latest quarterly macroeconomic outlook could forecast inflation returning to the 'just under 2%' target in 2017, a signal that it may not be necessary to extend the sovereign bond buying program beyond the fall of 2016 after all. If this is indeed to baseline forecast, it will still be tempered by the short term inflation outlook, which ECB President Draghi has warned will involve a period of negative inflation driven by the collapse of oil prices.

The same day as the ECB press conference, the too big to fail banks subject to the Fed's stress test will tear open the envelops to find out if they are all winners. Six days after that (March 11) the related outcomes of the Comprehensive Capital Analysis and Review (CCAR) will be made public. Last year 29 of 30 banks passed the stress tests, with only Zions bank falling short of minimum capital levels required, but another four banks (Citigroup, HSBC North America, RBS Citizens, and Santander Holdings) joined Zions in having their CCAR requests denied by the Fed. The CCAR denial was particularly embarrassing for Citigroup, whose leaders will undoubted do everything they can this year to ensure they can raise their measly one cent dividend. Overall, the banks should disclose modest requests to increase their dividends in the CCAR announcements, a sign of normalization in the finance market and perhaps a hint that lending institutions believe higher interest rates are finally be on the way after six years of extraordinary low rates that have limited the profitability of traditional commercial banking.

Acceptance Speech

Assuming no surprise bank stress test failures, the biggest problem for Fed policy this year may be the global economy, which the Fed took pains to point out in its January policy statement by adding a phrase about monitoring international developments. The proper employment conditions for pulling back on accommodation have been in place for some time, so when solid evidence of movement toward the second mandate of steady and stable inflation materializes, the Fed would be justified in raising rates. The quandary is that this would put the Fed way out in front of other global central banks, moving US monetary policy toward normalization even while central banks in Europe and Asia are going to new and unprecedented extremes of accommodation.

Fed speakers have given every indication that if the US economy gets some healthier inflation in the months ahead, the Fed is ready to pull the trigger on rate lift off. However, Chair Yellen and her crew have made it clear that this cycle of rate tighten will not be on autopilot as it has so often been in the past. Prior cycles of tightening policy have tended to involve steady 25 basis point hikes at six week intervals, meeting after meeting. But taking the current global environment into account - with major trading partners still struggling with growth and teetering on deflation, and the dollar undeniably strong - the Fed has said rate hikes will likely come slower and the endgame will be at a lower level, perhaps a 3.75% Fed funds rate in the longer term.

Each economic data point this spring will be scrutinized for whether it will bring rate lift off sooner, or later. The earliest possible date for the tightening cycle to start is now seen as the mid-June Fed meeting. Speculation about such an early lift off will be dashed at the March 19 meeting if the Fed retains its "patient" stance, which has been defined as no action for at least the next two meetings. If the data cooperates, that might make the Fed's meeting at the end of April the right moment to signal the policy shift by dropping the patient language, opening the path for the first rate hike in September, though still retaining the flexibility to wait another meeting or two if global development continue to weigh on the committee's outlook.

And the Nominees Are

One less thing Chair Yellen will have contend with this year is the coterie of FOMC dissenters who spoke out in 2014. The dovish dissenter, Minneapolis Fed President Kocherlakota, has rotated out of the voting membership for the next two years. Meanwhile the two leading hawks of 2014, Dallas Fed President Fisher and Philadelphia Fed President Plosser will both step down in March. Heading into their retirement, Fisher and Plosser have both spent a significant time giving TV interviews, trying to leave a lasting impression, though Fisher acknowledged recently that he had lost the argument for a Q1 rate lift off.

Without these three dissenting voices, policy setting should be more united in 2015, as two of the new voters include Atlanta Fed President Lockhart, a moderate who will likely stick with the consensus, and San Francisco Fed President Williams who agrees that rate lift off will probably happen in the second half of the year. The leading hawk among the voters will now be Richmond Fed President Lacker, who has been a skeptic of easy-money policies, though not as stridently as Fisher and Plosser. The Dallas and Philly Fed boards have yet nominate new Presidents, but reports have indicated that Dallas is looking for a candidate that shares the policy views of Fisher while Philadelphia wants someone with a strong academic background, as Plosser had. In any case, new members tend to keep a low profile for the first year of their tenure and the two will not be voters until 2017 [*March 2 update: Philly Fed nominates Patrick Harker, current president of the University of Delaware].

It's All Political

While the Fed may see more unity this year, divisive political issues continue to wrack Europe. A Greek meltdown was averted again, at least for a few more months, while the next slow moving political crisis may emerge from the UK.

As expected, for all of its anti-bailout electioneering talk, the new left-wing Syriza government in Athens turned out to be more pragmatic once in power. Prime Minister Tsipras and his rock-star Finance Minister Varoufakis kept the euro zone on edge with their rhetoric and a long list of demands, but ultimately lost their swagger and settled for a few cosmetic changes to gain a 4-month extension of the rescue package. The key concession Athens got was an agreement to halt austerity measures for the rest of 2015 due to "economic circumstances." Relaxing the austerity measures that helped push unemployment up to 25% and ultimately brought Syriza to power this year, should put Greece on the road to a more durable solution in the months ahead. For now, the reaction on the Greek street must be watched closely, as the technical oversight of the hated 'Troika' was shed in name only (one of the concessions Tsipras got was to refer to the ECB, European Commission, and the IMF as "the institutions" rather than the "troika" as they continue to carry out their mission directing the bailout program). If easing austerity isn't felt fast enough, public sentiment could put pressure on Syriza to take a harder line in the next round of negotiations in the months ahead.

The next potentially jarring political event on the horizon for Europe is the UK election in May. The event has not gotten much attention outside of Britain, as the Greek drama and the ECB's QE decision stole the limelight. Prime Minister Cameron has pledged that if his party wins an outright majority in this year's election, allowing them to shed the Liberal Democrats as a coalition partner, then he will undertake a yes-no referendum on the UK's membership in the EU in 2017. After the paroxysms caused by Greece's feints toward the euro zone, the prospect of the UK spending the next two years discussing a break with the EU could deal a grave blow to the notion of greater European unity.

I'd Like to Thank...Oil

The price of oil seems to be at the heart of any assessment of the current economy. The precipitous drop in crude prices is indicative of weak global economic growth, while simultaneously exerting even more downward pressure on already low inflation resulting from that slow growth. A month ago WTI crude fell to below $45/barrel and then surged a quick ten dollars and now lies near the middle of that range. The volatility being seen of late has divided oil traders into two camps, with some declaring definite bottoming action here, while others expect another leg lower into the $30's. Who will ultimately be correct depends on a number of factors.

Arguing for more stable oil prices is the fact that E&P firms have already slashed capital expenditures for this year as they batten down the hatches. North American producers are taking wells offline at a rapid clip, as indicated by the weekly Baker Hughes Rig Count. Historically the rig count has mirrored the through-the-cycle price of oil, which was more than halved. At the current pace the rig count could reach a 50% drop from its September peak before the end of April. That would bring the US rig count to under 1,000 in operation, which could mark a turning point for the global energy market as the shale producers begin to report lower production from their leaner operations.

The rig count can be a deceptive indicator, however, as the camp predicting lower prices would note that oil firms are "high grading" their production, shutting down rigs in their least productive locations but maintaining all of their higher production wells. Until some of these more productive wells are taken out of service too, the glut of oil in storage will persist. This could be further exacerbated by a tricky negotiation with refinery workers across the US that has already led to some strike actions. A broader walk out at refineries could lead to some curtailment of those operations and put even more downward pressure on the price of the raw commodity. Furthermore, some analysts have suggested that existing physical crude oil storage could soon reach maximum capacity, backing up the oil supply at the wellhead.

Another factor to consider when reviewing the energy market is the potential for defaults on debt related to drilling operations. Goldman Sachs chief commodities analyst Currie recently predicted oil would dip to around $40/barrel for the next six months, and that staying at that level for a sustained period could unleash "real default probabilities."

The periodic rumors about OPEC taking action were refueled lately when the Nigerian oil minister suggested that she may ask for an emergency meeting in the next few weeks if the price of oil continues to slide. Convening a meeting is based on a murky procedure for reaching a consensus, and it is considered against diplomatic procedure for a member state to publically call for a special meeting that might be rejected by other members. Such extraordinary gatherings are rare, the last being December 2010 to discuss quota compliance, and Saudi Arabia has downplayed the idea of meeting outside of the normal bi-annual schedule (the next scheduled meeting is June 5).

For its part, the Saudi government has indicated that it thinks Brent oil could settle in at around $60/barrel, about where it has been hovering for the last month. Oil minister Naimi has said he will stick to his guns no matter how low the price falls, though this resolve may be tested if Saudi Aramco's margins erode much further.

Trouble in the Middle East forever remains a source of potential upset in the energy market. The Pentagon announced that Iraqi forces will launch a spring offensive against ISIS in Mosul, pitting over 20 thousand Iraqi soldiers with US advisors and air support against some two thousand dug in militants. The odds seem to be well in favor of the Iraqis liberating Mosul, but if the army falters again as it did last year, it may doom the country to the kind of fractioning experienced by Libya, and potentially put its substantial oil supply at risk.

The Iran nuclear talks will also come to a head in March. The US appears to be unwilling to grant yet another extension, so a solid outline for an agreement must be achieved in the next few weeks or negotiations will collapse, a probability that President Obama handicapped at over 50/50 as of January. If nuclear talks fail, the full sanction regime will be reapplied, not to mention that Tehran hardliners will likely assert themselves and hamstring the pragmatic President Rohani.

Best Supporting Actors

The swoon in oil prices has weighed on already too low inflation, and coupled with the jitters about Greece caused some real volatility in early 2015. Remarkably, equity markets have shaken off these concerns and many major indices are marking record highs, and may get pushed even higher when the expected tailwind from lower energy costs start to be felt. That could translate into healthier global growth and inflation figures in the spring.

Central banks are still handing out stimulus like statutes on Oscar night - there are more categories than you would care to imagine and the program always seems to run too long. The ECB has added QE to its array of ABS, covered bond, and TLTRO programs, and China seems ready to do more around the margins. The operational minutiae of European QE should put to rest questions about the program being too big for the amount of qualifying instruments, though it may stir the pot on Greece one more time as Athens will likely be put on probationary status during its four month renegotiation period.

Over the course of the next couple months, the Fed will have enough data to narrow the window on when rates should lift off the zero bound, most likely settling on autumn for the start of a gradual rate tightening cycle, though it hasn't lost its "patience" yet. With its eyes on the prize of policy normalization, that stance could shift pretty quickly if the economy starts putting up strong, consistent numbers, especially if it includes wage inflation and renewed vigor in the still listless housing market. Conversely, if low inflation remains a stubborn problem and global markets experience more turbulence it could deny the Fed its rate lift off, and leave them saying "maybe next year."


1: China HSBC Final Manufacturing PMI
2: Various EU Manufacturing PMIs; Euro Zone Flash CPI Estimate; Euro Zone Unemployment; US Personal Spending; US ISM Manufacturing
3: German Retail Sales
4: Euro Zone Retail Sales; US ISM Non-Manufacturing
5: German Factory Orders; BOE policy decision; ECB policy decision and press conference; US Factory Orders; US bank stress test results
6: UK Construction PMI; US Payrolls & Unemployment; US Trade Balance

8: Japan Final Q4 GDP
9: China CPI & PPI; China Trade Balance (tentative)
10: US JOLTS Job Openings
11: China New Loans; UK Manufacturing Production; US banks CCAR results
12: China Industrial Production; US Retail Sales
13: US PPI; US Prelim University of Michigan Confidence

16: US Industrial Production; BOJ policy statement
17: German ZEW Economic Sentiment; Euro Zone Final CPI; US Housing Starts & Permits; Japan Trade Balance
18: BOE minutes; UK Annual Budget Release; FOMC Policy Statement & Press Conference
19: US Philadelphia Fed Manufacturing; China HSBC Flash Manufacturing PMI
20: Various EU Flash Manufacturing PMI readings

23: US Existing Home Sales
24: German Ifo Business Climate; US CPI; US Consumer Confidence; US New Home Sales
25: US Durable Goods Orders; Japan Industrial Production; japan Retail Sales
26: UK Retail Sales; Tokyo CPI
27: US Final Q4 GDP

30: German preliminary CPI; US Personal Spending
31: UK Final Q4 GDP; Euro Zone Flash CPI Estimate; Euro Zone Unemployment; US Chicago PMI; Japan Tankan Manufacturing Index; China Manufacturing & Non-Manufacturing PMI; China HSBC Final Manufacturing PMI
1: Various EU Manufacturing PMIs; US ISM Manufacturing
2: US Trade Balance; US Factory Orders
3: US Payrolls & Unemployment

7: BOJ policy statement; China Trade Balance
8: German Factory Orders; Euro Zone Retail Sales, FOMC minutes
9: China New Loans; BOE policy decision; China CPI & PPI
10: US University of Michigan Confidence

12: BOJ minutes
14: US Retail Sales; US PPI
15: ECB policy decision and press conference; US Industrial Production; China Q1 GDP
16: US Housing Starts & Building Permits; US Philadelphia Fed Manufacturing
17: Euro Zone Final Q4 GDP; US CPI

19: China HSBC Flash Manufacturing PMI
20: Euro Zone Flash Manufacturing PMI; US Flash Manufacturing PMI
21: German ZEW Economic Sentiment; Japan Trade Balance
22: BOE Minutes; US Existing Home Sales
23: German Ifo Business Climate; US New Home Sales
24: US Durable Goods Orders

27: Japan Household Spending
28: UK Preliminary Q1 GDP; US Consumer Confidence; Tokyo CPI; Japan Industrial Production; Japan Retail Sales
29: Euro Zone Preliminary CPI; US Q1 Advance GDP (1st reading); FOMC policy statement; BOJ policy statement
30: Euro Zone Flash CPI Estimate; Euro Zone Unemployment; US Personal Spending; US Chicago PMI; China Manufacturing PMI; China HSBC Manufacturing PMI
1: US ISM Manufacturing PMI