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."
CALENDAR OF EVENTS
MARCH
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
APRIL
1: Various EU Manufacturing PMIs; US ISM Manufacturing
2: US Trade Balance; US Factory Orders
3: US Payrolls & Unemployment
6:
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
13:
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
MAY
1: US ISM Manufacturing PMI
