TradeTheNews.com November-December 2015 Outlook: Trick or Treat
Mon, 02 Nov 2015 13:29 PM EST
The last couple of months have been a wild ride for the markets. A summertime
scare triggered by the Chinese stock market meltdown sent global equity markets
into corrections of 10% or more but they have since erased most of those
losses. 10-year treasuries have started to percolate above a 2.00% yield as the
Fed creeps closer to a rate hike. The dollar index has zigzagged several times
in recent months but is now trying to push higher, though not to the extent of
the much-touted prospect of euro parity. Energy prices have resumed a downward
trajectory, keeping pressure on weak inflation readings.
Reviewing the last couple of months, like a kid going through the spoils after
a long night of trick-or-treating, our baseline expectations were well
satisfied with a few surprises tossed in the bag. As expected, worries about
Chinese stock market gyrations subsided, though commodity-driven emerging
markets are still hurting from China's shift toward a slower growth domestic
consumption economy. That has contributed to the weak commodity environment
persisting, as predicted, keeping inflation pinned at low levels in the
advanced economies and driving the ECB toward more intervention. Some of the
political landmines of the last few months were diffused, most surprisingly the
debt ceiling debate in Washington (a two year deal that shows Congress is
perhaps ready to stop toilet-papering its own House and get down to a serious
legislative agenda). Others could still blow up: Brazil's President is still
under the cloud of a potential impeachment, and Spanish elections in December
could create ripples for Europe.
For the next couple of months markets will be more focused on central bank
activity than ever. Expectations are that the ECB will reach back into its
goody bag to dole out additional stimulus. China's PBoC and the Bank of Japan
may also be handing out more treats. By contrast, the Fed is contemplating
withdrawing some accommodation, and many market watchers may feel it's a dirty
trick if Fed doesn't raise rates in December. All of these decisions will be tied
to data on growth and especially inflation. Central bankers continue to insist
that low inflation is linked to transitory factors, but there is a growing
sense they may be whistling past the graveyard and feeling more nervous about
the issue underneath their masks of cool assuredness.
Rate Liftoff Haunts Markets
After what many Fed members described as a "close call" to keep rates
on hold in September, they stood pat in October but withdrew stated concerns
about global economic developments restraining growth. The October statement
also specifically referenced the next meeting in December as a moment for the
Fed to make a choice about rate policy. Though the Fed is always data
dependent, this shift in the latest statement, along with recent comments from Chair
Yellen and other key committee members that they still forecast a rate hike
this year, give a strong indication that the cycle could begin at the December
16 meeting. This view is also supported by the minutes of the September
Discount Rate meeting which showed that for the first time a majority of the
Fed regional bank boards urged an increase in the discount rate (8 of 12 sought
an increase, up from 5 at the prior meeting).
The decision to lean more hawkish at the October meeting but not to pull the
trigger on rates gave Yellen's team another six weeks of data to observe before
they render their final decision of the year. Among that data are two more
non-farm payrolls reports (November 6 and December 4). The Chairwoman will have
a good sense of this fresh jobs data by the time she testifies before Congress
on December 3, so she may use that platform to present a firmer opinion about
the timing of rate liftoff.
Should the Fed take the plunge in December, Yellen will make every effort to
put a positive spin on the decision. It will be touted as a show of confidence
in the strength of the economic recovery, and be seen as a positive development
for savers and for banks that have suffered under the low interest regime. The
Fed will also stress that the new neutral rate is much lower than it has been
historically and that this tightening cycle will be shallower than in the past
and will not be "mechanical" (i.e. not one hike per meeting).
Even senior IMF officials, who have been urging the Fed to postpone liftoff to
2016, recently admitted that a rate hike would not be "cataclysmic."
In addition, a Fed decision to move forward could make the path easier for the
Bank of England follow suit early next year. For the last several months
Governor Carney has stated that the decision to raise interest rates will come
into sharper focus around the end of this year. That makes it reasonable to
assume that the December 10 BOE meeting could lay out a clearer timeframe for
rate liftoff in the UK.
PREDICTIONS: As has often been the case in the post-financial crisis
era, the Fed is again facing a communication problem. It would not be a shock
if the FOMC decides to raise rates at the December meeting, but it might still
be considered a "surprise," given that fed fund futures are still
forecasting a less than 50% chance of a hike at that meeting.
On the other hand, if the committee decides to hold off yet again, it could
further erode confidence in Fed's forecasting abilities, since they have been
indicating for most of 2015 that rate liftoff would occur in the second half of
the year. A no-go in December would also fuel theories that the Fed suspects
that 'something wicked this way comes.'
Unless another black cat crosses the Fed's path, the likely outcome appears to be
a December liftoff. After a brief interlude of spotlighting foreign
developments, the Fed can focus back on domestic data to come to its decision.
A mixed bag of Q3 earnings reports from multinationals will be weighed on by
continued weakness at the energy majors, but should not be bad enough to deter
Fed action. A rate hike decision could be supported by two more solid jobs
reports and early Q4 GDP indicators that show better growth than Q3's tepid
result. The data should make this decision clearer by early December, and when
it sinks in the markets may be hit with another "freak out" moment.
That panic attack should be brief, however, on the realization that a second
rate hike is not imminent (Janet Yellen is not going to peel off a mask to reveal
Paul Volcker underneath).
ECB Handing Out More Candy
In the eventuality of a Fed rate hike (perhaps followed closely by a BOE move),
other central banks could ease the blow by increasing their accommodation.
Central bankers have already injected over $8 trillion into the global economy
since the start of the financial crisis, but even more may be on the way.
Even though the ECB's massive is quantitative easing program is less than
halfway completed, President Draghi appears to be drawing up plans to offer up more
treats for the markets. In his latest press conference Draghi announced that
the "degree of monetary policy accommodation will need to
re-examined" in December, when new economic projections will be available.
He said that while the domestic recovery is showing resilience, external demand
from emerging markets is weakening, creating downside risks to inflation and
economic growth exacerbated by continued weak commodity prices.
Draghi further extended his dovish commentary by revealing that additional rate
cuts are one of the options available, a shift from prior rhetoric that had
declared rates are at their lower bound. He made it clear that the choice of
instrument has not yet been made from a whole menu of options, but that for the
first time a lower deposit rate was among the choices.
The ECB's decision to do more will be complicated by the Fed's path toward
withdrawing accommodation. Nearly simultaneous moves in opposite direction are
bound to put some stresses on global markets, especially currencies. More talk
of the euro-dollar parity is certain to arise in the weeks ahead. Furthermore,
any action by the ECB could force the hand of other closely linked central
banks, like the Swiss National Bank, which had to abandon its currency peg in
January because of forex pressures created by ECB programs.
PREDICTIONS: The ECB has given every indication that more accommodation
is on the way. It could come in the form of negative rates, an affirmative
extension of the QE program, or some new innovation in monetary policy.
For central bankers, negative rates are still largely experimental, though a
few smaller economies have already implemented them during this economic cycle.
But at this point, negative rates for an economy the size of the Euro Zone probably
has too much of a mad scientist feel to it to throw that switch, not to mention
that it would further compress already pan-caked fixed income rates in Europe.
The safest route for Draghi's team would be to expand the QE program, a move
that many analysts have been expecting for months, rather than throwing
together a witch's brew of new policy measures. If the ECB's choice is to
modify the QE program, expectations are that it will be a timeline expansion
past the current presumed end date of September 2016, rather than any increase
in size of the 60 billion euro per month in bond purchases, which could create
an uncomfortable scarcity in certain bond categories. The mere discussion of
other options like a negative deposit rate can be held up as evidence that the
ECB is serious and prepared to do more in 2016 if deflation starts to take
Treats from the Orient
Like many other central banks in developed economies, the Bank of Japan has
struggled to gain traction toward a 2% inflation target despite three years of
its own version of QE. Similar to its peers the BOJ has blamed much of the
difficultly in achieving the inflation target on transitory weakness in
commodity prices. That slow progress has prompted many analysts to call for the
BOJ to further boost its 80 trillion yen per year expansion in the monetary
base (after its last expansion in October 2014).
Apparently the economic data ahead of the October meeting was good enough that
BOJ opted against this move. Instead the central bank pushed back the goal for
reaching its inflation target to the second half of next year from the first
Still, with the ECB and PBoC moving toward adding stimulus, the BOJ may not be
far behind. That decision will lie with the incoming data. Japanese consumer
prices excluding fresh food fell 0.1% in both August and September, dipping
below zero for the first time since early 2013 (though ex-food & energy
readings have been substantially higher). More numbers like this could mean the
witching hour is approaching for Japan and could certainly justify new action
by the BOJ.
China's central bank has bumped up its stimulus several times this year. Its
latest move was to cut key rates just ahead of the Communist Party plenum, a
gather of top party officials to craft a new long-term policy agenda.
The plenum set a target of "medium-high" economic growth over the
next five years, while a senior PBoC official declared that 6-7% growth remains
achievable over that timeframe, though they would not "defend that target
to the death." The plenum seemed to put more emphasis on social issues,
such as easing the nation's one child policy and beefing up spending on
poverty, education, environmental and healthcare programs.
China could get an external boost from an upcoming IMF decision on expanding
its currency basket (November 4). All indications are that the IMF is ready to
declare that the Chinese currency has matured enough to be added to its Special
Drawing Rights after being denied inclusion during the last SDR review five
years ago. Reports say the IMF has been sending Beijing encouraging signals
about the decision, and even China's surprise currency devaluation in August,
which dealt a brief shock to global markets, was praised by the IMF as a
positive move toward normalizing the yuan.
Inclusion in the SDR would be a point of prestige, essentially recognizing the
yuan as an international reserve currency. It would acknowledge China as
meeting two key criteria: the nation's importance to global trade and the
currency being "freely usable." China obviously meets the first test,
but there may be some reservations about the second given the country's
extensive capital controls. The IMF has said, however, that "freely
usable" does not necessitate the currency being "fully convertible."
By that standard the growing use of the yuan in bank reserves and international
transactions should be enough to meet muster.
PREDICTIONS: If the BOJ joins in the new stimulus pageant, a likely
scenario would be ramping up purchases of government bonds and other assets to
100 trillion yen a year from the current 80 trillion. Governor Kuroda said
earlier this year that "many options" are available for more monetary
policy action, so he could put forth a more creative option as well. In any
case, more stimulus will translate into a weaker yen after it has been pinned
close to 120 to the dollar for the last two months.
In China, the lack of more specific growth targets out of the Plenum seems to
indicate that Beijing is willing to sacrifice some growth in favor of its
continued reform agenda, which may benefit the country in the long run but
could spook economists in the short term. However, despite some discomfort in
the Chinese stock market, the consumer market remains fairly healthy. A hard
landing for China remains a possibility, but seems a low probability at this
point. Policy-makers in Beijing appear content with incremental and targeted
stimulus efforts. One future example of this could be to follow through on
promised assistance for the reeling Macau casino business.
An endorsement from IMF this month could result in the yuan being included in
the SDR as soon as next year. This stamp of approval should lead to even wider
use of the yuan for transactions and as a reserve currency and will encourage
Beijing to continue on its reform path.
Inflated Ghost Stories
Normal healthy inflation has been absent in developed economies for so long it
almost feels like it exists only as a fantastical ghost story told by central
bankers. But since returning to inflation targets is at the heart of most
central bank policies these days, it's a tale worth listening to.
By most accounts, the bogeyman in the story is the plunge in energy prices.
Cheaper oil over the last year has failed to engender the pickup in economic
activity that many economists had predicted, and it has laid waste to inflation
forecasts across the globe.
Since Saudi Arabia threw off the mantle of swing-producer in favor of
maintaining its market share, US oil firms have scrambled to shutter
unprofitable wells. After a year of this, US production is at a 12 month low,
but the remaining oil rigs are extremely productive and efficient. A couple of
brief WTI rallies have been attributed to the ever shrinking North American rig
count, but oil prices have not been able to make a sustained move out of the
The semi-annual OPEC ministers summit (December 4) would be an opportunity for
oil producers to address the oversupply in the market, but it does not appear
that Saudi Arabia and its Gulf allies want to take action at this time. The
Saudis have shot down the idea of a meeting with non-OPEC producers ahead of
the December gathering, indicating they are not ready to relent in putting
market share over market price.
Other factors could exert additional forces on the oil market soon. Western
sanctions against Iran could be lifted as early as next spring, which will soon
flood the market with up to a million barrels per day of additional oil,
presuming the Iranians don't violate any provisions of the nuclear accord. The
growing US military presence in Syria also poses a risk of an unfortunate
incident with Iranian or Russian military forces backing the Assad regime.
A bill to end a 40-year old ban on crude oil exports from the US, enacted
during the Arab oil embargo, is moving through Congress. If the export ban is
reversed it would force some rapid recalculations in the energy markets and
likely narrow the spread between WTI and Brent crude prices. President Obama
has issued a veto threat for a version of the bill that has already passed in
the House, but the issue could be used a bargaining chip for the White House to
get more clean energy funding.
PREDICTION: Oil prices will not be resurgent any time soon: supply
remains elevated, storage facilities are awash in excess, and demand is only
growing slowly. Producers may have to wait another year before global
imbalances resolve themselves, hopefully on the back of a stronger economy.
In the meantime, market watchers may get tired of central bankers calling the
phenomenon "transitory." Persistent low inflation will force at least
some central banks to hand out more goodies to the market.
1: China Caixin Manufacturing & Services PMI; Turkey Parliamentary Elections
2: UK Manufacturing PMI, US ISM Manufacturing PMI
3: US Factor Orders
4: US Trade Balance; US ISM Non-manufacturing PMI; IMF SDR review; BOJ
5: German Factory Orders; BOE policy statement & inflation report
6: US Payrolls & Unemployment
9: China CPI & PPI
10: China Trade Balance (tentative)
11: China Industrial Production; UK Claimant Count & Unemployment
12: US JOLTS Job Openings
13: Euro Zone Flash Q3 GDP; US Advance Retail Sales; US PPI; US
Preliminary University of Michigan Confidence
15: Japan Preliminary Q3 GDP
16: Euro Zone Final CPI
17: UK CPI & PPI; German Zew Economic Sentiment; US CPI; US Industrial
18: US Housing Starts & Building Permits; FOMC Minutes; BOJ Policy
19: ECB Minutes; US Philadelphia Fed Business Outlook
20: Euro Zone Flash Manufacturing PMI
23: US Existing Home Sales
24: German Ifo Business Climate; US Advance Q3 GDP; US Consumer
Confidence; BOJ Minutes
25: US Durable Goods Orders; US Personal Income & Spending; US New Home
Sales; Japan Retail Sales
26: German Preliminary CPI; Tokyo CPI
27: UK Q3 GDP second estimate
30: Chicago PMI; China Manufacturing & Non-manufacturing PMIs; China Caixin
1: UK Manufacturing PMI; Euro Zone Unemployment; US ISM Manufacturing PMI
2: Euro Zone Flash CPI estimate
3: ECB Policy Statement and Press Conference; US ISM Non-manufacturing
PMI; US Factory Orders; Fed Chair Yellen's Congressional testimony
4: German Factory Orders; US Payrolls & Unemployment; OPEC ordinary
7: Japan Final Q3 GDP
8: China Trade Balance (tentative); UK Manufacturing Production; US JOLTS Job
Openings; China CPI & PPI
10: BOE Policy Statement
11: China Industrial Production; US Advance Retail Sales; Preliminary
University of Michigan Consumer Sentiment
15: German Zew Economic Sentiment; US CPI
16: UK Claimant Count & Unemployment; US Housing Starts & Building
Permits; US Industrial Production; FOMC policy statement & press conf
17: German Ifo Business Climate; US Advance Retail Sales; Philadelphia Fed
18: BOJ policy statement (tentative)
20: Spain national election
22: Euro Zone Flash PMI; US Final Q3 GDP; US Existing Home Sales
23: UK Q3 Final GDP; US Durable Good Orders; US Personal Income & Spending;
US New Home Sales; BOJ Minutes
24: Tokyo CPI
25: Christmas Day
29: US Consumer Confidence; Japan Retail Sales
30: Chicago PMI
31: ECB Minutes; China Manufacturing PMI