TradeTheNews.com January-February
2016 Outlook: A Long Time Ago, in a Financial Crisis Far, Far Away
Wed, 06 Jan 2016 22:46 PM EST
It feels as if the 2008 financial crisis was a long time ago, and indeed it has
now been the better part of a decade since the bottom fell out. More than seven
years of CENTRAL BANK largesse has helped restore the global economy to modest
growth but it continues to suffer from problems with low inflation.
The "dark side" of the economy still holds sway as evidenced by how
2015 went out with a whimper. The S&P500 dropped about 0.9% to snap a three
year winning streak, and the Dow turned in its first losing year since 2008.
Oil was pummeled for the second straight year, yet cheap energy prices have
still shown little sign of trickling down into more consumer spending. Global
terrorism has the world on edge as the depravity in Syria has inspired ruthless
attacks far from the front lines in the Middle East.
The theme of global monetary policy divergence that has been theorized about
for the last year finally materialized in December. The Federal Reserve
followed through on rate liftoff last month, yet many questions remain about
whether this divergence from global policy easing was prompted by a stronger
economy or by the Fed backing itself into a corner with its rhetoric. Markets
took the news of higher US rates even better than expected, with only a mild
and brief bout of indigestion as the punch bowl was partially drained. Almost
simultaneously, that bowl was replenished by other central banks. The ECB
followed the script by expanding its QE program, though some market
participants were disappointed that it grew only in breadth and timeframe, but
not in the size of monthly purchases. To a lesser extent, the central banks of
Japan and China also contributed new stimulus measures. And, as expected, oil
prices continued to slide to multi-year lows as Saudi Arabia did not blink at
the semi-annual OPEC meeting.
A period of market retrenchment is almost inevitable as the policies of central
banks diverge - it's only a matter of when and how extreme the reaction is. The
scope of the market rebalance could be determined in the next few months as
forecasters refine their predictions for the shape of the Fed tightening cycle.
To a large extent, Fed policy will be the force driving the global economy, as
most market and policy movements will play off of how far the Fed pulls away
from the global easing regime. The policy divergence will put new stresses on
the global economy that will be observed in equities, fixed income, energy, and
foreign exchange markets and in how other central banks rejigger their own
policy strategies.
The Fed Awakens
After some months of hemming and hawing, the Fed went ahead with rate liftoff
last month. By early December, the jobs numbers had solidified expectations
that the Fed would make its first move toward normalization at its last meeting
of the year. The decision was unanimously supported by FOMC voters, suggesting
the doves and the hawks were able to reach a collegial consensus, though there
may have been some added pressure to move since failing to do so risked the
central bank's credibility after members had all but promised the first move
would occur in 2015.
The new slate of FOMC voting members for 2016 has a decidedly more hawkish
leaning, appropriate for a year in which rates are expected to rise.
Cleveland's Loretta Mester (hawk), St. Louis' James Bullard (hawk), Kansas
City's Ester George (hawk), and Boston's Eric Rosengren (moderate) will replace
a more dovish group of Fed Presidents from last year. This new roster is not
likely to shy away from rate hikes if conditions merit. If a dissenter does
emerge, it might be either a hawkish George or dovish Rosengren. Back in 2013,
the last time they were voting members, George dissented against prolonging the
QE3 program on concerns it could spark inflation, while Rosengren later registered
his opposition to the initial tapering of that program.
So the big question now is "when will they raise rates again?" Early
indications from the Jedi Masters at the Fed have been that rates will rise
slowly and will find a lower peak rate than in past tightening cycles. The
first and most consistent guidance from Fed Chair Yellen has been that rate
hikes will not be "mechanical." This means that rates moves will
depend on the incoming data, and won't step higher at each successive meeting. Fed
speakers have also used "gradual" to describe the expected rate path.
One Fed president (Lockhart) has elaborated that gradual suggests a hike at
every other meeting. These code words combined with the FOMC 'dot chart' have
set the initial expectation that rates will be increased four times in 2016, to
bring the key rate above 1.25% by the end of the year.
Since the Fed wants to be transparent as possible, the committee may deem it
logical to provide a signal for the next raise one meeting in advance. Thus, an
otherwise uneventful January meeting could still hold some intrigue should the
Fed add language that sets up the sequel to rate liftoff in March.
PREDICTIONS: With the first move out of the way, the Fed must face the
challenge of managing future rate expectations in a context of a global
economic malaise that is forcing other central banks to add even more stimulus.
If the Fed keeps pulling rates farther off of the zero bound while other
central bank policy regimes are sinking below zero, the policy divergence could
begin to have unintended consequences and create a backlash in markets.
The second rate hike now becomes all important to the policy schematic, and its
timing will be hotly debated. So far it's penciled in for March, but it could
be knocked off track by a number of potential events including a stock market
swoon or negative developments in the global markets (which blocked Fed liftoff
in September).
The key question for the Fed is whether members need to see continued
improvement toward its dual mandate (jobs & inflation) before approving a
second rate hike, or if they are prepared to keep raising rates until bad data
stops them. Some forces believe the Fed will not be able to muster more than a
couple of rate hikes this year, and the markets may actively try to test the
Fed's resolve with stock market correction.
Though rate liftoff in December was framed as a vote of confidence in the
economy, mixed data in recent weeks suggest that the US is hardly a bastion of
strength even compared to the anemic global economy. Many forecasters expect US
Q4 GDP will be subpar and even the Atlanta Fed has cut its GDPnow tracking
estimate to as low as 0.7%. Lingering concerns about low inflation and the
strong dollar could also leave the Fed extremely cautious. The uncertain start
for markets in the New Year seems like a strong reminder that even the best
laid plans often go awry, foreshadowing some difficulties ahead that could
delay more Fed rate action until the spring.
"It's a Trap!"
So what might disrupt the Fed's plan of attack? A broad variety of developments
could put new stresses on the economy and markets, raising questions about the
viability of monetary policy divergence. These could range from a simple stock
market correction as Q4 earnings reports come in, to falling energy prices
sparking a high yield crisis.
It's almost universally agreed that global easing has inflated equities, so the
Fed taking its foot off the gas could hamper stocks. Former Dallas Fed
President recently asserted that the Fed deliberately front-loaded an enormous
equity rally over six years and that he would not be surprised if the market
goes through a period of digestion now as stimulus is lifted, and could see a
10-20% correction.
That prediction could be tested as some potentially unsettling corporate
earnings reports start to roll in during mid-January (Alcoa unofficially kicks
off earnings season on January 11). The warm weather in December wreaked havoc
on many retailers who couldn't sell off large inventories of winter clothing
during the holiday sales season.
There could also be trouble in store for Apple. 2016 is now expected to be the
first year ever in which iPhone sales will shrink as the company's suppliers
are tamping down iPhone production due to high existing inventories of the 6S
handsets. If leading consumer brands like Apple can't get traction in the
quarter, it does not bode well for other firms that are reliant on outsized
holiday retail sales.
Fed tightening cycles generally lead to a pullback in equity indices, though
the good news for bulls is that it's sometimes a year or two into the cycle
before stocks peak. The fact that rates are coming off of historic lows and
that their upward trajectory will be shallow should also ease the blow. And at
least one sector - the big commercial banks - should start to see better
returns as rates rise after years of making their organizations leaner.
The energy sector was the biggest drag on stocks last year and conditions could
get worse for these companies in early 2016. Smaller energy services firms
without the resources of an ExxonMobil have been struggling to right-size their
businesses and their dividends to cope with the downturn in oil prices.
Oversupply issues could continue to plague the oil market for a long time to
come, so crude prices could go lower still. Demand for energy has risen, too,
but not enough to overcome the crude glut, and there are now even some concerns
that storage at the Cushing crossroads could eventually fill to capacity
(Cushing storage is at record highs near 64 million barrels, edging closer to
its 71 million barrel capacity).
The geopolitics of the Middle East always bear close attention, and more so
than ever as relations between Saudi Arabia and Iran have reached an all-time
low in recent days. In response to the Saudis execution of a popular Shiite
cleric on terrorism charges, the Iranian government allowed protestors to
ransack the Saudi embassy in Tehran. The Saudis, who are already embroiled in
proxy wars with Iran in Syria and Yemen, then decided to cut off all commercial
and diplomatic relations. A direct confrontation between the two is highly
unlikely, but the heightened tensions could lead oil speculators to push Brent
crude a bit higher. On the other hand, this latest clash might steel Saudi's
resolve to continue oil production at full tilt to hurt Iran just as it works
to bring more supply back to market as nuclear sanctions are lifted.
The collapse of oil prices has also bedeviled the junk bond market. Many
smaller oil firms issued significant amounts of high yield debt to fund their
growing operations during the shale oil boom, but the reversal in energy prices
has raised concerns about default on those debts. As oil prices stretched to
multi-year lows in December, the high yield market was hit by news that Third
Avenue Management, a large mutual fund specializing in high-yield bonds, was
liquidating the fund and had blocked investors from withdrawing money as it
wound down. Jitters over Third Avenue lasted only a couple of sessions but some
powerful voices in the markets such as Carl Icahn suggested it was another sign
that a long-prophesied high yield debt meltdown could be underway. For the high
yield market, each step higher in Fed rates could become the straw that breaks
the camel's back as yield-starved investors who packed into junk bonds start
seeing better and safer opportunities in more conventional instruments.
PREDICTIONS: The crucial Q4 earnings season will tell the true tale of how the
holidays played out for retailers and other seasonally impacted businesses. So
far, lower gasoline prices have not translated into any noticeable rise in
economic activity, but perhaps the November-December shopping period got a
small boost.
The Fed has made it clear that it worries about stock market performance, and
the market may decide to test the central bank's resolve early this year. The
old saying "as January goes so goes the market" holds true about 70%
of the time, so a poor performance in the next few weeks could bode poorly for
the year.
Stock prices remain intertwined with the energy market, and no relief is in
sight on the supply side. Iran and Saudi have had a long rocky relationship as
the centers of their rival branches of Islam, but they don't appear to be ready
to spill blood over oil. When Iran turns the spigots back on it may be forced
to ramp up oil exports only gradually to avoid further price erosion.
May the Forex Be With You
It was China that got 2016 off to a rocky start. New stock market circuit
breakers were tested on the very first trading day of the New Year as Shanghai
and Shenzhen equity indices tumbled 7%.
The first economic data point of the year was another disappointing industrial
reading: the December Caixin PMI Manufacturing number missed estimates and
registered its tenth straight month of contraction. On top of that, forex
watchers noted with concern that the PBoC fixed the yuan to its weakest level
in five years.
Since the PBoC shocked the FX market with a sudden 4% devaluation last summer,
it has steadily weakened the currency fixing. In the New Year this has begun to
shake confidence in the Chinese economy. The concern is that the PBoC may
overuse the currency as a tool for stimulating its weakened economy. If China
allows its currency to depreciate further it could make large amounts of dollar
denominated debt held by state owned companies harder to repay.
Some of the early equity weakness may also be linked to a ban on large
shareholders selling stakes in Chinese firms that regulators put in place to
reinforce the stock market last July. That six month ban on insider sales will
soon expire (January 8th) and some traders may be front running expectations
that large shareholders will be eager to sell.
It's not a pretty picture in Europe either, where the ECB was forced to
supplement its stimulus program last month, magnifying the policy divergence
with the tightening Fed. The ECB cut its deposit rate another ten basis points
into negative territory, to -0.30% and expanded its QE program. The bond buying
program was extended by six months to March 2017 and expanded to including
regional government bonds, widening the variety of assets that can be bought.
Markets were apparently disappointed that the ECB failed to boost the monthly purchase
size of €60 billion, but ECB President Draghi defended the measures taken as
"adequate." In addition, he explained they would also commence
reinvesting principal as bonds mature, a move that would add €680 billion in
liquidity to the system by 2019.
Despite assurances from Draghi that more monetary stimulus is possible, there
is some speculation that the ECB council is near its limit. A recent poll
conducted by the Financial Times found that many experts don't believe the ECB
has the wherewithal to increase the asset purchase program again. The December
decision to extend the QE program drew five dissenters, including
representatives from Germany, Netherlands, Estonia, and Latvia. The minutes of
the December meeting to be released on January 14th will amplify that this
growing rebel faction is unhappy with the snowballing amount of accommodation.
This could relegate further jawboning by Draghi to the status of an ineffectual
Jedi mind trick.
Some smaller central banks are having difficulties coping with the stresses
created by grand schemes of the major central banks. For example, Sweden's
Riksbank threw down the gauntlet at an emergency meeting on January 4th. The
Riksbank said that the Krona's appreciation is a threat to its efforts to
return inflation to its 2% target. To that end, Swedish officials said they
stand ready to intervene in the FX market without notice, and could take other
measures including extending QE or making indirect loans to companies if
needed.
Monetary policy regimes at many other foreign central banks required some quick
adjustments after the Fed rate liftoff. Almost immediately, several Latin
American central banks that are closely aligned to Fed policy, like Mexico's,
raised rates to discourage depreciation of their local currencies. They may be
compelled to mirror additional Fed moves.
PREDICTIONS: After smart money predictions of EUR/USD parity in 2015 were
dashed, forecasts are more varied in the New Year. Some banks including
Citigroup expect four Fed rate hikes to create enough policy divergence to
foster euro parity by the end of this year. Other analysts are less optimistic
about the US outlook and think some of the dollar strength is speculative
froth. They see the ECB growing less tolerant of additional easing, and predict
fewer rate hikes from a cautious Fed, which could actually lead to a modest
strengthening of the euro.
The dollar index rose more than 9% during 2015 on the run up to rate liftoff,
so some of the strength is already baked in, but higher US yields will act as a
magnet for funds from abroad and that should result in sustained strength for
the greenback. So as the Fed continues to raise rates it's likely to further
strengthen the dollar against major currency pairs.
Despite the Treasury's oft repeated mantra that a strong dollar is in the
interest of the US, in some cases it isn't. If the dollar gets even stronger
there could be an outcry from large US firms, given that a large chunk of their
earnings comes from exports and currency headwinds are already hurting
business.
A stronger dollar could also have negative spillover effects in emerging
markets, where corporate debt has increasingly been dollar-denominated. As that
debt becomes more expensive in local currencies, it could ratchet up financial stresses.
Meanwhile, the PBoC will likely content itself with slowly dropping the value
of the yuan, since another large, sudden devaluation could create a panic.
Pol Wars
As the rhetoric heats up on the Presidential campaign trail, cooler heads have
prevailed in Washington. Congress and the White House signed off on a two year
budget and debt limit increase that gives the government authority to borrow
freely through March 2017. This averts the threat of a government shutdown
during the Presidential campaign, and may allow the Congress to work quietly on
smaller issues during Obama's lame duck year.
The campaign for the White House will soon kick into hyper-drive now that the
voting is about to begin. A year of wild stump speeches and unruly debates will
culminate in actual voting starting on February 1st at the Iowa Caucus.
On the Democratic side Bernie Sanders has energized many liberals and he may
pull off a victory in New Hampshire, but his rebel campaign is unlikely to
overthrow the Hillary Clinton juggernaut. Meanwhile, there is a great
disturbance in the Republican side of the field. Donald Trump, who has led in
most GOP polls almost since he launched his bid in June, has confounded pundits
who keep predicting his campaign will blow up more spectacularly than the Death
Star. But despite some controversial statements and the disdain of the party
establishment, Trump still has a full head of steam going into the Primaries.
Thus, he will get a chance to prove whether or not his base of disillusioned Republicans
will actually pull the lever for his name.
Trump fended off an autumn surge in the polls by Ben Carson, who seems to have
all but vanished from the race, but now a new challenger is rising in the form
of Ted Cruz. With the backing of evangelicals Cruz could win the Iowa Caucus
and gain some momentum headed into the next primary states (New Hampshire Feb
9th, followed by South Carolina and Nevada a couple weeks later, and then Super
Tuesday on March 1st). It is hard to believe that a political "padawan"
like Trump could lead the GOP race from wire to wire, and if The Donald's fan
boys don't get out to the polls then Cruz might assume the mantle of the
"outsider" candidate.
It's well known that Mr. Cruz thrives on thumbing his nose at the establishment
wing of the party (making him the most despised figure within a legislative
body since Jar Jar Binks). Many political observers are betting that Cruz and
the radical Republicans will ultimately face off with Marco Rubio who is
leading the pack of more traditional candidates that are palatable to the
establishment wing.
In Europe, the inconclusive election in Spain has yet to produce a new
government. With opposition parties apparently unwilling to form a coalition,
it appears that Madrid is on its way to establishing a minority government
later this month. Portugal's presidential election on January 24th is expected
to have a more certain result. The center right Social Democratic Party is
expected to hold on to power as President Silva steps down.
PREDICTIONS: By the end of March, the US Presidential field should be weeded
out considerably. The congested GOP side might even be ready to ordain Trump,
Cruz, or Rubio as their champion (or less likely, Chris Christie or Jeb Bush
could make a late surge). But it might not go smoothly. The Republican Party
was embarrassed last year when a report emerged that they were considering the
possibility of a brokered convention if no single candidate could grab a
majority of delegates.
If the Republican Party can't coalesce around a credible candidate in the next
few months, it could damage the chances of the eventual nominee in the general
election. Four more years of a Democratic President dueling with a Republican
Congress promises another long stretch of brutal gridlock in Washington.
Border security has become a prominent issue in the face of global terrorism
that touched Paris and California late last year. The unfortunate occurrence of
any further terrorist incidents could weaken the incumbent party as scared
voters could flock to a candidate that promises to make them safer from the
phantom menace, helping Republicans in the US and nationalist parties in
Europe.
CALENDAR
JANUARY
4: German Prelim CPI; UK Manufacturing PMI; US ISM Manufacturing PMI; China
Caixin Manufacturing PMI; Puerto Rico $1B debt payments due
5: Euro Zone Flash CPI Estimate
6: UK Services PMI; US ISM Non-Manufacturing PMI; US ADP Employment; US Trade
Balance; US Factory Orders; FOMC Minutes; China Caixin Services PMI
7: German Factory Orders; Euro Zone Unemployment
8: US Payrolls & Unemployment; China CPI & PPI
11: US JOLTS Job Openings; Alcoa earnings report (unofficial start of
earnings season)
12: UK Manufacturing Production; China Trade Balance
13:
14: ECB Minutes; BOE policy decision
15: US Retail Sales; US PPI; US Industrial Production; Prelim University of
Michigan Consumer Sentiment
18: US Markets Closed for Martin Luther King Day
19: UK CPI; German ZEW Economic Sentiment; China Q4 GDP; China Industrial
Production
20: UK Claimant Count & Unemployment; US Housing Starts & Building
Permits; US CPI
21: Various EU Flash Services & Manufacturing PMIs; Euro Zone Final CPI; ECB
Policy Decision & Press Conference; US Philly Fed Manufacturing
22: UK Retail Sales; US Existing Home Sales
24: Portugal presidential election (second round Feb 14th if needed)
25: German Ifo Business Climate
26: US Consumer Confidence
27: US New Home Sales; FOMC Policy Decision (no press conf)
28: German Prelim CPI; UK Prelim Q4 GDP; US Durable Goods Orders
29: Euro Zone Flash CPI Estimate; US Advance Q4 GDP; Chicago PMI
31: China Manufacturing & Non-Manufacturing PMIs
FEBRUARY
1: UK Manufacturing PMI; US ISM Manufacturing PMI; US Personal Spending; Iowa
Caucus; China Caixin Manufacturing PMI
2: Euro Zone Unemployment
3: UK Services PMI; US ADP Employment; US ISM Non-Manufacturing PMI; China
Caixin Services PMI
4: BOE Policy Decision & Inflation Report; US Factory Orders
5: German Factory Orders; US Payrolls & Unemployment; US Trade
Balance
7: China Trade Balance
8:
9: US JOLTS Job Openings; China CPI & PPI; New Hampshire Primary
10: UK Manufacturing Production
11:
12: Euro Zone Flash Q4 GDP; US Retail Sales; Prelim University of Michigan
Consumer Sentiment
15:
16: UK CPI; German ZEW Economic Sentiment
17: UK Claimant Count & Unemployment; US Housing Starts & Building
Permits; US PPI; US Industrial Production; FOMC Minutes
18: ECB Minutes; US Philly Fed Manufacturing
19: UK Retail Sales; US CPI
20: Nevada Dem Caucus; South Carolina GOP Primary
22: Various EU Flash Services & Manufacturing PMIs;
23: German Ifo Business Climate; UK Inflation Report hearings; US Consumer
Confidence; US Existing Home Sales; Nevada GOP Caucus
24: US New Home Sales; Q4 Mortgage Delinquencies
25: UK Q4 GDP Second Estimate; Euro Zone Final CPI; US Durable Goods
26: German Prelim CPI; US Prelim Q4 GDP (second estimate); US Personal Spending
27: South Carolina Dem Primary
29: Euro Zone CPI Flash Estimate; Chicago PMI; China Manufacturing &
Non-Manufacturing PMIs
MARCH
1: UK Manufacturing PMI; Euro Zone Unemployment; US ISM Manufacturing; China
Caixin Manufacturing; Super Tuesday Primaries & Caucuses in 12
states (AL, AK, AR, CO, GA, MA, MN, OK, TN, TX, VT, VA)
2: US ADP Employment Change
3: US ISM Non-manufacturing PMI; US Factory Orders; China Caixin Services PMI
4: US Payrolls & Unemployment; US Trade Balance
