TradeTheNews.com March-April
2016 Outlook: March Madness
Thu, 03 Mar 2016 23:05 PM EST
Leonardo DiCaprio's now infamous run-in with a bear may have been a harbinger
for the markets early this year. Just a couple of days into the New Year, it
was apparent that global markets were going to test the resolve of central bank
policy makers. Stocks and oil prices were mauled, currencies saw outsized daily
movements, and bond yields experienced renewed downward pressure - all
signaling discontent in the markets.
Looking back, the last two months of retrenchment were not entirely unexpected
after the rough start seen in the opening days of 2016. As predicted, the
markets didn't have much appetite for the Fed's tightening message, and
expectations are growing that the Fed will take an even slower rate tightening
path. The fourth quarter earnings season was subpar, as retailers continued to
struggle against ecommerce at Christmas, a number of tech firms failed to
justify their large multiples, and Apple appeared to turn the corner from a
growth stock to a value stock. The US Presidential race has been pared down,
with only three viable GOP candidates left, and a likely Clinton versus Trump
general election moving toward a reality. Meanwhile, the PBoC refrained from
any new big currency moves, as expected, and even pushed the value of the yuan
up over most of February to discourage speculative trading.
For the time being, the optimism about the US recovery that led the Fed to
raise rates in December has been dampened by a fresh round of global
uncertainties ranging from persistent low inflation to an unprecedented
political environment. These problems are being magnified as Europe and Asia
are still struggling to right themselves.
The question for this spring is how bad the current economic environment will
become. It may just be another short lived "tantrum" caused by the
Fed starting a tightening cycle years before other central banks can follow
suit. Or it could be the prelude to a recession, which is a growing minority
opinion. In the worst case scenario, it could be a global deflationary wave eroding
confidence in central banks set to trigger a fresh financial crisis at a time
when central banks are low on ammunition.
Marching to a Different Drummer
Stubbornly low inflation remains at the heart of the current economic malaise.
Central bankers in the US, Europe, and Japan would roll out the red carpet for
any sign that consumer and industrial demand was starting to edge inflation up
toward target levels. But inflation has so far defied numerous predictions that
an upturn is just around the corner, leaving economists and central bankers to
repeatedly push out their forecasts for rising prices.
While other factors are certainly at play, oil prices have been emblematic of
the low inflation problem. Crude futures have surrendered all of their
speculative froth, while the Fed has been describing the effects of low oil
prices as "transitory" since December 2014. The two-year long
collapse in energy prices has still not seeded any of the consumer spending
that economists were counting on, and razor thin margins are pummeling the
energy extraction industry, resulting in dramatic capex cuts and the loss of
many high paying jobs.
Despite some high cost wells being shuttered, all indications are that crude
still has lots of excess inventory to work off. Cushing crude stocks continue
to hit fresh record highs almost every week and the big refinery turnaround
season underway in the next two months will exacerbate the glut. In another
anecdotal indication of oversupply, a recent report said that port of Rotterdam
has 50 tankers awaiting unloading, the highest number since 2009 and double the
normal amount. To top that off Middle Eastern oil supplies will expand as Iran
ramps up its production as sanctions are lifted.
Russia and Saudi Arabia have raised hopes for an end to the misery in the oil
market by striking a tentative deal to freeze output levels. Under the
agreement brokered by Qatar and Venezuela, participants would freeze production
at January levels. This would not eliminate the supply and demand imbalance any
time soon, but could create the prospect for a more wide reaching production
accord when participating nations meet to discuss the freeze sometime during
March (the meeting date has not been specified yet).
Mounting global uncertainties are also contributing to the low inflation
environment, as consumers fear overspending when they can't predict if the
economic recovery will continue or if recession is around the corner. One
inescapable source of uncertainty is the strange dynamic of the US Presidential
race. A year of populist revolt has seen the rise of Donald Trump as the now
likely GOP nominee and a strong challenge from Bernie Sanders against Hillary
Clinton. The untimely death of Justice Scalia may become the deciding factor as
President Obama's Supreme Court nomination in the next few weeks will draw out
partisans on both sides (assuming Obama can find a sacrificial lamb willing to
expose her life to the political circus with little chance of ever being
rewarded with a confirmation hearing).
The other major ongoing political story is the UK referendum on remaining in
the European Union, with a vote now scheduled for June. PM Cameron came back
from Brussels with a reform deal to keep the UK in the union, but some high
profile members of his own party, including a number of cabinet members and the
flamboyant London mayor, have come out in support of a Brexit. The uncommitted
vote is still large enough to swing the referendum in either direction, so
Cameron will have to campaign hard, and the polling will be watched very
closely between now and June.
The other prickly topic in Europe these days is the continuing flood of
migrants fleeing the Syrian conflict. The EU and Turkey will hold a summit on
March 7th to discuss the flow of refugees through Turkey and into Europe. There
has already been a backlash in many EU states and the burden for Greece --
being on the front line of the migrant influx -- is causing complications in
Athens' ongoing debt discussions with European creditors. The issue has even given
some Euro-skeptics ammunition to suggest that the Schengen agreement, a
cornerstone of the Union which allows unhindered travel between states, should
be suspended.
PREDICTIONS: Crude prices have been behaving better in the last couple weeks,
showing tentative signs of stabilization. Russia and Saudi Arabia have made a
good show of their oil freeze accord, but it won't make much difference if the
agreement doesn't bring in other large oil producers. So far, Iraq has
expressed support for the idea but has not agreed to sign on to it, and Iran's
oil minister declared the production freeze to be "a joke."
Saudi drew its line in the sand on production two years ago and it will take
some time for shrinking capex budgets to trickle down into a tighter oil supply.
The good news is that the gyrations in oil prices may be more about the oil
market itself than about a prospective global downturn. Economists note that
recessions tend to be proceeded by rising energy prices, not falling prices.
They also still hold out the hope that consumers will start spending their
energy savings more readily when some of the uncertainties that have led them
to save the money start to dissipate.
For the markets, the ultimate question will be how far ahead we can anticipate
the eventual rebound in oil prices. Some optimistic OPEC ministers are hoping
for better prices in the second half of this year, but more conservative
estimates see prices finding somewhat higher levels in 12 to 18 months. Oil
market speculators could push up that timetable in anticipation a more balanced
market, so late 2016 might indeed be a better time for oil prices and energy
companies.
The major political campaigns of this spring will continue to create
uncertainties for the voters and the markets. The Presidential race looks
poised to enter the general election campaign with two highly flawed
candidates, marked by some of the highest negative polling ratings in history.
Dreams of a white knight at a contested Republican convention (Mitt Romney) or
a miraculous third party entrant (Mike Bloomberg) could keep stirring the
political pot for months to come. Meanwhile in the UK, an affirmative Brexit
vote is still seen as the outlying case. However, if the polling should drift
toward that result in the weeks ahead, it should be noted that an HSBC analyst
has predicted that a Brexit would wipe 20% off the pound sterling.
Beware the Ides of March
A lot of central bank activity will converge around mid-March. For more than a
month, the ECB has been teasing new measures at its March 10th meeting. The BOJ
will hold its monthly conclave a few days later, and then on the 16th the Fed
will take its turn in the spotlight.
The ECB has all but guaranteed more stimulus at its upcoming policy meeting. At
the last meeting, President Draghi promised to fully review and
"reconsider" policy in March alongside the release of updated
economic projections. He said the council would weigh a full range of policy
options and gave assurances that there are still many monetary policy tools at
their disposal as well as the required "power, willingness and
determination to act."
There must be some concern, however, that the ECB is no longer getting the bang
for its buck (or rather, the 'effect for its euro'). The new measures announced
just last December disappointed markets to some extent. Though the key rate was
cut another 10 basis points to negative 0.30% and the scope of QE was expanded
in both duration and composition, the monthly size of QE purchases was not
increased. Reports at the time indicated that a northern European block
objected to going further and indeed there were five dissenting votes on the
council (led by the Bundesbank's Lautenschlaeger and Weidmann).
The German contingent has led the hawks throughout Europe's navigation of the
financial crisis, but this time they may sit on their hands when Draghi calls
for new stimulus because Germany's largest bank is at the center of the latest
financial storm. Negative rates and a still slow loan environment have been
especially tough on Deutsche Bank, which has prided itself on providing the
entire menu of banking services, even at the expense of the bottom line. The
ECB's Coeure recently indicated that the council is sensitive to the burden
that negative rates are putting on European banks and hinted that the next
stimulus package could include provisions to help banks deal with adverse
consequences of prolonged negative rates. If true, that could convert prior
dissenters into affirmative votes.
Even as the ECB has been telegraphing its next policy moves, Asian central
banks have tried a different tactic. The BOJ shocked almost everyone with its
decision to match Europe's negative rate posture. And in China, the PBoC
continues to utilize the element of surprise in its efforts to thwart the
speculators that the government vilifies.
With only a month gone by since its surprise rate move, the BOJ is not expected
to do more than jawbone at its March meeting. The government, however, may be
on the move again. Reports say that Prime Minister Abe's cabinet has begun to
consider new emergency economic measures to provide additional support. This
comes as corporate profits deteriorated last quarter, leaving many Japanese
firms bracing for further weakness as a stronger yen has undermined the PM's
growth initiatives.
China got a lot of the blame for the market retrenchment in the New Year on
escalating fears that policy makers were losing control of the currency. The
Chinese central bank has refrained from any more jarring currency moves like
the sudden devaluation that caught markets off guard last summer, but further
yuan weakness in early January raised some questions about whether monetary
officials were still in control. The PBoC has since firmed up the yuan to
thwart currency speculators, and to assuage concerns of foreign partners that
China might export deflation to the world. Furthermore, at the G20 meeting of
financial ministers that was just hosted by China, Beijing gave assurances that
it would not initiate more sudden movements in its currency.
Over the first half of March, China's National People's Congress will hold its
annual meeting to introduce major policy initiatives and set new targets for
growth and inflation (announcements expected March 5). Going into the congress,
reports say that the CPI target is likely to be maintained at 3% and the M2
money supply target could be raised one percentage point to 13%. The GDP target
could step down another notch as PBoC officials are forecasting growth between
6.0-7.0% this year after 2015 came in just under the target of "around
7.0%." Additionally, the PBoC statistics department has called for the
fiscal deficit to be increased by one percentage point more than previously
planned to 4% of GDP. Presumably that would promote greater government spending
on stimulative public works projects.
Back in the US, the Fed has to consider scaling back its plans for higher
rates. At the March FOMC meeting, the policy statement probably will not change
drastically after the economic outlook was downgraded earlier this year. In the
January statement, the Fed said it now expects inflation to remain low in the
near term and it deleted a reference to being "reasonably confident"
about inflation being on track. Commentary about global concerns was also
intensified, as the Fed struck language about the outlook for economic activity
being balanced. Altogether these changes signaled the Fed would probably be on
hold for a while.
In their individual speeches, Fed officials have tried to create the impression
that they have an open mind about the March meeting, with many of them saying
every meeting is still "live" for potential rate hikes. However, the
Fed's data dependent stance won't leave much room for policy action in March,
because the data has not been particularly good.
Though payrolls have been solid, a lot of the job creation has been in low
paying entry level jobs. It's true that unemployment has edged below five
percent, but the economy has been near full employment for the better part of a
year, so the low jobless rate has lost some of its positive psychological
impact. Wage inflation is still elusive, and that, coupled with continued weak
industrial production data, should give the Fed enough cover to keep rates on
hold in March.
The Fed's updated Summary of Economic Projections (SEP) will be the most
closely scrutinized part of the FOMC release. In December, the SEP predicted a
central forecast of four rate hikes in 2016, which would be a pace of every
other meeting. Global economic conditions clearly no longer warrant such an
aggressive tightening schedule, and the dot chart is expected to reflect this
in March.
PREDICTIONS: The periodic application of fresh stimulus has kept markets in a
risk on mode for most of the last several years, but there is growing evidence
of diminishing returns. Markets retrenched throughout the first two months of
the year despite the ECB's expansion of QE in December (and the promise of more
in March) and the BOJ's surprise rate move. The experimental use of negative
rates pioneered by the ECB, shows central banks can continue to innovate,
though it has also created some misgivings.
The ECB President may hear fewer dissenting voices if he brings out the bazooka
again, possibly completing the QE trifecta announced in December by increasing
the pace of monthly bond purchases from the current €60B/month. For good
measure, the ECB may also cut rates another 10 to 15 basis points into negative
territory, as long as they find a way to shield commercial banks from the blow.
After pledging new action for the last six weeks, anything less would surely
disappoint markets.
For the time being, Japanese officials will probably choose rhetoric over
additional action, taking time to assess if negative rates are having the
desired effect. Yet, now that the BOJ has crossed the threshold to experiment
with negative rates, it seems likely that further cuts will be forthcoming
eventually. In the meantime, the government may provide a supplementary budget
with targeted stimulus, or give more consideration to postponing the next phase
of a planned consumption tax hike.
Growing pessimism about the prospects of the world's second largest economy
demand that China keeps up its ad hoc stimulus initiatives. The People's
Congress will set achievable targets as it continues to ease the economy into a
consumer driven model. Further monetary easing is likely to be proposed and
executed periodically to help cushion the pain of reform efforts.
In the US, the Fed can afford to be patient on any further tightening.
Uncertainty abounds, and another rate hike at this fragile moment could tip
things in the wrong direction. Also, other central banks are cutting rates,
which is the equivalent of the Fed tightening - so, relatively speaking, the
Fed can essentially tighten just by standing still.
Fed Funds Futures aren't fully pricing in the next Fed rate hike until early
2017, way out of line with the December dot charts that predicted FOUR more
hikes this year. Clearly something has got to give and that will probably be
the Fed forecast, which could be trimmed to three hikes or even two, but
certainly won't give up on the notion that the tightening cycle should
continue. In giving this ground Chair Yellen will reprise her warning that a
slower start to the cycle is apt to lead to steeper hikes later on.
CALENDAR
MARCH
1: UK Manufacturing PMI; Euro Zone Unemployment; US ISM Manufacturing PMI;
Super Tuesday Primaries & Caucuses in 12 states
2: UK Construction PMI; China Caixin Services PMI
3: US ISM Non-Manufacturing PMI; US Factory Orders
4: US Unemployment & Payrolls; US Trade Balance
5: China National People's Congress annual meeting
7: German Factory Orders; EU Summit on Refugees; Japan Final Q4 GDP; China
Trade Balance (tentative)
8:
9: UK Manufacturing Production; China CPI & PPI
10: ECB policy statement and press conference; US JOLTS Job Openings
11: US Preliminary University of Michigan Confidence
12: China Industrial Production
13: BOJ policy statement
14:
15: US PPI; US Retail Sales
16: UK Claimant Count & Unemployment; US Housing Starts &
Building Permits; US CPI; US Industrial Production; FOMC policy statement
& press conference
17: Euro Zone Final CPI; BOE policy statement; BOJ Minutes
18: Philadelphia Fed Manufacturing
21: Various Euro Zone Flash Manufacturing readings; US Existing Home Sales
22: UK CPI & PPI; German ZEW Economic Sentiment
23: German Ifo Business Climate; US New Home Sales
24: UK Retail Sales; US Durable Goods Orders; Tokyo CPI
25: US Final Q4 GDP
28: US Personal Income & Spending; Japan Retail Sales & Household
Spending
29: German Retail Sales; German Unemployment; US Conf Board Consumer Confidence
30: German CPI; US ADP Employment
31: UK Final Q4 GDP; Euro Zone Flash CPI; ECB Minutes; US Chicago PMI; Japan
Tankan Manufacturing & Non-Manufacturing; China Manufacturing &
Non-Manufacturing PMI; Caixin Manufacturing PMI
APRIL
1: UK Manufacturing PMI; Euro Zone Unemployment; US Unemployment
& Payrolls; US ISM Manufacturing PMI
4: UK Construction PMI; US Factory Orders
5: German Factory Orders; US Trade Balance; US ISM Non-Manufacturing PMI; China
Caixin Services PMI
6: FOMC Minutes
7: US JOLTS Job Openings
8: UK Manufacturing Production
10: China CPI & PPI
11:
12: UK CPI & PPI; China Trade Balance (tentative)
13: US PPI; US Retail Sales
14: Euro Zone Final CPI; BOE policy statement; US CPI; China Q1 GDP;
China Industrial Production
15: US Industrial Production; US Prelim University of Michigan Consumer
Sentiment
18:
19: German ZEW Economic Sentiment; US Housing Starts & Building Permits
20: UK Claimant Count & Unemployment; US Existing Home Sales
21: Various Euro Zone Flash PMI readings; ECB policy statement & press
conference; US Philadelphia Fed Manufacturing
22: German Ifo Business Climate
25: US Durable Goods Orders; US New Home Sales
26: US Conf Board Consumer Confidence; BOJ policy statement
27: UK Prelim Q1 GDP; FOMC policy statement; Japan Household Spending; Tokyo
CPI; Japan Retail Sales
28: German CPI; US Advance Q1 GDP
29: BOJ Outlook Report; German Retail Sales; Euro Zone Flash CPI; Euro Zone
Unemployment; US Personal Income & Spending; Chicago PMI
30: China Manufacturing & Non-Manufacturing PMIs