Friday, May 20, 2016

Markets Reprice Fed Policy Risks Weekly Market Update: Markets Reprice Fed Policy Risks
Fri, 20 May 2016 16:07 PM EST

The FOMC minutes out on Wednesday drove a major reconsideration of the Fed's policy outlook this week. With the sense that the economic weakness of the first quarter was passing and a bottom had been found in energy markets, Fed officials were out in force telling markets they were wrongly pricing in a more cautious Fed policy view. Risk assets swooned with the repricing action that followed the minutes on Wednesday, but the impact was notably short-lived and equities were already climbing higher on Friday. Separately, China released a raft of weak April economic data last weekend, but even that had no more than a passing impact on global markets and commodity prices, suggesting that a newfound sense of robustness appears to be supporting global markets. Equity markets churned sideways and for the week the DJIA slipped 0.2%, the S&P eked out a 0.3% gain, and the Nasdaq added 1.1%.

The FOMC minutes indicated that most Fed participants feel current and future conditions in economic activity, labor markets and inflation could be supportive of tighter policy by the time the committee meets in June. The language echoed the FOMC position last October that economic trends were already likely to justify a December rate hike, although analysts caution that the corresponding passage in the April minutes was more conditional. Most importantly, the FOMC did not reach a consensus about whether conditions had already been fulfilled, but agreed that a rate hike would become likely if the economy improved further, and remained divided about whether that improvement would actually materialize. Fed fund futures significantly repriced the chances of a June rate hike in the latter half of the week, rising from around 4% on Monday to around 30% at week's end (off the 35% chance seen in the immediate aftermath of the minutes).

A chorus of Fed speak accompanied the report, aiding the overall repricing theme. Ahead of the minutes, Fed moderates Kaplan, Lockhart and Williams emphasized that rates need to start rising and that the June meeting would very much be live. Later in the week, Dudley said that if his personal economic forecast is on track, then June or July tightening is a reasonable expectation, while Lacker said he would like four rate hikes this year and chastised markets for overestimating how likely the Fed was to pause its tightening campaign. The greenback saw its third straight week of gains, with the dollar index rising to near two-month highs in the wake of the minutes. Commodities prices suffered, and crude prices paused on their march back toward $50.

Last weekend saw the release of disappointing China April retail, industrial output, and fixed asset investment reports. Retail sales fell to an 11-month low and industrial output was lower than expected, restrained by the key power generation component, which returned to contraction. The M2 money supply fell to a 10-month low and new loans hit a 6-month low. Property prices were a rare bright spot: home prices posted their fastest growth in two years in April, with gains in regional centers indicating a broader recovery beyond major cities. Earlier this year, a brace of terrible Chinese economic data would have driven big declines across global markets, but today markets have reconciled themselves to the "slowing China" theme and traders have more pressing issues to worry about. Chinese officials kept up a drumbeat of commentary to drive home the "stability" message, and Premier Li Keqiang once again repeated that Beijing would be able to keep economic growth "within a reasonable range."

The preliminary look at Japan's first quarter GDP performance surprised to the upside thanks to better consumption levels. The better result contrasted strongly with the contraction seen in the final quarter of 2015, helping the economy avoid a technical recession. The q/q sequential Q1 preliminary GDP hit a one-year high at +0.4% v -0.3% prior, while the annualized measure was +1.7% v -1.1% prior. Exports returned to growth and consumption hit a three-quarter high of +0.5%, however no recovery was seen in capex spending. Meanwhile, the debate raged on over the planned April 2017 sales tax increase - an important component of the third arrow of Prime Minister Abe's grand economic reform plan. Press sources once again reported the hike would be delayed, but officials quickly denounced the stories. Ruling LDP lawmakers recommended that PM Abe proceed with his plans and add an extra budget to deal with the impact. Abe aide Yamamoto said the extra budget could be as high as ¥10T, plus an additional ¥5-10T for aid to quake-hit Kumamoto prefecture.

There was some tension at the G7 conference in Sendai, Japan as US and Japanese officials sparred over currencies. US Treasury officials said that yen moves continued to be "orderly," signaling that Tokyo has no justification to intervene in the market soften the currency. Japan Finance Minister Aso responded by reiterating his government's standing policy view that excessive and disorderly FX moves were undesirable, hinting that Tokyo won't hesitate to intervene if they think it necessary. US officials fired back by saying currency moves are only "disorderly" enough to warrant intervention when they are triggered by a crisis. While post-FOMC greenback strength appeared to be limited on Friday, the yen continued weakening, with USD/JPY marking fresh three-week highs just shy of 111, before reversing back toward 110 on a Nikkei report that the BOJ had begun building reserves to pay for an eventual exit from monetary easing.

There are five weeks to go until the referendum on the UK's European Union membership on June 23rd and the polls suggest voters are all but deadlocked over the question of whether to stay or go. On Tuesday, an ORB telephone poll showing a 15% point lead for stay, but within hours a second poll, conducted online by TNS, showed the out campaign with a three-point lead - the first time a major poll put the leave camp in the lead since February. In many polls, the undecided camp is taking more than 20%. After falling to 1.4350 last week, cable surged to test above 1.4650, although that had much more to do with the FOMC minutes than Brexit polling. BoE Governor Carney faced plenty of politicized backlash for his remarks at last week's policy meeting regarding the negative economic implications of Brexit (higher unemployment, slower growth, higher inflation), and this week he said that ignoring the risks would not make them go away.

Goldman Sachs reversed its famously bearish view on the oil market - it was calling for $20 crude earlier this year - in a note that argued oversupply might be over and the market may be facing shortfalls. According to Goldman, the physical rebalancing of the oil market has finally begun, and while supply remained higher in the first quarter of the year, the market has likely shifted into deficit in May. Factors adding to the situation include the Canada wildfires and the Nigeria outages. Crude prices hit fresh six-month highs, with WTI and Brent ending the week just shy of $49/bbl.

There was more carnage in the retail sector this week, with Target leading the charge lower. Share of TGT were down as much as 10% at one point following the retailer's terrible comp sales performance and weak guidance. L Brands sagged 9% on the week at its worst. The women's clothier may have maintained positive comps and met expectations in its first quarter, but it also slashed its FY view and warned that May sales comps were in the red. Footlocker and Ross Stores saw losses despite decent earnings reports, as analysts slammed the entire mall chain sector. Meanwhile, Walmart rose nearly 10% after earnings as it beat expectations, while TJX gained around 5% on very strong comps. In the home improvement space, Lowes saw strong gains on a very good first quarter, while Home Depot was down on the week despite turning in a pretty decent result.

Spurious takeover rumors whipped around consumer staples name Church & Dwight and natural gas powerhouse Apache midweek. Relatively obscure sources pushed stories that the firms were looking at potential takeover offers, but the thin reports were dismissed relatively quickly. In more substantial M&A news, Pfizer reached a deal to acquire Anacor Pharmaceuticals for $5.2 billion just a month after it scrapped its $160 billion deal to buy Allergan Plc under pressure from new regulations on tax inversions. Valued at $99.25 per share in cash, the deal adds an eczema gel to Pfizer's portfolio. Papua New Guinea-based firm Oil Search reached a deal to acquire rival InterOil for $2.2 billion. InterOil's best assets include a 36.5% interest in the Papua LNG Project and its Elke-Antelope field, one of Asia's largest untapped gas fields.