The Federal Reserve took a big step back this week.
On Wednesday the Fed cut its outlook for interest rate increases in 2016 to two from four, telling the markets — which were long betting against four rate hikes from the Fed this year — that they were right all along.
The Fed turned a clear eye towards international developments in its statement, which said that, “global economic and financial developments continue to pose risks.”
Elsewhere in markets this week we saw the Dow and the S&P 500 both move back into positive territory for 2016, even if just barely. After what was a brutal start to the year many investors started be living this could be the year the post-crisis bull market finally cracked. And while this still might be the case, stocks have proven resilient so far.
This week we’ll get several updates on the US housing markets, as well as data readings on the services and manufacturing sectors, and the final measure of economic growth in the fourth quarter of 2015.
Markets are closed on Friday for Good Friday, and so here’s what you need to know ahead of a short week for markets and the economy.
- The Federal Reserve took a big step back. “The March FOMC statement and projections were more dovish than we expected, with the median dot for 2016 at just two hikes,” wrote Bank of America Merrill Lynch economist Michael Hanson. “Most surprising to us was the lack of conviction about the inflation outlook. This seems hard to reconcile with the recent pop higher in inflation, but it could reflect lingering concern about the disinflationary impact of a strong dollar or the soft deterioration of inflation expectations. While we remain comfortable with our call for the next hike in June, it will be important to get more clarity from Fed officials about the main factors they see driving the inflation outlook.” On Saturday, we noted that the signal out of the Fed’s Wednesday meeting was simple: they are going to let this thing run hot. And whether an economy that is growing at just 2% and has seen inflation run below-target for years can even run hot might be a subject for another debate, the Fed made clear on Wednesday it is intent on finding out.
- Stocks are back into the green for the year. After a chaotic start to 2016 that saw markets in the US and around the world sell-off hard for the first six weeks, the major US indexes rallied back into positive territory for the year this week. The S&P 500 gained about 1% this week and after the Dow moved into positive territory for the year on Thursday, the benchmark stock index followed suit on Friday. We noted how bearish sentiment got back in February with the AAII’s sentiment survey hitting its lowest reading since the crisis on February 11. The stock market’s bottom for this year? Hit on February 11. At the time we had lawmakers asking Fed Chair Janet Yellen about negative interest rates and analysts spending dozens of pages writing about contingent convertible bonds. Truly alternate-reality stuff. Now? Inflation might be rising too fast and the Fed might be too dovish. What a difference a month makes.
- People are still worried about bond market liquidity. “Trading liquidity has dried up significantly. Or so we have been told repeatedly since the financial crisis,” writes Deutsche Bank’s John Tierney. “However, the simplicity of this observation masks the inherent complexity of the issue… Even if liquidity appears decent most of the time, it is also apparent that liquidity risks are no longer a continuum, from more to less, but a binary outcome, from existent to nonexistent.” Writing on Sunday, Business Insider’s Matt Turner gave a detailed overview of the idea that liquidity is a fleeting and binary event. And really, it depends who you ask. Traders accustomed to making a few calls to find a buyer for, say, $10 million worth of bonds may be disappointed with current conditions. Regulators looking at bid-ask spreads for guidance on how well markets are functioning will likely see smooth charts indicating little stress in the marketplace. But what’s clear is that concerns over how well — or not — the bond market is working are not going away.
- Existing Home Sales (Mon.): The February report on existing home sales is set for release at 10:00 a.m. ET Monday morning. Expectations are for the pace of sales to fall 2.9% to an annualized rate of 5.31 million. January’s pace of 5.47 million homes sold was the fastest in six months. “Existing home sales are currently near their cycle highs, although they remain well below their prerecession peak,” writes Wells Fargo economist Sam Bullard. “Tight inventory on the market should remain a major headwind; although total housing inventory rose 3.4% during the month, they are still 2.2% below their year-ago level.” Wells expects a 1.7% decline in the pace of new homes sold in February.
- FHFA Home Price Index (Tues.): The January reading on home prices from the Federal Housing Finance Agency will cross at 9:00 a.m. ET Tuesday morning. Expectations are for home prices to rise 0.5% over the prior month, more than the 0.4% month-on-month increase seen in December.
- Markit Flash Manufacturing PMI (Tues.): The preliminary reading on manufacturing activity in March from Markit Economics will cross the tape at 9:45 a.m. ET Tuesday morning. Expectations are for the reading to improve to 51.9, up from 51.3 in February’s final reading. This measure has been closely watched as activity in the manufacturing sector has taken a hit due to the decline in energy prices and the strength of the dollar, which has weighed on US exports.
- Richmond Fed Manufacturing Index (Tues.): The March reading on manufacturing activity from the Richmond Federal Reserve bank will be released at 10:00 a.m. ET on Tuesday. Expectations are for the index to hit 0, indicating no increase or decrease in manufacturing activity in the region during the last month. February’s reading hit -4, indicating a slowing pace of activity.
- New Home Sales (Weds.): New home sales should rise at a pace of 3.2% in February to an annualized rate of 510,000 homes. February’s report is due out at 10:00 a.m. ET on Wednesday. January’s report showed a 9.2% drop in the pace of sales, which almost all came from an appreciable drop in sales from western US states.
- Initial Jobless Claims (Thurs.): The weekly report on initial jobless claims should show new filings for unemployment insurance totaled 268,000 last week, up slightly from the prior week’s 265,000. As we note time and again, this report is our best real-time reading on the US labour market and but for a very slight blip in the first few weeks of 2016, has done nothing to indicate the US job market is cooling off. The 300,000 claims level is the one to watch, but claims have been well below this level for most of the past few months and economists expect this trend will continue.
- Durable Goods Orders (Thurs.): Durable goods orders should fall 3% in February with orders excluding defence and aircraft orders falling 0.5% from the prior month. January’s report, which showed headline durables orders rising 4.7% while “core” — ex-air, ex-defence — orders rose 3.4%.
- Markit Flash Service PMI (Thurs.): The preliminary reading on service sector activity in March from Markit Economics will cross the tape at 9:45 a.m. ET on Thursday. This measure is expected to show a big bounce-back from February’s final reading of 49.7, which indicated contraction in activity from the services sector, the first decline since October 2013. The services sector accounts for the vast majority of GDP. In that report, Chris Williamson, chief economist at Markit, said, “Business activity stagnated in February as malaise spread from the manufacturing sector to services. The Markit PMIs are signalling a stagnation of the economy in February, suggesting growth has deteriorated further since late last year.” We’ll see if this trend shows signs of reversing on Thursday.
- Fourth Quarter GDP — Third Estimate (Fri.): The third and final estimate on economic growth in the fourth quarter of 2015 will cross the tape at 8:30 a.m. ET on Friday. Expectations are for no revisions to come up in Friday’s report with fourth quarter growth expected to be affirmed at 1% while consumption growth will remain at 2% and the quarterly increase in consumer prices, excluding the cost of food and gas, will hold at 1.3%. “The third release of real GDP growth in the fourth quarter is likely to confirm that economic activity decelerated to end 2015,” writes Wells Fargo economist Sam Bullard. “As first quarter data continues to emerge, we expect real GDP growth to be around 1.4%, led by personal consumption, housing, and government spending. The inventory correction and continued drag from trade are likely to restrain headline growth. Our current forecast has full-year 2016 real GDP growth at 1.9%.”
Let’s extend a metaphor.
In professional cycling races there are typically two races happening at once: there is a breakaway and a peloton. The breakaway is just a few riders — maybe a dozen or so — while the peloton is everyone else, usually well over one hundred riders.
For reasons of physics and mental fortitude, after several hours breaking the wind and riding in a small group, the breakaway is often gobbled up by the peloton before the finish line.
Think of the peloton, in a sense, as the market. We expect markets to revert to the mean: the breakaway stocks, managers, trends, and so on, can only exist on their island for so long. Eventually, the market will bring things back. Everything mean reverts. Market pros know this is true and so do pro cyclists. Rules are rules.
Dragging this metaphor even further, let’s look at the world of central banks and consider that the world’s biggest monetary policy players — the Federal Reserve, the Bank of England, the Bank of Japan, and the European Central Bank — are often moving in generally the same direction, at the same time, with the same commitment. Together, they are the world’s monetary peloton and moving away from this pack is often not a durable long-term strategy.
Writing on Sunday, Morgan Stanley global economist Manoj Pradhan argues that with the Fed, the BoJ, and the BoE not moving towards further easing while the ECB remains committed to easy policies into the foreseeable future, there is more of a divide among the world’s big central banks than one might think.
“The global central bank peloton has always pulled back breakaway attempts in the past, until now,” Pradhan writes.
“In the past, currency appreciation led to disinflation, and forced the hitters to pare back their plans to tighten. The Fed, the BoE and the BoJ have all been pulled back by the central bank peloton. But the attack has not been completely repelled this time around.
“As the uncertainty over growth has simmered down, all three central banks have shied well away from indicating that any substantial easing is forthcoming. The ECB, on the other hand, is clearly easing aggressively, and a host of DM central banks and those in North Asia are biased to ease for a long while. In a nutshell, the divide has narrowed a touch, but there is clear daylight between the hitters and the peloton.”
This week we saw the Fed pull back the reins on tightening policy faster than markets expected. In a way, the peloton caught the Fed. But the most creative and aggressive monetary policy right now is coming out of the European Central Bank.
And for now, they are standing apart from their peers.
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