Said Chinese FinMinister Lou
Our growth this year might not get to
While we reinvent
Our ‘conomy’s latest world view
If ever there was proof positive that the equity market rally has been based entirely on the Fed’s policy actions, yesterday was it. Wednesday afternoon, Chairman Ben essentially promised not to raise rates anytime soon, and voila, equities rally with a vengeance. Of course, this also impacted Treasuries, which have rallied 20bps by this morning from their worst levels, and the dollar, which has fallen against most currencies in the past 2 days. As I have written before, the biggest impact on markets are the comments by various officials, not the data releases that show what is actually going on in the global economy. And the number one voice remains Bernanke, with Draghi, Carney and Kuroda-san far behind in influence. With this new promise by the Fed, in conjunction with last week’s comments by Carney and Draghi regarding extended periods of monetary ease, it is time to reevaluate the current market situation.
So what do we know? Discussion at the FOMC is active with a large contingent of members believing it is time to think about moderating the QE program, but a slight majority, including BerDudLen, willing to expand the balance sheet for many months to come. As such, I expect we will hear more dissent over the coming months, but we will not see a policy adjustment unless the employment data starts to really improve dramatically. But even though there is not likely to be a change at the Fed soon, it remains clear that of the four major central banks, the Fed is closest to withdrawing its easy money. And so, the dollar should remain underpinned by this idea. The importance of the monthly payroll data has probably increased now, if that is possible, so the first Friday of every month will offer that much more excitement. We know that both the BOE and the ECB are committed to easy money for at least another year, and probably more. This is especially true for the BOE, where Governor Carney seems to be pushing very hard to expand QE there or create some other policy to imply further monetary ease. And we know that the BOJ is going to continue its QE program until the money supply in Japan has doubled from its level of 4 months ago. So the liquidity game that has been driving markets around the world is still afoot.
Looking to the next most important central bank, the PBoC, and the Chinese situation, we learned late yesterday that growth of 6.5% in 2013 seems to be acceptable now. As I have written before, the extraordinary growth story in China is slowly coming to an end. This is due more to the law of large numbers than any real failings in policy there. It is just very hard for a $10 trillion economy to expand 10% a year. However, there have been some policy failings there, notably the recent cash squeeze that drove interbank lending rates up 10% overnight. Also, some portion of the past growth was arguably of a synthetic variety. I am sure you have heard of the phantom cities, where the Chinese have built an entire city in the hinterlands but nobody lives there. So the building activity added to growth, but the investment has been wasted thus far. At any rate, the current Administration seems ready to make adjustments in the historic growth mix in China, with more domestic consumption focus and less export orientation. And according to FinMin Lou Jiwei, they seem prepared to grow at 6.5% this year and going forward. Well, that is a big difference than the current average forecast of 7.5%, and will weigh heavily on commodity prices. It is no surprise that despite the dollar’s relatively poor performance during the past two sessions, AUD has performed even worse. A growth rate of 6.5% implies that demand for Australia’s commodities is going to be much lower. This will have a double effect of reducing the GDP numbers in Australia and encouraging the RBA to use some of its current scope to cut interest rates further. Neither of these related outcomes is going to support the AUD and so I would look for further underperformance there. In the past 3 months, Aussie has fallen almost 15%. While it seems to have stabilized over the past weeks, I think this news will be the catalyst for the next leg lower. I see 0.85 in the Aussie’s future.
With only PPI (exp 0.5%, 0.1% core) and Michigan Confidence (84.7) to be released today, I think the market is likely to continue to focus on the Fed story and the dollar will tend lower. Emerging market currencies, which have rallied nicely during the past two sessions are likely to see a little profit taking into the weekend though, so a modest decline in most of those should be expected.
Overall, while I have not adjusted my long-term views, it seems clear that the timing of those moves may be extended somewhat as the Fed tries to deal with its unprecedented dilemma. Just how will they unwind the most massive stimulus program ever initiated, and how much market volatility will they tolerate. Remember too the law of diminishing returns. While recent verbal intervention has seemed successful, the next round will be less so, and the following even less. They will have to conjure new methods to prod markets in their preferred direction at some point. While today is not shaping up as too exciting, there remains a great deal of excitement built into the world and that excitement will play out as more volatility going forward.
Good luck and good weekend