Running Scared

The FOMC’s running scared
It seems they were quite unprepared
For all the bond selling
And market rebelling
Now can their mistakes be repaired?

Over the weekend, pretty much every story about markets was about the FOMC’s attempts to walk back the Bernanke comments from two weeks ago. It is remarkable how many Fed members were quoted as saying the market is wrong and has overreacted. Now I don’t doubt for a moment that the market overreacted, that is a given with markets, but I am concerned that the illustrious Fed members were completely surprised that markets have responded in this manner. After all, what we are witnessing is the beginnings of a change in the most extraordinary monetary policy stimulus in history. And throughout history, when central banks, notably the Fed, have changed their policy stance from easing to tightening, or vice versa, the market response has been both large and volatile. One would think that the response to this change will be the largest and most volatile in history given the starting point. It could make one think that the FOMC is unaware of the history of its actions. At any rate, while no one denied that at some point QE would end, to a man the entire Fed said that the timing is much later than the market is implying. I think the lesson to learn from this is that the Fed may have finally figured out it cannot directly control, or even impact, unemployment; and that the Fed can only impact inflation with a significant time lag, so it’s only timely feedback is market prices for stocks and bonds. Ipso facto, the Fed is trying to manage the stock and bond markets, which do respond in a timely manner directly to their actions. Just not always the way they want. This story is going to be with us for quite a while yet, so despite the movements we have seen in markets already, don’t expect volatility to decrease any time soon.

Looking at the FX markets this morning, the yen is notable for its ongoing weakness, making another move back toward 100 after the Tankan report was released at 4, up from 3, and indicating continuing recovery in Japan. While there is no doubt that 100 will prove to be a difficult level to once again breech, I am confident it will do so, perhaps sooner than my initial expectations which were following the Upper House election in 3 weeks.

As to the euro, the PMI data showed a modestly better picture, with German PMI slightly softer at 48.6, but EC PMI slightly stronger at 48.8. To me this is all ‘shades of grey’. After all, the readings across the continent remain below 50, and while they have been edging higher, the trend remains one of a very slow return to growth. At the current trend, it will be March 2014 before the PMI prints at 50.0 again. That’s another 3 quarters worth of weakness. All that being said, the euro did manage to rally slightly on the release, although it continues to hover just above 1.30. It appears that there is somebody who is very eager to prevent the euro from falling below 1.30 for now, but I continue to believe that its decline is inevitable.

The pound rallied first thing this morning as the PMI data there was yet another positive surprise for the economy, printing at 52.5 rather than the expected 51.4. As Mark Carney steps into the BOE Governor role today, his job seems to be getting easier. Rather than figuring out how to stop the UK economy’s decline, he merely needs to figure out how to unwind the unprecedented policy prescriptions in place in the UK. While the magnitude of the issue is not as large as the Fed’s, it is still an enormous task for the UK economy. However, you have to like the pound more than the euro here, as at least the UK’s prospects seem much brighter than Europe’s for now.

Looking at the emerging markets, the picture is mixed. The most notable change from last week is INR, which seems to have responded quite positively to the Fed’s efforts to change market views. The Rupee has rallied more than 1% in the last two sessions and is the best performer in the space. It will be interesting to see how BRL opens this morning given its ongoing weakness in the wake of the protests throughout the country. President Roussef’s approval rating has plummeted to 30% from near 60% prior to the outbursts, and it is not yet clear that she will be able to address the concerns of the population. It is always very difficult for a corrupt government to address corruption, no? On the bright side for her, Brazil won the Confederations Cup last night, so I’m sure there will be much celebrating for a little while anyway. My guess is BRL performs well today, but the pressure remains on the government to enact positive changes, and I have a feeling that will be more difficult for them to implement. I look for BRL to weaken further over time.

Finally, this week brings a great deal of data in the US, culminating in the payroll report on Friday:

Today ISM Manufacuring 50.5
ISM Prices Paid 50.5
Tuesday Factory Orders 2.0%
Wednesday ADP Employment 160K
Trade Balance -$40.2B
Initial Claims 345K
Continuing Claims 2965K
ISM Non Mfg 54.0
Friday Nonfarm Payrolls 165K
Private Payrolls 175K
Mfg Payrolls 0K
Unemployment Rate 7.5%
Avg Hourly Earnings 0.2%

We will discuss Payrolls tomorrow. Overall, I see no reason to change my views on both bonds and the dollar, lower and higher respectively, but remain amazed at the resilience of the equity markets.

Good luck