That was the week that was – Sunday 24th January 2016

Markets
The equity markets fall from the previous week gathered pace until non-US central bankers raised their heads and promised action. As expected by Market Monetarists, markets rallied at that point. The power of expectations is awful to behold, especially at turning points.

Financial market participants often use the cliché that “bad news is good news”. This very often refers to the phenomenon when bad economic news is interpreted by markets as meaning central banks are likely to ease monetary policy. It usually leads to flat, directionless, stock markets.

Things look best when “good is news is good news”. For me this is when central banks are set on a course of monetary easing and it is working. As good macro news appears it does not deflect the central bank from its course. The initial and early to middle stages of the three bouts of Quantitative Easing (QE) carried out by the Fed are classic recent examples, especially QE3.

Until the turnaround late last week in markets we had an example of the third combination of this cliché, “bad news is bad news”. This is horrible and a sign of gut-wrenching panic. It is when bad economic news arrives against the background of monetary tightening. The Fed is definitely set on that track following the potentially infamous rate rise on 16th December 2015. Markets just hate that feeling that not only is no-one in control of the macro-economy but that those that are meant to be its guardians are actively trying to bring it down. It’s awful, and no wonder stock markets slump.

US rate curves came down appreciably as both the short end and longer ends of the curve saw yields fall back to November 2015 levels. Back then some half-decent economic news had led rate rise expectations to build, that were then fulfilled in December. Short end rates are not yet back to the levels of expecting no rate rises, but will be soon if US economic data continues to disappoint. Our readings of historic trends in NGDP , the Atlanta Fed’s real time GDPNow, indicate data will continue to disappoint. Longer end rates are back to the pre-November levels, in expectation of little or no inflation. Others have commented on the record low implied inflation rates derived from TIPS spreads.

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Europe

This last week instead of China as the culprit, the Euro Area was the savior, or at least its top central banker. Draghi’s statement at the press conference on 21st January was very dovish, and more dovish than expected. The second paragraph with its “or lower levels” made very clear the direction of travel for the instruments of monetary policy:
“… we decided to keep the key ECB interest rates unchanged and we expect them to remain at present or lower levels for an extended period of time”.

The other major item that we always look for is when Draghi first mentions the self-defeating, party-killing, monetary-policy, target of “below, but close to, 2%” for inflation. Remarkably, it was in line 5 of the 11th paragraph of the introductory statement to the press conference! This was the mostly delayed mention for at least a year, no wonder the markets responded well to his remarks, usually it is right up front in the 2nd or 3rd paragraph, destroying any optimistic mood engendered by a rate cut or news of an extension to QE.

It is always, always, thoroughly depressing to hear all the good work of potential and actual QE undone by those five words. The thoroughly inflexible inflation ceiling means that so much of the ECBs good work under Draghi is undone by medium to longer term expectations of what would happen if inflation did finally pick up and begin to approach 2% – which it won’t while this cap remains so firmly in place. At least the Euro Area economy continues to gradually improve and base money continue to grow, good news is therefore good news. It is still somewhat surprising to us that the negative effects of US monetary policy still wash so strongly through Euro-Area stock and rates markets. For the stock markets this is probably because of the non-local, global, nature of many large companies in the indexes, or where they are local, they are mostly banks, as in Italy for instance with special problems of their own.

US Data

There was little macro data last week to move the dial in the US. Housing starts were dull, but perhaps a little less bad than expected helping residential investment component of the expenditure method for modeling RGDP used by the Atlanta Fed for its GDPNow forecasts. CPI came in a little lower than expected, at a “deflationary” negative 0.1%, perversely good for the real (inflation-adjusted) economy over the nominal economy. Forecasts for real consumer spending could be raised a touch. As a result, the GDPNow forecast for 4Q15 RGDP rose by 0.1% to a still modest 0.7% QoQ annualised. On Friday we get the official result from the Commerce Department with their first estimate of 4Q15 GDP.

There is very little data released to move the RGDP dial next week except manufacturing, a small component of GDP, influencing the forecast for the business investment part of GDP.

The big event for markets will be the FOMC meeting and planned press conference on Wednesday. Depressingly high focus will be on the thoughts of Chairwoman Yellen and the detailed expectations for inflation and rates on the dot charts expressing the concrete views of the FOMC members.

One piece of data not obviously closely monitored by the markets or the financial press is BASE money. It is a key part of our financial and economic forecasts however. We don’t pay too much attention to weekly numbers, preferring to look at trends over a number of months. That said, it was hard not to notice the week on week, and year on year, falls over the last several weeks of data. Finally, a partially expected upturn arrived in the release on Wednesday 20th January. It is just about trending 0% YoY but for six weeks has been reported worryingly negative. The continued reinvestment of maturing Fed holdings of Treasury and mortgage debt should at least keep the total level, but the target rate rise could lead to some strange, negative, moves.

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That was the week that was – Sunday 17th January 2016

Markets
Equity markets fell across the globe. Non-US markets fared worse, having not rallied to the pre-September highs they now fell below the post-September 2015 lows. The S&P only fell to the September lows. US rates fell below the post Fed-rate rise mini-rally in yields. As we had feared raising the target rate for Fed Funds has in fact led to lower rates.

Commentators seem unable to really pin the blame on where it is really due. To us it is clear: the Federal Reserve became public enemy no.1 when it raised rates on December 16th 2015. Some have cast around for other causes, e.g. China.

China
China has received a lot of attention. Their managed stock markets and exchange rate inevitably leaves people puzzled as to the “real” monetary policy. To us it looks as messed up as that of the United States or the Euro Area, and many other countries.

Chinese authorities don’t want their stock market to tank so “order” a recovery and then arrest those who have brought about that recovery, causing a crash. They then arrest those who brought about the crash. FX policy doesn’t as far as we know lead to arrests and disappearances, but it is hard to figure out what are the ultimate objectives. China doesn’t want currency volatility but wants to its currency to become an international reserve currency. These objectives are incompatible.

US Data
We like to keep things simple at NGDP Advisers. The Atlanta Fed considers around 120 data points for its GDPNow “nowcast” but only releases its updates after eight of the major ones. It is tries to recreate the expenditure-based method for the early estimate of RGDP used by the BEA. Later in the reporting cycle the BEA also calculates the income-based and output-based estimates, before adjusting to one final estimate of RGDP.

The advantage of Atlanta’s GDPNow over Blue Chip forecasters is that it publicly announces a new forecast a few hours after each major release. Blue Chip forecasters may also calculate in real time but only publicly announce every few weeks or so. Markets will react in real time, of course to each new data point.

Eight major data points for Atlanta GDPNow 4Q 2015 “nowcast” (US release date and time, EST)
ISM Manufacturing Index 1/4/2016 10:00 a.m.
International trade (Full report) 1/6/2016 8:30 a.m.
Wholesale trade 1/8/2016 10:00 a.m.
Retail trade + inventories 1/15/2016 8:30 a.m.
Housing starts (C30) 1/20/2016 8:30 a.m.
Advance durable manufacturing 1/28/2016 8:30 a.m.
Personal income and outlays 2/1/2016 10:00 a.m.
ISM Manufacturing Index 2/1/2016 10:00 a.m.

Of these items by the far the most important is retail trade since 68% (in FY2014) of the expenditure method of calculating GDP is personal consumption expenditures. Of that two-thirds is the hard to pin down spending on services, or around 45% total expenditures. The rest of the expenditure method is a miscellany of smaller items that are often easy to measure and grab headlines but often signify little. This miscellany includes things like investment spending on equipment (6%), structures (3%), “intellectual property” (4%) and residential housing (3%). Net international trade (-3%) generates huge heat but very little light as it has to be balanced by capital flows. Equally, changes in inventories provokes an inordinate amount of chatter but, like trade, sums to zero over time. Bringing up the rear is “G”, government spending and investment, at 18% of GDP by expenditure. Keynesians tend to love G, the bigger the better. Supply-siders see it as constant drag on the rest of the economy. The Atlanta Fed’s GDPNow does not regard the release of G as a major event, probably because it moves so slowly and predictably.

The big data release of the week, and the biggest of all, was retail sales for December. And the number was poor, even if apparently expected. The figures are nominal, i.e. they don’t dis-aggregate volumes and prices. They are actually quite close to Nominal GDP. Sales were down 0.1% in December from November, and up a mere 2.1% in 2015 over 2014 – the worst FY/FY growth since 2009.

Of course, stripping out all sorts of volatile items could produce better looking numbers, but what the figures are saying is that consumers are not spending. There are some categories showing better growth as a result of the oil price falls curbing gas prices and utility prices but overall things are weak, indicating that oil price weakness is more a function of demand weakness than supply strength.

The update after the Personal Income and Outlays release merely acts as a check on the retail sales figures and perhaps help in the dis-aggregation required to separate nominal growth from real growth.

Some optimists have criticised the GDPNow figure of just 0.6% annualised 4Q GDP growth for being too buffeted by temporary factors. In particular, the reversal of Q3 inventory build is dragging it down by 0.6%, making for an inventory-adjusted number of 1.2, and Final Sales GDP is actually growing at 1.6%. Of course, the running down of the inventories could well be accompanied by falls in actual production, so it may not be a harbinger of glad tidings in the next or even current quarter.

Trend RGDP and NGDP growth are down and the Fed is tightening. A combination that can’t end well.
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