That was the week that was – Sunday March 20, 2016


The S&P500 rose 1% over the week. All of the rise came after the unexpectedly dovish FOMC statement and Yellen press conference. The move up in equities built on the ECB good news/US$ weakness from the previous week, and the shrugging of bad economic news.

We really seem to be in a “bad news is good news” phase at the moment as the Fed tightening seemingly has been put on hold whatever the data says, either worse than expected fundamental data or higher than expected inflation news. Any good economic news should thus be taken very well by markets. Sadly, we don’t expect much of that given the continuing legacy of the tight monetary policy in place since 2014.

The major decline in near term rate expectations that occurred on Wednesday with the FOMC statement was consolidated by the end of the week culminating in a drop in the 12m benchmark yield from 0.69% to 0.61% – a long way from the FOMC’s near 1.5% forecast rate for the end of 2016 prior to the meeting.

The two year benchmark yield dropped form 0.96% to 0.85% on the day of the FOMC meeting and also a long way from the FOMC’s 2.00% forecast.

The yield curve steepened a bit on the day as the 10yr benchmark yield fell by less than the 2yr yield. By the end of the week the 10yr fell a bit more so the curve remained about the same steepness. There is no strong belief in the recovery of the economy or inflation as the 10 minus 2 year yield spread remains only just above its medium term lows. It is a long way back to the heady days of QE3 in full swing and a 2.50% spread at the end of 2014.


The US$ weakened as you would expect after an unexpectedly dovish FOMC meeting. It is unlikely to weaken further vs the major reserve currencies, indeed it is more likely to go back up to the top of its 15 month trading range than to the bottom. Both the Euro Area and Japan have more active easing biases, even if they are not able to implement them as practically as they wish. By far the best way for them to ease would be for the ECB and the BoJ to adopt an NGDP growth target rather than the highly unsatisfactory and artificially tight inflation ceiling targets.

Topic of the week – rate expectations

Even at 0.6% the US short term rate outlook remains quite elevated and well above the slump in 12m rates seen in the second week in January caused by a “bad news is bad news” week. Back then, unexpectedly bad economic data fanned fears that the Fed’s tightening bias, as epitomised by Fischer’s infamous “four more hikes” interview, would bring disaster. The Fed Funds target rate remains at 0.5% but uncertainty about where it will go next remains high.


January’s FOMC meeting had eased fears of excessive tightening to come. In early February, and somewhat suspiciously a day or two ahead of the stronger than expected January wage data, there was a small rally in those 12m benchmark yields. Although those yields fell back a little the rally was consolidated by higher than expected CPI and PCEPI data.
Markets naturally priced in a stronger likelihood of rate rises later in the year. This is now changing.

Thanks to the “dotplots” release with the March FOMC meeting we can see that committee members forecasts of 2 rate rises, down from 4, now more coincides with the markets current expectations of one rate rise by December.


Over the week Base Money declined a bit, but stayed well within the two year range of $3.8tn-4.1tn. At $3.9tn it is still towards the lower end of this range and thus remaining on a modestly declining trend YoY. This weak to negative trend is the principal fuel for our expectation of continuing poor fundamental economic data.

After the initial excitement of the final December data and preliminary January data the GDPNow has continued to drift off. Real GDP for 1Q is now back at 1.9% QoQ annualized growth.

The drift sideways in the GDPNow forecast was not helped by the major data release of the week for Retail Trade. We had expected weak numbers and they were indeed weak, mostly due to a major downward revision to the surprisingly strong January numbers. A month ago we had expressed some scepticism about that January number given a sharp drop in the non-seasonally adjusted figure.

It will be interesting in two weeks’ time to see whether the unexpectedly strong January nominal PCE numbers will also be revised down at the time of the release of the preliminary February data.

Industrial production, was also disappointing with a bigger fall than expected. The utilities industry output was the main culprit, possibly due to warmer weather than normal leading to less electricity consumption. Manufacturing makes up 75% of IP and was a bit stronger than expected. Overall the trend is still poor indicating it is more than just the weather! It is important to remember that utility output also powers the hard-to-measure service sector and not just manufacturing.

The very poor January and February Service Sector outlook figures we have seen, the nearly zero real weekly wage growth, and both the Fed’s Labour Market survey and the NFIB Small Business Optimism index from the previous week, are all signs that the negative IP index could well be correctly calling a recession underway right now.

What should be bad news for a “data-driven” Fed is that the CPI figures are showing greater than expected growth with Core CPI at 2.3% YoY. Fortunately, the Fed does not target something as unreliable as CPI but favours the slightly less unreliable PCEPI.

However, here too the Core PCEPI is moving higher, though still well below 2%. Goods price growth is still negative, though a bit less so. Fuel prices had a big drop. Service sector prices rose faster than expected, but this may be only a relative price shift, as savings on goods and fuel especially, are switched to services. The oil price drop certainly causes a lot of noise – making consumer price data even less reliable than usual.

We fully expect to see more tales of woe about productivity, as measuring output growth in the service sector is near impossible, and if there is growth there without real wage growth productivity will be falling.

There is little official data next week except durable manufacturing goods on Thursday, expected to show a 3% drop. Surveys of March activity are always interesting, especially those for the service sector like the Philly Fed Non-Manufacturing Region Activity Index that has been weak recently. Final estimates for 4Q15 GDP, to be released on Friday and expected to be unchanged at 1% annualized, will be of mostly historical interest.

It’s is also the big Easter weekend coming up in any case.


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