That was the week that was – Sunday March 27, 2016

Markets – weak

An Easter shortened week turned out quite dull. US equities drifted off the recent highs, as surveys of March activity came in weak and a bunch of less important, mostly non-voting, regional Fed governors complained about the dovish outcome of the March meeting.

Tough. Goldman Sachs is still reeling from its wrong call about rates and has now doubled down, and started campaigning for higher rates. It seems silly but they are known to be influential with the Fed and so it is actually a tightening of monetary policy when Goldman’s come out all hawkish.

US rates were equally unmoved over the week. The US$ did begin to rally off the bottom of its trading range as we had expected, the DXY rising 1% over the week.

Topic of the week – It’s the economic models not the dots that are the problem

There has been lots of chatter about the meaning and usefulness of the FOMC’s dot plots. Kocherlakota tried to help:

The dot plot has two big perception problems. The first is the belief that it reflects officials’ interest-rate forecasts. It doesn’t. Rather, it shows what each participant thinks the Fed should do, based on his or her individual forecast of how the economy will evolve and what the optimal response would be.

The second issue is that investors tend to see the dot plot as a commitment about the trajectory of rates.

I think the first point is a fairly fine distinction. There isn’t much difference between a forecast result and a recommended result if the forecast is made by someone in a position to influence that result. The key is in the economic forecasts of RGDP, PCE Price Inflation and unemployment.

What is striking is that the FOMC thinks it has to raise rates despite Core PCEPI well below 2% now and projected to rise to only 2% in two years time and that unemployment can now only go up from current levels. One can only infer that they think Core PCEPI will rise well above 2% in two years time unless they raise rates further and that employment will not suffer from the rate rises.

The FOMC members must be very confident about the economic recovery and the future path of PCEPI and employment. Their view contrasts with the much more cautious view of the market on these fundamentals. And herein lies the interesting and market-moving clash. Are the FOMC willing to put their money, or rather decisions, where their mouths, or projections, are?

If they do move to raise rates and the economic data follows current trends then they will be doing damage to the economy. Markets will drop further and the economy further weaken. If they hold off from rises then their economic forecasts will be shown to be wrong again, their models faulty. This is the heart of the FOMCs credibility problem: their economic models are wrong, not their interest-rate forecasts which follow the economic models.

Getting rid of the dots as some have suggested or amalgamating them into one projection will not get rid of the faulty models. And the market will anyway continue to speculate on the future path of the target Fed Funds rate. The UK has no dot plot or rate projection, but the market has created an implied one – and the BoE use it in their models!


The most interesting survey to watch was the bi-weekly Markit flash Services PMI. the last two Markit surveys had been very weak. Consensus was for a good bounce. It did bounce but not as much as expected – registering 51.0 in March, up from 49.7 in February, to indicate only a marginal expansion of service sector activity. As a result, the latest index remained well below its post-crisis trend of 55.6.

The “official” one comes out once a month from the ISM and the March report is not due until 5th April. Both January and February have been weak, so it will be interesting to watch. As with all short term data, it can be very volatile, but there is only ever short term data when it comes to the latest news.


There was mixed news from various regional Fed surveys of activity. This data tends to be quite volatile, as is perhaps inevitable with regional surveys. Most seemed to show better than expected results (Richmond/Philly Fed), some others (KC Fed) less so.

Some people watch Durable Goods orders since they do feed into Industrial Production figures and the investment part of GDP, eventually, but are rather too much old economy. The figures were weaker than expected.

Sales of existing housing was also weaker than expected. This data and the durable goods report both served to bring down the GDPNow forecast for RGDP for 1Q16 to just 1.4%. The final sales estimated growth is also low at 1.7%.

If RGDP is just 1.4% it will be poor but it will not drag down YoY growth because 1Q15 was a very weak quarter for RGDP at just 0.6% YoY.


The chart above includes the final estimates of GDP for 4Q15 that were released on Friday. RGDP was shown as rising 1.4% annualised rather than 1%, driven by somewhat better than expected consumption at the end of 2015. The 0.1% revision to the non-annualised quarterly figure barely shifted YoY quarterly growth rates. Annual RGDP is now estimated to be growing at 2% in 4Q vs 1.9% at the time of the second estimate. NGDP now shows 3.1% vs 3.0%. Big deal. Both are still way too low.

A potential future recession indicator was in the first look at corporate profits. These were as poor as expected dropping 3.6% YoY in quarter 4 2015.

Next week has big releases. On Monday we get the preliminary PCE figures for February. Retail Sales have already come in poor, with a big revision down in January’s figures. Will PCE’s big January growth figure also be revised down?

The two jokers in the pack are:
1. The deflator. Retail Sales are nominal while the headline PCE figure that consensus follows is “real”, ie inflation-adjusted. The PCEPI (the deflator) will also be very closely watched in themselves since the February CPI numbers were stronger than expected.

2. The PCE figures include a much wider array of spending, including far more of the service sector than Retail Sales, in particular services bought on behalf of consumers by employers like medical services. It also tries to impute the value of “free” financial services from banks and other financial firms.

Now we are at the end of March, the power of February data to shock the markets is diminished as we have so many March surveys, as well as the February Retail Sales and Industrial Production figures.

The other major release is on Friday with the March payroll numbers. Consumer confidence remains high even if employers’ confidence is a lot less good, so the jobs and wage numbers should be fine. Wage growth is expected to bounce back from the February weakness. Consumers will only become less confident if and when the jobs outlook changes. This may still happen if the negative trend in corporate profits continues and business confidence surveys stay weak.


Leave a Reply

Your email address will not be published. Required fields are marked *