That was the week that was – April 8, 2016

Markets – equities begin to get it>

Last week we suggested that US bonds were “getting it” and equities were too optimistic. Well, this week bond yields continued to fall and equities began to “get it” too. Nominal growth is poor and it’s not good news.

The key data point of the week were the two surveys of the services sector for March. Both showed a weak rebound from a run of very weak readings. Even if slightly ahead of expectations they painted a very dull picture for 80% of the economy. “Slightly better news as neutral news”.

Bond yields had already fallen heavily the weak before on the “no surge in inflation” PCE PI information and horribly weak actual PCE data. This consolidated those falls by pushing yields slightly lower, with the two-year yield dipping below 0.70% by the end of the week. Ten-year benchmark yields dropped to 1.72%, flattening the curve further. No nominal recovery here and potentially worse to come.

The CME Rate Watch market also barely implies one rate rise by the end of the year, quite a change from one month ago. “Economists” consensus is, weirdly, for two, as a Bloomberg reporter tweeted on Friday: “Only four of the 72 forecasters surveyed by Bloomberg see no Fed rate hikes this year. 19 expect one hike, 39 see two, nine see three.” I guess they need to keep getting invited to Fed seminars so can’t be as unfeeling as the market.

10-year implied inflation from the TIPS market did rebound but that rally has stalled too. The TIPS market is not a great guide to inflation since it only tracks CPI, not even the somewhat better PCE PI targeted by the Fed. But neither really measure inflation well. And that is part of the problem as inflation is probably a lot lower than indicated by both, so targeting either pushes down actual nominal GDP and nominal GDP expectations, something we are seeing in the actual PCE data on a monthly basis.

Equities went sideways to down as the S&P 500 fell 1% over the week. Although it is widely expected that the quarterly reporting season will be weak, new news will mostly come in the form of guidance on future earnings and sales. Actual sales are likely to be poor, reflecting the weak state of actual PCE in the first quarter.

The broad index measuring the USD was flat over the week despite a 3% plunge in its value versus the JPY. There appears to be confusion in Japan about the next step in monetary policy. QE has been working modestly well as underlying inflation has been responding but more could be done. There are rumours the BoJ will adopt NGDP Targeting. That’s doubtful, but we hope so.

The fall back in bond yields was reflected in the pull-back in our MAST Index to the 50 level by April 4th.

Topic of the week – Firepower vs Targeting

The recent confusion in Japan has partly arisen because of the scale of QE. There is increased questioning of the “firepower” of central banks. There are two related questions. 1. Are they running out of safe assets to buy? 2. Does it matter?

If safe assets are considered as the existing stock of risk-free government debt or high quality mortgage and corporate securities, then the answer is yes. There is a finite amount of these in issue. However, many people, including some Market Monetarists, say that the government could just issue infinitely more securities and use the money to cut tax. Helicopter money enthusiasts are effectively saying the same thing, but suggest using the money to increase government spending via direct handouts to the population.

It seems to me that Market Monetarist’s work on monetary offset actually provides the only credible way out of this problem. If the inflation target remains an inflation rate of 2% two years out, as it is either explicitly or implicitly for all major central banks, then central banks cannot countenance monetisation of new debt issuance. They will act to offset any benefit.

No amount of firepower will convince economic players that a central bank is serious about promoting inflation if at the same time they have a 2% inflation ceiling. It is so much more straightforward to simply change the target rather than engage in monetisation experiments.

While we are modestly happy that the FOMC has swung with the wind, epitomised by arch- swinger Bullard swinging towards caution about rate hikes, his stance also epitomises the problem. Any sign of growth picking up immediately leads to him and his fellow swingers to start wringing the hands, furrowing their brows and talking up the prospect of rate hikes, automatically leading to a downgrading of growth prospects as predicted by “automatic” control theory.

So when we see a headline like this week’s “While growth remains weak we won’t raise rates, says Bullard” I wonder, is this is a promise or a threat?

Data – 1Q GDP shaping up to be poor

The Atlanta Fed GDPNow strangely ignores the surveys of the service sector. I am not sure why as they are good real-time indicators of the state of output and thus of both the March expenditure and income data announced over the next few weeks. It prefers to look at actual expenditure data. Thus next week’s retail trade figures for March will be important, though not so crucial as the trend for the quarter has already been set by the release for the first two months.

Last time these figures were released, for February, there was a deep negative revision to January’s strong initial data. We know that the weak underlying trend of NGDP is unchanged so any strong data is likely to be anomalous, but could be taken badly given that the FOMC claims it is data-driven.

That said, the GDPNow did drop heavily at the end of this week as March wholesale sales were reported as weak and inventory build was both low in March and revised lower for earlier in the quarter. Inventory movements are a noisy and not very helpful guide to underlying growth but do impact GDP a lot in the short term. The weak inventory growth means lower “investment” and led to annualised QoQ RGDP growth being cut to a mere 0.1%. YoY the growth rate would still be respectable 2% as 1Q2015 was also very poor.

Base money consolidated at the new, lower, levels seen since the start of 2016.

In addition to the retail trade figures on Wednesday, next week also sees the equally quick-fire release of the March CPI figures on Thursday. Hawks love this data. We think it is essentially useless. Nominal activity is far more important, so we shall be watching actual, nominal sales. But we have to watch the useless figures because the useless figures on the FOMC watch them, and the FOMC reaction has to watched. Circular we know, but such is life with a Fed still beholden to the false Philips Curve.

March Industrial Production on Friday is unlikely to be good given the wholesale sales numbers, even if not quite as bad as in the first two months of the year. Of more interest, given the service sector bias of the economy, the National Federation of Independent Business’ (NFIB) Small Business confidence index and hiring expectations will be important on Tuesday. Confidence fell to two year lows last month and hiring expectations look like they have peaked.

Various FOMC members are due to give speeches, the most important of which is William Dudley on Monday. The FOMC minutes last week revealed a split inside the committee between the large number of hawks and majority of doves with interestingly strong views being expressed on either side.

The hawks are constantly emboldened by the fact that the Fed staffers (aka the Fedborg) are so hawkish also. Their stream of always overoptimistic forecasts, based on the false Philips Curve macroeconomic model rather than a monetarist one, means they are always seeing the economy on the verge of overheating any time unemployment reaches respectable numbers.

Such overheating is theorized as causing excessive wage growth and thus propels projected inflation above two per cent and causes them to want to tighten monetary policy preemptively. It’s nonsense as experience has proved time and time again, but they are a stubborn bunch.

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