Market Outlook | March 13, 2017

“Trouble springs from idleness, and grievous toil from needless ease.” (Benjamin Franklin, 1706-1790)

Summary: 1) Rising interest rates are being seriously considered. 2) The Populist vs. Central Bank Relationship is not clear-cut, as witnessed by Yellen-Trump relationship 3) Catalysts are awaited after a relatively calm period 4) Recent minor trends are worth tracking closely.

Shifting Narrative

Last week marked a massive pivot towards discussion of higher rates in the US, which is nothing new. Interestingly, even the European Central Bank had some discussion about rate hikes recently (article below). Meanwhile, it is quite clear the Federal Reserve appears to sense some confidence and may be potentially gearing for a premature “victory march” after several years of higher stocks, averted panics, lower volatility and widely accepted perception of positivity. Despite the expanding populism in the Western world, stocks do continue to soar.  Perhaps that’s caused by the brilliance of the Central Banks in its ability to lead a coordinated message, influence investors’ mindsets and successfully shape market behaviors. Now, even the skeptical observers of the market rally are forced to obey the Fed's demand. Sure, resistance of this Central Bank coordinated reality is a choice, but as highlighted last week, money managers have paid a huge price for betting against the consensus view.  Yet, it’s what’s ahead that’s worth deciphering, and a rate hike may raise more questions than answers.

Convenience Driven

The market narrative is forming a newer tune. Instead of highlighting the failure of Central Banks to stimulate the economy (beyond stocks), the vibe these days is the self-praise of Central Banks who are looking to justify upcoming rate hikes. Conveniently, the White House appears not to shy away from taking credit of this ongoing market rally and economic strength based on government data. Plenty of ironies here. Amazingly, before the election, the Yellen-Trump rift and disagreements on interest rate policies were highlighted. Today, the Yellen-Trump alliance is a matter of convenience, as long as stocks roar and traditional economic data points prove to be somewhat positive. Simply, confrontation of the status-quo is dangerous for policymakers as well as investors. Feeling too much ease is, frankly, risky, especially when the narrative is not clear at all.

Trump, like any politician, would love to take any positive financial news under his term as a momentum builder. That's only natural. At the same time, Yellen, who's been losing credibility about rate hikes, would love to exploit the current bullish climate to fire away with raising rates from ultra-low levels. Also, Trump, the non-establishment candidate, put a lot of weight on fiscal rather than monetary policies and is caught in a dilemma. On one hand, overly praising the Federal Reserve might be a capitulation of the pre-election message which got many "anti-Fed" observers attracted to his message. On the other hand, enjoying a near-record high stock market since taking office can drum up cheerful slogans.

All that said, the bottom-line is the impact to risk takers, investors and market observers given this dynamic. In a puzzling manner, investors will have to reconcile this mysterious alliance between the anti-establishment US president and the ultimate conductor of the bullish status-quo.

Mysterious Catalysts

DC, under Trump-GOP leadership, is maneuvering quickly on some matters and taking longer on others. Yet, the direct impact in financial markets remains to be seen. The pending and highly anticipated fiscal stimulus, less regulation and lower taxes are truly hard to quantify. Has the market priced that in already? Is this baked in part of the current market? That's unclear, to be bluntly honest. It all remains a mystery for the next 2-3 years.

The markets have spoken with a few clues that can shape the weeks ahead. Crude prices fell 9% last week hinting at the oversupply and a step back for hopes of a commodity revival. Retail Sales have struggled, as well. And financial services are going through various consolidations. With this backdrop, how’s the Fed going to raise rates in a sustainable manner? The global growth picture does not seem as rosy as some may think. Certainly, if commodities and Emerging Markets can not find a revival and the US relative appeal slows down, it can set the stage for some panic-like responses. The Federal Reserve seems confident of strength and economic revival, but many other indicators don’t seem convincing. Thus, this divergence will be discovered soon if the econ is stronger than discussed or if weakness is grossly masked.

Article Quotes

“Part of the ECB’s reasoning for exploring the possibility of raising rates before finishing its 2.28 trillion-euro ($2.4 trillion) bond-buying program lies with the structure of the euro-area economy, the people said. The negative deposit rate is squeezing banks’ profit margins because they can’t generally pass the cost -- charged by the ECB on overnight funds kept at the central bank -- back       to their customers. That potentially holds back lending to companies and households… Some market indicators point to the possibility of a rate hike in 2018 and BNP Paribas has predicted the deposit rate will be increased this September. QE is currently intended to run until at least the end of this year, and most economists surveyed by Bloomberg before the last policy decision said they expect tapering to last until at least mid-2018.” (Bloomberg, March 10, 2017)

“Mickey Levy, an economist at Berenberg, said the central bank was in a difficult situation given the absence of any formal tax reform legislation on which to base its policy expectations. But if Congress does push through pro-growth reforms “the Fed’s policies would not only be behind the curve but way behind the curve,” he argued.  That is not a conclusion that senior Fed policymakers share, with Ms Yellen insisting the Fed has not waited too long to tighten policy. In a recent speech she signalled continued support for the median prediction of three rate increases in 2017 contained in the central bank's December forecasting round…. One key question is whether the Fed will act as soon as June or wait until the northern hemisphere autumn before lifting rates again. The strength of Friday’s jobs data prompted analysts at Goldman Sachs to predict the next move after March would come in June, instead of September previously. Official data showed an extra 235,000 jobs being added in February and unemployment slipping to 4.7 per cent.” (Financial Times, March 11, 2017)

Key Levels: (Prices as of Close: March 10, 2017)

S&P 500 Index [2,372.60] – The March 1 peak of 2400.98 sets the benchmark for all-time highs. The Index hovers around record highs and needs another excuse for re-acceleration.

Crude (Spot) [$48.30] – A weekly sharp-sell off leads to annual lows. The supply-demand set up is not favorable for prices as witnessed in recent years. This is reminiscent of recent years when the commodity sector sold aggressively. Again, supply has expanded dramatically. 

Gold [$1,226.50] – Since peaking in 2011, Gold prices are still seeking a solid footing around the $1,200 range. There has been no evidence of strength or meaningful momentum that suggests a notable upward move. 

DXY – US Dollar Index [101.25] – Strength remains intact. Since November 2016, the dollar index has stayed above 100, reaffirming the strength of the currency. The low of February 2, 2017 at 99.23 is a critical point to keep in mind. 

US 10 Year Treasury Yields [2.57%] – In November, yields went from 2.30% to 2.60%. Similarly, after bottoming at 2.30% on January 17, 2017, yields are back to the prior peak of around 2.60%.  Last Friday’s intra-day highs of 2.62% stands out again as a possible near-term peak.

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