QE vigilantes 1, The Fed 0

Surprise! Most, including myself, had expected the Fed to announce a tapering at today's meeting. My view - likely in the $10 billion range.

Instead, there was no change in policy.

My thoughts:

1. The Fed doesn't have much confidence in its economic outlook

2. The Fed is concerned about the back-up in interest rates and the possible effect on housing

3. There is some concern about fiscal restraint and the budget battles that loom.

Much of this comes directly from the Fed's statement.

Just to illustrate: 

“The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market (italics,underlined my emphasis and a new addition to the September statement vs the July statement).

"...but mortgage rates have risen further and fiscal policy is restraining economic growth."

Stocks surged, with the Dow and the S&P hitting a new record, but the focus will shift to the upcoming budget battles. Plus, will investors get that uneasy feeling since the Fed isn't seeing the kind of economic activity they had envisioned?

For now, the QE vigilantes that drove rates skyward seem to have forced the Fed to blink, and Bernanke is no longer so focused on a jobless rate that had given him the green light to taper.

Damage control, feral hogs, and the QE vigilantes

It's just been a few days since Bernanke told us that QE is on the chopping block if the economic data play out like the Fed expects. Market reaction, however, has been less than kind.

So we're seeing some damage control today by a couple of more hawkish Fed members - non-voting FOMC members but nonetheless influential Fed members.

First, Minneapolis Fed head Kocherlakota felt compelled to issued a statement saying it may be appropriate to keep the fed funds rate at an extraordinarily low level at least until the unemployment rate falls below 5.5%. Recall that Bernanke's threshold is 6.5%.

Then we have the always colorful Dallas Fed President Richard Fisher who told the Financial Times, "...big money does organize itself somewhat like feral hogs. If they detect a weakness or a bad scent, they’ll go after it.”

Though he has never been a fan of QE, he repeated he doesn't want to go from" wild turkey to cold turkey overnight."

This brings us to a new group of bond traders on the Street - the QE vigilantes.

Most of have heard of the bond vigilantes.Wikipedia offers a good definition - When investors perceive that inflation risk or credit risk is rising they demand higher yields to compensate for the added risk. That in turn helps keep inflation and government spending in check.

In recent years, the vigilantes have been dormant against the backdrop of trillion dollar deficits. A lack of near-term inflation anxieties are playing a role.

Those inflation bond vigilantes may now be morphing into the "QE vigilantes," as they launch waves of bear raids on the market, hoping to slow growth and force the Fed to keep the liquidity hose aimed at the bond market.

Fisher is standing in the gap.

Stocks - like watching the grass grow

Seemingly inspired by last week’s ‘sigh of relief’ employment report, the major stock market indices topped new milestones in what can only be described as a ‘watching the grass grow’ rally.

Sure, it’s been dull, but who says rising portfolio values have to be accompanied by heightened exuberance. 

Same 'ole, same 'ole 
Earnings season is winding down, and you know it's a slow week when the most important economic report is weekly jobless claims.

But the general themes that have been in place since the beginning of the year - stronger corporate profits, accommodative global central banks, an expanding economy, and very quiet credit markets - were all a part of the equation.

Oh. In case you were wondering, jobless claims hit a fresh 5-year low.

Euro-zone problems continue

Earlier in the week, we found out that the euro-zone unemployment rate held at a record 12.0% in February, highlighting the difficult problems being faced by policy makers on the other side of the Atlantic.



Today, the European Central Bank offered little comfort with the exception of touting its past achievements that have kept the woefully under-capitalized banking system from blowing apart at the seems.

I guess we really should be thankful for small favors.

ECB President Mario Draghi still believes the euro-zone will experience  a gradual recovery in the second half of the year, but he added a caveat - that any recovery is “subject to downside risks.”

It sounds as if he may be losing a little faith in his own forecast. At 75 bp, monetary policy is accommodative, but he’s not offering much more stimulus.

A rate cut was discussed “extensively,'” but a 25 bp or even a 50 bp rate reduction would be mostly symbolic. And don’t expect much in the way of fiscal stimulus.

Europe’s in a mess, and its weak banking system isn’t in a position to supply needed credit.

All this shouldn’t be lost in the U.S. investor. Sure, the market has pierced all-time highs, but weak sales in Europe seem likely to hinder profits at home.

Keep an eye on comments from the multinationals, as they report profits.

Cyprus hopes to trip up the bulls

Over the weekend, news broke that Cyprus will levy a tax on its depositors to help with a bailout of its faltering banking system.

Not surprisingly, we saw a run on ATM machines in the country, but no bank lines as the financial institutions were closed today and are expected to be closed until Thursday.

The uncertainty created by the situation on the tiny island in the eastern Mediterranean shook global markets amid concerns that we might evenutally see a repeat in larger countries like Spain or Italy. The last thing we want to see is Italian depositors lining up around the block, demanding their life savings.

Stocks in the U.S. opened lower but pared losses by the close. In a flight to safety, Treasuries jumped as trading began but came off highs as cooler heads prevailed. Even better, junk bond fund fully recovered from early losses. Want a canary in the cold mine? High-yield funds are the closest you'll get.

What we saw today was an attempt by U.S. markets to sort through the noise.

But let's take a step back. Cyprus is barely 0.25% of euro-zone GDP, and countries such as Greece, Italy, Spain, Portugal, and Ireland have failed to sink the euro.

I don't have a crystal ball, but it seems unlikely that a cataclysmic euro-zone event might originate with Cyprus. Volatility? Probably. Stocks never move in a straight line.

Bottom line - Europe's problems have subsided and the relative calm in the credit markets has been a boon to U.S. stocks - think the removal of a roadblock. As we saw today, euro-zone woes haven't been put to rest.

Looking skeptically at September’s unemployment rate

The unemployment rate unexpectedly fell in September by three ticks to 7.8%. Most economist had anticipated an unchanged reading or a small rise to 8.2%.

In the meantime, nonfarm payrolls rose by a muted 114,000 last month. That was generally in line with expectations given the weak economic recovery. Further, the private sector managed to generate just 104,000 jobs.

So what gives? Why the outsized drop in the politically sensitive indicator?

The unemployment rate did not decline due to discouraged job seekers leaving the job market, which has occurred in some of the prior reports.

In fact the rolls of the employed rose by an astounding 873,000 (including 582,000 part-time workers), according the the household survey!



Quirks in seasonal adjustments?
The last three years have recorded outsized gains in part-time employment September, which then washes out in October.




The BLS might want to review their statistical models.

The Fed–shoot now, ask questions later

The markets had anticipated the Fed would act, but the magnitude of the FOMC’s open-ended commitment to increase its balance sheet was met with a bullish stampede today.

And it wasn’t just stocks. Oil, gold and a host of other commodities gained ground.

The Fed is trying to reflate, and it won’t stop until it sees substantial progress in the labor market. In fact, the Fed’s statement was clear:

“If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”

So it's not just looking for improvement. The Fed will continue its bond purchases until it sees "substantial improvement."

At least publicly, it does not believe it will materially add to inflation, but the key question is whether its latest path will aid the economy and move the needle on the unemployment rate.

QE1 and QE2 - or $2.3 trillion in bond buys - have failed to significantly lift the economy. Bernanke even acknowledged in his press conference that "I don't think our tools are that strong."

The Fed chief has said before that monetary policy is not a panacea, but that was an interesting remark as the central bank embarks on a new chapter.

The 3 E’s–Earnings, Economy and Europe

While investors brace for the upcoming earnings season, Europe, and Spain in particular, are still on the radar, while the economy remains front and center.

Sluggish growth has liquidity-addicted traders hoping for a lifeline from the Fed, but the latest minutes the last meeting offered few concrete signs that a new burst of liquidity is on the way.

A few Fed members thought “further policy stimulus likely would be necessary,” but  several others felt new actions “could be warranted if the economic recovery were to lose momentum.”

The Fed will never send a definitive signal of future action, but traders were hoping for something a bit stronger.

With interest rates at a record low, however, many doubt a flood of new cash into the financial system would have much impact on the real economy.

Spain’s bailout–the thrill is gone

A hastily announced bailout of Spanish banks last weekend – to the tune of up to €100 billion ($125 billion) – managed to spark a rally in the Dow that lasted barely an hour on Monday morning.

As we’ve seen in the past, the devil is in the details, and surging Spanish, and to a lesser extent Italian bond yields, are reflecting a market that was not convinced Europe is turning the corner.

Stocks, however, have posted decent gains thanks to growing expectations that the Fed will offer up new measures at its meeting next week.

Further, a report yesterday by Reuters that global central banks may act in a coordinated fashion if credit markets significantly tighten following next Sunday’s election in Greece also supported sentiment.

Attention is now turning to the parliamentary elections in the Hellenic Republic this Sunday. A victory by pro-austerity parties would likely soothe concerns, especially if a coalition can be formed.

However, if the radical left comes out on top, fears of a Greek exit from the 17-nation currency could further jar markets, barring any central bank intervention.

A discouraging nonfarm payrolls report

Nonfarm payrolls rose a disappointing 69k in May, less than half what was expected; June revised downward from 115k to 77k

The unemployment rate rose from 8.1% to 8.2%.

The internals of the nonfarm payrolls number were poor.

I’m hearing some chatter that this is still weather-related payback from a mild winter?  So let’s look at some of the numbers.

· The service sector produced 218k in Feb, including 89k in professional and business services in Feb.

But in May those categories fell to 97k and -1k, respectively.

It’s hard to argue that a hiring manager in a high-rise looks out the window and checks the Weather Channel before making his/her hiring decision.

If there is a silver lining, the household survey that measures the unemployment rate showed a 422k rise in employment, but a 642k increase in the labor force produced the 0.1% increase in the unemployment rate. Pick up in June activity?

This is a volatile measure of employment and markets ignored it. DJIA futures went from -100 to -200 in the blink of an eye, and the 10-year Treasury fell from 1.53 to 1.48%.

The Fed –

This raises chatter of QE3, but the 10-yr is already near 1.5%!

If the Fed wants to get rates down, Europe and economic worries are accomplishing this. However, the action in the bond market, coupled with weakness in employment and commodities is troubling. And low rates just aren’t jump-starting growth.

That a monetary policy that focuses on asset appreciation. Still, there’s only a tenuous link between higher stock prices and consumer action. And the blunt action of Fed bond buys could reignite commodity inflation.

But if the Fed moves ahead, purchases of mortgage-backed securities may be considered, as the 30-year fixed mortgage has badly lagged the drop in the 10-year Treasury.

One last point, action in commodities and the recent “collapse” in 10-year yields is worrisome. The bond market, which does a better job than the stock market in terms of future activity, is screaming the “R” word.

Bernanke’s testimony next Thursday now becomes an even bigger market event.

Bernanke talks unemployment

Ben Bernanke's primary focus in today's speech - the unemployment rate.

While some in the press attribute today's advance in equities to Bernanke's positive spin on the recent decline in the unemployment rate, I tend to believe that his caveats temper his optimism.

Bernanke called the "notable decline in the unemployment rate" to be "good news," but immediately added, "some key questions are unresolved." And he's not optimistic that the recent rate of decline will continue unless we see a pick-up in growth.

What may be driving equities today (Treasury yields are higher), his remark that the "Federal Reserve's accommodative monetary policies, by providing support for demand and for the recovery, should help, over time, to reduce long-term unemployment as well” may be the primary driver.

And he reiterated at the end of his speech that "accommodative policies to support the recovery will help address this problem (cyclical unemployment) as well."  He clearly didn't back away from some new form of QE3, but it's a tougher calls as to whether he inched back toward it (gold is up). Goldman Sachs, for examples, expects QE3 sometime in Q2.

Finally he cited three possible explanations for the recent dip in unemployment.

• The first two, he mostly dismissed: GDP data will be revised upward and discouraged workers have left the labor force. He did not, however, provide much explanation on the substantial decline in the labor force participation rate.

• The third explanation - firms fired too quickly in 2009 and are now playing catch-up - was his most likely reason for the recent dip in the employment rate (see chart below from Bernanke's speech)

While Bernanke believes much of the still-high rate of unemployment is cyclical and not structural - and I agree - I tend to disagree with his assessment that firms laid off too quickly in 2009  - see chart below:



The drop in GDP matched the drop in nonfarm payrolls.

Since Bernanke believes the high rate of unemployment is being caused primarily by a lack of economic growth, QE3 remains an option. And this has implications for bond yields, money markets, CDs etc.

Of course, it also has implications for stocks and potentially commodities.

Fed opens door wider to QE3

We're not there yet but comments coming out of yesterday's Fed meeting strongly suggested that the Fed will eventually implement a new round of QE3.

None of this should come as a surprise since a majority of Fed voting members have been bemoaning the high rate of unemployment for a while.

Sure we've seen a modest pick up in growth since the summer, but progress on unemployment has been slow, and publicly, that is the Fed's reason for its focus on QE3.

Economic projections are far from rosy

1. Sluggish GDP growth. In fact, a slight dip in the GDP forecast from Nov.
2. Slow progress on unemployment.
3. Subdued inflation within the Fed’s target.

In Bernanke's opening statement of his press conference, he said the Fed is "prepared to provide further monetary accommodation if employment is not making sufficient progress towards our assessment of its maximum level, or if inflation shows signs of moving further below its mandate-consistent rate.”

So if inflation slips some, the Fed has the extra wiggle room to buy bonds. Helicopter Ben couldn't pass up that opportunity!

And he added in a follow up to a question that QE3 is an “an option that’s certainly on the table.”

Earnings less than impressive, but sun shines on stocks

Let's talk earnings first.

Major bank earnings stung by capital market pressure.  The major banks posted less-than impressive earnings – blame uncertainty in the capital markets and weaker trading revenues.
But there have been positive takeaways:

• Lending growth has started to accelerate, mimicking loan data provided by the Fed
• Credit quality is slowly improving
• Capital ratios remain solid

Earnings, Earnings, Earnings: It’s still early but just 47% of the companies of the less than 10% of the S&P 500 that has reported through Jan 18th have topped estimates, down from 70% in the previous four quarters (Wall Street Journal). And it’s been a much-reduced bar that companies have had to clear.

The earnings season is young. Let's see if we get a shot in the arm from the non-financials.
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Despite the slow start to earnings season, it's RISK ON in the market! Last year's losers, materials and financials are this year's winners, as funds rotate out of last year's winners, utilities and consumer staples.

But let's be clear, despite the massive amounts of liquidity offered by the ECB, troubles in Europe haven't gone away, and we aren't seeing the needed fiscal reforms that would put the continent on a path toward fiscal solvency. But for now the focus has returned to our shores, as the economic data have been generally upbeat.
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Turning to the data,

1-Weekly jobless claims tumble 50k to 352k. That's impressive and strongly suggests the expanding economy is forcing companies to hold onto employees.

But let's wait one more week on this volatile indicator. Yes, it's timely and suggests 2012 is off to a fast start, but quirks in January's data can sometimes dull the value of the report at this time of year.

2-Housing starts - Housing stocks caught fire late last year and yesterday's rise in home builder sentiment to less pessimistic levels (4 1/2-year high) attracted new buyers. And Dec's drop in housing starts is a bit misleading due to a huge drop in multi-family starts.

Both single-family starts and permits advanced. No wonder builder sentiment is improving.


Stay tuned.

Weekly jobless claims back below 400,000

Weekly jobless claims fell 37,000 in the latest week to 391,000, the first time since early April that jobless claims dipped back below the psychologically important 400,000 level.

The unexpected decline also had a favorable impact on the 4-week moving average, which slipped 5,250 to 417,000.

Although this is one of my favorite leading indicators because of its timeliness and its read on business confidence – note, its rise above 400,000 in the spring provided an early warning signal on the impending slowdown, I’m skeptical about today’s welcome drop since there has been little else to suggest that a much-needed pick up in economic activity is at hand.

Further, Bloomberg News reported that difficulties in making seasonal adjustments may have played a role.

I’d like to wait for another round or two of data.

Fed begins two-day meeting against weak backdrop

The Fed began its two-day meeting today and will conclude tomorrow against the backdrop of a floundering economic recovery and a jobless rate north of 9%.

Most analyst believe the Fed, which pledged to hold rates low until at least mid-2013 at the August meeting, will take another step toward easing in the hopes of jump-starting employment growth.

Promising to hold rates low for another two years appears to have done very little for the economy and many believe new steps will have just a limited impact.

The Street expects the Fed to extend the length of its bond portfolio, popularly called “Operation Twist,” by swapping shorter-term debt for longer-term debt.

Theoretically that might lower longer-term rates.

But how much this is already priced into the yield curve is unknown, and long-rates are already at historic lows – a 4% 30-year fixed rate mortgage. And potential home buyers aren’t jumping at the bait.

So it stands to reason that even lower rates would have just a muted impact on the economy.

Despite expectations, correctly calling what the Fed may do can be as dicey as calling the offensive play on third and goal at the five.

Will it be a run up the middle, sweep around the end, QB rollout and pass? Maybe it’s not that tricky but it’s possible the Fed could surprise.

A full-blown QE3 – always a possibility – could be implemented, but the track record for QE2 – higher inflation and anemic growth – suggests we’d get even less bang for the buck this time around.

The Fed could cut the rate it currently pays on excess reserves (near $1.6 trillion) from 25 basis points, as it hope to encourage lending.

However, lending institutions are already forgoing higher rates on credit cards, mortgages, auto loans and business loans by earning just a paltry 25 bp!

Cutting the rate by 10, 20 or the full 25 would provide little incentive to lend when many are shying away from new debt.

Further eliminating the rate on excess reserves could make it more difficult for the Fed to manage the fed funds rate.

Unfortunately for the millions who remain jobless, the Fed has few credible options left in its arsenal.

Faltering consumer confidence takes a toll on retail sales

Consumer confidence, as measured by both the Conference Board and the University of Michigan, went into a tailspin in August – thanks in large part to the divisive debt ceiling debate, the S&P downgrade, the faltering stock market and the deepening gloom emanating from Europe.

With growing uncertainty and weak job and income growth, retail sales out this morning had been highly anticipated since it would provide a concrete gauge on the public’s mood.

Unfortunately, the best consumers could muster was a flat reading in August. Excluding autos, sales managed a meager 0.1% rise.

Further, June and July were revised lower.

Last month’s free-fall in consumer confidence, along with the factors mentioned above, very likely accounted for the weak showing at the nation’s malls.

If there is a silver lining, sales did not mirror the steep drop in confidence, and it appears the economy continues to expand at a very tepid pace.

But the anxiety many of us feel is being reflected in the latest numbers offered up by the government.

Growth in nonfarm payrolls stalls

The government reported this morning that nonfarm payrolls in August were unchanged from the prior month.

That’s right – no change, zero. In the meantime, the private sector added just 17,000 jobs and the unemployment rate held steady at 9.1%, the fifth consecutive month the jobless rate has held above 9.0%.

A more formal look is available at Examiner.



Simply put, fiscal and monetary policy have their limits and we are seeing this play out before our eyes.

The president proposed and passed an$800 billion stimulus package early in his administration.

And the Fed has kept rates at zero for over two years and has pledged to keep rates low for another two years.

It has also pumped over $2 trillion into the economy in what is popularly called QE2.

The end result: very weak economic growth and a stubbornly high unemployment rate.

Pending home sales reflect sluggish housing market

The Pending Home Sales Index, a forward-looking indicator based on contract signings, slipped 1.3% to 89.7 in July from 90.9 in June.



One again, Lawrence Yun, the NAR’s chief economist, noted that tight lending standards continue to hamper the existing home market.

Based on anecdotal evidence from realtors, he is probably correct, but his assertion that “The market can easily move into a healthy expansion if mortgage underwriting standards return to normalcy” is a bit premature in my view.

Potential buyers continue to fret over the direction of home prices, and others who would like to move are finding it difficult to sell their current home or are unable to fetch a price that would leave them with the necessary equity to invest in a new house.

Further, job insecurities and lackluster consumer confidence, along with competition from foreclosures, remain a headwind.

Spending powers ahead
A welcome surprise for an economy that has been awash in weak data. Consumer spending grew by a healthy 0.8% in July.  A rebound in purchases for durable goods, including autos, led the way but gains were broad-based.

Even accounting for a rise in headline inflation, real spending, or spending adjusted for inflation, increased by a solid 0.5%, the best reading since December 2009.



But the overall trend remains lackluster, as the slowdown in income growth – compliments of weak employment growth – hinder spending.

Additionally, the debt ceiling debate that has sapped confidence may not manifest itself in the numbers until August. Stay tuned.

Bulls sniff out another round of Fed easing

Fed Chief Ben Bernanke’s talk on Friday at Jackson Hole, WY will likely be the event of the week given the recent unexpected weakness in the economy and the many debt problems that are plaguing Europe.

Clearly, this has tripped up the bulls over the last month, taking a big toll on equities and lending a helping hand to Treasuries.

But Monday and Tuesday have come as a big relief to investors, especially the strong advance yesterday.

Many traders tend to take the final week or two of August off, and a potential lack of liquidity may be accentuating the market moves.

Bargain hunting – stocks appear to be cheap if you are betting against a recession or a near-term default in Europe – is likely a contributor to the rally.

But the biggest reason, in my view, is the lack of any damaging headlines out of Europe and the expectation that Bernanke’s Fed is ready to come to the rescue with more talk of easing.

Recall that Bernanke first hinted at what would eventually be known as QE2 at last August’s meeting in Jackson Hole. That surprised markets.  And he surprised them again in early July by lowering the bar for implementing a more aggressive monetary policy.

Inflation is higher today than a year ago but this time around, the economy is unusually fragile.
Stocks have become addicted to regular Fed injections of liquidity, and another sugar high – compliments of the central bank – seems like a good short term fix.

But the last round of QE did little for the real economy since the $600 billion in new money is currently being held by banks and is on loan back to the Fed in the form of excess  reserves.

And inflation in the U.S.is higher today while emerging market economies like India and China are hiking rates in order to contain rising prices.

The Fed may try to surprise markets by calling for further unconventional action or measures that haven’t been publicly discussed, but the last round of QE was counter-productive since it exacerbated commodity inflation and contributed to higher rates overseas, which has slowed U.S. exports.

Stocks slump, economic data weak

A sell-off that began early this morning in Europe quickly spread to U.S. markets amid lingering fears over European debt and concerns that the U.S. and European economies may be poised to enter a new recession.

The flight out of equities continued to bolster Treasuries, with the 10-year bond briefly falling below 2% for the first time ever, while gold also benefited from the fall in stocks.

In the meantime, the latest economic data did little to discourage a small but growing view that the U.S. economy is either poised to enter a new recession or may already be in a new slump.

The Philly Fed’s Business Activity Index fell an astonishing 33.9 points in August to -30.7, far below the level of zero, which marks the line between contraction and expansion.

Yes, the index can be volatile but there's little good to say about August's number.


Losses in the sub-components were broad-based, suggesting the survey is detecting serious weakness in the mid-Atlantic region.

In the meantime, existing home sales unexpectedly fell last month, continuing a downward trend that re-established itself early in the year.

A lack of confidence in the economic recovery, worries about prices and job insecurities played a role.  Additionally, the NAR expressed growing frustration that conservative appraisals are scuttling some deals.

All-in-all, rather disconcerting.