Economy is keeping pace, expect Fed exit to as well

Coming to Terms with Reality

The swift reversal for U.S. benchmark indexes midweek saw the S&P 500 index drop like a stone from within 4-points of setting a fresh record peak. Three weeks ago investors appeared to cross the Rubicon by discounting tepid data as a temporary phenomenon with activity and hiring afflicted by the cruel winter weather. For sure, first quarter growth will suffer but investors appear to be expecting positive payback for the remainder of the year. Indeed JPMorgan’s David Kelly on the back of Thursday’s Financial Times suggests that, barring any fresh financial setback around the world, the Fed’s latest projection for growth and employment may be a good call from the typically over-optimistic central bank.

As much as the weather did impact output and crimp activity, the reality is that the economy is slowly normalizing and that monthly payroll creation above 200,000 is likely to happen this year. That reality of course helps explain the arrival on the scene of discussion, if not contemplation, of a rise in short-term interest rates. Talk of a fed funds rate shift as early as the summer in the January minutes dominated much of the financial media’s headlines Thursday, with some onlookers reminding investors to favor stocks over bonds.

However, getting to the crux of the matter is the simple fact, as illustrated by dovish views in the FOMC minutes, that inflation is very likely to remain contained as far as the eye can see. And while the Fed now has its work cut out for it in safely explaining what conditions would cause it to consider a shift in rates, the framework was written by Yellen in a 2012 speech highlighting various metrics of the labor market that help explain whether its plight is structural or cyclical. Mr. Bernanke went on to use that same framework just months later to highlight Ms. Yellen’s analysis. In addition the Fed must be sensitive in positioning for any change in its fed funds rate on account of fresh financial crises around the world. 

Walmart’s lackluster earnings report further dulled investor appetite for stocks, yet once again the reality remains that the US consumer is not shrinking as stock selling might suggest. The very low price model built by Walmart is leading its base to seek out braver pricing at other discounters and the retailer needs to adapt in its own wake.

Likewise, homebuilding companies who recently suffered at the hands of winter disruptions have seen their share prices mark time as investors’ patience wears thin.

Unlikely to go away is investors’ concern over the external environment and what that might mean when central banks are at diverse stages of policy stimulus. Some investors expect the ECB to embark upon further easing next week and just as the Fed has started to reduce its pace. The Bank of Japan extended its asset purchases programs at a larger size starting next month. But it is the Fed’s withdrawal that upsets investors most, particularly in respect to emerging markets.

 China’s manufacturing sector saw its pace of expansion slow to its lowest in seven months according to the private HSBC survey released overnight. Meanwhile investors were relieved that the Peoples Bank failed to further drain liquidity as it mulls how to deal with Trust bank failures resulting from over lending.     

Coming to terms with reality is a quest for investors at a time when not much has really changed. The domestic economy continues to heal nicely and this year will undoubtedly be better than last. Panic if you must over discussion of a shift in interest rates or use Walmart’s earnings as a barometer for consumer health if you choose. For now U.S. equity investors must do battle with the prospect of changing probabilities of financial tempest in other parts of the globe. In the absence of such problems, the bull is likely to charge unchecked.

 

 

About the Author
Andrew Wilkinson

Andrew is a seasoned trader and commentator of global financial markets. He worked for several London-based banks trading cash and derivatives before moving to the U.S. to attend graduate school. Andrew re-joins Interactive Brokers following a two-year stretch at a major Wall Street broker-dealer as their Chief Economic Strategist. His coverage of stocks, options, futures, forex and bonds regularly surfaces in global media, and over the last several years Andrew has made many TV appearances on Bloomberg, BBC, CNBC and BNN and Yahoo Finance.

Comments
comments powered by Disqus
Check out Futures Magazine - Polls on LockerDome on LockerDome