Federal Reserve

Fed chief, Jay Powell, indicates return to quantitative easing and potential interest rate cut in US next month

jay powell fed

The US Federal Reserve, “The Fed”, chairman Jay Powell, said today that it will restart purchases of Government bonds to expand its balance sheet in order to prevent a repeat of the recent disruption in short-term lending markets, chairman Jay Powell said on Tuesday. A process called QE or quantitative easing which was last deployed heavily post the financial crash of 2009.

At the Fed’s September meeting, they stated there were considering resuming “organic” expansion of the balance sheet by purchasing assets at a regular pace to match growth in its liabilities.

He said QE 5 was directed at solving “recent technical issues” rather than materially affecting “the stance of monetary policy.” and was not anywhere of the scale used in the financial crisis.

n recent weeks, the New York Federal Reserve has deployed billions into short-term lending markets to prevent a repeat of the problems in September this year when borrowing cash overnight, The Repo Rate, via repurchase agreements rose by around 10 percent.

The repo rate back has since been brought back within a normal range of around 1.8 per cent. Powell said “While a range of factors may have contributed to these developments, it is clear that without a sufficient quantity of reserves in the banking system, even routine increases in funding pressure can lead to outsized movements in money market interest rates. This volatility can impede the effective implementation of monetary policy, and we are addressing it. Indeed, my colleagues and I will soon announce measures to add to the supply of reserves over time.. As we indicated in our March statement on balance sheet normalisation, at some point we will begin increasing our securities holdings to maintain an appropriate level of reserves. That time is now upon us.”

However, commentators have stated that organic expansion of the balance sheet may not add reserves fast enough to solve the issue. Some suggest that they buy between $200 billion to more than $300 billion of shorter-dated Treasury bills over the next six months.

Powell also confirmed expectations of a 25 basis-point cut at its next October meeting as inflation remains subdued at 1.8 per cent, and has been at or below the Fed’s target. With a “symmetric approach” he downplayed the risk of cutting inflation risk too much and damaging the economy .. “We will act as appropriate to support continued growth, a strong job market, and inflation moving back to our symmetric 2 per cent objective.”

Market ripe for a pull back as era of ultra cheap money starts to unwind and investor fatigue sets in

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S&P 500

August 2012 - August 2017

S&P 500 august 2012-august 2017

August 2016 - August 2017

s&P 500 august 2016-august 2017

Nasdaq 100

August 2012 - August 2017

nasdaq 100 august 2012 - august 2017

August 2016 - August 2017

Nasdaq 100 august2016 - august 2017

Everyone's saying that the US market's second-quarter earnings season supports the stock market’s current valuations. But some of the valuations look crazy high in several sectors, particularly technology and small caps. For example the small cap Russell 2000 index's true P/E of 79 today is higher than it was at either the top of the internet bubble or the 2007 bull market peak. The p/e of the major tech companies like Alphabet, Amazon and Facebook are back in 1999 dot-com bubble comparisons.

Russell 2000 valuation 2017 versus 1999 and  2007

S&P earnings grew 11% in the second quarter of 2017, the second straight quarter of double-digit growth and the fastest two quarters of growth since 2011. More than half of S&P companies beat forecasts, the highest percentage since the second quarter of 2010.

Goldman Sachs wrote " Of the S&P 500’s 11 primary sectors, forecasts for 2018’s profits have come down for six of them." The average estimate of analyst forecasts for the S&p 5o0 is $141.81 a share in 2018, down from the $142.15 a share estimate that was forecast at the end of June 2017.  For 2017, analysts see earnings of $130.46 a share for the S&P 500, down from $135.25 forecast at the end of April. 

At 2,425 for the S&P 500 the makes the 2017 p/e around 18.65, not cheap by historical valuations. But corporate earnings seem robust and US non-farm payrolls are strong, with the labour market underpinning sentiment. However, a market with no 5% pull backs as we've seen over the last 18 months or so seems unhealthy. The Korea blip seen last week was quickly erased as "bargain-hunters" piled in to buy shares. But these are more nervous times than at the start of August as a correction looks necessary and timely to eradicate over exuberance. 

Shorting technology looks an obvious trade at the moment and plenty of hedge funds are doing it. Unsuccesfully so far in 2017 with markets hitting all time highs!

The world's central banks have been buying assets like crazy, since the financial crisis of 2007/2008.

Central bank assets 2000-2017

Federal Reserve Balance sheet @ August 2017

The Federal Reserve currently holds $4.4 trillion of assets, including $2.5 trillion of US treasury bonds. All this buying of bonds and mortgage backed securities by the Fed and also the European Central Bank (ECB) and Bank of England (BOE) has held down interest dates as bond yields have collapsed with all this demand. But central bank intervention can't carry on forever and with the strong US economy, the Fed is figuring out how to lighten its balance sheet with out spooking the markets. Certainly interest rates are on the way up in the US and sooner rather than later in the UK and probably Eurozone. No one wants to be holding bonds when interest rates are likely to rise. 

With all this cheap money sloshing around the world, just like in 2007, investors have been buying stocks, property, you name it, anything that generates a yield. If you can borrow money for 0.25% and make 5-10%, its a no-brainer! But the central banks aren't going to allow this for ever. Assets like property in major cities of the world look horribly expensive right now. Watch the central banks, they have supported the market since 2007 and its worked (look at the last few non-farm payrolls in the United States) but the era of cheap money must be coming to an end. 

Federal Reserve decision to hold rates unnerves market about state of global economy

On September 14th I wrote, "It seems like a 50:50 whether the Fed push the button and raise by 0.25% this week and on-balance I would not be surprised to see a delay until December to see where the world's second largest economy, China, comes out. But from a market sentiment perspective it would be better to get the news out of the way. Markets hate uncertainty and waiting yet again to December will add fuel to market fears."

Yesterday the Federal Reserve's FOMC announced that US interest rates were on hold for now at 0% but with an expectation that a tightening would occur during 2015. This has sent markets down today as investors fear about the reasons for the delay i.e. a worsening in the global economic outlook and particuarly China. 

After 9 years of near zero interest rates in the world's largest economy which has been accompanied by a bull market in the S&P 500 and Nasdaq which last lasted since the depths of the last financial crisis in 2009. 

Major stock markets are down around 1% as investors digest that fact that there is more uncertainty about the timing of US interest rate rises and uncertainty is bad for sentiment.

There doesn't feel like much good news ahead and if US exporters catch a cold from weak global demand for their products, the next earnings season could be mighty interesting! But saying that many commodity stocks look mighty cheap right now.

World holds it breath as Federal Reserve FOMC meets to discuss US interest rates

federal reserve building

The Federal Reserve's key FOMC (Federal Open Market Committee) meeting is happening early this week and for the first time in a long time markets are guessing whether finally the time has come to raise US interest rates. The first rise for nine years!

The FOMC meeting concludes on Thursday afternoon with the end of meeting coinciding with the release of  the latest economic projections, and Federal Reserve Chair Janet Yellen will hold a press conference.

If the Fed does decide to take action it won't be a great surprise as many members including Yellen have signalled that they will raise interest rates when economic conditions and jobs reports are on a firm footing. The last few non-farm payrolls and durable goods order have been good or "good enough".  But those with a more cautious view have talked about the impact of a slowing China and violent swings in world stock markets and emerging markets currencies (on average Latin American currencies have devalued 26% against the US since May 2015 with big economies like the Brazilian Real down over 35%). Global sentiment appears to be on a knife edge and with little signs of inflation in the US, it is worth the risk for policy makers?

If interest rates go up, it probably means that US dollar will strengthen even more, bad news for oil and other dollar based commodities.

It seems like a 50:50 whether the Fed push the button and raise by 0.25% this week and on-balance I would not be surprised to see a delay until December to see where the world's second largest economy, China, comes out. But from a market sentiment perspective it would be better to get the news out of the way. Markets hate uncertainty and waiting yet again to December will add fuel to market fears.

Federal Reserve Beige Book reassures investors and calms nerves, now for US Non-farm payroll data on Friday

calming lake scene

After a mixed start to the day yesterday with European markets falling early on, September 2nd and the publication of the latest Federal Reserve Beige Book proved to be the chill pill the markets needed.

The US rallied strongly after the ADP employment report showed the US economy added 190,000 and the Fed said that the US economy was in pretty good shape with moderate/modest growth in most parts of the country.

In addition the European Central Bank (ECB ) is holding its policy meeting this morning with some speculating that the bank may try to stimulate the European economies even more after the turmoil caused by China.

The FTSE closed up 0.4% or 25 points at 6,083, the S&P 500 moved up  35 points or 1.8%  to close at 1,948. The Dow Jones Industrial Average gained 293 points, or 1.8%, to 16,351. The Nasdaq Composite Index was up 114 points, or 2.5%, to close at 4,750.

The latest Fed beige book covered the period from July through to mid-August, before the latest stock market sell off. Eleven of 12 Federal Reserve districts reported "moderate or modest growth"; the Cleveland district reported "slight growth". 

Most districts reported “relatively stable wages,” with “slight to modest” increases at the start of the third quarter compared with the previous six weeks but half of the districts reported shortages in labour.

The St. Louis Fed said almost three-fifths of companies that responded to the survey had raised wages in the prior three months, whilst the San Francisco district, which includes Silicon Valley, reported “upward wage pressures” for skilled workers in information technology. The New York region reported “pressure on starting salaries and the Cleveland Fed reported “intensifying wage pressure” among construction, retail and transportation industries.

The big date to put in the diary is the next Federal Reserve meeting on September 16th-17th, with markets still 50:50 on a rate rise. The US non-farm payroll data due tomorrow will also help to sway the decision of the FOMC so the information due at 1.30 EST will be key and keenly watched by investors tomorrow. Watch this space!

As I've said before and I'll say it again, the US is in good shape, Europe mixed, China and  emerging markets are in poor shape with some worse than others (e.g. Brazil - the Brazilian real had collapsed agains the dollar in 2015 ). 

Federal Reserve likely to signal interest rate hike in September

The era of near zero interest rates in the United States is surely coming to an end.

Later today (7pm UK), the US Federal Reserve is expected to signal a possible interest rate increase in September after a 2 day meeting.

The last time the Fed increased interest rates was as far back as June 2006, with the FOMC making it clear that any increases would be dependent on employment, inflation and GDP data.

Chairman Janet Yellen has been priming the markets that a rate rise is coming saying that the US job market and economy and growing moderately and that 2015 would be the likely year when rates would start climbing again, albeit to a modest 2% by 2017. 

Rate rises in the US has meant that together with the fall in commodities, emerging markets currencies have been battered as money is repatriated for higher returns and safety back in the America. Brazil, Columbia, Thailand and Venezuela are paying the price as their currencies hit 15 year lows.

 

Gold, the US dollar and commodity prices play a merry dance

Gold is currently trading at $1099, the lowest for 5 years and 43% down versus the all time high of $1923 an ounce in April 2011. Prices have been on a downward path for some time as the US Federal Reserve gears up for an interest rate rise probably by the end of 2015. As investors dump commodity funds, it has also helped put additional downward pressure on the metal. It was particularly surprising that gold failed to rally during the height of the Greece crisis when Grexit and all the eurozone turmoil it would have brought was at its height a few weeks ago. The safe haven of gold has been replaced by bonds, and currencies like the US dollar and Swiss Franc. 

Dollar index July 2014-15

Talk of an interest rate rise in the United States has also put emerging markets currencies under the cosh. With investors steering clear of euro denominated debt, the dollar is further strengthened and commodities go even lower. With commodities weak, emerging markets economies like Brazil and Russia are really feeling the pain.

China is currently looking to the IMF to accept the Yuan as a reserve currency, a club currently formed by the US dollar, euro, the British pound and Japanese Yen.  But with China having considerable US dollar exposure it is not in the country's interest to talk up the Yuan as a potential reserve currency and a strong dollar is good for Chinese imports into the US but of course bad for exporters.


Janet Yellen will be keen to give the markets more certainty about the future direction of American interest rates but in the meantime a strong dollar is playing hello with gold, other commodities as well as emerging markets. It seems unlikely that given Yellen's comments to date that rates will rise aggressively though and the Fed will take a cautious stance to avoid spooking the markets and potentially kill off the nascent recovery after the 2008/2009 sub-prime recession under Ben Bernanke's tenure.