The markets were EXTREMELY quiet (read: dead) Wednesday morning and early afternoon, but traders hoped that the later afternoon report would wake things up. It didn’t happen. The market remained in its zombie-like status as it slowly ate its way higher with no life (volume) whatsoever.
The afternoon report that trader’s had hoped would make the market move were the minutes of the prior FOMC meeting. There were more than a few rather eye-opening comments made during that last meeting and were heretofore unknown to us all, but since the world is still pegged at ZERO interest rates, even this information was ignored.
From Stone McCarthy:
- The minutes from the May 2-3 FOMC meeting strongly support our view that the FOMC will raise interest rates and announce its balance sheet normalization plans at the upcoming June 13-14 FOMC meeting. In line with our expectation, “nearly all” Fed officials agreed it is “likely appropriate” to begin reducing the balance sheet later this year.
- Consistent with a gradual implementation of a “passive and predictable” unwind of the balance sheet, policy makers are considering a “preannounced schedule of gradually increasing caps to limit the amount of securities that could run off” the balance sheet in any given month. Initially, this appears to be a more gradual phase-in than we assumed in our base-case scenario.
- In line with our expectation, Fed officials signalled they will likely begin to reduce the balance sheet later this year and the details of their final plan could be announced soon – we anticipate that happening at the upcoming June 13-14 FOMC meeting. Consistent with a gradual implementation of a “passive and predictable” unwind of the balance sheet, policy makers are considering a proposal for “a set of gradually increasing caps, or limits, on the dollar amounts of Treasury and agency securities that would be allowed to run off each month, and only the amounts of securities repayments that exceeded the caps would be reinvested each month”. Initially, this appears to be a more gradual phase-in than we assumed in base-case scenario. In our base-case scenario we assumed that the FOMC would phase-in the reduction in debt reinvestments by allowing 50% of the maturing Treasury and MBS securities to roll-off in the first year of implementation. However, starting in the second year, the FOMC’s plan might be in line with our view in which there is a full ceasing of debt reinvestments.
- Beyond June, assuming the current political chaos does not greatly dampen economic activity via a negative confidence shock, we look for another rate hike in September. This would lift the mid-point of the Fed funds target range to 1.38%. Our read of the minutes provides support for this call, though some policy makers “judged that it would be prudent to await additional evidence” that slower growth was transitory. Our forecast that real GDP growth rebounds above 3% (annualized) in Q2 argues for another rate hike in September. Thereafter, in Q4, the FOMC could initiate balance sheet reduction and refrain temporarily from lifting the Fed funds rate during the quarter.
There are other major firms that agree with most of this, like Goldman Sachs and Citibank, but I believe that the Fed will do what it always does: it will make it up as it goes along, and will always do what’s best for the stock market, not Main Street.
As I noted yesterday, the direction of the global financial markets in the near future will likely be most influenced by the impact of the proposed US budget and the outcome of labor policy reforms in France. I discussed the Trump administration’s proposed budget yesterday, and now it is time to focus on President Emmanuel Macron’s labor reform proposals. Again, the key impact of these two policy issues is that they will have a large impact on growth of their respective economies, particular with regards to employment levels and foreign investment.
Emmanuel Macron, the newly elected President of France, ran on a platform that included promises to slash unemployment and boost business growth overall in France as well as the European Union. French unemployment has been hovering around 10% for years, with unemployment of younger people hovering at over 20%. This means much of France’s prime work force candidates are struggling to find or keep work. Add to this a large influx of migrants and an existing large base of established immigrants who are yet to integrate into the general French culture, and you have a situation that has been growing consistently worse over time.
Macron has promised to mend the situation by reforming labor laws that he believes are one of the root causes of the problem. Specifically, he is pushing for reforms that will greatly reduce barriers to employment by people who are unskilled or underskilled. While this is likely to impact younger native French workers, it will likely have the greatest impact on past and recent migrants who come from backgrounds of unskilled labor. In much the same way as US labor laws have allowed low or unskilled migrants to our country to more easily obtain employment, Macron seeks to lower the barriers for access to employment in France by weakening French labor unions. He seeks to accomplish this task by shifting wage negotiations from being industry-wide to being focused on individual companies.
As a consequence of this, collective bargaining power should be reduced in the major industries and larger multinational companies should benefit by making it easier for them to hire and train low or unskilled workers. However, a likely consequence of these reforms will be drop in wages as it seems unlikely that the number of jobs available will increase faster than the rate of newly eligible workers. In the end, profits for larger scale companies are likely to be boosted by Macron’s reforms, but it is not clear if this will create enough growth to outpace that of the United States. I still expect the US dollar to gain versus the euro due to greater economic growth, but for now let’s watch how each of these policies develops and what outcomes are realized.
Now that the smoke has mostly cleared surrounding allegations of potential obstruction of justice by the Trump administration in the ongoing investigation into Russian collusion (at least cleared for now), the global markets are now back to focusing on probably the two most important economic developments this year. These are the proposed US federal budget submitted by the Trump administration, and planned labor reforms by France’s newly elected President Emmanuel Macron. The ultimate direction of these economic policies for their respective countries is likely to have a large impact on the direction of global markets going forward through the end of this year and beyond, with the largest impact likely being felt in the exchange rate between the US dollar and the euro.
President Trump’s proposed budget is not very surprising in that it features most of the things one would expect from a Republican administration, namely budget cuts on certain social welfare programs and taxes, as well as boosts in military spending. The current budget proposal is $4.1T in spending, and as noted by many will likely face pushback from both sides of the aisle. Some areas of likely contention will be proposed cuts in SNAP benefits for people without social security cards (a clear move to curtail benefits going to illegal immigrants), medicaid cuts and student aid cuts. The infrastructure proposal is also likely to be contentious, but most likely at least a large part of the proposal should be ultimately approved. Of course, a rejection of an initial budget proposal by a new administration is the norm, but it remains to be seen just how much of the original proposal will remain. Tax cut proposals remain somewhat vague, but the markets are clearly anticipating a successful reduction in corporate tax rates, which if ultimately passed should catalyze the markets forward and help to increase demand for investment in US financial instruments.
I will discuss Macron’s labor market reform proposals in tomorrow’s commentary. The success of Trump’s and Marcon’s separate proposals will weigh on the balance of investment in the global marketplace, and should set the tone of things to come for the next few years or more. Look for volatility to remain low for the time being, and for the US markets to remain in a range near the all time highs for now as well.
I suppose that over the course of history there may have been one or two divorces that were settled quickly and amicably, but that’s not what usually happens. It’s rare. I’m not sure if there is a precedent for two countries getting a divorce, and although one half of this marriage isn’t a country by itself, I think you get the idea: when the UK divorces the EU, it may be very messy!
The Guardian recently reported: Brexit talks could collapse over UK divorce bill, says EU negotiator
“The EU’s chief Brexit negotiator, Michel Barnier, fears the refusal of member states to soften their demands over the size of Britain’s “divorce bill” could lead to a collapse in talks and the UK crashing out of the EU without a deal, minutes of a meeting of the European commission reveal.
Barnier has told the commission president, Jean-Claude Juncker, and other senior officials that the stakes are so high because Berlin and Paris are refusing to pay more to cover the UK’s departure, while those governments who receive the most from EU funds are opposed to any cuts in spending.
“Mr. Barnier considered that this issue would doubtless be one of the most difficult in the negotiation,” the minutes of a top-level meeting held earlier this month note.
“However, should there be no agreement on this point, he believed that the risk of failing to reach an agreement on an orderly withdrawal of the United Kingdom would become real, since none of the 27 member states wished to contribute more to the current multi-annual financial framework or receive less in projects financed under the framework.”
As positions have hardened on the continent, with estimates of the size of the bill now reaching as much as €100bn, Juncker noted that Theresa May appeared to be softening up the British public for failure to strike a deal.”
The European Union (EU) has been able to tell the only other “trouble maker,” Greece, exactly what to do and when to do it. And since Greece has dutifully followed along, the EU believes it can do the same to the UK. It is finding out that this is a different marriage, indeed. So the divorce is coming; but if it comes early because the UK walks away from the negotiating table and says it will pay nothing out of frustration, watch for greater volatility in the markets (and then the ECB to immediately increase QE).
Wednesday’s increased volatility continued Thursday. The S&P500 futures (ES) traded a great deal of volume before the open and had put in a large range overnight, so it looked like the early action would indeed be volatile. It was, but it didn’t last forever.
Traders were still grappling with the political football that was thrown into the trading pits: would the sacking of the FBI director, Comey, lead to major scandal in the White House? Or was it just another witch hunt?
The ES was highly volatile early, but settled into an up trend and then stopped for quite a while. Was it over? No. In fact, the rally resumed very quickly when some news about Comey hit the tape. Although it wasn’t new testimony, a May 3rd video and comments of Comey testifying under oath that “he has not been pressured to close an investigation for political purposes.” This would equate to less turmoil in DC and is therefore bullish, which led the ES to a 16-point rally.
In the chart below you can see clearly when the Comey news hit the wires. Buyers bought a lot of ES futures near 2359.00, which didn’t stop until 2375.00! It looks like the politically charged sell-off has already faded.
When traders on the floor of the CME, CBOE, NYSE, etc want to get rid of a trade (stuck) that they are holding and believe is a loser…and another trader wants to buy it…the stuck trader screams “SOLD TO YOU!” And like that, he has unloaded a bad position.
Wow, so there was a lot of yelling on Wednesday right? What about the other side who screams “BUY’em!” Not so much; the selling cascaded as the afternoon proceeded. “Sold.. to … anyone….(crickets)…?” Well, not this time and that was the problem; there were no willing buyers until the market fell quite a bit more than the recent normal.
For those of you living in some sort of time-chamber, this is NORMAL. Yes, think back….the market would normally fall due to some scare – then rally to new highs. Is it guaranteed to happen again (new highs)? No, of course not…but do you hear a feint cry of “buy’em!”…? Hmmm
Volatility in the US markets has been D E A D, so this recent movement has been a blessing for all traders. Whatever the reason – you can hate Trump or the Democrats – all that matters to a trader today is the glorious movement in the indices!
The European Central Bank is being pushed to end its current policy of easy money, and it has helped to prop up the euro currency against the US dollar. The euro has enjoyed steady rise in value over the course of this year as traders anticipate the impact of continued tapering of ECB asset purchases, which has been the primary means by which it has increased the money supply of the euro and thus created an environment of easy credit.
However, these measures have yet to create the sustained levels of inflation desired by the ECB. Although Eurozone inflation has now reached 1.9% for April, we must now wait to see if this can be sustained. Moreover, some notable EU members are voicing strong warnings of the potential negative effects of continuing the current policies for much longer. German deputy Finance Minister Jens Spahn, for example, recently stated that he believes the ECB should begin unwinding its current monetary policy very soon in order to avoid what he described as a an increase in damaging side effects of the current loose policy. The German minister argued that the current problems in the ECB required structural reforms, echoing the sentiments of other Eurozone leaders such as Emmanuel Macron of France.
All things considered, the ECB is likely to take further steps to curtail its current monetary policy, but this will not likely create a favorable situation for continued strength in the euro currency very soon. Instead, I still expect to see weakness against the US dollar to increase overall given that the ECB will not be in a position to raise interest rates anytime soon if it wishes to sustain the current uptick in inflation. Nevertheless, the rate at which the euro declines in value may be slowed or stalled for the time being.
As I’ve repeated many times recently, volatility was likely to increase as we approached the French election because of its importance to the global marketplace. Also during and before that time, we had other major issues such as US policy changes and the Dutch elections. Indeed volatility did increase substantially from its January 2017 lows after the end of the US elections and the conclusion of the Italian referendum. We saw the VIX rise consistently from around January 16th to April 10th 2017.
But after the French election made it clear that populist movements would not take the lead role in European politics for the immediate future, the markets have signalled clearly that major risk to global markets is perceived to be exceptionally low. Despite the ongoing spectacle over the firing of FBI Director James Comey and the still ongoing investigation of potential Russian collusion in the 2016 US election (in addition to allegations of interference in the French and Dutch elections), the financial markets have continued to make new highs.
This has come as a surprise to many, and in my case I will say that I am surprised at how low the VIX currently is while I am not surprised by the trajectory of US equity markets. As I’ve mentioned previously, the world will tend to favor the US marketplace over others due to the favorable economic picture in this country. The likelihood of US equities continue to perform well is much stronger here due to the likelihood of a more favorable environment for businesses due to proposed deregulation and lower taxes. All of these things could become derailed, but since they are so strongly agreed upon by most Republicans and favored by the President and his administration, the likelihood of success for these agendas remains high. We can expect volatility to remain relatively stable and low going forward until we reach the new major election in Europe, which will be in September of this year for the German federal election. Otherwise, surprises are possible but not as probable.
I’ve noted previously the magnitude of the importance of the French election that concluded earlier this month with the election of Emmanuel Macron as president. It was seen as the election that, more than any other, dictated the continued existence of the European Union and the euro currency. Macron won the election by being promoted as a political outsider who will reform the political and economic climate in France as well as in the European Union as a whole. It is this latter point that should make it clear to all watching that Macron has been anointed as the new face of European politics, and his policy proposals ultimately will reflect the direction that the eurozone will take as a whole.
However, when one examines these policies, it becomes apparent that Macron is merely continuing the legacy of his predecessor, Francois Hollande. He has essentially given these policies a second wind, and it seems clear that this was the expectation of the markets to begin with seeing the degree of comfort demonstrated by the global indexes upon Macron’s victory in the first round of the French election in April.
The similarities stand out most in Macron’s push to create a European Parliament, which is something that has been proposed by EU members (including Hollande) in the past but was blocked by lack of commitment from countries such as the UK. The proposed EU Parliament would essentially create a central government for all EU members where legislative decisions would be made for the EU as a whole. While this may not appear to be a major change, one must realize that it would greatly increase the power of the European Union over the economic and social policies of its member states to the point where the EU states would be more like the individual states of countries such as the United States.
In effect, the EU parliament would replace the majority of the roles of the parliaments that now exist in the individual countries, further removing the legislative powers of EU members in favor of a single centralized government. In fact, this government would even control to a large extent the fiscal policies of EU members. As of now, the EU is only able to dictate monetary policy via the European Central Bank. But if a new European Parliament is created, fiscal policy will also be dictated by the EU for its member states, a move that is promoted as a means to control financial shocks due to poor synchronization of fiscal policies between its member states.
With all of these things in mind, it is clear that Macron is not representing a revolutionary change in French politics. We can expect some changes, but the general picture is still the same, but now it seems the expansion of EU power over its members is more likely. Therefore, I expect the euro currency to continue to weaken versus the US dollar as a direct consequence of EU policies.
The financial results of Obamacare have been horrible. Young people refuse to pay the ridiculous premiums that that are accompanied by outrageously large ($10k for ex) deductibles before a penny of the insurance kicks in. I have talked to people claiming that they would need to pay about $15 to $20,000 if they paid the deductible plus the annual premium cost. Unlike politicians, when it comes to their own finances regular people consider it a TAX, which it is. Therefore, they simply pay the small fine until they need it.
Who didn’t see that coming? Oh yeah, politicians – of course.
You may have read some of the decisions that insurance companies have made recently: In Tennessee there are 16 counties that have ZERO insurance coverage, and in Iowa next year 90% of the entire state will have ZERO coverage through Obamacare.
That sounds like an implosion to be sure, but it’s getting worse. On Thursday Aetna announced that it is pulling out of the remaining areas that it offers health insurance through Obamacare. From Reuters we read the following – http://www.reuters.com/article/us-aetna-obamacare-idUSKBN1862XK
“Health insurer Aetna Inc said on Wednesday it will exit the 2018 Obamacare individual insurance market in Delaware and Nebraska – the two remaining states where it offered the plans.
Aetna had already said it would exit the individual commercial market in Virginia and Iowa, after pulling out of several other states last year.
Aetna has now “completely exited the exchanges,” the company said in an emailed statement.
Insurers Humana Inc and UnitedHealth Group Inc have also pulled out of most of the government-subsidized individual health insurance market.
Republicans in the U.S. House of Representatives last week voted to undo the Affordable Care Act, often called Obamacare, the signature domestic achievement of former President Barack Obama.
But even if the Republicans’ bill – known as the American Health Care Act – is passed by the Senate it would not solve a critical outstanding issue for insurers looking at 2018: Will the government continue to fund the cost-sharing subsidies that help individuals pay for care?
Health insurers have said they cannot plan amid the uncertainty. In addition, the balance of sick and healthy customers has been worse than expected, and premium rates on the individual insurance market went up 25 percent this year.”
By the end of 2017, Aetna states that it will have lost nearly $1 billion due to the Obamacare Act. Can you blame them for exiting the exchanges?
Even if you are a fan of this bill for some reason despite all of this bad news, because you ignore the financial side of the issue and focus on the touchy-feely side, think of this: How much value would your home lose if you were in one of the counties that had ZERO health care coverage and needed to sell it fast? Who is going to knowingly buy your home if they would then fall into the same category – no insurance for the family? If your home value plummeted by 50% because of this, I’ll bet even the ardent supporters out there would change their attitudes very quickly.
Sadly, the morons on BOTH sides of the political aisle in D.C. are ignoring the real issue: the cost of care, not insurance. Maybe we’ll talk about that next time.
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