Janet Yellen said nothing new in her Congressional testimony yesterday as she repeated for the umpteenth time the word ‘gradual’ in terms of raising the fed funds rate and said balance sheet unwind (QT) should start “relatively soon.” It is the “relatively soon” part that begs the question of whether it starts on July 26th when the FOMC next meets or two months later at the September meeting. Either way, we’re getting more tightening within the next few months.
On the inflation issue, Yellen, in her prepared text, said “It appears that the recent lower readings on inflation are partly the result of a few unusual reductions in certain categories of prices” as she was referring to wireless phone plans for example. What is not being acknowledged by the Fed and their focus on the PCE inflation figure is that it’s also being weighed down by the government price fixing of Medicaid and Medicare payments at low rates as healthcare makes up 25% of core PCE, in contrast to core CPI where its only 10%. PCE measures both out of pocket and medical services paid for by “employers through employer provided health insurance, as well as medical care services paid for by governments through programs such as Medicare and Medicaid.” CPI ONLY measures out of pocket. The point is, no amount of money printing and low rates is going to raise this portion of inflation and in fact will be a natural suppressant via government reimbursement that may only worsen. Ask any doctor what their reimbursement rates are for many standard procedures. It’s not much and keeps sinking. Because the Fed didn’t focus on core CPI instead, they ended up hiking rates only 3 times while core CPI was 2%+ for 17 straight months.
If we get QT beginning in September, it will coincide with further tapering from the ECB. DJ reported at 7:12am: “ECB could announce plans to wind down QE as its September 7th policy meeting—ECB officials.” Draghi will be speaking in Jackson Hole in August, less than 2 weeks before that September meeting. The euro was selling off from about 3am to 7am and then bounced on that story. Sovereign bond yields are off the morning lows and European stocks are off their early highs.
Continuing the trend of improving trade this year after 2 years of softness, China said exports in June in dollar terms rose 11.3% y/o/y, above the estimate of up 8.9% and imports also surprised to the upside with a 17.2% y/o/y jump vs the forecast of up 14.5%. The trade surplus with the US rose to the most since October 2015 to the dismay of some at the White House as exports to the US were up 20% y/o/y. Exports were strong too to Europe but fell to Hong Kong and Southeast Asian countries. With respect to the imports of commodities and the voracious appetite that China still has, they were higher by 23.5% y/o/y for coal, 14% for crude oil, 11% for fuel oil, 9.3% for iron ore, 5.3% for steel products and 14% for soybeans (FT article last month was titled “As China’s meat consumption rises, the soybeans that feed livestock have become the world’s fastest growing crop, outpacing corn and wheat”). Copper was really the only area of notable weakness as imports here fell 18% y/o/y.
Copper prices didn’t move on that report and sits around $2.70 a pound, near the upper end of the $2.50-2.80 range it’s been at since mid November. The Shanghai comp bounced by .6% while the H share index continues to rip higher by another 1.5% and is up by 4.5% over the past 3 trading days. The Kospi and Sensex closed at record highs and they remain 2 of my top 3 favorite emerging markets with Brazil being the other. In Brazil, President Michel Temer has the support to not get indicted and they just passed desperately needed pension reform. Also, a potential candidate for President next year, the ex President Lula, is going to jail for almost 10 years.