For a market that is so beholden to monetary policy and desperately wanting to know ‘are we there yet?’ in terms of ending the tightening, I only thought of this yesterday after Powell basically said we are: //www.youtube.com/watch?v=18AzodTPG5U. BUT, as long as QT is still in place, we really aren’t there just yet. Their balance sheet is still expected to shrink by $600b next year.
From a monetary standpoint we knew that 11 years ago we were certainly not in Kansas anymore. Now on the backside where policy is tightening, we can reaffirm that we’re still not in Kansas anymore. I include the chart below that captures about 20 years of the REAL fed funds rates from 1981 up until 2000. The beginning captures some of what Volcker did and I stop at 2000 to take out Greenspan’s beginning push to take the fed funds rate to 1% (negative real rates). The mean real rate during this time frame was 283 bps. Of course there was no such thing as a ‘neutral rate’ up until last year but the Fed today basically considers it a real rate of 100 bps. In the mid 1980’s it was between 450 bps and 600 bps. In 1989 before the recession a year later the real rate stood at 517 bps. After Greenspan hiked rates sharply in 1994 it got to about 300 bps. In the late 1990’s it also was about 300 bps.
REAL FED FUNDS RATE
So yes, we can celebrate a Fed that is almost done raising rates. In fact, before Powell’s comments yesterday the fed funds futures market was already saying the same thing and that the terminal rate in this cycle was going to be 2.75% vs an inflation rate of about 2%. But, that also means the limited number of rates the Fed has to cut whenever the next downturn brings an easing cycle. Also and until then, the Fed’s balance sheet will shrink by another $600b next year and is their other form of tightening. Bottom line, we are still not in Kansas anymore and I don’t see getting back for a long time.
We do get the FOMC minutes at 2pm from the meeting 3 weeks ago but after hearing from Powell yesterday, you heard everything you need to know.
I do believe the AAII measure of individual investor sentiment did capture yesterday’s stock market rally and Bulls rose 8.6 pts to 33.9 off last weeks lowest level since August 2017. Bears fell by 7.7 pts to 39.5 from the highest level since February 2016. The very bearish sentiment last week along with a very oversold market was the perfect set up for Powell’s ‘just below’ comment. Now if only Trump and Xi can have an amicable dinner Saturday where not just the food is good…
The Powell put rally was mostly contained to the US. Most of Asia did rally but Chinese stocks were in the red and the Nikkei was higher by just .4%. European stocks are both red and green with the only real winner being sovereign bonds today. The US 2 yr yield is back below 2.80% and the 10 yr is knocking on 3%. After falling yesterday after Powell’s speech, the dollar index is up slightly.
Switzerland and Sweden, two bastions of the negative interest rate experiment saw both economies contract in Q3 q/o/q. The Swiss economy fell .2% q/o/q vs the estimate of up .4%. The State Secretariat for Economic Affairs said “The strong, continuous growth phase enjoyed by the Swiss economy for one and a half years was suddenly interrupted. Switzerland is thus following the significant downturn seen at the same time in other European countries, particularly Germany.” The Swedish economy also shrunk by .2% q/o/q vs the forecast of growth of .2%. This as the Riksbank is about to hike rates and begin the process to get out from underneath NIRP. If we include the ECB, all of Europe is going into this economic slowdown with negative interest rates. Nice job.
The German economy has certainly slowed but the labor market remains rock solid. In November, the number of unemployed fell by 16k, 6k more than expected, marking the 17th straight month of declines and the unemployment rate fell one tenth to 5%, the lowest since reunification.
The Euro area Economic confidence index for November fell to 109.5 from 109.7 but that was a touch above the estimate of 109.1. It is though the weakest since May 2017. The manufacturing component rose .4 pts after falling by 1.7 pts last month. Services were unchanged as was construction. Consumer confidence weakened to the lowest level since March 2017. Retail sales rose slightly. Bottom line, while never a market moving number it confirms the more muted outlook.
Retail sales in Japan in October were better than expected with a 1.2% m/o/m increase, well more than the forecast of up .4%. September was also revised up. This is good because the Japanese consumer has been a missing piece of their recovery since Abenomics took hold.