With ECB QE set to expire in December, Mario Draghi has no choice but to tell us what his plans are for tapering and extending it into 2018. Today was a first step in setting us up for that when he said “All the signs now point to a strengthening and broadening recovery in the euro area. Deflationary forces have been replaced by reflationary ones.” With inflation he went on to say “While there are still factors that are weighing on the path of inflation, at present they are mainly temporary factors that typically the central bank can look through.” Here is his more explicit message of the tapering to come: “As the economy continues to recover, a constant policy stance will become more accommodative. The central bank can accompany the recovery by adjusting the parameters of its policy instruments, not in order to tighten the policy stance, but to keep it broadly unchanged.” Just as we did in 2014, we’ll all have another ‘is tapering tightening?’ debate. Central bankers will say no. I say yes. Either way, there is less air going into the balloon.
Bottom line, here is my message to markets: Central banks are no longer your friends anymore. About 10 yrs of extraordinary policies are coming to an end (for now) as the Fed, ECB, BoJ, BoE, BoC and possibly some others take away some of your monetary drugs that you have been so reliant on in driving asset prices to the moon. I understand, the drugs will still be flowing and rates will still be very low but it is the change in direction that you should be paying attention to. Don’t forget what got you here and it wasn’t all because of the ‘fundamentals’. As for bond prices, I’ll stick to my belief that the biggest risk to long end US bond yields and seeing them higher is NOT an acceleration in economic growth and/or inflation but the inevitable reversal of the European bond market bubble. In 2015 when the German 10 yr yield went from 6 bps to 100 bps in 2 months, the US 10 yr yield went from 1.87% to almost 2.5%. On Draghi’s comments, European bond yields are rising across the board and US yields are lifting too. The German 10 yr yield is at a 3 ½ week high with a 5 bps rise and the 2 yr note yield is the least negative since last June. The French 10 yr yield is up by 7 bps and Italian yields are higher by 6 bps. European bank stocks are cheering the comments as maybe a more normal curve can result but most everything else is being sold modestly. The euro is higher by .7% vs the US dollar and you can see this chart to visualize the immediate reaction to Draghi’s comments:
Mark Carney also spoke today and the BoE wants UK banks to add more capital in order to position themselves better from a balance sheet perspective from the possibility of rising consumer credit defaults and Brexit. They believe that most of the buildup in consumer credit is related to car loans. So the BoE will use the good old ‘macro prudential’ regulatory steps to deal with excessive debt taken on via artificially low interest rates rather than using interest rates. UK banks are not moving lower on the news however because of the rise in interest rates. Carney did not tip is hat at all on when the BoE will raise rates but he did respond to fellow BoE member Kristin Forbes’ criticism of him and BoE policy when she argued the almost paralyzing behavior of the BoE in raising rates and beginning the reversal of its extreme policy. He of course disagreed.
Data wise in the UK, the CBI retail sales index did improve to 12 in June from 2 in May. The estimate was 5. The CBI said, “The start of summer has seen shoppers hit the high street, lifting sales, if only modestly. However, there’s no getting away from the fact that life is getting tougher, with retailers clearly cautious over the near term outlook.”
Let’s focus again on the early stages of the recession that is the US auto sector. It happens to touch about 3% of US GDP and 5% of the workforce in some fashion so it’s of course hugely relevant. Yesterday, JD Power and LMC Automotive trimmed its 2017 estimate again for new vehicle sales to 17.1mm from 17.2 previously. This is the 3rd straight month they’ve cut their forecast. An analyst at JD Power said “The auto industry is pacing towards its weakest first half since 2014. While the retail selling rate has declined in four of the first six months, the broader concern remains the negative health indicators behind the sales results.” Also, total incentive spending is up 11.7% y/o/y year to date. With respect to inventories, “days to turn…remained at 70 through June 18. This is the highest level since July 2009 (80 days). Most of the sales declines is related to a drop in fleet volume (down 8% y/o/y) but retail sales are still down .6% y/o/y according to their estimates.
This of course was followed by GM coming around to what JD Power said by lowering its 2017 vehicle sales estimate to the “low” 17mm range from their previous estimate of around unchanged with last year which was 17.55mm, a record. Thanks to falling used car prices, GM’s CFO said pricing has become “very, very competitive.” He did acknowledge however that in order to maintain profits, incentives have “moderated recently.”
Bottom line, in size this is certainly not the US housing/mortgage market but we are witnessing the early stages of another Fed driven, pull forward economic activity and lever up bust after the multi year boom.
Janet Yellen speaks at 1pm est time on “Global Economic Issues.”