A new political regime took hold on November 8th and tomorrow we’ll see if there is any acknowledgement of that from the FOMC and whether we’re about to embark on a new monetary regime. I would define ‘new monetary regime’ as anything more aggressive than the pace of one rate hike per year. I’ve argued that a new market driven interest rate regime (end of the bond bull market) began in August when the BoJ started to let its yield curve steepen, followed by other factors even before Trump won. Trump’s victory and upcoming policies only solidifies the rate regime change. Is the Fed listening to the message the markets are sending? The story of 2017 will be the butting of heads between the fiscally driven growth initiatives vs the inevitable rise in interest rates.
We last heard from Janet Yellen on November 17th in her testimony to the Joint Economic Committee. She said in that speech,
“Were the FOMC to delay increases in the federal funds rate for too long, it could end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of the Committee’s longer-run policy goals. Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and ultimately undermine financial stability.”
To what extent will the Fed adhere to this logic in 2017? The market has already called out the Fed with its dramatic rise in rates over the past 4 months believing in the gradual pace of fed funds hikes and not wanting to wait around. The Fed thus has two choices, 1) be left with having to abruptly tighten policy because you’ve been so slow in raising rates and fiscal policy is about to send long rates spiking or 2) continue to believe this, “the risk of falling behind the curve in the near future appears limited, and gradual increases in the fed funds rate will likely be sufficient to get to a neutral policy stance over the next few years.” That is also what Janet Yellen said in that same speech.
I’ll update the amount of US debt that would get impacted by a higher cost of money. In last week’s Q3 Flow of Funds statement from the Fed, total US non financial debt rose to $47T, up 5.8% y/o/y and higher by 9.3% from two years ago. This is 252% of GDP, a new record high. Thus, every 100 bps higher in interest rates would add $470b of higher interest expense per year. Of course not all of this matures at once and is spread out by many years but you get the point. Of this total, business debt is up to $13.2T. Thus, $132b of higher interest expense for every 100 bps. Compare this to the potential corporate income tax cut where we estimate companies will save about $80b next year. I also caught this stat last week from a piece my friend Danielle Dimartino Booth from Money Strong wrote. There is $400b of all forms of US commercial real estate loans that mature in 2017 and “only 40% produces sufficient income to ensure refinancing is a sure thing.” Lastly, back in February, S&P estimated that there was $1.9 Trillion of GLOBAL corporate debt maturities in 2017.
In today’s 30 yr bond auction, buyers took advantage of the highest 30 yr bond yield since July 2015 as the auction was decent. The yield of 3.152% was below the when issued of 3.16-.17%. The bid to cover of 2.39 was slightly above the previous one year average of 2.32. Direct and indirect bidders took a combined 73% of the auction vs the one year average of 71%.
Bottom line, many of the buyers of long end paper are the pension funds and insurance companies and they have been given the opportunity to buy a yield they haven’t seen in a year and a half. This comes after a mixed bag of auctions yesterday in the 3s and 10s. Treasuries are rallying a touch in response to the auction. 25 hours from now we’ll not just get the rate hike from the Fed, we’ll get to see another round of worthless dot watching. That said, the market is only pricing in almost 2 hikes next year and any commentary or dot plot that implies something much greater will be worth noting. As said this morning, will the Fed acknowledge the different world we are now in? For the sake of their credibility, they better.
What a difference an election makes. The November NFIB small business optimism index rose to 98.4 from 94.9 in October. “Before election day small business owners’ optimism was flat, and after election day it soared” said the NFIB. That is the best level since December 2014. Plans to Hire jumped 5 pts to 15, matching the most since January ’07. Those that Expect a Better Economy spiked 19 pts to 12 from -7. Those that Expect Higher Sales rose 10 pts to 11 and those that said it’s a Good Time to Expand was up by 2 pts. The disappointment within the data was a 3 pt drop in those planning Increased Capital Spending (this must improve if Trumpnomics is going to be fully effective) and a 4 pt drop in both current Net Compensation and Net Compensation Plans even though there was a rise in Positions Not Able to Fill. On inflation, those that expect Higher Selling Prices rose by 3 pts to 5, the most since January 2015.
In China, after falling to the slowest rate of growth since last year, retail sales grew by 10.8% y/o/y, above the estimate of 10.2%. Industrial production was up by 6.2%, a one tenth uptick from October and also one tenth better than the forecast. Lastly, fixed asset investment ytd y/o/y was up by 8.3% as expected. As I keep saying, it’s clear that the data in China has stabilized but I don’t know what is policy driven and what is organic anymore. Retail sales was certainly helped by Alibaba’s Singles Day on November 11th. After yesterday’s drubbing in Chinese markets, they barely responded to this data as the Shanghai index was flat and the Shenzhen index was up by .3% after yesterday’s near 5% drop. The yuan is mixed.
Lastly in Europe, the German ZEW December economic expectations of investors was unchanged at 13.8, a hair below the estimate of 14. The current situation component though saw a nearly 5 pt gain to the best since September ’15. The ZEW said “The considerable economic risks arising from the tense situation in the Italian banking sector, as well as the political risks surrounding upcoming elections in Europe, seem to have faded into the background at the moment.”
As the Brits deal with a much weaker pound, UK CPI grew by 1.2% y/o/y in November, up 3 tenths m/o/m and at the highest level since October ’14. The core rate accelerated to 1.4% from 1.2%. Expect these figures to continue higher as wholesale input prices were up by 12.9% y/o/y (although below the estimate of up 13.5%). With respect to housing inflation, it remains rampant as home prices grew by 6.9% y/o/y in October. London prices were up by 7.7% but that is the slowest pace of gain since June 2013. On the higher than expected CPI data, the pound is higher but gilt yields are lower, along with most global bonds, after yesterday’s selloff. The UK 10 yr inflation breakeven is up by 1 bp to 3.08%. It was 2.31% on the day of the UK vote.