QE3 Was in Control
Good day… And welcome to the final approach of the third quarter; so make sure your seats are in their full and upright positions. As Chris mentioned on Friday, I’ll assume the captain’s seat this week as he is out of town giving presentations and Chuck remains on the mend. I still can’t believe we’re on the cusp of the fourth quarter. It seems just like yesterday I threw the long sleeves and jackets toward the back of the closet, but now it’s time to gather the cold weather supplies and make sure they’re on standby. The various financial markets were far from cold last week and it looks like we could be seeing the beginning of a heat wave.
As Chris mentioned on Friday, the Fed finally bowed to mounting market pressures to take additional stimulus measures so we started the third chapter of this unfinished novel. I know we’re only a handful of days outside the announcement, but if part three has the same storyline as the first two, I don’t see much in the way of a happy ending on the horizon. If this doesn’t work or get the desired result, then what? Do we keep going down the same path? I’m usually tolerant of the three strike rule but this isn’t like someone showing up late for work or something that only impacts the offender. This is a big deal since we have an entire country at stake.
I’m sorry if I’m being a Debbie Downer, but my disappointment levels are right there with Chuck. We’ve had the better part of four years to come up with a “Plan B” and the only thing that has significantly increased is the debt load. I was driving home Friday afternoon listening to the radio when a beer commercial aired and the disclaimer at the end said drink responsibly. Is it sad the only thing that popped into my head was “legislate responsibly”? Maybe someone can use that as their campaign slogan. Anyway, I need to move on. The currency market and the stock market bought the rumor and the fact, so both continued to party until close of business on Friday.
With that said, the QE3 punch bowl was big enough to wet the whistle of the Asian, European, and American trading sessions with plenty of leftovers still on hand. If we look back to the currency market in the months following parts 1 and 2, the dollar took quite a tumble and deservedly so. As Chris touched on, these measures are nothing but inflationary so supply and demand forces are currently at work. He also mentioned bond yields were on the rise, which is in direct conflict with its intended result, and I think that can be attributed to several reasons.
First, the Fed has put inflation concerns on the back burner so investors are being forced to seek higher yields elsewhere. In other words, the Fed said interest rates aren’t going higher for at least another 2 ½ years so if any upticks for inflation go unchecked, there’s a good chance we’ll see real rates in negative territory for quite a while. Not only that, the Fed action along with the ECB’s stimulus efforts have some calling for higher global growth so we had some “risk on” trading entering the picture. With the large amount of cash still sitting on the sidelines, any type of movement into risk assets, such as stocks or currencies, from treasuries should cause yields to rise. It’s just not a good combination right now.
The party honoring QE3 was so loud on Friday that we really couldn’t hear anything else. If we take a step outside where it’s quieter, we’ll see there was plenty to talk about with the US economic data. Let’s start with August CPI, which includes the cost of both goods and services. Well, consumer prices saw the biggest monthly gain since June 2009 and the annual figure increased to 1.7% from the previous reading of 1.4%. A majority of the rise can be attributed to higher gas prices, which the Labor Department said accounted for 80% of the increase, but what’s going to happen when we see higher food prices as a result of this summer’s drought.
Additionally, the table is being set for oil prices to continue rising, which incidentally touched $100 on Friday. Let’s take a look at some of the factors involved. First, we have the dollar falling and putting upward pressure not only on oil but most other commodities. Any inkling of increased growth, both domestically and globally, will tend to push oil prices higher, as consumption theoretically increases, so the Fed’s all-out blitz on tackling unemployment would look to provide support for higher prices if it succeeds. Then we have the Middle Eastern geopolitical issues to contend with here and there, so unless we see the stock market fall and investors make a mass exodus or growth slow even more, there isn’t much that would point toward depressed oil prices.
The US consumer is holding most of the cards and it’s not looking like a very good hand right now. We saw jobless claims increase last week, but price adjusted August average hourly earnings fell by 0.7% from July and was the biggest fall since June 2009, while real wages stalled out on an annual basis. With that said, let’s take a look at the August retail sales figure. From the outside, the results looked good as sales increased 0.9%, the largest rise in six months, but digging a little deeper didn’t yield the same result. First of all, we saw downward revisions to the July numbers in all categories, including a 0.2% reduction to the headline figure.
I usually go straight to the ex auto and gas figure to get a sense on discretionary spending, which I feel is the true pulse of consumer spending, and saw it fell to 0.1% from the downward revision of 0.8% in July. The core number, which is more stringent as it excludes auto sales, gas, and building materials, was even worse as it decreased to -0.1%. This figure is important since it’s the number factored into GDP, so not exactly the makings of a sustainable foundation. We do have the holiday season fast approaching so I’m sure we’ll see a pop in this figure, but the question now becomes how much. I’ve already seen some retailers advertising free layaway, but I think it’s going to take a lot more than that to entice the already pinched consumer.
If the price of sustainables — such as food, gas, and utilities — continue to rise or show no signs of easing, consumers will be faced with two choices since discretionary income will be squeezed. Either cut back or go into debt, and I’m sure you know how this will end. I veered off course there, but the meat and potatoes of it all remains without vehicle sales and spending more at the gas pump in August, it would have been a dismal month. I heard someone on the radio say that consumers can’t pull back forever, and I agree, but at the same time they need, not only jobs, but also sustained wage growth to get out there and spend. It’s a vicious circle that keeps coming back to employment.
Moving on, we saw yet another disappointment as August industrial production fell 1.2% and shouldn’t come as a surprise with manufacturing heading down the wrong side of the slope. While hurricane Isaac is thought to have reduced this figure by 0.3%, we’re still in the red. The previous report was revised down to 0.5%, so the month on month decline was the biggest since March 2009. Capacity utilization, which measures plant usage, fell to 78.2%. I saved the best for last, and I have to admit it came as a surprise, but I finally have something good to report, or so it would seem.
The first release of the U. of Michigan consumer confidence report blew the estimate out of the water, as it came in at 79.2 and was well above the expected result of 74. These confidence reports might as well be called The Monthly Investment Portfolio Value Gauge since it seems to closely follow the current stock market trend. It looks as though pre-crisis stock prices and a slight rise in home prices were way more than enough to offset rising gas prices and a lackluster trend in the labor market. Again, they didn’t ask me but I don’t share the same jubilation. Sure, it’s nice to see my investment statements rise in value and look on the internet to see my house is worth a little more, but what about the big picture. I guess we have to start somewhere.
It’s going to be a relatively quiet week for us in the data department as the only reports that have any real teeth will be August home sales. If we sprinkle in the usual weekly reports, some second tier economic data, and August leading indicators, that pretty much makes the week. The only thing on the docket for today is the September Empire (New York area) manufacturing report, which is expected to remain in negative territory. I think we’ll get a better idea of where things stand after the markets have a chance to sleep it off over the weekend with the distraction levels at a minimum throughout the week.
The currency market concluded last week on a high note as the euro (EUR) claimed the top spot with nearly a 2.5% gain. The only two currencies left in the dust were the Japanese yen (JPY) and South African rand (ZAR). There really aren’t many specifics to discuss with the currencies as their moves were a direct result of action taken by the ECB and the Fed. As I left the office to enjoy the weekend, the euro was firmly trading in the 1.31 handle and the Australian dollar has gained back most of the ground it lost over the past month. It seems like so long ago when the euro was trading toward 1.20 at the end of July and calls for its implosion were growing louder by the day.
That’s not to say we can’t revisit those levels as quickly as we left them, but the Fed’s action certainly has the attention of the markets right now and is at least giving European officials some breathing room to get things figured out. Euro-area inflation increased for the first time this year for the same reason it has everywhere, namely oil. The ECB is in the same boat as the Fed by taking expansionary measures and really no way to combat higher prices. But, their immediate goal of containing the peripheral nations’ bond yields has at least succeeded for the moment. The European debt crisis hadn’t come to a full boil when the first two legs of QE were introduced, so we may see focus shift back and forth between the Fed and ECB as we head into the new year.
The Canadian dollar (CAD) was one of the few currencies, albeit marginally, that ended the day in the loss column. We did see July factory sales fall to nearly a one-year low, so that didn’t help matters, but some investors feel it may have moved too fast and took some profits off the table. While it’s still trading above parity at $1.03, the government officials haven’t backed away from their hawkish overtones but traders have pushed back expectations of a rate hike until the third quarter of next year. If the price of oil remains in this area, the economy and the currency should continue to be well supported.
We also saw a revision made to second quarter GDP in Sweden that trimmed a full point, so we’re now looking at 1.3% growth instead of the original report of 2.3%. I guess the central bank knew something that we didn’t when they unexpectedly cut rates at the beginning of the month so the chatter is starting to pick up for a follow up in October. The Indian rupee (INR) was the big winner on Friday as it gained 2% on the day after officials took steps to help reduce the budget deficit. The current account deficit increased to a record level in the first quarter, so talk of another ratings downgrade has really put the currency in a tough spot this year.
As I came in this morning, the US dollar was marginally higher as concerns about Spain have reentered the minds of investors. It looks as though protests over additional austerity measures were enough to steal some of the spotlight and shift focus back to Europe. We also saw Spanish bailout talk heating up so questions as to whether they will or won’t need further assistance have returned to the markets and has caused anxiety level to be on the rise so far today.
To recap… The euphoria over QE3 remained in place on Friday and had total control over the markets, but what happens if this doesn’t work. Since the stimulus measure is inflationary by nature and investors felt more comfortable taking risk, the unintended consequence of higher Treasury yields were the immediate impact. We saw several economic reports on Friday yield disappointing results, which showed manufacturing continuing to slow and retail sales, at least on the discretionary level, come in well below expectations. Consumer confidence, on the other hand, showed a sharp increase. It’s going to be a quiet week in the data department and most of the currencies ended the week on a high note.