The Week Ahead: Eyes on the Fed. Don't expect much.
Politics took a back seat last week and Central Bankers took center stage again. The Fed continues to make it clear that if they see positive growth measures, they will hike in March (the Fed meets this week). In our view, growth metrics do not convince. We see reasonable job numbers (see below) but ISM labor conditions, the trade deficit, consumer credit and inventories continue to point to more of this so-so recovery. So, on balance surprises more to the downside than upside.
Stocks tracked sideways last week. They’re down 1.2% from their peak a few weeks ago but still up 5% this year. International and Emerging Markets continue to hold their gains, with a strong showing in Germany. And the long bond yield climbed about 12bps. There seems to be resistance to rise much above 2.6% for any sustained period. We think for most of this year we will trade in a range 2.4% to 2.8%.
1. Talking of Central Bank speak: the European Central Bank stood firm on rates and indicated it is not likely to ease further. The chart shows the policy rate at 0% even though inflation in the Eurozone climbed to a cyclical high of 2%.
The ECB has a tough job mainly because tying together the needs of Germany, Italy, France and Spain (the big 4) is a compromise exercise. Inflation in Germany is around 0.2% but in France and Italy more like 1.5%. Then there’s the base effect of low gasoline prices a year ago putting upward pressure on prices (a similar story in the U.S.) so they have to work on the harmonized ex-food and energy prices. Put it all together and we’re likely to see easy money for a while, which is one reason (along with some decent earnings), we like European stocks right now. And just to be clear, European stocks have a large financial weighting at around 23% compared to the S&P 500 at 15%. Any (yes, any) upward change in rates will send those financials sharply higher.
2. We have to talk jobs: Friday’s job report was likely to be better than recent months if for no other reason that March numbers have come in higher than expected in four of the last five years. Here’s the chart:
So, this is what we know. The labor force continues to grow by around 1.1m or 0.7%. It grew by 340,000 last month. Non-Farm payrolls grew 227,000 (so not enough to absorb new entrants) and 2.2m in the last 12 months. So far so OK. But wage growth barely moved (it’s that creeping yellow line at the bottom) and most of the job growth (but not this one it must be said) is in low paying jobs like retail and leisure, which are 21% of the labor force. Again, put all this together, and we think this so-so recovery will run. Yes, it’s in its seventh year but it has barely broken a sweat in that time and trundles along at a less than inspiring 2%.
3. And so to bonds: Treasuries traded better on the jobs numbers, so the 227,000 number was priced in. We'd argue that the lower revisions to Q1 GDP ( the Atlanta Fed is particularly good at this) the low earnings number and absence of inflation make bonds a reasonable bet. Yes, front-end rates can rise but the following can mitigate a bond sell off: high real rates, more issuance of longer dated Treasuries, credit spread compression and lower term premiums. So bond bears can write their doomsday plays, we stick to the facts.
We came across an interesting chart the other day and recreate it here:
It shows the growth of Federal Debt and the 10-Year Treasury note. The suspension of the debt ceiling in 2015 meant the Federal Debt grew at around 5%, spiking in October 2016. There is a good fit with the 10-Year Treasury, which ratcheted up back in 2010 and again recently. So if debt growth tapers off, we may have seen a near-term peak in rates.
The longer the health care debate continues, the longer the delay of any stimulus package. The market expects something so stocks may just hit the snooze button for now. We have not had a serious correction in months and volatility is weirdly absent. Not saying it’s coming but, you know, eerie.
--Christian Thwaites, Brouwer & Janachowski, LLC
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All charts from Factset unless otherwise noted.