There is a lot of uncertainty on how Brexit will play out. The UK government is now rudderless, as is the main opposition party. Technically, it appears that the UK government does not have to follow through on Brexit or could call another referendum. But, both possibilities are said to be long shots. This uncertainty is clearly a negative for global stocks and for Sterling and the Euro. But, all the markets can shift suddenly if there are any developments that clarify the situation.
There are three consequences of the situation that deserve attention:
1. The drop in the British Pound shows that the UK was benefiting from being a part of the EU. British people were able to buy imports at lower prices when the Pound was being pulled up by its association with the EU. Being a part of the EU gave the UK benefits, such as ease of access to other markets. Ending this association means the UK has to work harder to maintain the same standard of living as before. The drop in the Pound boosts import prices, thereby lifting inflation and depressing UK purchasing power and real incomes. The drop in the Pound should eventually lift exports and cut imports, but this entails increased UK production. So, the UK has to work harder to get back to the same level of real spending as before.
2. The desire to restrict immigration -- apparently important to those who voted for Brexit -- would be another channel boosting inflation. A smaller labor force should result in higher wages, which would likely be passed through to prices.
3. The loss in purchasing power from higher import prices will likely hurt lower-income UK people -- who voted for Brexit -- more than higher-income people, as the former likely spend a greater share of their income on imported goods than do the latter.
These consequences would likely follow any shift away from globalization in the US, as well. While much political rhetoric in the US focuses on job losses stemming from trade agreements, there is little, if any, mention of the resulting lower prices and increased purchasing power, which benefit everyone.
Sunday, June 26, 2016
Sunday, June 19, 2016
Yellen and Brexit
The two key events this week -- Yellen's "Humphrey-Hawkins Testimony" and the Brexit vote -- should not be a problem for the stock market. But, Treasuries -- particularly longer-term maturities -- risk being sold.
Yellen's Testimony
1. Yellen's H-H Testimony typically follows the message from the prior FOMC Statement, in this case June's. The June Statement and projections effectively implied a slight easing, as the forward guidance moved toward only one rate hike this year. So, her testimony should be benign with regard to monetary policy. This would be a positive for stocks, but should steepen the Treasury yield curve.
2. To be sure, the Fed also lowered its forecast of GDP Growth over the next couple of years. This, in principle, is not a positive for stocks but is a positive for Treasuries. However, the Fed's economic forecasts have not been reliable and thus its latest view is of little significance except to the extent that it convinces the Fed not to tighten in the next few months. In particular, Yellen still should signal a very gradual approach to tightening even if her current "downside risk" -- Brexit -- is eliminated in the vote.
Brexit Vote
1. If Brexit is voted down, then there is no question of it being a positive for stocks -- unless stocks have fully reversed their earlier Brexit-fear sell-off by then: a buy the rumor/sell the fact phenomenon. But, the window for new highs into July remains intact (as predicted in my May 8 blog).
2. If Brexit is approved, there are two reasons why any knee-jerk sell-off in stocks should be bought: /1/ Central Banks will likely ease to counter market reactions, as indicated by Bank of Italy President Viscio in the press. /2/ Negative fall-out on the UK economy or contagion effects on other European countries will likely take a few years to show up. So, they can be ignored short term.
Yellen's Testimony
1. Yellen's H-H Testimony typically follows the message from the prior FOMC Statement, in this case June's. The June Statement and projections effectively implied a slight easing, as the forward guidance moved toward only one rate hike this year. So, her testimony should be benign with regard to monetary policy. This would be a positive for stocks, but should steepen the Treasury yield curve.
2. To be sure, the Fed also lowered its forecast of GDP Growth over the next couple of years. This, in principle, is not a positive for stocks but is a positive for Treasuries. However, the Fed's economic forecasts have not been reliable and thus its latest view is of little significance except to the extent that it convinces the Fed not to tighten in the next few months. In particular, Yellen still should signal a very gradual approach to tightening even if her current "downside risk" -- Brexit -- is eliminated in the vote.
Brexit Vote
1. If Brexit is voted down, then there is no question of it being a positive for stocks -- unless stocks have fully reversed their earlier Brexit-fear sell-off by then: a buy the rumor/sell the fact phenomenon. But, the window for new highs into July remains intact (as predicted in my May 8 blog).
2. If Brexit is approved, there are two reasons why any knee-jerk sell-off in stocks should be bought: /1/ Central Banks will likely ease to counter market reactions, as indicated by Bank of Italy President Viscio in the press. /2/ Negative fall-out on the UK economy or contagion effects on other European countries will likely take a few years to show up. So, they can be ignored short term.
Thursday, June 9, 2016
Less Than Meets the Eye in Today's Claims Data
Today's Claims data came in stronger than consensus, but I would not conclude that they offer much guidance on whether economic growth is picking up. And, it is still likely that next week's FOMC Statement will drop the comment that "labor market conditions have improved further." But, Fed hawks should still be pushing for rate hikes ahead.
1. Seasonal factors may not have correctly adjusted for Memorial Day, which was in the week. This appears to be particularly a concern regarding the very large 76k w/w drop in Continuing Claims. Typically, a large drop in Continuing in a holiday week is followed by a sizable rebound in the following week.
2. The -4k w/w decline in Initial Claims to 264k brings them back to the relatively tight 260-264k range (of monthly averages) seen from February through April. To be sure, Initial Claims start June below the 277k May average. The latter could have been boosted by the Verizon strike. Or, they could have reflected some slowdown in the economy that month, which today's Claims data would suggest is over.
Both the Atlanta Fed and NY Fed's Nowcasting Models are projecting about 2.5% (q/q, saar) for Q2 Real GDP Growth, while the NY Fed model predicts 2+% growth in Q316 as well. These projections are in line with the Fed's goal and be above what is likely a very low pace of potential growth (1.0-1.7%). So, Fed hawks should still be pushing for rate hikes ahead.
1. Seasonal factors may not have correctly adjusted for Memorial Day, which was in the week. This appears to be particularly a concern regarding the very large 76k w/w drop in Continuing Claims. Typically, a large drop in Continuing in a holiday week is followed by a sizable rebound in the following week.
2. The -4k w/w decline in Initial Claims to 264k brings them back to the relatively tight 260-264k range (of monthly averages) seen from February through April. To be sure, Initial Claims start June below the 277k May average. The latter could have been boosted by the Verizon strike. Or, they could have reflected some slowdown in the economy that month, which today's Claims data would suggest is over.
Both the Atlanta Fed and NY Fed's Nowcasting Models are projecting about 2.5% (q/q, saar) for Q2 Real GDP Growth, while the NY Fed model predicts 2+% growth in Q316 as well. These projections are in line with the Fed's goal and be above what is likely a very low pace of potential growth (1.0-1.7%). So, Fed hawks should still be pushing for rate hikes ahead.
Friday, June 3, 2016
Weak May Job Growth -- Soft Economic Growth or Catch-Up?
The question for the Fed and markets is whether the weak April-May Payroll growth reflects soft economic growth in Q216 or just catch-up to the strong job growth seen in Q116. It is probably a combination of both:
1. The job growth in Q126 was excessive relative to the 0.8% Q1 Real GDP Growth, so the weak job growth in April-May could have just brought the level of jobs better in line with the level of GDP -- and this weak job growth understates Q2 GDP Growth.
2. But, there are other reasons to think that the expected pickup in Q2 GDP Growth will be only modest. So, the Fed may very well be on hold until after the November elections.
If economic growth were, in fact, as weak as the job growth suggests, the Unemployment Rate should have risen. Instead, the Unemployment Rate dropped to 4.7% from 5.0%. While the drop in the Rate resulted from a drop in Labor Force, this could have reflected a quirk of the small Household Sample Size. So, while many Street Economists will likely dismiss the drop as reflecting discouraged workers, this may not be the case. The broader measure of unemployment -- U-6 -- was unchanged m/m at 9.7%.
That said, the pickup in Q2 Real GDP Growth may very well disappoint the Fed's expectations for it. The April FOMC Minutes showed that the Fed staff lifted their forecast for Q2 Real GDP after admitting that Q1 GDP appeared to have come in weaker than expected. This improved outlook for Q2 GDP got support from some strong April economic data, which had led to the Atlanta Fed's GDP Model projecting 2.9% (q/q, saar) for Q2 Real GDP. However, the model lowered its projection to 2.5% after Wednesday's reported drop in April Construction Spending. And, I think that May Retail Sales --Total, Ex Auto and Ex Auto/Ex Gasoline -- (due June 14 -- also the first day of the 2-day FOMC Meeting) could be weak, as well, based on some anecdotal evidence from retailers. So, I would not be surprised if the Atlanta Fed Model's projection is cut again. With Q1 GDP Growth of 0.8%, the H116 Real GDP Growth would be under the Fed's target of 2.0%.
If Q2 GDP Growth disappoints, the message from the sluggish growth since Q415 would be that the underlying momentum in the economy is lower than the Fed believes. It would probably be a mistake for the Fed staff to push ahead stronger growth, as it did after the weak Q1 GDP, particularly since uncertainty over the November Presidential Election could weigh on business and household spending decisions in Q316. So, a Fed rate hike may not happen before the elections.
1. The job growth in Q126 was excessive relative to the 0.8% Q1 Real GDP Growth, so the weak job growth in April-May could have just brought the level of jobs better in line with the level of GDP -- and this weak job growth understates Q2 GDP Growth.
2. But, there are other reasons to think that the expected pickup in Q2 GDP Growth will be only modest. So, the Fed may very well be on hold until after the November elections.
If economic growth were, in fact, as weak as the job growth suggests, the Unemployment Rate should have risen. Instead, the Unemployment Rate dropped to 4.7% from 5.0%. While the drop in the Rate resulted from a drop in Labor Force, this could have reflected a quirk of the small Household Sample Size. So, while many Street Economists will likely dismiss the drop as reflecting discouraged workers, this may not be the case. The broader measure of unemployment -- U-6 -- was unchanged m/m at 9.7%.
That said, the pickup in Q2 Real GDP Growth may very well disappoint the Fed's expectations for it. The April FOMC Minutes showed that the Fed staff lifted their forecast for Q2 Real GDP after admitting that Q1 GDP appeared to have come in weaker than expected. This improved outlook for Q2 GDP got support from some strong April economic data, which had led to the Atlanta Fed's GDP Model projecting 2.9% (q/q, saar) for Q2 Real GDP. However, the model lowered its projection to 2.5% after Wednesday's reported drop in April Construction Spending. And, I think that May Retail Sales --Total, Ex Auto and Ex Auto/Ex Gasoline -- (due June 14 -- also the first day of the 2-day FOMC Meeting) could be weak, as well, based on some anecdotal evidence from retailers. So, I would not be surprised if the Atlanta Fed Model's projection is cut again. With Q1 GDP Growth of 0.8%, the H116 Real GDP Growth would be under the Fed's target of 2.0%.
If Q2 GDP Growth disappoints, the message from the sluggish growth since Q415 would be that the underlying momentum in the economy is lower than the Fed believes. It would probably be a mistake for the Fed staff to push ahead stronger growth, as it did after the weak Q1 GDP, particularly since uncertainty over the November Presidential Election could weigh on business and household spending decisions in Q316. So, a Fed rate hike may not happen before the elections.
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