Week Ahead: Monday 22nd – Friday 26th August
Last Monday the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite simultaneously closed out at fresh all-time highs for the second time in less than a week. At the end of 1999 the same occurrence marked the final stages of the “Dot Com” boom and a sharp sell-off soon followed. Last week the three major US indices were unable to build on early gains and effectively drifted in directionless trade.
In terms of significant economic events, it was Wednesday’s release of minutes from the Fed’s FOMC meeting in July which was most keenly anticipated. These were interpreted as being dovish as voting members of the FOMC (Federal Open Market Committee) said they wanted to wait for more data to provide evidence that the US economy is robust enough to weather another rate increase. However, what was particularly interesting was the divergence of views within the Fed. Esther George was the only voting member of the FOMC to want a rate hike in July. However, a number of non-voting members were against any further delay in tightening monetary policy. Some expressed concern that the current low interest rate environment is helping to destabilise markets as it pushes investors into riskier assets as they seek out a return on their investments. But voting FOMC members (ex-Esther George) felt a delay was in order saying that inflation (as measured by their preferred PCE measure) was still some way below the 2% target while there was still slack in the employment situation. In addition, they cited concerns over the economic fall-out from the Brexit vote together with worries about the Italian banking sector with its high level of non-performing loans.
In some respects the FOMC minutes are already old news. Since the 27th July meeting we’ve had the first look at US second quarter GDP (which was disappointing), the latest update on Non-Farm Payrolls (stronger than expected) and a poor retail sales number. From outside the US we’ve had the European Banking Authority Bank Stress Test Results (inconclusive as negative yields weren’t considered and Greek and Portuguese banks weren’t included) and a stack of Manufacturing and Services PMI updates from the US, the euro zone, China, Japan and UK (mixed). On top of this the Bank of England cut rates and restarted its Asset Purchase Facility, even adding corporate bonds into the mix while Japan announced fresh monetary and fiscal stimulus. We’ve also seen German GDP (declining), Japanese GDP (flat) and a number of inflation releases (mixed but benign).
But we also heard from a number of individual Federal Reserve members. At the beginning of last week San Francisco Fed President John Williams released a paper arguing that central banks may have to raise their inflation targets. This would lead to lower rates for longer. He also said that central banks should pay more attention to economic growth and push governments for more fiscal stimulus. The dollar fell sharply on the news. Then New York Fed President William Dudley claimed that "the market is complacent about the need to gradually hike rates and the time for a rate hike is edging closer." Later on, Atlanta Fed President Dennis Lockhart said that the US economy was probably strong enough to withstand at least one rate hike before the end of the year.
St Louis Fed President James Bullard countered this expressing his view that only one rate hike should occur over the next two years. However, John Williams shot straight back when he appeared to contradict the message from his paper and instead signalled his support for an interest rate hike in coming months. He said that waiting too long could be costly for the economy.
The Jackson Hole Economic symposium begins this Thursday when central bankers, finance ministers and economists get together to discuss the global economy. Fed chair Janet Yellen delivers a speech on Friday. While nobody expects her to say explicitly if the Fed is prepared to move in September, there are hopes that she will give some clear insight into the Fed’s thinking. This is a big speech for her. Dr Yellen has lost a lot of credibility amongst market participants recently as her public performances have lacked clarity and given her the appearance of a rabbit caught in the headlights. Hopefully she’ll turn this around later this week.
This week’s major economic releases include:
CAD Wholesale Sales; AUD CB Leading Index
JPY Flash Manufacturing PMI; CHF Trade Balance; EUR French, German and Euro zone Flash Manufacturing and Services PMIs, Euro zone Consumer Confidence; GBP Inflation Report Hearings, CBI Industrial Order Expectations; CNY CB Leading Index; USD Flash Manufacturing PMI, New Home Sales
AUD Construction Work Done; CHF UBS Consumption Indicator; EUR German Final GDP; GBP BBA Mortgage Approvals; USD Existing Home Sales, Crude Oil Inventories
AUD Private Capital Expenditure; EUR German Import Prices, German Ifo Business Climate; GBP CBI Realized Sales; USD Core Durable Goods Orders, Unemployment Claims, Flash Services PMI, Jackson Hole Symposium
JPY Tokyo Core CPI, National Core CPI; EUR GfK German Consumer Climate, M3 Money Supply, Private Loans; GBP Second Estimate GDP, Prelim Business Investment, Index of Services; USD Prelim GDP, Prelim GDP Price Index, Consumer Sentiment, Inflation Expectations, Jackson Hole Symposium
The second quarter earnings season is winding down now and last week brought a clutch of reports from major US retailers. Top amongst these was Wal-Mart. The world’s biggest retailer reported earnings per share of $1.07 on revenues of $120.85 billion against analysts’ estimates of $1.02 and $120.16 billion respectively. The company also raised its full-year outlook even as it expects to take a $0.05 per share hit from its pending acquisition of Jet.com. Same-store sales in the US grew 1.6%, which represented an increase from the first quarter's 1% growth and the biggest same-sales gain in four years. Customer numbers rose for the seventh consecutive quarter which shows that it’s far too early to write off this flag-bearer of “bricks and mortar” stores.
But rival retailer Target is having a tougher time. While earnings per share came in much better than expected ($1.23 versus $1.12) revenues were a touch light at $16.17 billion on expectations of $16.18. On top of this, Target repeated the pattern which has been so common over the last five quarters for S&P500 stocks. Revenues and earnings were both lower when compared to the same period last year. Also, comparable sales fell 1.1% during the three-month period. In contrast to Wal-Mart, Target saw a downturn in footfall. This last quarter marked the first time in eighteen months that fewer shoppers visited its stores. Again, unlike its biggest rival, the company lowered its guidance for the full year, citing what it characterized as a "difficult" retail environment.
Finally, retail home improvement company Lowe’s reported fiscal second-quarter earnings of $1.31 per share on $18.26 billion in revenue. Analysts had expected earnings of $1.42 a share on $18.44 billion in revenue. The company lowered its full-year guidance but this reflected its acquisition of Canadian retail company Rona, which was completed in May.
It is worth bearing in mind that US Retail Sales were pretty solid in the second quarter, but were flat in July – the first month of the third quarter. Without a pick-up, retailers may have a tougher time when they report again in three months’ time.
Meanwhile, FactSet Research point out that for the second quarter S&P500 companies are reporting a year-over-year decline in earnings of 3.5% and a fall in revenues of 0.2%. Analysts now expect revenue growth to return in the next quarter and earnings growth to return in the fourth quarter of 2016. Around ninety S&P500 companies have so far issued forward guidance. Of these, 69% have issued negative guidance which, FactSet point out, is below the 5-year average of 74%.
Commodity/ FX Outlook
Crude oil shot higher again last week, boosted by dollar weakness and ongoing speculation of an output freeze by major producers.
The current rally began earlier this month and so far there has been only one trading session since 3rd August when oil prices suffered a significant loss. Crude had fallen around 20% from its highs in June and there were a number of factors which contributed to the turnaround. Firstly, the short side of the trade had become very overcrowded as speculators piled on board hoping to see crude back below $30 per barrel as it was earlier this year. Secondly, WTI had effectively retraced 50% of its Feb-June rally so was technically set up for a rebound. Thirdly, the US dollar was in the process of pulling back from its post-Brexit highs as investors realised that the UK’s decision to leave the EU wasn’t as immediately disruptive as they imagined. On top of this, the political situation in the UK settled down as Theresa May replaced David Cameron as Prime Minister in a relatively seamless manner. Then the Bank of England cut rates and restarted its Asset Purchase Programme, adding corporate bonds into the mix. Finally, just to make sure the rally had enough strength to drive out all the speculative shorts, some OPEC members (Venezuela, Ecuador and Kuwait) renewed their calls for an output freeze.
Of course, it wasn’t long before analysts were reminding everyone how the production freeze meeting in April turned out. Major OPEC member Iran didn’t even attend and the event in Doha ended without agreement. In addition, given that the International Energy Agency estimates that the world is currently oversupplied by around 300,000 barrels per day, it would take a cut rather than a freeze to make any significant difference. Also, back in the day when OPEC operated as a cartel (rather than its present free-for-all) members would agree to quotas but then completely ignore them. Why should an agreement to freeze output be any different?
On the other side of the argument, Saudi Arabia's energy minister Khalid al-Falih said that producers would discuss rebalancing of oil market when they meet in Algeria next month. Then Alexander Novak, energy minister of non-OPEC member Russia, told a newspaper that he was consulting with Saudi Arabia and other producers to achieve stability in the oil market. But perhaps the icing on the cake is that Saudi Arabia just hit a fresh record production level – perhaps ramping up output ahead of agreeing to a freeze. At the same time, OPEC output has also hit a record high of 33 million barrels a day.
Gold made solid gains early in the week and got a lift from weakness in the US dollar. The greenback sold off sharply after San Francisco Fed President John Williams released a paper calling for (amongst other things) the Federal Reserve to consider raising its inflation target, effectively implying lower interest rates for longer. Investors immediately interpreted this as suggesting the US central bank would keep rates on hold through to December at the earliest, so taking next month’s meeting out of the reckoning. Wednesday’s FOMC minutes from the July meeting were also dovish. With just one exception, the other nine voting members of the committee all expressed their wish to keep rates on hold until more economic data came through. They also expressed concern over the possible negative economic effects of the Brexit vote and the instability of Italian banks which are saddled with around €360 billion of non-performing loans. All this helped to lift gold although silver struggled throughout the week.
Then on Friday both precious metals sold off hard, with silver suffering particularly badly. The main reason was the recovery in the dollar which bounced back following further comments from FOMC members. On Thursday New York Fed President Bill Dudley suggested a September rate hike was still a possibility. This followed his comments from earlier in the week when he said "the market is complacent about the need to gradually hike rates and the time for a rate hike is edging closer." Atlanta Fed President Dennis Lockhart appeared to concur when he said that the US economy was probably strong enough to withstand at least one rate hike before the end of the year. Then John Williams appeared to backtrack from the views expressed in his paper when he joined Dudley in support of a rate hike in the coming months. Dallas Fed President Robert Kaplan and St Louis Fed President Jim Bullard were less hawkish. However, investors were placing more weight on the doves and this led to a rebound in the dollar. The prospect of higher US interest rates tends to weigh on gold and silver as investors seek out assets that offer a yield rather than the uncertainty of a capital gain. It also boosts the dollar which makes dollar-denominated commodities such as gold and silver more expensive to buy for non-dollar holders.
The US dollar managed to put in a half-decent rally on Friday. However, the greenback still ended the week sharply lower last week and traded back around levels last seen ahead of the UK referendum on EU membership. The Dollar Index came within a few ticks of 94.00 – a level which acted as support throughout 2015 while the EURUSD closed in on resistance around the 1.1400 area. But perhaps the most significant move came in the USDJPY which broke below 100.00 on a number of occasions. This is a particular concern for Japanese policymakers who are desperate to push the yen lower to keep the currency competitive. A stronger yen is a real problem for Japan’s manufacturers who rely so heavily on overseas sales. Not only that but this latest rally comes after the Bank of Japan (BOJ) announced further monetary stimulus at the end of July and after Prime Minister Shinzo Abe unveiled details of a 28 trillion yen ($280 billion) package of fiscal stimulus. The yen fell around 6% following this double dose of stimulus but it has since made back all these losses. There’s no doubt that investors were disappointed by both the size and scope of the monetary and fiscal package. However, last week it was overall dollar weakness which really did the damage.
The initial trigger for the sell-off in the greenback was the publication of a paper by San Francisco Fed President John Williams. In it Mr Williams said that central banks and governments must come up with new policies to protect their economies against persistently low interest rates which threaten to make future recessions deeper and more difficult to avoid. Such policies could include raising inflation rate targets and setting up government spending programs which would automatically kick in during economic downturns. Mr Williams suggested raising the Fed's 2% preferred inflation target or replacing this by focusing on nominal GDP instead.
But later in the week Mr Williams joined Bill Dudley and Dennis Lockhart when he appeared to back calls for a rate hike in September. Mr Williams said the central bank should raise rates "sooner rather than later" given domestic economic momentum. While Mr Williams is not a voting member of the FOMC this year, he is known to have the ear of Fed chairman Janet Yellen. As a consequence he’s taken seriously by market participants.
But we’ve been here before. The Fed seems determined to keep September “live” as a potential stage for hiking rates and this is helping to keep a floor under the dollar for now. But there still seems little chance of the US central bank tightening monetary policy before December – no matter what Fed members say to the contrary. The US central bank really isn’t in a hurry to risk a market disruption (like the one that followed its rate hike at the end of last year) just ahead of the US Presidential Election in November. Maybe we’ll know more after Janet Yellen delivers her Jackson Hole speech later this week.
David: The Jackson Hole Economic symposium begins this Thursday when central bankers, finance ministers and economists get together to discuss the global economy.
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