Equity markets have given a fairly resounding response to Janet Yellen’s comments last night and the response has been positive. Sharp gains across the board on European indices have followed her indication that most of the FOMC felt that a 2015 rate hike would be appropriate. There was a decisively negative response to the recent FOMC statement and Yellen’s press conference in which the Fed opted to focus far more on the international developments in preventing a rate hike. This concerning development resulted in a flight out of risk (ie equities lower) and into safer havens such as Treasuries. This move is now reversing. But where does this now leave us? Could there be some dark clouds on the horizon as Yellen seems to be preparing the market for a December rate hike?
The German DAX is up 2.8% today, FTSE 100 is up 2.5% and the French CAC 40 is leading the way up 3.2%. As I write this, only one constituent of all three of Europe’s major indices is trading lower, and that is Randgold Resources, which is a gold miner on the FTSE 100 (FYI gold is down sharply today).
With Yellen saying that the Fed is likely to hike at some stage before the end of the year (and also that the path of rate rises would be shallow) this may seem somewhat counter intuitive to a positive environment for equities which have been driven for so long by the accommodative monetary policy of the Federal Reserve. However it would appear that from the sharp selling pressure on markets in the wake of last week’s FOMC meeting, and the subsequent bull reaction today, it is all about one precious market factor, confidence.
Clearly the message being sent out is that equity markets would be happy if the Fed started to normalize monetary policy as it sends out a signal to the world that the US is ready to move away from the emergency rates that were necessary to combat the financial crisis. I would imagine there will be volatility around the time of the rate hike, but ultimately it should be seen as a positive move.
Yellen’s comments could be seen as preparing the market for a hike, after expectations had been perhaps taken too far the other way in the wake of the FOMC meeting. Currently the fund funds futures are pricing a rate hike by the December meeting at around 40% which would suggest the market is not anticipating one yet. So the reaction to her perhaps laying the groundwork has been positive for risk. Perhaps the market was too quick to dismiss December for the path of normalization?
This all sounds great. However, there is also a counter view to this which I heard in the run up to the September FOMC decision last week that I dismissed at the time, but now perhaps should be given some thought. Maybe the Fed needs to begin to start raising rates because it knows that the next economic downturn may not be too far in the future? This is a rather cynical view, but I have been looking at the regional Fed surveys that at a series of recent data releases which do not make for happy reading.
The regional Fed surveys are seen as lead indicators for the broader economy. Five of the recent regional Fed surveys have been negative with many worse than expected:
- Kansas City Fed at -8 and this remains very negative which it has been throughout this year.
- Richmond Fed at -5 was a big miss of the +4 reading that had been expected and is the worst figure since early 2014.
- Philly Fed fell to -6 which was the worst since February 2014
- New York Fed fell to -14.7 having been expected to have been just -0.5 and this is now the worst two months since 2009
- Dallas Fed fell to -15.8 having been expected to be -4.8 and this remains extremely negative.
In aggregate these are very weak signals. Readings below zero reflect below average periods of growth for the regions but also less inflationary pressures. This does not paint a particularly positive picture of the US economy going forward. It also suggests that there is still little inflationary pressure in the system, so the Fed would not be tightening in order to combat rising inflation, that’s for sure. The Fed tightening rates in a low inflation environment suggest real interest rates going up. One instrument that certainly would not be performing well with rising real interest rates, is gold…
Here are the charts below which do not make happy viewing…