In a classic example of ‘buy the rumor, sell the fact’, weak economic data that the equities had managed to ignore as they anticipated a successful outcome to the Greek Parliament confidence vote seems to have finally caught up with them this morning. However, that was to be expected, as there are still many aspects of the Greek debt deferral situation which need to be implemented (not the least of which is their approval of the next austerity program by next week) prior to the major stressor of the equities being fully mitigated. And as the equities move forward, it will become more apparent that defraying any worsening of the European Debt-Dilemma doesn’t really do much for the global economy. Greece might present a significant financial risk, but its direct economic impact is minuscule.
In fact, fiscal reform in the US should really begin to bite sometime soon, as it will be advanced as part of any US debt ceiling increase deal. That and the cooling in previous strong sister economies like India and especially China will mean much more than Greece not defaulting for now. And while we do not believe the FOMC statement or Mr. Bernanke’s press conference will present much risk to the equities, there is always an outside chance of a mistake; either of expression or inference. It’s all about ‘transitory’ and ‘accommodation’.
The last time a Fed influence was extremely pernicious for equities goes back to the extended trading at the top of the rally in May 2008. In that case it was the much less than accommodative FOMC minutes released on May 21, 2008. [For more historic background on that and other cases see our May 18th “Tick, Tick, Tick… Minutes Count...” posting on the importance of the BoE and FOMC minutes back at that time.]
In this case we have the luxury of the immediate expansion of whatever the FOMC statement tells us through Mr. Bernanke’s extended expression of policy and its practical application at the press conference. In the two aspects which are going to be most interesting to the press and financial markets are what he has to say about the likely duration of the extended ‘accommodation’ which the Fed has been applying so far, and the degree to which it still believes what are now significant inflationary tendencies remain ‘transitory’. To the degree that he wants to continue the former, he must also still be very pointed that the latter is also still the case.
While the chances of there being any QE3 as QE2 is winding down are very remote (even the biggest Doves allow there is a very high bar), the degree to which the Fed can take other measures is apparent. Undoubtedly during the press conference today there will be several aspects of that discussed, which some have referred to as ‘QE-lite‘. However, we suppose it is only fair that the Fed is not going to take any dramatic steps to shrink its balance sheet while the key US housing and employment drags on the economy remain troubling for the central bank as well as the political class.
On the other hand, quite a few factors are pointing toward the degree to which inflationary impacts are not really all that transitory. In fact there has been quite a bit of sentiment among the general public and politicians (if not the financial powers that be) that the next person who uses the term ‘transitory’ should be taken out and shot. It is all fine and good for the economic analysts to consider that the duration of the impact of things like energy prices have been relatively brief in terms of the broader economic cycle. Yet, for the folks who are suffering with the grassroots impact of sustained elevated energy prices, it just seems to remain very bad for much longer than they would like.
As an example, consider that the recent average cost for a family that spent little more than $200 to fill up the tank for a month one year ago had jumped to $370 in recent weeks. While the recent softening of crude oil prices has allowed the US price at the pump to drift back down from roughly $4.00 per gallon to $3.70 per gallon, that has not really provided much relief for the consumer; especially compared to a price at the pump that was little more than $2.00 per gallon a year ago.
And that factor has also impacted the price of all goods across-the-board through a couple of different avenues. The first, and most obvious, is the degree to which higher transportation costs for everything on the store shelf is also creating additional pressure on the average consumers’ discretionary spending. Yet there are even more pernicious factors at work in other areas. Those include the degree to which petroleum products are a major component of agricultural fertilizer, which has duly also jumped in price. That will be a drag on the grain and soya production which underlies so much else of the pricing of agricultural products that filters down to the consumer level.
All of which is compounded by an additional factor which has a significant impact on headline consumer inflation. [And just to be clear, headline inflation is indeed what affects consumer spending. "Ex-food and energy" may seem like a great statistical smoothing tool, but will only be truly relevant once the average consumer stops heating and cooling their home, traveling, or consuming any food.] On the current cycle that factor has also been exacerbated by the extreme weather in the US. We are referring of course to the near doubling of the price of corn since last summer. Due to the degree to which that is a primary input in red meat production, it creates a disincentive for farmers to maintain (much less expand) red meat production. With meat prices already high in the supermarket cooler, there is certainly no way an extension of that component of inflation can be considered ‘transitory’ in any way.
EXTENDED MARKET IMPLICATIONS
So the real question becomes whether Mr. Bernanke finally comes around to allowing that a good bit of the allegedly ‘transitory’ inflation factors are actually considerably more entrenched than he would like to allow. That might prove a real mistake for the equity markets, as it might weaken the credibility of his ostensible commitment to continued accommodation at a time when the US economy does indeed remain weak. And insofar as many of the Hawks would like to see something done about the inflation, it must be allowed that it is significantly supply driven, and not the more pernicious demand-pull variety. The latter would only be likely in a scenario where a broad wage-price spiral had taken hold; and he would be right to presume that’s not likely in a US economy which is still burdened by very weak employment.
On the assumption he will indeed remain ‘accommodative’ and continue to characterize the inflation factors as transitory (based upon supply driven high prices ultimately curtailing demand), the equity markets will likely appreciate what he has to say. Any digression into concern that inflation factors are becoming more entrenched, and the Fed may have to do something about that sooner than not would obviously have the opposite effect. As such, we suspect the recent strength of equities that has allowed the September S&P 500 future to ratchet back above the 1,274-69 interim technical support is likely to continue (allowing for a hostage to fortune in the form of any further untoward influences out of the current Greek debt crisis.)
And as noted in yesterday’s TrendView Brief Update (http://bit.ly/igHtML), as it has already traded down near the important 1,250 area mid-March lows the current rally may carry well beyond the next immediate resistance in the 1290-88 area. Please see that analysis for further considerations on how high the market might get on this recovery rally; even if that is likely just another upside reaction as part of building a broader top, reinforced by the global economic factors noted above.
Of course, that would also mean that the long dated government bonds can likely come back under pressure, especially if there is any reversal of the economic data that includes some sort of good news. There is also the prospect of the normally upbeat equities influence attendant to the beginning of earnings season. It is especially of note that into yesterday’s June T-note future expiration the September T-note future traded at no better than the lead contract 124-08/-16 resistance, and has recently been unable to post a daily close back above 124-00. In spite of the recent week economic data, if equities should continue higher in the near term, it will likely represent a drag on any significant further improvement in long-dated government bond prices as well as short money forwards.
That also leaves the US dollar and commodities significantly influenced by the equities decision. Of late the US dollar has returned to its normal counterpoint tendency to the equities and firmed up when equities are under pressure. That becomes more important now with the US Dollar Index having failed back up around its critical .7580 resistance, and the EUR/USD having held down into its 1.4100-1.4000 support. That said, it is important to keep in mind that the full Tolerance of that support is not until the 1.3900 area; and also that EUR/USD is not really out to the upside again unless it pushes through 1.4500-1.4600.
Thanks for your interest.