This week was expected to be quiet before next week’s Fed meeting, but it has been anything but! Since last Friday’s jobs report, China reported a massive fall in exports, which shook the markets Monday night into Tuesday.
Thursday morning, the European Central Bank threw a desperation pass, cutting two key rates and increasing their version of QE by more than expected. Equities rebounded quickly but faded back not long after. Another Central Bank failure? We’ll see soon enough. Central banks are pulling out of the stops to stimulate economies. Investors are beginning to see the manipulations just aren’t working.
The audience is paying attention and we see that Central Banks don’t have any bullets left to fire. It may soon be the case that, it’s not a matter of “if” things get worse, but “when” things turn upside down.
Thanks to Dent Research, here is our weekly information roundup ending the week on March 11, 2016. We hope this information will help you separate the noise from the news. We start each subject with what you hear in the news and finish with what that information means to you.
The European Central Bank (ECB) Increased QE by 20 billion euros per month, and Lowered Interest Rates… In an unexpectedly strong move, the ECB increased its monthly bond buying from 60 billion euros to 80 billion euros, drove commercial deposit rates from minus 0.30% to minus 0.40%, and cut a main refinance rate from 0.05% to 0.00%. The central bank also widened the scope of debt it would buy to include investment grade, non-financial, euro-denominated corporate debt.
What it means – Failure is not an option, even if it is the reality. The ECB's stated goal is to create inflation, arguably by enticing borrowing and spending. Low interest rates didn’t make that happen, and then lower rates couldn’t do the trick either. Buying bonds so that banks had more cash didn’t generate much lending interest, and recently charging banks to hold balances hasn’t produced the desired results. So the ECB will do more of the same, hoping for different outcomes, which is never a good plan.
The eye-catcher in the ECB release is that the central bank will buy corporate bonds. This puts the bank on a slippery slope to ownership of private companies if any of the issuers default. That might sound unlikely, but two years ago so did $25 oil. Things happen.
For the moment, the upshot is that the ECB’s stronger, if not new, approach, won’t make a bit of difference.
The Fed Won’t Raise Rates Next Week… According to Jon Hilsenrath, the Wall Street Journal reporter and chosen mouthpiece of the Fed, the central bank will hold off raising rates this month, but will leave the door open for a for a hike in April or June.
What it means – Fed watching… It means more Fed watching, which I hate. There is no excuse for running the monetary policy of a nation based on monthly economic reports. Given that so much rides on Fed actions and intentions, their policies should be clear, well communicated, and long-term. I give the Fed Board of Governors credit, they want to be clear and they want to communicate, but their policies aren’t long-term. This leaves the financial sector waving in the wind every time the Fed meets.
First-Quarter Earnings Estimates Down 8.3%... At the start of the first quarter, analysts expected earnings of the companies in the S&P 500 companies to grow 0.3%. They now estimate earnings to fall 8.0%.
What it means – Every quarter, analysts start out with rosy projections and then spend the next three months dialing them back a bit. It’s normal to see earnings estimates drop by 3% or so over the course of a quarter. But, 8.0%? That’s pretty big.
If earnings do fall, it will be the fourth consecutive quarter of lower earnings, the worst stretch since the financial crisis. Amazingly, this is the “strong economy” that the rest of the world is counting on, and what Janet Yellen points to when discussing higher rates.
Ontario Considers Paying Basic Income… The Canadian province is planning to introduce a basic income program in place of other support programs.
What it means – Basic income usually means the modest amount a person or family needs to pay for food, housing, and health care. Ontario hasn’t fully outlined its proposal, but the gist of it seems to be scrapping subsidies and support programs and replacing them with a check. Several Northern European countries are trying this approach as well.
The extreme form of basic income, or Universal Basic Income, is to send every person cash with the stipulation that they spend it. Father Coughlin and Huey P. Long introduced this in the U.S. in the 1930s. It’s making a bit of a comeback today as people grapple with how to create demand. One way is to take away people’s fear of financial insecurity in the future. Of course, to send people money, you have to get it from somewhere.
In today’s low-interest rate environment, government borrowing is cheap. But it won’t always be that way. Putting such programs into place is easy; shutting them down when they get out of hand would be very difficult.
Oil Prices Reached $40 per Barrel… Even though oil inventory rose again this week to another record level, the price of oil jumped several percentage points mid-week.
What it means – U.S. oil inventory now sits at 520 million barrels, and that doesn’t include the Strategic Petroleum Reserve, which holds another 700 million barrels. But even with the added supply, prices jumped. There is some speculation about long-term short sellers covering positions, driving up the price a bit.
Time will tell if this is just a temporary move before prices turn lower since we still have too much supply and not enough demand. Even if the gains hold, it’s hard to see the price of oil moving up too quickly in the weeks and months ahead. If it does, expect a lot of frackers to crank up production!
One interesting note: when oil jumped over 4% on Wednesday, the equity markets didn’t follow suit. Perhaps that trade is losing its luster.
Japanese 10-year Government Bonds Traded at Minus 0.20%… After selling at a negative yield for the first time in history, Japanese 10-year bonds dropped further into negative territory.
What it means – Invest for 10 years and pay the government for the privilege. Brilliant! Of course, no one thinks this is a great deal, sustainable, or anything approaching normal. But with rates exceptionally low for so long, and now negative rates showing up around the world, this certainly could be the “new normal,” especially because none of it has yet translated into strong economic growth.
There might be a short pop in rates if the Fed raises rates in April or June, but it shouldn’t last long.
Chinese Foreign Reserves fall $29 billion in February… The outflow slowed substantially last month after dropping $118 billion in January, and more than $500 billion in 2015.
What it means – It’s not that fewer Chinese or foreign investors want to get their cash out, it’s just that the Chinese government has finally gotten serious about stopping the flow. Their foreign currency reserves have fallen from a peak of roughly $4 trillion to $3.2 trillion, putting a serious dent in their cash cushion, and they don’t like it. The government wants all the firepower it can muster to keep the Yuan in check. If foreign reserves fall too quickly, then the move toward the currency exit door will become a stampede and the value of the Yuan will plummet.
But where there’s a will, there’s a way. Consumers and business are still moving cash out of the country. One enterprising individual purchased a work of art in a foreign market using his credit card. That way, he’d get a local bill in Yuan, and then pay it in another currency. The cool part is the price of the piece — $170 million. I wonder if he got any cash-back rewards with that?
Chinese Government Will Allow Banks to Convert Non-Performing Loans to Equity… Reuters reported the Chinese government will announce the new policy in the next week.
What it means – If this is true, it’s a major step in the contraction of the Chinese financial system. When debt converts to equity, the bondholder loses his senior claim on assets as well as his stream of income. He also exchanges a normally low-volatility asset (a bond) for one that can be all over the map (a stock). Remember, banks use depositors’ cash to buy investments. What happens when they want their money back, but the stock investments have dropped in value? This isn’t idle speculation, since the banks are getting equity from companies that obviously can’t pay their bills.
Eventually, this all leads to a central bank or central government bailout. The big question – really, the only question – is how much non-performing debt exists? No one knows the answer yet.
Next Week – The week of March 14 includes reports on consumer prices and housing starts, but attention will be focused on central banks. The Bank of Japan will announce its policies on Monday, and the Federal Reserve announces on Wednesday.
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