By Everett Millman, head content writer at Gainesville Coins, a leading gold and silver distributor.
ABSRACT: After the prolonged losing streak for U.S. stocks extended into this week, the equity markets turned around by midweek and wiped out their steep losses to begin 2015. The precious metals surged in response to stock market weakness on Monday and Tuesday, yet were steady even as paper assets recovered and Treasuries eased by week’s end.
GOVERNMENT & POLICY
Data-Driven? Another Broken Promise
On Wednesday, the minutes from December’s meeting of the Federal Reserve Open Market Committee (FOMC) had the rather predictable effect of bolstering the stock markets in the U.S., which had–equally predictably–plunged in back-to-back sessions leading up to the release of the meeting minutes. With a solid retail showing this holiday season and seemingly ever-improving economic conditions Stateside, it would appear the markets became antsy ahead of the FOMC transcript. Perhaps market participants expected the Fed to take its most hawkish position on monetary policy since the financial crisis. With the available data, you can’t blame them for thinking so.
But, of course, the meeting minutes revealed not a hawkish Fed, but one that doesn’t anticipate the first interest rate hike to come before April. The dovish tenor of this committee consensus aside–and Wall Street eats up anything remotely dovish–this flies in the face of Chair Yellen’s concern that the FOMC ought to be careful not to feed the markets calendar-based forward guidance. The last time the Fed raised rates, about a decade ago, it was very clear about the timing and nature of its incremental increases to the federal funds rate. Consequently, speculators were able to game the markets ahead of Fed announcements.
Especially after Yellen’s adamance in recent press conferences that the committee will be “data-driven” in its decisions about how to best steer the economy, the “no-changes-before-April” declaration seems to be a harbinger that history is doomed to repeat itself. See, if the Fed was truly to be data-driven, then its hand would be forced rather soon: U3 unemployment is now at 5.6%, very close to the Fed’s 5.2%-5.5% range for “full employment,” and though inflation remains low, manufacturing and consumer spending are helping move the economy along.
With falling oil prices dragging down inflation further, and the stock markets responding more to the pulse of the FOMC than to the real economy, the Fed is likely to remain as dovish as ever to keep stock indices chugging along. Tightening policy “too soon” would risk setting off an equities sell-off; when stocks went on a 5-day losing streak that bled into the beginning of this week, investor funds poured into Treasuries at an alarming pace. Save for some divine moment of clarity, expect Yellen and the Fed to eschew their own warnings in favor of Wall Street, basically recreating the dicey circumstances of 2007-2008.
Stocks Undulate, Dollar Dominates
U.S. stock indices went on a roller coaster ride this week, albeit a rather unimaginative one. Continuing last week’s trend, all three major indices sank by about 1.8% on Monday, with the Dow Jones shedding over 300 points. This marked the biggest single-day loss for U.S. equities in 3 months. Although CNN jokingly suggested that is was a bad “case of the Mondays,” the slide continued into Tuesday at a more moderate pace. Meantime, precious metals advanced, with gold adding about $35 over two trading days despite WTI crude oil dropping below $50/bbl. With the outflow from stocks, 10-year Treasuries saw significant safe haven flight, driving yields lower for the 8th consecutive day, the longest such streak in more than 2 years. By midweek, the 10-year T-note yield fell as low as 1.95%.
The dollar surged throughout the week, rising above 92.0 on the DXY index (a 9-year high) while the euro continued to drop. The purchasing parity between the two leading world currencies fell below $1.20 per euro for the first time in nearly a decade. The strength of the dollar has hidden gold’s performance, as the yellow metal touched €1,030/oz, its highest pricing in euros since September 2013. For context, over the course of 2014, gold was up more than 11% in both euros and yen.
Wednesday’s market activity was largely overshadowed by the horrific terror attacks on French satirical magazine Charlie Hebdo, but stocks nonetheless began to reverse direction while the precious metals were largely flat. The Dow Jones, S&P 500, and Nasdaq each added about 1.25%. WTI crude actually rose about 1.75% even though Brent crude closed slightly in the red, bringing the spread between the two benchmarks closer together as energy demand wanes in Europe. This of course boosted the dollar, as the USD and oil prices have an almost perfect inverse correlation. On Thursday, stocks jumped even more sharply, with the Dow adding over 300 points to erase nearly all of its 2015 losses. The precious metals held their price positions before advancing moderately on Friday. In spite of an otherwise strong non-farm payrolls report, the stock markets tracked slightly lower in Friday trading due to poor wage growth numbers: December saw a 0.2% decline in wages, while November’s 0.4% gain was revised downward to 0.2%. Treasury yields finally eased, settling back above 2.0%.
GEOPOLITICS & WORLD EVENTS
For Now, U.S. Stands Apart From Struggling World Economy
Little by little, economic conditions seem to be improving here in the States. No, they haven’t yet returned to “normal,” pre-crisis conditions, and there is plenty of room for improvement; but in a relative sense, the widening chasm between the U.S. and the rest of the world is startling. Too startling to merely be a product of the Bureau of Labor Statistics possessing better book-cooking skills than its international counterparts. Let’s be honest, every country manipulates its economic data as best they can; the diverging paths of the U.S. economy and those abroad cannot be accounted for by our superiority at fudging the numbers. (This author would posit that China probably wins that contest, anyway.)
It’s clear that sinking oil prices have an important role to play in this divergence of macroeconomic fortunes. Yet, the far-reaching ramifications of cheap oil notwithstanding, this is not what triggered the current fork between the U.S. and the rest of the world. It has certainly exacerbated it, and is a symptom of it, but waning global demand for energy was a development that was coming down the proverbial pipe irrespective of the outcomes it produced. There’s simply no getting around supply and demand.
So, what is it? Why is the U.S. faring so much better than the rest of the field, its rivals and partners alike? Perhaps that is best answered with another question: Why do investment outflows from emerging markets during periods of uncertainty invariably end up back in dollar-denominated assets? Well, that’s because the USD is the world’s reserve currency, and just about every central bank on the planet holds dollars. The dollar is trusted–many consider it “as good as gold.” The dollar has been consistently climbing as of late, meaning other currencies are in decline relative to the greenback. This is the grand “Currency Wars” strategy outlined by James Rickards, a race to the bottom in order to gain a competitive advantage on exports.
For the moment, the dollar is robust. In fact, it gained against all 31 of its peers in 2014. (Interestingly enough, gold was actually 2014’s second-best performing “currency.”) Yet, a firm dollar means U.S. exports are expensive and not competitive, instead encouraging ever-more imports with the added purchasing power of the U.S. dollar (thus ballooning the trade deficit). This tradeoff is not sustainable, especially not within the evolving model for a healthy, globally integrated economy. This means that the economic chasm that this column opened with is going to be transient: it’s only here because the rest of the world is struggling. Greece is approaching a fiscal crisis that threatens to spread to the rest of southern Europe: Italy, Spain, and Portugal, in particular. This kind of contagion, a potential domino effect, is really already taking place. Consumer prices are falling across Europe, and several of the Eurozone’s more stable countries are seeing their bonds approach negative yields. Elsewhere, Japan continues to cling to Abenomics despite its apparent failure, and even China is expected to implement monetary stimulus to combat a slowing economy. In short, conditions appear good in the States because of weakness around the rest of the world combined with the dollar’s unique role in global finance. If the USD’s position as reserve currency is ever challenged, this whole house of cards will come tumbling down rather quickly. Consider where you want to keep your money when, not if, the day comes.
A LOOK AHEAD: Next week is littered with new economic data, especially at the end of the week: the Producer Price Index (PPI) for Final Demand comes out Thursday along with the previous week’s jobless claims. On Friday, the Consumer Price Index (CPI), consumer sentiment gauge, and industrial production numbers will all be released.