Weekend Update March 20

ABSTRACT: The markets were subdued early in the week but started to move after the Federal Reserve’s announcement on Wednesday afternoon after a two-day meeting. The precious metals rallied in response and moved into the green by week’s end. Treasuries saw fresh demand while stocks were volatile throughout the week.

GOVERNMENT & POLICY

Selling On Yellen

The biggest factor that moved the needle of the markets this week was undoubtedly “Fed Day” on Wednesday, when Federal Reserve Chair Janet Yellen gave her press conference following the FOMC’s announcement from this week’s meetings. Initially, the tenor of the Fed statement seemed relatively hawkish: the committee chose to remove “patient” from its forward guidance, opting instead for a meeting-by-meeting approach to foreshadowing when the central bank will finally begin to raise interest rates.

As Wednesday afternoon progressed, however, it became clear that the markets had interpreted Yellen’s subsequent clarification of the committee’s stance to be decidedly dovish. Not unlike the last time the FOMC released a statement after its January meeting, investors have been left to wonder whether the Fed is serious about hiking rates as soon as June, or if it is merely trying to keep everyone guessing while they hold off longer on normalizing monetary policy.

Gold, stocks, and bonds all spiked in the U.S. following Yellen’s press conference. Meantime, the dollar pulled back from its recent surge, which may have been exactly what the Fed was hoping for. The stronger the dollar is, the harder it is to justify raising rates too soon because it could lead to a runaway rally for the USD. This would eat into export revenues for American corporations even further, allowing the easy money stimulus programs in Europe, Japan, and elsewhere to continue to erode U.S. competitiveness on the international markets.

It’s interesting to note that the Fed and its principal mouthpiece, Chair Yellen, are very shrewd about quietly resetting their near-term indicators for a full economic recovery. At the beginning of the Fed’s taper off of QE, the FOMC suggested that the unemployment level would not be an overarching factor in its decisions, choosing instead to use the inflation rate as the preferred metric to target. Well, after 33 consecutive months of sub-2% inflation–held down recently by the plunge in oil prices–and headline unemployment (the U3 measure) squarely within the Fed’s target of 5.5% when seasonally adjusted, it would seem that the Fed could solve its disinflation conundrum by simply writing off the measure as unimportant to its decisions.

Economic trends are admittedly more complicated to predict or affect than where the Fed chooses to place its attention, but there is definitely some irony at play in all of this. Where the Fed directs its attention is, by extension, where the markets tend to set their own sights. In this manner, it doesn’t ultimately matter whether the FOMC is right or wrong in its analysis and forward guidance; as long as they are the focal point of investors’ strategies, they can effectively manipulate market behavior with these kinds of hawkish-yet-dovish (or vice versa) set-ups. 

Don’t get me wrong–it’s perfectly reasonable to develop trading and investing strategies based on where one expects Fed policy to go. Just keep in mind that the FOMC is well aware of the influence its signals have on the markets, and it uses this knowledge accordingly. For my money, I’d much rather play the skeptic and the cynic than play the fool.

MARKETS

King Dollar Finally Pulls Back

The U.S. markets–and global forex trading, for that matter–have been defined by the strength of the U.S. dollar for much of 2015. The greenback finally eased its foot off the petal this week after surpassing 100.0 on the DXY dollar spot index last Friday. This easing helped lift the precious metals from their prolonged slump while equities and bonds were more volatile.

Monday saw stocks jump, as the Dow Jones added over 200 points and all three U.S. indices advanced about 1.3%. Fortunes reversed on Tuesday as stocks pulled back, while the precious metals slid for the second straight day. Platinum sank to a fresh 5-and-½-year low, while the palladium price cratered some $40 after showing considerable resilience in prior weeks.

Wednesday, however, was the big moving day. After both U.S. and European markets were rather anxious leading up to the Federal Reserve’s announcement, the statement by Fed Chair Janet Yellen was seen as dovish: gold, stocks, and bonds each rallied. The Dow Industrials again rose by more than 200 points, passing back above the 18,000 mark, while all indices were up about 1%. Gold jumped 2% while silver advanced about 3%, climbing back above $16/oz.

After the Fed announcement, the euro surged from a low of $1.06 to $1.10 before easing up. The USD came back to earth, falling to about 98.5 on the DXY index. This marked the worst week for the dollar since 2013, while the euro enjoyed its best week in 18 months.

U.S. equities kept up the volatility on Thursday, slipping back into the red. Though the S&P 500 and the DJIA were both markedly lower, the Nasdaq proved stronger by poking its nose just into positive territory, approaching a new all-time high. Thursday was also the beginning of the frenzied sporting event known as “March Madness,” college basketball’s championship tournament, which is estimated to cost U.S. employers billions in lost worker productivity as they follow the action over the next few weeks.

In Europe, stocks were on the rise again on Friday after Greek Prime Minister Tsipras vowed to speed along the country’s proposed reforms to satisfy their Eurozone creditors, who are meeting in Brussels this week and Berlin next week. The tepid optimism was much-needed, as the Greek government could quite literally run out of money by the end of the month if it does not receive its next scheduled bailout loan disbursement, which the EU is tethering to the aforementioned reforms. While it’s clear the Greek situation is far from “risk-off” as it currently stands, Europe’s broad Stoxx 600 index hovered less than 1% shy of its all-time high (set back in 2000) on Friday.

In Asia, Japan’s stock market keeps chugging along. A weak yen has spurred 6 consecutive months of export growth as Japanese firms undercut their competitors with relatively cheaper prices. The solid export data, especially in the smartphone gaming industry, has helped push the Nikkei 225 index above 19,500 after it was trading below 17,000 for stretches in January. Nintendo shares spiked over 20% on Tuesday, reaching their daily limit on the Nikkei. The benchmark stock index has risen nearly 35% since mid-October.

Japan is also now essentially in parity with China as the United States’ biggest creditor after the latter began dumping U.S. Treasuries in earnest over the last year. (Both countries hold about $1.239 trillion in government debt.) Nonetheless, U.S. bonds have been surging of late, with yields on 10-year notes dropping from over 2.0% to as low as 1.91% this week. By Friday afternoon, 10-year yields were right around 1.95%.

Friday was also the “quadruple witching” of expiries in U.S. markets: stock index futures, stock index options, stock options and single stock futures. This convergence of expiries typically leads to increased volume and volatility on the markets, as traders’ positions must be closed out or rolled over. U.S. indices were each about 1% higher by midday. Meantime, the beleaguered crude oil benchmarks rose on Friday afternoon, with WTI a whopping 4% higher above $45/bbl and Brent advancing about 2% to north of $55/bbl.

GEOPOLITICS & WORLD EVENTS

Partners Spurn U.S. For China

U.S. officials have been futilely warning their partners in Europe and abroad not to join the soon-to-be Asian Infrastructure Investment Bank (AIIB), as this marks a clear break from the U.S.-dominated IMF and World Bank. In addition to EU leaders such as the U.K., France, and Germany, both Switzerland and Australia have also indicated that they will join the Chinese-led AIIB. This is seen as an even greater challenge to Western hegemony in the financial sector than the BRICS partnership between Brazil, Russia, India, China, and South Africa; leaders from the U.S. have been couching their concerns about the incipient AIIB in the potential for lax governance and environmental ethics on the part of China.

Going For Gold

Even with the scrapping of India’s 80:20 rule for gold imports, whereby those who brought gold into the country were required to re-export 20% of it, the retention of the country’s steep import duties on gold have kept premia on physical bullion high. Gold premia are at their highest levels of 2015 in Mumbai, encouraging continued gold smuggling into India through its neighbors in the region.

Ireland’s Finance Minister, Michael Noonan, made headlines this week when the public record of his current investment holdings showed that the Irish FM had dumped European shares from his portfolio in favor of buying gold. Though stocks in Europe have actually been rising, Noonan’s move speaks to the uncertainty surrounding the global economy.

A LOOK AHEAD: Next week gets off to a quick start with existing U.S. home sales and the Chicago Fed National Activity index being announced. Across the pond, the CBI industrial trends survey comes out in the U.K., and flash consumer confidence numbers from the EU also come out. In Asia, Japan and China will both release their respective Flash PMI manufacturing indices.

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