25 January 2012 at 15:28 GMT
As so many of us are all dizzy with bullishness on all of the latest good data and Apple earnings, lets remind ourselves of how the central bank QE game works when things appear to be going well.
No doubt about it – the economic numbers rolling in look great - especially out of the US of late, while those in Europe have merely shown a tentative stabilization and other issues are afoot in the EU – more on that further below. Back to the US – the good news is that growth was a healthy 3% in Q4, we’ve failed to see a drop-off in at least regional manufacturing and jobless claims numbers so far this year, Apple reported super-duper earnings, and housing market activity appears to be “surging”. (Though that surge is back to….what would have been considered catastrophic unprecedented lows if this were a pre-2008 environment – but more on that below.)
One key thing we must remember as we head into the FOMC meeting later today – markets have been enthusing about the strong data at the same time they are enthusing about the ECB’s success in administering an avalanche of LTRO liquidity and the supposed prospects for further QE from the Fed within months. But the grand irony here is the same as it was back in 2010: if the economy begins growing, the nominal increase in QE slows or stops and the government begins to ponder its balance sheet wounds. In other words , there are important structural “austerity headwinds” as our Chief Economist Steen Jakobsen calls them, any time things begin to turn up. (See
Steen’s Chronicle from a short while ago.)
So are we to believe that from these levels, it is time for the famous Tepper trade (to paraphrase: if economy is growing, great, stocks and asset prices will continue to soar, if not, great, because the Fed will bring on the liquidity gravy) or should we think more along the lines of mean reversion, i.e., that we’ve had a nice run here, but success will mean lower prospects of a further liquidity boost from the Fed and we’ll need to at least pull in the reins for a while on risk assets. As for today specifically, the brakes could be applied on risk if we see a very bland FOMC statement together with projections from some FOMC members that the economy will do so well that policy could begin seeing normalization by the end of next year.
Regarding those longer term Fed rates forecasts, the market by now knows that Fed forecasting of the economy is worse than bad, so it is more interested in the signals for the immediate future that will be contained in the actual refresh of the monetary policy statement. And there may be few hints of anything besides praise for the improvements in economic activity. And at the press conference, we may simply see Bernanke administering a pat on his own back. If that’s the case, we find out if this market has been gunning for stronger QE signals – if so, the adjustment lower could be rather rapid (USD higher, risk currencies hit hardest, USDJPY getting capped, etc…). If Bernanke and company, however, make stronger new commitments on liquidity than I expect, consolidation may await from higher levels.
Perspective on US housing
The latest monthly data for December showed housing starts still under an annualized 700k. The previous post 1959 low was about 800k in 1990. Adjusted for population, that would be closer to 1000k, so we still have to see starts grow another 50% to reach historic lows! Yes, of course it gives an idea of the potential upside (Yes, it is good news and yes, it will contribute positively to growth, but this is more a sign of normalization rather than a true resurgence. That normalization will take a decade or more as the entire mortgage market is still almost entirely a government sponsored enterprise in the US.
Chart: US Housing Starts adjusted for population
This puts the latest “surge” in the US housing activity in a bit of perspective as we adjusted historic data for population changes (to show the equivalent number of starts per capita, i.e., assuming population had been constant. Note that the data for 1960-1990 was interpolated because only once a decade numbers were available.) Is this good or bad? The chart merely shows that US housing activity is still incredibly low relative to the past 50 years adjusted for population growth. The good news is that the potential upside is very large if we are to work our way back toward historic norms. The bad news is that household formation in the US is negative as the baby boomer’s enter retirement and as the population ages. Also, the previous boom has yet to be fully absorbed and mortgage financing is still run almost entirely by the US government.
EU woes
Reality intruded yet again today for the EU. Despite the positive preliminary January PMI readings yesterday and a solid German IFO survey today, the Euro turned south once again as the market fretted Merkel’s rhetoric at an interview at the Davos World Economic Forum, in which we see signs that Merkel considers Greece a lost cause and the risk that the German dream of extensive intrusion on sovereignty with the new “fiscal compact” rules (the new EU sub-treaty that will supposedly be up for possible passage at the EU summit next week) is guaranteed to raise eyebrows if not protests all over the EU. See the
Guardian article from today that has received significant attention. While this speech was a blow to sentiment and the new attention Portugal is receiving on the potential need for a second bailout deal served as Euro negatives, other indicators failed to show consistent news signs of distress.
Other notes
USDJPY just teased the key 78.30 area today ahead of the FOMC meeting as Japan’s trade balance. If risk comes off and bonds rally, it’s tough to see any significant breakthrough today, but we’ll stay on our toes there. Elsewhere, the GBP survived a sell-off against the Euro despite an ugly GDP report and BoE minutes suggesting that inflation was set to fall sharply in the months ahead (personal note – as a local resident – I have to agree for the at least the short term as a significant supermarket pricing war has gotten underway lately that is seeing amazing deals for food shoppers). Still the GBP is weaker against the USD today and if the FOMC doesn’t deliver anything new, one has to wonder if this is the end of the sharp GBPUSD rally.
Stay careful out there.