Up and Down Wall Street
When the Fed’s Bullard Speaks, the Market Listens
The St. Louis Fed chief’s words can push shares up…or down, as they did last week. Also, the coming trouble in China.
By Randall W. Forsyth
They had been at 152 basis points on Feb. 17, when he cautioned against rate hikes.
Those low odds seem justified by persistently tepid gross-domestic-product growth. The GDPNow tracking model from the Atlanta Fed was lowered last week to a real annual rate of just 1.4%, about half the estimate in early February, and no better than the revised final fourth-quarter GDP report released on Friday.
Is it a bull market or a bear market? Or maybe just a Bullard market?
That is, as in James Bullard, the president of the Federal Reserve Bank of St. Louis. Not only is he among the voters this year on the policy setting Federal Open Market Committee, he is also perhaps the most vocal member of the panel’s adjunct, the Federal Open Mouth Committee.
While many members of the FOMC (however defined) seem eager to air their views in many venues, Bullard appears to be the Fed’s version of Chuck Schumer. It’s well known in Washington that the most dangerous spot is any place between a microphone and the senior senator from New York, famous for letting nobody stand in the way of his endless quest for media exposure.
In his habit of speaking early and often, Bullard has developed a nearly unequaled ability to move markets, which was on display last week. In various appearances, he suggested that the central bank’s next interest-rate increase could come as soon as the FOMC’s meeting on April 26 and 27.
That should be a statement of the obvious, since that’s what the Fed’s solons will be gathering to decide. But it is decidedly against the odds put down in the futures market and contrary to the expectation of virtually every Fed watcher.
No press conference is scheduled following the April confab; despite Fed Chair Janet Yellen’s insistence that every meeting is live, and that a conference call with the media could be done on the spot, the suspicion remains that the panel wouldn’t move without a regular presser. More importantly, economic data remain sufficiently ambiguous to delay a rate boost.
Bullard’s point last week was that the conditions that let the FOMC make its long-awaited initial increase in its short-term interest-rate target in December—to 0.25%-0.5%, 25 basis points (a quarter-percentage point) above the near-zero level where it had been held for seven years since the dark days of the financial crisis—were present. That is, unemployment had met the Fed’s target, at just under 5%, while inflation was closing in on the central bank’s goal of 2%.
But that was far different from what the St. Louis Fed chief was saying just last month. On Feb. 17, he contended in a speech that it would be “unwise to continue a normalization strategy”—read, rate hikes—while inflation expectations were declining.
So, in five weeks, Bullard has gone from arguing to hold off on higher interest rates, as the FOMC opted to do at the March 15 and 16 meeting, to putting them on the table as soon as next month.
What has changed so radically in that span?
The market-based measure of inflation forecasts did advance. According to the St. Louis Fed’s own charting, five-year forward inflation expectations (derived from the spread on Treasury inflation protected securities, or TIPS, versus regular Treasury notes) did tick up to 172 basis points on Wednesday, when Bullard made his comments to the New York Association for Business Economics.
That’s a mere 20-basis-point uptick over that span, and 30 basis points from the low touched on Feb. 11. Arguably, what has really changed since then has been the stock market, which rallied sharply, with the Standard & Poor’s 500 index jumping more than 12% above its February low to last week’s peak. After Bullard made his comments on Wednesday, stocks retreated in tandem with a renewed slide in crude-oil prices and a pop in the dollar, ending their five-week winning streak.
In that period, the world’s central banks all got on board with accommodative policies: Interest rates plumbed deeper into negative territory, the European Central Bank expanded its stimulus, and the Fed stepped back from its previous timetable of four rate hikes in 2016. The last suggestion helped spur the 11% correction from the end of 2015 through February, amid the ongoing slide in oil, a toxic deflationary combination.
This was far from Bullard’s first market-moving flip-flop. In October 2014, as stocks were sliding ahead of the well-advertised end of the Fed’s quantitative-easing program, Bullard suggested that the central bank could continue its bond purchases, again citing too-low inflation expectations. On the date of those comments, Oct. 16, the S&P 500 made its lows, and went on to rally some 14% to its peak last May.
The circumstantial evidence also suggests that Bullard’s comments coincided with swings in stocks as much as inflation expectations. With the S&P 500 having mostly corrected its early-year correction, if you will, and the index solidly north of 2000, the St. Louis Fed head adopted a hawkish tone. But he was distinctly dovish when the S&P 500 was in retreat in the low 1800s, most recently in February and previously in October 2014.
This doesn’t suggest that the Fed is explicitly targeting the stock market. The causality arguably runs in the other direction. Expectations of more rate hikes result in a stronger dollar; weaker prices for crude oil and other commodities; a flatter yield curve—all disinflationary indicators—and retreats in risk assets, such as high-yield bonds and equities. When rate-increase expectations subside, those markets reverse.
At this point, the federal-funds futures market is definitively pricing in only one 25-basis-point hike this year, with odds of 60% by September and 73% by December, according to Bloomberg. For April, when Bullard thinks an increase should be considered, the futures market’s probability is just 6%.
Bullard seems to be the most visible telltale of the shifting winds of Fed expectations. Investors navigating the choppy waters of the financial markets are forced to change tacks accordingly.
CHINA IS ANOTHER MARKET that has rebounded with the help of the authorities. But, according to Anne Stevenson-Yang, it amounts to a “dead-panda bounce.”
The Chinese stock market and its currency, the renminbi or yuan, have firmed in tandem with the rosier hue taken on by markets around the globe. But in the case of China’s equity and property markets, she writes in a report to clients of J Capital Research, “the root of nearly every part of the ‘rebound’ story is cash stoking an asset bubble, and that will not last long. It does suggest a degree of political panic.”
For now, the authorities are attempting to portray confidence. Curbs on margin lending and short-selling, two big culprits in last year’s market debacle, are being eased. Moreover, the yuan has been guided subtly higher by the People’s Bank of China this year, albeit against a weaker dollar, following last August’s sudden decline.
There has been a robust bounce in property speculation that Stevenson-Yang says is being likened to that of the stock market at its frenetic peak last year. Behind it is a stunning surge in government-backed lending to smaller banks and nonbank financial institutions that, in the first two months of this year, equaled almost half of China’s reported GDP for 2015, or 36 trillion renminbi—more than $5 trillion. In the past four months, lending by those institutions has exceeded all of last year’s GDP by RMB20 trillion.
“Leverage is the only idea left in the Chinese government, and is reaching truly suicidal levels,” she contends.
The financial pumping supports the “unrelenting jawboning from the top about the strength of the economy,” Stevenson-Yang continues. While she concedes that her forecast of a further weakening of the yuan—to 6.80 to the dollar versus the current 6.51—has been off the mark, she says that delaying the needed adjustments will worsen their cost and potential severity.
But capital flight—from both Communist Party elites and more modest families seeking to build wealth pools and income streams abroad, as well as attempts to acquire foreign companies, such as agribusiness giant SyngentaHOT in Your Value Your Change Short position (HOT)—puts Chinese monetary authorities in a box. Pumping liquidity into the domestic economy further weakens the yuan. To counter that, the central bank sells dollars to meet the demand for foreign currency, which tightens domestic liquidity.
The easiest way to sort out this conflict would be to let the yuan continue to fall. That has been the biggest bet by hedge funds this year, and it has been Beijing’s aim to make the hedgies lose that wager.
But, to reiterate, burning the fingers of the yuan short sellers runs counter to the authorities’ attempt to pump liquidity into the domestic market. Which means that the effect of the Chinese authorities’ efforts to manipulate their currency has been to boost it artificially, not to drive it lower, as a certain U.S. presidential candidate insists.
Indeed, Stevenson-Yang says that Beijing may have to end the already-limited convertibility of the yuan to stanch capital flight. She claims that the $130 billion decline in currency reserves in January and February was a “manipulated number,” to the downside, a figure that, like so much of China’s data, is uncorroborated.
And when the numbers and sums no longer can be juggled, the poor panda may come back down with a thud.