Saturday, May 31, 2014

Blah news is good news...

Below are yesterday's important economic indicators: the actual reading, the consensus forecast, and my view of what each means in terms of Fed policy going forward.

The month over month (MoM) Personal Consumption Expenditures (PCE) Price Index (this is what the Fed looks at instead of CPI as an inflation gauge): +0.2%. Forecast: +0.2%. Signal: Inflation remains tame. Fed implications: Supports present interest rate policy.

Personal Spending (MoM): -0.1%. Forecast: +0.2%. Signal: Consumers are hanging onto their cash, doesn't bode well for Q2 GDP. Fed Implications: Supports present interest rate policy.

Chicago Purchasing Managers Index (PMI): 65.5. Expectation: 61. Signal: Manufacturing activity in the Chicago region is picking up. A reading above 50 signifies expansion. 65.5 is the second highest reading (67 in October '13) since November 2011. Fed Implications: Could, if the trend is higher going forward, inspire the Fed to, at a minimum, attempt to normalize interest rates.

The University of Michigan Consumer Sentiment Index: 81.9. Forecast 82.5. Signal: The consumer feels relatively positive about the future, but not quite as much as anticipated. Fed Implications: Could, if the trend is higher going forward, inspire the Fed to, at a minimum, attempt to normalize interest rates.

I was originally thinking that I'd highlight the entire week's published indicators, however, in the interest of your time and attention I decided I'd stick with Friday's. Plus, Friday's published data represent precisely what I've been seeing of late, which is a very mixed economic picture. Whether it's what I listed above, or durable goods orders that came in a little better than expected last Tuesday, or the revised GDP number that showed a, albeit expected, .1% contraction in the weather-torn first quarter, suffice it say that---while when I dig deep, I can find glimmers of growth, and potential inflation---there's really nothing remarkable (one way of the other) about the state of the economy, at least from what I can glean from the indicators. And, frankly, that's been very good news for the stock market.

That's right, a blah economy keeps traders very much engaged. Why? Why would blah news be good news? Because, clearly, traders remain fixated on the Fed---which is why I added "Fed implications" above. You see, traders love an easy money Fed. It keeps short-term interest rates low and, presumably, liquidity high. The bullish trader's favorite term since the spring of '09 has been "the Bernanke put (insert "Yellen" today). A put option is a contract a speculator can purchase that guarantees the sales price of a security (for a limited period). To say that the market is benefitting from the "Yellen put", is to assume the Fed will step in with both barrels should some exogenous surprise hit the market. This, by the way, in my view, has not been the primary driver of equity prices these past five years, and by no means will the Fed be able to circumvent the next major correction/bear market. In fact, the longer we go with subpar growth amid easy Fed policy, the more the efficacy of all its machinations gets called into question. I.e., the law of diminishing returns surely, over time, diminishes the Fed's reputation.

Those last sentences, by the way, are not entirely lost on today's trader. I do believe we are finally past the bad news is good news scenario. I submit that if the data were truly bad, traders---seeing that Fed policy isn't "working"---would sell this market. So-so news, on the other hand, means we're moving forward, but at a pace tepid enough to keep the Fed supportive.

As for yours truly, I say the Fed, and, more importantly, the economy, would be well-served if it would call an immediate end to its monthly bond purchases (QE) and begin gradually bumping up short-term interest rates. Make no mistake, the market would welcome such abrupt action like you would a root canal, but the idea of allowing the bond market to find its equilibrium sooner than later, and allowing for the unwinding of whatever asset price distortions have resulted from all this thin-air money creation would be, long-term, the healthiest thing.

However, alas, that's not about to happen. The Fed, when it finally does begin to tighten, will do so in the most gingerly fashion. We can only hope that some monster inflation isn't lurking somewhere under the indicators just waiting to spring up when least expected. For, with all due respect, I don't know that this Fed has the political will to truly tackle what will have been its very own Frankenstein.

That last paragraph said, I'm not seeing anything in the numbers that yet hints of extreme inflation risk. Which partly explains why the bond market has, to my surprise, been so stubbornly strong of late....

Stay tuned...

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