Two big themes dominate: Yellen's speech and oil prices

Outlook:

We get some fresh data today, but two big themes will probably dominate Yellen’s speech at the NY Economic Club and oil prices. Speaking at a conference in Singapore ahead of Yellen, San Francisco Fed Pres Williams said “there is some upside risk that inflation could hit the Fed's target sooner, but more data is needed to make a convincing assessment,” according to Reuters. He also said the US economy is on track for gradual rate hikes and “fears over the impact of a slowing global economy and bouts of financial volatility are overdone.”

It would seem Yellen cannot avoid commenting on the split between the more cautious FOMC and her five hawks (not all of whom are voters). If she doesn’t volunteer a comment, someone is sure to ask. Our best guess is that this is not the venue or the timing for Yellen to show any doubts about delay. Everyone will be watching the wires all the same.

The other big story bigger, probably is the Bloomberg story quoting Barclays on a looming commodity price crash as traders rush for the exits. The Bloomberg story is the splashy one but Reuters and the WSJ have similar stories quoting other big-name analysts. And they all say the same thing commodities in general and oil in particular have rallied this quarter more than is justified by the fundamentals. Copper can fall to the low $4,000 (from almost $5000 last week) and oil can fall to the low $30’s.

“Commodities rebounded from a more than 25-year low in January amid speculation that prices may now be bottoming after they lost 11 percent in the final three months of 2015 and 14 percent in the third quarter. Oil and copper have recovered from the multi-year lows seen in the January and February, and Barclays estimated net flows into commodity products totaled more than $20 billion in the two-month period in the strongest start to a year since 2011. ‘Given that recent price appreciation does not seem to be very well founded in improving fundamentals, and that upward trends may prove difficult to sustain, the risk is growing that any setback will result in a rush for the exits that could again lead commodity prices to overshoot to the downside.’”

For oil, Barclays sees Brent at $36 in Q2 and $40-43 in the second half. Oh, dear. This implies a stock market slump. It also implies a slowdown in the rise in inflation in the few places that have any inflation, chiefly the US. This presumably puts the Fed on hold even longer. See the Bloomberg chart of core PCE. Looks promising but the trajectory can flop.

And let’s consider the level of commitment of the oil producers for the output freeze. The Saudi central bank reported net foreign assets fell 17.3% y/y in Feb, the lowest since May 2012. The WSJ reports “The central bank, which acts as Saudi Arabia's sovereign wealth fund, has been drawing down its assets to cover a huge state budget deficit caused by low oil prices.” First, “net foreign assets” must include a large portion of US Treasuries. Second, we have been hearing about Saudi budget woes for some time, including stories about new borrowing to replace oil revenues. We don’t know how to evaluate the degree of crisis but we do know, or think we know, that the change in policy from preserving market share to stabilizing prices is a giant change.

At a guess, the output freeze is a done deal and despite signals long in advance, the oil gang will still profess surprise when it comes an announcement effect. We don’t know what else the Freeze Gang is going to propose. If we assume that Barclays is right about the natural course of oil and other commodity prices returning to a saner link to fundamentals but probably going overboard, as usual we could be in for some unhappy surprises. In other words, freezing output at one level or another is not the only trick up the Saudi sleeve. It’s the opening gambit.

Oh, good. Two of the biggest influences on western financial markets arise from Communist China and from a country ruled by 7th century ideas.

And underlying it all is the relative impotence of central banks, considered to have run out of stimulative tools and to be running on fumes (whatever Draghi says about having plenty of tools left). No central bank is more beleaguered by this charge than the Bank of Japan, which has tried everything under the sun and still failed to goose the Japanese economy. The Nikkei news reports that after the fiscal first quarter data is in and around the time of the G7 meeting in Japan on May 26-27, Abe is likely to put for-ward another supplemental budget and delay the April 2017 sales tax hike.

The new stimulus initiatives may “include ‘premium’ shopping vouchers worth more than their face value, child care vouchers and cash handouts. To tackle the shortage of nursery schools, Abe will call for a 4%, or 12,000 yen, increase in monthly pay for those working at nursery schools, including a raise already implemented. The package may also include public works projects, such as land improvements to strengthen farm infrastructure, renewing aging roads and bridges, upgrading ports to welcome cruise ships and building facilities for magnetic-levitation trains.”

In other words, helicopter money. Now contrast desperation in Japan with a comment by a BMO Capital Markets analyst to Market News: "A growing chorus of relatively centrist officials (Harker, Williams, Bullard and Lockhart), along with several hawks (George, Lacker and Mester), are leaning toward an April move, though they might face resistance from the core FOMC (Yellen, Fischer and Dudley), which continues to worry about the economy's lack of momentum."

No wonder Fed chief Yellen is in a state of conflict. Her own team sees the US economy recovering enough for normalization but the rest of the world, aka the eurozone and Japan are in dire straits. Does this mean policy paralysis? Well, the Fed gets a respite if the Barclays’ views on oil are correct. A drop in oil prices and then stabilization near $40-43 can be viewed as delaying the rise of inflation in the US. Yellen may be willing to get behind the curve on inflation, especially if the Fed’s economists see inflation as calming down because of oil. Here we go again we wish the Fed would come right out and disclose what they think about the relationship between oil and inflation, something it is weirdly unwilling to do. That leaves the rest of us speculating wildly.

We speculate that Yellen will bow down to conditions elsewhere, including Japan and its plan for helicopter money, and signal the usual “lower for longer.” The stock market will like that. Dollar holders will not. Postponement of a widening differential is a big, fat dollar-negative.