The US economy squeezed by 32.9% annualized in the second quarter and jobless claims are worryingly high. Will the dollar continue falling? Where next for stocks? And how does everything fit in with politics? Joseph Trevisani and Yohay Elam thrash out the data, what the Federal Reserve can and cannot do, and what to look for in hot summer in markets.
Yohay Elam: The US economy fell by 32.9% annualized, better than expected but a historic collapse nonetheless. The dollar is marginally lower, and stocks seem calm. Is all the bad news priced in?
Joseph Trevisani: All the bad news from the second quarter yes, but there is plenty of potential for new bad news ahead. Witness the initial claims for the last two weeks.
Yohay Elam: Indeed, perhaps the minor market reaction is related to the increase in claims? Continuing claims are up above 17 million in the week ending July 17, when Non-Farm Payrolls surveys were held.
Joseph Trevisani: We are back in the Covid waiting room, or as I put it yesterday..doing the Covid limbo.
Yohay Elam: The virus is the boss.
Joseph Trevisani: How low can rates or the economy go?
Yohay Elam: The Federal Reserve clearly rejected negative interest rates, and reporters stopped asking about it. But long-term rates...
Joseph Trevisani: As Powell until people feel secure going about all their normal activities the economy will not fully recover. They said nothing about Y2C, but it is the next logical step.
Yohay Elam: He committed to more action without revealing anything. Seemingly hiding behind the upcoming policy review. Can we expect something big in Jackson Hole?
Joseph Trevisani: Yes, but he has been promising that all along. A specific target on longer-term rates is a major policy innovation. It put the Fed in control of the yield curve, rather profound economic implication. Think of the times where the Fed was going one way or on hold with rates and the credit markets were headed in another. The bond market is usually right.
Yohay Elam: Ten-year yields are at 0.544% at the time of our conversation. Depressed.
Joseph Trevisani: Think of Jean Claude Trichet and the ECB raising rate just before the financial crisis.
Yohay Elam: Not the best policy move in the history of central banking...
Joseph Trevisani: Yes just ahead of the 0.498% record low from March. Perhaps not.
Yohay Elam: The Fed could hint about the next moves in Jackson Hole and act in September, but perhaps bonds are already going that way. Markets are doing the Fed's work. Powell stressed that the Fed has lending but not spending powers, one of the comments nudging politicians to act. Is he waiting for elected officials to act, and therefore holding his cards close to the chest?
Joseph Trevisani: Perhaps, but I think the Fed is waiting to see where the economy goes.
Yohay Elam: Powell mentioned high-frequency data. Is he waiting for the Non-Farm Payrolls?
Joseph Trevisani: If the Fed institutes Y2C, ---do you think that will catch on?--it assumes a vast amount of responsibility for the economy. I think a bit of humility may be striking the FOMC.
Yohay Elam: Powell and his colleagues must be looking to Japan. The BOJ is running yield curve control for several years. In addition to negative rates.
Joseph Trevisani: Yes...not a great example of success.
Yohay Elam: Japanese inflation is going nowhere fast. Indeed.
Joseph Trevisani: Nothing in Japan is going anywhere fast except the population..which is doing down. Japan is a negative example.
Yohay Elam: Perhaps the Fed would be more efficient lending more money to local and state governments, lowering their borrowing costs? The federal government's borrowing costs are already at rock bottom
Joseph Trevisani: It seems the locals are not lining up to borrow.
Yohay Elam: Are there any other tools in the Fed's shed?
Joseph Trevisani: Interest rates can only do so much, again Japan is the cautionary example with rates below 0.5% for two decades I think? The Fed has basically one tool..interest rates.
Yohay Elam: It has been innovative with tools. And may have to find new ones. Perhaps enhancing forward guidance, allowing inflation to catch up with previous weakness before raising rates. Or targeting nominal GDP. Or just wait for the medical issue to be resolved.
Joseph Trevisani: Market have come to expect too much from the Fed. Inflation has a demand function as well as a monetary supply function and demand is lacking
Yohay Elam: The government can trigger stronger demand. Politicians are tussling in Washington over the next relief package. McConnell has expressed optimism, but he's a lone voice. All the rest, on both sides, report no progress.
Joseph Trevisani: Yes, it is unfortunate but hardly a novelty that both sides are looking for political advantage.
Yohay Elam: I would expect a fast deal three months from the elections.
Joseph Trevisani: I think the Fed will choose patience on this.
Yohay Elam: Perhaps it is a matter of days.
Joseph Trevisani: Yes, I expect a deal also.
Yohay Elam: Indeed, it seems that Powell has been holding his cards close to the chest, leaving the stage for politicians.
Joseph Trevisani: More than a bit like Legard and Draghi.
Yohay Elam: Looking forward, Friday features personal income and spending, figures which have been quite surprising in recent months and seem to have a market impact. But the big event is already close, Non-Farm Payrolls.
Joseph Trevisani: Personal spending is for June and GDP is already out. July NFP is important especially with the rise in claims, a poor number might reverse some equity gains and it will send the dollar lower.
Yohay Elam: I also think we will see the dollar extending its decline, even if NFP shows a gain in jobs. Yet the rally in stocks has defied all my bearishness and gravity.
Joseph Trevisani: Equities are discounting an eventual recovery which is realistic, but the timing is moving away.
Yohay Elam: Well, as we speak, the S&P 500 is another leg lower. The longer it lasts, the longer it will take to rise from the bottom. Pre-pandemic levels in 2022 instead of 2021. That may trigger more bankruptcies.
Joseph Trevisani: What is needed is confidence in virus outcome. Cases have started to decline in Fla and Texas and fatalities never rose much, nothing like the earlier wave, but more than that is required.
Yohay Elam: It's a large collection of epidemics. The total is a flattening in cases but daily deaths are still rising. Each state with its own curves.
Joseph Trevisani: True but the actual danger is very low and there is the unfortunate juxtaposition with the presidential election. An active epidemic assumed to be a negative for reelection.
Yohay Elam: Markets have been ignoring the elections, but perhaps things will warm up shortly. President Donald Trump's tweet about postponing the elections may have hurt stocks, more than GDP, claims... hard to separate when many things happen at once.
Joseph Trevisani: The pandemic has taken all the bandwidth.
Yohay Elam: Everything is related to the virus and not much else is happening. Hardly any sports to gamble on...
Joseph Trevisani: I think we are all a bit worn out on the virus. I know I am.
Yohay Elam: Indeed. Refocusing on the most recent data, it seems dollar-negative and potentially also adverse for stocks. Yet the next moves depend on fiscal stimulus and the NFP. Makes sense?
Joseph Trevisani: Agreed. The stimulus will pass which should at least initially support stocks, but after that, we are back to the viral course. NFP will likely expand in July but at a slower pace than June., 2.260 million is forecast. There is a decay factor at play. The longer a recovery is thwarted the worse the economy will become. The danger is the negative cycle, rising unemployment means falling consumption which means rising unemployment.
Yohay Elam: Agreed. A vicious cycle such as you describe is a growing danger.
Joseph Trevisani: Unsettling, since the fiscal and monetary authorities have already expended so much effort. Optimism is a bit lacking but I think it will return.
Yohay Elam: Optimism may come from the relentless US consumer. After next week's NFP, we have retail sales. Contrary to popular belief, August is never boring in financial markets!
Joseph Trevisani: Yes, I am still a bit surprised that the consumption numbers did not have more impact. I think revisions may answer that but the first is a month away, a long time in today's economic and political world.
Yohay Elam: Everything is moving fast.
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