Central Banker Speak

From the May 25, 2015 HRA Journal: Issue 233

We near the end of May with most major indices again at or near record territory.  Traders have pushed back their estimates of the first Fed rate increase.  This came in the face of slightly stronger US economic readings and slightly weaker ones just about everywhere else. 

Gold is holding its range better than the last three times and base metals are trading better than most mainstream publications would have you believe. More importantly, companies with real good news continue to see traction. That is the first step to the resource sector rebuilding itself – if it lasts. 

The big test, namely the summer doldrums, are dead ahead of us now.  Let’s see of the juniors can hold their price and better yet generate gains where it’s deserved on an individual basis.  If that happens we could see a good fall for the first time in four years if traders can get past their Fed obsession.

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New economic readings and a lot of jawboning by central bankers have brought the markets back to something like a normal alignment. 

The chart below shows a fairly strong comeback by the USD in the past week or so which has now turned positive for the month of May.  There were a few better US economic readings but I think you can “thank” the ECB for the bulk of the move.

The USD bottomed after the European Central Bank promised to step up bond purchases.  Northern summer is slow in the bond market like it is in many others.  There have been concerns that there would be insufficient liquidity to allow for the €85 billion a month QE program. 

The ECB assured traders that it planned to “front end load” purchases in coming weeks.  On top of that, ECB head Mario Draghi reminded traders that he had the option to extend the program past next September.  Add some lackluster (though not really weak) Eurozone PMI numbers and the top was in on the Euro.

A weaker Euro is of course exactly the outcome the ECB wanted.  Euro weakness has been a main contributor to the turnaround in the Eurozone economy which is far from complete.  While I personally think the bottom is in on the Euro we can expect more jawboning from the ECB if the common currency strengthens again.  Europe needs the trade advantage to help kick start weak domestic demand across most of the continent.

The situation is exactly the opposite on this side of the Atlantic though the Fed has less wiggle room.  There have been several studies out recently about the impact of weak exports and, by extension, the strong USD on American GDP growth. The chart below from Goldman Sachs shows a huge negative impact to Q1 growth. 

That isn’t a surprise to you dear readers as I have commented on this several times but it does quantify it. As I noted in the last issue the March trade numbers still need to be included in the Q1 GDP revision. It doesn’t take much imagination to see which way they will push the growth rate.

The run up in the USD had the predictable effect on the gold price as you can see from the chart below.  While gold has had yet another pullback it’s holding up better, so far at least.  After briefly hitting a three month high bullion has managed to stay above $1200.  It didn’t immediately fall back to $1180 like it did the last three times it bounced off the top of its trading range.  The negative correlation with the USD isn’t as strong either which indicates some buying in other currencies.  Traders continue to be almost solely focused on a Fed rate hike as a driver for the gold price.  Again, I think this is an oversimplification but it’s tough to fight the tape.

The stronger USD has been a lot tougher on base metals and soft commodities than precious metals.  The base metal complex gave back most of its gains from April and early May once the Dollar bottomed out.  This gives us a good indication that some of those gains were purely currency related.  Continued weak readings on the Chinese economy haven’t helped either.

Last issue we talked about the market dichotomy with some markets seeming to anticipate inflation that wasn’t apparent yet.  Traders on that side of the trade got some back up (though only some) when the latest US CPI numbers were released.  Media trumpeted the one month and three month core rates which “jumped” though the year-over-year change was flat. 

 

If we assume oil prices have bottomed there is reason to think CPI should move higher too, at least a bit.  The most telling statistic in the latest release is shown on the chart to the right.  The “sticky CPI” which measures a number of items that only see occasional price changes clocked the highest monthly change in six years.  A single date point could always be a fluke but it was data like that which led to a big move up in USD and drop in gold price on the day of the CPI release.

Traders took the CPI number as evidence the Fed will pull the trigger.  Current consensus is that the Fed will raise rates 25bps in September.  Later comments by Fed chair Yellen were interpreted as “guaranteeing” a rate rise this year.  Strange, since she actually stuck to her usual “data dependent” line which is the equivalent to dodging the question.

I don’t know whether we’ll see a sustained rise in CPI.  It’s hard to imagine with the weak numbers being reported in most of the world’s economies. 

If we see another rise in CPI next month traders may sell gold though those that do are looking at the situation backwards.  If inflation increases and wages don’t accelerate that is NOT good news.  I think that combination would make the Fed hesitate since it could quickly generate a drop in consumer spending that would sink the economy.

As things stand now, a moderate increase in CPI will make real interest rates even more negative.  Unless inflation literally took off I think there is no chance the Fed would try to get ahead of the curve on it.  That would require rate increases that would freak the markets out.  Not a happy place for the Fed to be but it’s their corner and they painted themselves into it.

The final chart this issue is an updated one for Shanghai.   That market had a brief pullback early in the month but that’s ancient history now.  The market hit another multiyear record today.  

The chart above shows a roughly 60% gain in the index moving from the left side of the chart to the right and it’s only a 3.5 month chart!   Traders expect the powers that be to keep stimulating the economy until something works.  The level of faith in China’s leadership is touching.  Should make for interesting times when this market tops. 

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A trader’s hangout you should try:

Tommy Humphreys has developed a very good chat application that is attracting a lot of traders and observers of the Venture market scene.  It works on your computer or iPhone.  There are usually interesting and informative people hanging out there and the site offers some useful bonuses like insider trading reports on stocks you’re interested in.  Drop in and give it a test drive at: www.chat.ceo.ca

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