Covenant Weekly Market Synopsis as of March 25, 2016

March 28, 2016

Following five consecutive weeks of gains in which global equity markets have risen about 11%, risky assets retreated last week. Global equities declined around 1%, precious metals fell a little more than 3%, and WTI Crude moved about 1.3% lower to $39.50 per barrel. This was a rather modest pullback as risky assets are enjoying a very solid month: most broad equity indices are up more than 5% and WTI Crude has gained nearly 17% in March. The price of US Treasuries moved only marginally during the week, with the yields on the 10-year (1.9%) and the 30-year (2.7%) holding stable. The US Dollar, following several weeks of declines, reversed course last week rising 1.3% (vs. a basket of trade partners’ currencies).

Detailed asset class performance data is available here.

Market Movers: The simultaneous reversal in risky assets (down) and the US dollar (up) last week, coincided with hawkish comments from several members of the Federal Open Market Committee (FOMC), the group that sets the Federal Reserve’s target interest rate level:

  • James Bullard, President of the St. Louis Fed (and one of the most vocal members of the FOMC), suggested during a number of speaking appearances last week that another interest rate increase could come as soon as their next meeting in late April.
  • John Williams, President of the San Francisco Fed, said that he will advocate for a rate hike in June, if not April during an interview.
  • Charles Evans, President of the Chicago Fed, made comments in support of two rate hikes this year.

 

My belief is that the Fed is intentionally sending hawkish messages, perhaps well in advance of when they actually intend to raise rates. The reason for doing so is to allow foreign central banks (that hold large amounts of US Dollar-denominated debt) and investors that have become accustomed to ultra-accommodative monetary policies to get their respective affairs in order such that that future Fed actions have mitigated impacts on the global economy and financial markets. One indication for why the Fed might believe this hawkish jawboning is necessary is that the market is pricing in a single interest rate increase for late this year and a mere 6% chance that the Fed will raise rates in April – apparently there is doubt about the Fed’s resolve and/or ability to normalize interest rates. And while the Fed may desperately wish to normalize rates, the several trillion dollar question that has yet to be answered is whether the economy is growing fast enough to generate worrisome levels of inflation that will require higher interest rates. The economic data, thus far, seems to indicate it is not…

Slow Growth: On Friday, the U.S. Census Bureau released their final revision to Q4 2015 GDP growth which showed an improvement to 1.4% from the previous estimate of 1.0% (annualized). This was welcome news as the revision was largely due to increased Consumer spending, the primary driver of the U.S. economy. Still, even with the upward revision, the U.S. economy only expanded by 2.4% for all of 2015, which is consistent with the pace of growth experienced during the recovery from the Financial Crisis. In other words, growth in the U.S. economy is still not accelerating six years into the recovery. Offsetting some of the positive news about the upward revision is that corporate profits declined 11.5% year-over-year, the largest quarterly decline since the end of 2008. Even though the profit declines were heavily concentrated in the Energy sector, the lack of corporate profitability should serve as a reminder to the Fed that the economy remains vulnerable to shocks and tighter monetary policy will only increase that susceptibility. Moreover, it doesn’t appear that the U.S. economy is picking-up speed, as current estimates for Q1 2016 GDP growth are about 1.5%.

Economic Data Summary: Existing Home Sales data for February missed expectations, declining 7.1%, to 5.08mm. Despite the month-over-month decline, home sales were 2.2% above the February 2015 level. The bottom line is that housing still appears to be in the midst of a recovery, where tight credit, limited supply and rising home prices are the limiting factors rather than a lack of demand. February’s New Home Sales, at 512k, were in-line with consensus estimates and above the 12-month average level of 499k. Interestingly, developers are beginning to react to demand as inventory levels (at 236k) reached the highest level since late 2009. Durable goods orders for February fell about 2.8%. While the headline number was in-line with expectations, the widespread weakness is highlights the effects that weak global demand and a strong US Dollar are having on the domestic manufacturing sector.

Be well,

Jp