A Little More Ado about a Little More Nothing


“We chose to wait.” – Janet Yellen, chairperson of the Federal Reserve

So the Fed did what everybody expected it to do – leaving rates untouched (again) and promising (again) to raise them down the road. Maybe. Unless the data say something else. The bank also did some things that were certainly not expected, and that could show up in stock prices. With the Feds’ September meeting out of the way and the election looming, more volatility would appear to be in store for the market.

Among the unexpected: the staff’s unusually dour outlook for future growth (see more in The Economic Beat below) and – much more eye-catching to the market – three dissents from governors in favor of raising the rate. The dissents may have been something of a charade designed to mini-tighten financial conditions, but they certainly got the market’s notice. There is a heavy slate of Fed governor-speak slated for the current week, and the general rule of thumb for this cycle is that whichever way the latest financial headlines are leaning (right up to that morning), the governors will tend to lean the other way.

As to the post-meeting rally, I wouldn’t get excited about it. So long as the Fed did not actually raise rates, it’s as automatic as it is transient. That’s not to say that prices will continue Friday’s sell-off, only that the rally was a short-term trade without solid underpinning. Both the New York and Atlanta Fed cut their current-quarter outlook for GDP during the week, and the earnings estimates are currently for a 2.3% decline for the quarter that ends this week. That implies that the Street is actually expecting a slight gain, but the biggest cuts will come the next weeks. The key read will come on October 7th – if consensus is for a decline of 4% or more, expect another down quarter, if it’s for 3% or less, there’s a good chance for breakeven or better; in between means the Street isn’t sure either.

Talk of the profit recession being “over” has already begun, but in my mind it hasn’t even gotten started. The declines have been quite mild so far and are most significant when looked at next to the dizzying equity valuations. A sideways quarter after five down in a row would mean a lot more if the declines had been the broad, deep ones that accompany recession, instead of the mixed set of shallow declines and gains that we have been experiencing and that typically come at the end of the cycle. In the current circumstances a sideways quarter would only mean that the current cycle has managed to lurch sideways another step while it awaits the coup de grace. In such an event, expect a lot of triumphant talk about profits being ready to take off for the second half (!) of the recovery and other, similar “rope-a-dope” talk.

Beware also the “Goldilocks” nonsense that came out as soon as stocks rallied (they couldn’t be wrong, right?). Equities moved up as a trading reaction to the Fed not raising rates and saying the economy has “room to run,” or in other words is hardly so hot as to need increases to put a lid on rampant speculation (though here in the Boston area, real estate speculation has indeed been over the top, which may explain Boston Fed President’s Eric Rosengren’s dissent). That didn’t stop the usual fund-management promoters from taking to the airwaves with talk of what a sweet world it is out there and how we all need to put more money into equities and what a magic moment it all is. Yeesh.

Next week will see some maneuvering around quarter-end (Friday) – you might expect that prices would have an upward bias for such an event, but the third quarter typically ends on a down note. In the interim, we’ll all be digesting more central bank talk and the first debate verdict while we wait for the start of the quarterly earnings season. I can hardly wait.

The Economic Beat

The Fed dominated the week, and an item that should have received more attention were the staff projections for the economic outlook. They are low and stay low for the future. That is more significant than the fact that they have been reduced, which has happened every September in the current cycle. The Fed is expected to be somewhat optimistic, and then in the third quarter, it faces the music of reality in much the way corporate profit projections come down. The year just isn’t going to happen the way it was drawn up.

All well and good, but when the Fed cuts its outlook as low as it has now, it’s a definite warning shot regarding the cycle. The Fed won’t ever predict a downturn, because it would invite too much turbulence and blowback, but it does quietly cut projections to very low levels, and then you know the clock is ticking.

How low in this case is 1.8% real (i.e., inflation adjusted) for all of 2016. Not such a significant cut in arithmetic terms from the June outlook of 2.0% true, but crossing below 2% is a significant step. What the staff has done with post-2016 projections: 2.0%, 2.0% and 1.8% for the next three years, with a “longer run” tendency of 1.8% and a “central tendency” range of 1.7%-2.0% is arguably more important. One can argue that the posture is only accepting the “new normal,” but it’s more than that. The Fed staff has given up on projections of foreseeable improvements in growth, and that should be taken as an acknowledgement that the cycle is nearly over.

After the usual sun-rose-again rally (it’s so amazing), the market started to wobble. Part of that may be due to the conviction – strongly hinted at by the Fed and backed up by the three dissents to no change – that a December rate is baked in. Don’t bet the farm on it. It could happen, but it could also happen that the financial markets start to give it up in the fourth quarter. The current economy is too weak to withstand any genuine problems, and the real question now is whether it rolls over quickly or slowly. A push from the wrong direction will do the trick, but I can’t tell you what it will be, only suggest the usual list – political problems, credit binging, employment rolling over, and so on. It’s too difficult to pick out the guilty culprit at this distance.

Do take heed that the Fed statement is still a form of policy tightening. Some will rush to get the last dumb loans done, but others will start making contingency plans for a rate increase, and I am quite sure that some members are hoping that the close call will have the salubrious effect of encouraging the unwinding of positions over-leveraged to no rate change. Time will tell.

The week led off with some cross-currents in housing, with an especially robust reading from the homebuilder sentiment survey – 65, vs. expectations for 60 and a neutral level of 50. It’s the highest reading of the cycle, yet it was followed by slightly disappointing news on housing starts the next day. Both starts and permits fell in August, taking the year-on-year rate down below 7% to 6.1% . Single-family data wasn’t bad (+9.1% y/y), which probably explains the survey results the day before and the apparent contradictions in the data for existing home sales that came a couple of days later. They fell in August, by 0.9% to 5.33mm (seasonally adjusted and annualized), and the year-on-year rate fell to 0.8%. New-home sales are due on Monday, and the homebuilder survey suggests a rising number.

None of the other data was of much interest to the market – retail sales are still weak, the Markit PMI survey affirmed the same weakness seen elsewhere, but there were a couple of interesting nuggets that came out of the weekly claims data. One is that the not-seasonally-adjusted unemployment rate fell to a new low of 1.3% – I believe that to be a new low for the series – and the other being the diminishing change between the current four-week average of 258,500 (SA) and the year-ago average of 261,250, or just over a 1% difference. When claims stop improving year-on-year, the party is over (though the police will probably not have arrived, so there is likely to be time for another drink).

Next week starts off with new-home sales, but the most important report of the week will probably be the advance estimate on August durable goods. It may take some of the “Goldilocks” talk out of self-promotional mouths. The last scheduled revision for second-quarter GDP is Thursday, but I wouldn’t expect anything miraculous unless there is a big change in inflation deflator, the percentage adjustment used to go from nominal (current-dollar) GDP to “real” (inflation-adjusted) GDP. That number does come in for the occasional big revision, and while it means little to the economic trend, it can mean a lot on Wall Street.

Other reports on the schedule include regional manufacturing surveys from Dallas, Richmond and Chicago, August pending home sales (Thursday), personal income and spending on Friday and international goods trade on Thursday. The latter two should lead to adjustments in the outlook for current-quarter GDP.

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