Thursday, September 1, 2016

Is The Fed Set To Hike Rates?

Tom DeChristopher of CNBC reports, Mohamed El-Erian is right: The Fed is about to hike, economists say:
Some economists are siding with Allianz's Mohamed El-Erian, who on Tuesday said he sees an 80 percent chance the Federal Reserve raises interest rates in September if Friday's jobs report comes in strong.

"I think he makes a good point. I think the Fed is actually pretty dovish, but they're data-dependent and they want to keep their credibility," Randy Anderson, chief economist at Griffin Capital, told CNBC's "Squawk Box" on Wednesday.

The Fed has signaled it will raise rates at least once this year, after backing off earlier expectations for four increases. The central bank has not moved since December, when it lifted its benchmark Fed funds rate by a quarter of a percent from near zero.

Anderson said he believes the Fed would prefer to wait until its December meeting, but policymakers don't want to risk missing their window to raise rates in 2016. That could happen if they hold off in September and are then delayed by some exogenous event like Britain's surprise vote in June to leave the European Union, he said.

A third consecutive month of employment gains in excess of 200,000 positions could provide an excuse to move, according to Anderson.

Closely watched investor and Omega Advisors CEO and Chairman Leon Cooperman echoed that view during an interview on CNBC's "Fast Money: Halftime Report" on Wednesday.

"If the employment report comes in at, say, 200,000 or more, they'll go for sure in September. If it comes in 150,000 or less, they'll probably wait until December," he said.

ADP and Moody's Analytics on Wednesday reported private employers added 177,000 jobs in August, though most of the gains were in services and manufacturing employment fell.

The market puts the probability of a rate hike at the Federal Open Market Committee's September meeting at 27 percent, according to the CME's FedWatch tool. The odds increased after Fed chair Janet Yellen said the case for raising rates had strengthened during an annual retreat in Jackson Hole.

Barclays Chief U.S. Economist Michael Gapen said Wednesday a September hike has always been on the table. The Fed kept rates unchanged in June following a disappointing April jobs report and dismal May data, but labor markets rebounded in June and July.

"If the April-May data was a fluke, I thought they'd be right back looking at a September hike," Gapen told "Squawk Box." "If you get a good number, I think they'll go."

Chicago Fed President Charles Evans this morning said the U.S. economy appears to be permanently slowing down, making it a bad time to raise rates. But Gapen said Evans is in the minority of policymakers who do not want to move until inflation reaches the Fed's 2 percent target.

"I think Yellen's comments at Jackson Hole were pretty clear. Labor markets send a signal, we'll move on a forecast of inflation," he said.
El-Erian's former co-CIO at Pimco, Bill Gross, appeared on Bloomberg Television calling for two Fed hikes at double the pace seen by the market:
Bill Gross is recommending the Federal Reserve raise interest rates twice by as early as March. The market doesn’t expect that degree of monetary tightening even by the end of 2017.

Speaking in an interview on Bloomberg Television, the billionaire manager of the Janus Global Unconstrained Bond Fund called for the first hike at the Sept. 20-21 Federal Open Market Committee meeting. Futures imply about one-in-three odds of action then, even after hawkish comments by Chair Janet Yellen and her colleagues drove up short-term yields and consigned Treasuries to their worst month since June of last year in August.

“I would say ‘C’mon, let’s raise interest rates by 25 basis points in September,’ and ‘C’mon, six to nine months from now let’s do it again,’” Gross told Bloomberg’s Erik Schatzker on Wednesday. The money manager said the Fed and other central banks “are addicted to low and negative interest rates,” and need to break the habit even if it means economic pain now as opposed to later.

The benchmark 10-year Treasury yield was little changed at 1.59 percent as of 7:38 a.m. in New York, after surging 13 basis points, or 0.13 percentage point, last month. The price of the 1.5 percent security due in August 2026 was 99 6/32.

Narrowing Spread

The two-year note yield was little changed at 0.81 percent, after a 15 basis-point jump in August. The spread with the Treasury 30-year bond yield rose two basis points to 144 basis points, after being as little as 140 basis points on Tuesday, the narrowest level since January 2008. Shorter-dated debt is more sensitive to the outlook for monetary policy.

Investors are awaiting a U.S. payrolls report Friday that Fed Vice Chairman Stanley Fischer has said will be key to how policy makers assess the recovery in the world’s largest economy. Employers added a net 180,000 new positions in August, according to the median estimate of economists surveyed by Bloomberg, following gains of more than 250,000 in each of the previous two months.

Gross said an increase of 150,000 or more positions in August should be enough to provoke Fed tightening this month.

“To me, that sort of cements it,” he said. “If those types of numbers, and perhaps a 3 percent GDP quarter, do not allow for an interest-rate increase, then what does?”

Fed fund futures signal just a 36 percent chance the central bank will tighten policy this month, and about 21 percent odds for two quarter-point increases by March, according to data compiled by Bloomberg.

The odds for one increase were as high as 42 percent last Friday after Yellen said in Jackson Hole, Wyoming, that the case for higher rates had strengthened. The probability of a single boost by year-end stands at 60 percent, with the calculation assuming the effective fed-funds rate will average 0.625 percent afterward.

Gross’s $1.5 billion Janus unconstrained fund has gained 5.5 percent in the past year, outperforming about 85 percent of its peers tracked by Bloomberg.
Now, you may be wondering what I'm wondering, how is Bill Gross handily outperforming 85% of his peers? Either he's taking spread risk, piling into junk bonds and emerging market bonds or he's emulating obscure large hedge funds, leveraging up his Treasury holdings betting rates will continue going lower.

The point is just because Bill Gross comes out to publicly call for two Fed rate hikes, it doesn't mean much unless you are privy to his book and can assess his positions, credit and duration risk. I tend to ignore these gurus and I don't trust anything they say publicly.

So, is the Fed going to hike rates in September and then follow up with another rate hike in December? Maybe, who knows? Most experts think you need a really "wow" jobs report on Friday to justify a September rate hike but given that employment growth has been decelerating (year over year), I seriously doubt we're going to see another huge upside surprise in the US jobs numbers and today's lackluster manufacturing numbers don't augur well for a September rate hike.

More importantly, let's take a step back and think about the repercussions of the Fed hiking rates once, twice or more:
  • The US dollar will climb relative to the euro and yen, something I foresee no matter what the Fed does. A rising US dollar will impact commodity prices and lower US import prices (on goods). Lower goods prices lead to lower inflation expectations, which is what the Fed is trying to stoke higher.
  • Emerging market stocks (EEM) and bonds will likely get hit but so will commodity and energy shares. This is why in my comment questioning to sell everything except gold, I explicitly stated to steer clear or even short gold miners (GDX) and junior gold miners (GDXJ), Metal & Mining (XME) and Energy (XLE) shares and pretty much anything leveraged to emerging markets.
  • If things get really bad, you can have another emerging markets crisis which will mean the US and Europe will be importing deflation for a very long time.
Now, I know what you're thinking, emerging markets are outperforming, Soros is wrong on China, global growth will surprise to the upside led by the US, the market discounts everything including Fed rate hikes, so relax, even if the Fed hikes, it won't be such a big deal.

In fact, my buddy who runs a currency hedge fund, thinks the Fed should start raising rates gradually and keep raising. He told me: "Last December, the Fed raised once, stocks got clobbered in January and then came back to make new record highs. What does that tell you? The Fed should have continued raising rates."

My other friend, Frederic Lecoq, who trades stocks keeps telling me: "The Fed has to raise. With inflation at 2%, why not gradually raise to 3%?".

But I keep reminding both these astute traders that the majority of the population isn't like them. Their balance sheets are in the red, they have debt up to their eyeballs which is why their top priority isn't investing but to get out of debt. And a significant increase in rates will clobber the majority of grossly indebted Americans (not to mention leveraged financial funds).

The problem we have right now is monetary policy of "QE, ZIRP and NIRP" has been a boon to elite hedge fund managers and the top 0.0000001% but it hasn't done much to enrich the majority of the US population which is paying down debt and can't afford to invest in stocks or bonds.

Nonetheless, low rates will buy them time to keep shoring up their balance sheet, so net net, I'm not sure if the Fed's unconventional policies have exacerbated rising inequality. I believe they have and rising inequality is a huge concern of mine because it is extremely deflationary, which ironically is the exact thing the Fed and other central banks are fighting tooth and nail against.

What will happen to stocks and other risk assets if the Fed starts raising rates? They will likely pull back but there's such unprecedented liquidity in the global financial system, not to mention so many chronically underfunded pensions sinking and starving for yield, that they will bounce back and keep making new highs.

But as I told you in my recent comment on plunging into stocks, you need to pick your stocks and sectors very carefully because if you don't, you're not going to make money and might lose a ton too.

What's going to happen Friday after the release of the August payroll figures? We'll see, if the numbers come in line or below estimates (which is what I'm thinking), then agitated investors worried about the Fed hiking rates in September can breath a little easier.

What if we get another monster jobs report? Then you might see a bounce followed by a selloff as the market starts repricing the odds of a Fed rate hike in September, December and beyond. But even if they sell off, don't be surprised if stocks and other risk assets come roaring back, forcing portfolio managers to chase them higher or risk underperforming the market.

I still maintain the Fed would be nuts to raise rates in a world where global deflation is still lurking. All this will do is reinforce deflationary headwinds around the world and risk another emerging markets crisis and a prolonged deflationary episode, one that might hit the US economy.

Quite frankly, no matter what the Fed and other central banks do, all they're doing is buying some time. Inevitably, the deflation tsunami will strike the developed and emerging world, and this will likely bring about a massive fiscal policy response, but by then, it will be way too late.

On that cheery note, let me get back to trading and accumulating some biotech shares (IBB and XBI). This is where I see huge potential (and risk) going forward no matter what the Fed decides to do.

Below, Mohamed El-Erian, chief economic adviser at Allianz said he currently sees a 60 percent chance of the Federal Reserve raising the federal funds rate at its September meeting, but those odds could rise as high as 80 percent. I'm not sure that "domestic conditions are flashing green" for a rate hike.

Also, Louis Navellier, Navellier & Associates Chairman & Co-founder, and Randy Anderson, Griffin Capital Chief Economist, debate the likelihood of a September rate hike in the wake of the jobs report on Friday as well as how the markets could react. Very interesting discussion, I agree with Navelier's comments (except I'm not keen on nat gas).

Third, speaking in an interview on Bloomberg Television, Bill Gross, manager of the Janus Global Unconstrained Bond Fund called for two Fed hikes at double the pace seen by the market. You can watch this clip here as Bloomberg clips are not blog friendly and easy to embed.

Gross raises important issues but my hunch is he too is betting on deflation and privately definitely doesn't agree with clowns warning of a bond bubble.

Lastly, Jim Mylonas provides a preview of BCA's annual investment conference. All of the sessions and the speakers list for BCA’s 36th Annual Investment Conference at the Grand Hyatt New York have now been finalized. This promises to be a very interesting conference.

I'm taking Friday off for the long weekend and will be back next Tuesday. As always, please take the time to support this blog by subscribing and/ or donating via PayPal at the top right-hand side under my picture. Thank you and have a great long weekend!

Update: As I expected, the August jobs numbers came in weaker than expected as the US economy added 151,000 jobs last month and wage growth is slowing. Weakness in manufacturing was the main culprit behind the less than stellar jobs report. Employment growth is clearly decelerating.

What does this mean for the Fed? In all likelihood, no September rate hike. The short end of the yield curve (2-year bonds) rallied as did Fed fund futures. The US dollar index (DXY) declined but that is a knee jerk reaction to the Fed not raising. I still see the greenback rallying in the months ahead even if the Fed stays put. Equity futures are rallying somewhat but we'll see if they sell the news on Friday.

I added a couple of clips below. First, Jan Hatzius, Goldman Sachs chief economist, weighs in on the recent jobs report and the likelihood of a Fed rate hike. He thinks there is a 55% probability the Fed hikes in September and if not, an 80% probability it hikes in December.

But most experts don't think the Fed will hike in September. In an op-ed for CNBC, Gerald P. O’Driscoll, Jr., former vice president at the Federal Reserve Bank of Dallas, said "notwithstanding the weak case for a September rate hike, Yellen has put the credibility of the FOMC on the line with her talk of a rate hike."

And William Lee, head of North America economics at Citigroup, told CNBC that his firm "never thought September was seriously on the table." He said on "Closing Bell" that the data-dependent Fed is not ready to move because "the doves have the power at the Fed."

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