For a while, it looked like the good old days in markets. Traders shrugged off two days of losses to push the S&P 500 Index up as much as 0.6 percent soon after the open. Then came the Federal Reserve and the gains turned into losses, before recovering to end little changed and avoid their first three-day loss since the start of December.
It's not as if the Fed said anything surprising. As expected, it left interest rates unchanged and reiterated that gradual increases were warranted, though the central bank did insert the word "further" before "gradual." So, what gives? Perhaps its the sense that the Fed has greater confidence in meeting its 2 percent inflation target. Perhaps it's all about uncertainty. This was Janet Yellen's last meeting as chair of the central bank before she hands the reins to Jerome Powell. Although Powell is currently a Fed governor, the change in leadership comes at a critical time. There are concerns about excesses in risk assets, talk of a budding global currency war and the bond market is in jeopardy of rolling over just as the Trump administration embarks on a plan to step up borrowing.
“There is a numbness out there, there is an ambivalence out there that’s concerning,” Citigroup Chief Executive Officer Michael Corbat said last week on a panel in Davos, Switzerland, hosted by Bloomberg’s Tom Keene. “When the next turn comes -- and it will come -- it’s likely to be more violent than it would otherwise be if we let some pressure off along the way.” Jes Staley, the head of Barclays, said trouble could occur if central banks such as the Fed push up borrowing costs faster than investors anticipate.
YELLEN CORALS BOND TRADERS
For all of Yellen's accomplishments, perhaps one of the least appreciated is her ability to win back the respect of the bond market. Coming out of the last recession, bond traders -- rightly -- ignored the central bank's annual forecasts of faster inflation and multiple interest-rate hikes. But that started to change in late 2017 as the Fed finally followed through on its projections and raised rates three times. The Fed is also projecting three rate increases in 2018, but the difference now is that the market is pricing in a 38 percent chance of that happening, with the first one in March. At this time last year, it was pricing in just a 22 percent chance of three rate increases for that year. Also, the bond market is finally pricing in the prospects of faster inflation, with the yield on the benchmark 10-year Treasury note reaching 2.75 percent Wednesday, the highest since 2014. “Nothing in Treasuries” looks like a great opportunity right now, Hall of Fame bond investor Dan Fuss, vice chairman of Loomis Sayles, told Bloomberg TV. The Bloomberg Barclays U.S. Treasury Index is down 1.42 percent this month through Jan. 30, putting it on track for the worst start to a year since 2009, when traders were bracing for a ramp-up in government borrowing to combat the recession, according to Bloomberg News' Elizabeth Stanton. It would also be the biggest setback for any month since November 2016.
THERE'S A COLD WAR IN CURRENCIES
And the U.S. is winning! At least that's the assessment of Pacific Investment Management Co. The greenback’s almost 12 percent plunge since the start of 2017 is being fueled by fiscal and monetary policies as well as rhetoric intended to debase the U.S. currency, Pimco global economic adviser Joachim Fels wrote in a blog post. Central banks from Europe to Japan have refrained from pushing back too hard amid fears of increased protectionism from the Trump administration, according to Bloomberg News' Lananh Nguyen. “Cold wars are not fought in open battle (for example, with currency intervention), but with words and covert actions,” Fels wrote. “These actions are sending an implicit but very clear signal to markets: A weaker dollar is the goal. Markets have understood the signal.” A widening trade deficit will foster continued American interest in a weaker dollar, according to Fels. At the same time, the ability of major U.S. trading partners in Europe and Japan to stem their currencies’ appreciation will be constrained given the U.S.’s willingness to wield protectionism as a policy tool.
MUNI BONDS TAKE A FALL
Here's something President Donald Trump, who touted a coming $1.5 trillion infrastructure plan in his State of the Union speech Tuesday, won't like: The municipal bond market is falling out of bed. Trump will likely rely on the muni market to fund part of his infrastructure plan, but state and local government bonds were poised for their first January loss since 2011 and the biggest for the month since at least 1981, according to the Bloomberg Barclays Municipal Bond Index. At the same time, sales slid to about $16 billion, or half what analysts forecast, according to Bloomberg News' Danielle Moran and Zachary Hansen. Citigroup analyst Vikram Rai said the expectations for strong monthly performance were upset by speculation about rising interest rates, diminished buying by banks and insurance companies and concern among some buyers about the consequences that the federal tax changes would have on high-tax states. To be sure, flows into municipal bond funds are strong, which may presage a rebound in returns, Bloomberg Intelligence municipal strategist Eric Kazatsky wrote in a research note. The selloff has left muniss looking "cheap" on a tax-equivalent basis for this in the 28 percent or 37 percent tax brackets, Kazatsky wrote.
WOOD IS EXPENSIVE
Data released this week on the U.S. housing market showed that home prices in 20 U.S. cities increased in November by 6.4 percent, the most in more than three years as measured by S&P CoreLogic Case-Shiller. The reason for the increase was given as a lingering scarcity of housing inventory. That may be true, but don't discount rising lumber prices, at least for newly built homes. Lumber futures are trading near their highest in at least 32 years amid rising demand for building materials ahead of the critical spring construction period, according to Bloomberg News' Jen Skerritt. U.S. tariffs on softwood imports from Canada are also adding to costs. Firms such as West Fraser Timber are sold out through February and American consumers are taking the price hikes “on the chin” as buyers replenish their inventories, according to Kevin Mason, managing director of Vancouver-based ERA Forest Products Research. Lumber futures have gained 43 percent the past year, making them the top performer of 34 commodities tracked by Bloomberg. On Wednesday, futures rose as much as 2.1 percent to $477.80 per 1,000 board feet in Chicago. Earlier this week, prices reached $489.90, the highest since at least April 1986.
With the January Fed meeting over, the focus quickly shifts to a pair of high impact economic reports Thursday and Friday. First up is the Institute for Supply Management's monthly manufacturing index for January. Although the consensus is for a slight dip to a reading of 58.6 from 59.3 in December, that would still keep the index at some of its highest levels since early 2011. Readings above 50 signal that the manufacturing sector is expanding. The measure averaged 57.6 in 2017, which was the highest in 13 years and fueled by more domestic business investment, improving global economies and steady spending by American households, according to Bloomberg News' Katia Dmitrieva. The week ends with the government's monthly jobs report, which is forecast to show January was another month of solid job gains and wage increase.
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It's Too Early to Judge Janet Yellen: Danielle DiMartino Booth
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