TODAY’S S&P 500 SET-UP – September 17, 2012

As we look at today’s set up for the S&P 500, the range is 40 points or -2.24% downside to 1433 and 0.49% upside to 1473. 











  • ADVANCE/DECLINE LINE: on 09/14 NYSE 1130
    • Decrease versus the prior day’s trading of 1701
  • VOLUME: on 09/14 NYSE 899.79
    • Increase versus prior day’s trading of 12.15%
  • VIX:  as of 09/14 was at 14.51
    • Increase versus most recent day’s trading of 3.27%
    • Year-to-date decrease of -37.99%
  • SPX PUT/CALL RATIO: as of 09/14 closed at 1.06
    • Down  from the day prior at 1.11 


  • TED SPREAD: as of this morning 28.86
  • 3-MONTH T-BILL YIELD: as of this morning 0.10%
  • 10-Year: as of this morning 1.87%
    • Unchanged from prior day’s trading
  • YIELD CURVE: as of this morning 1.63
    • Up from prior day’s trading at 1.62 

MACRO DATA POINTS (Bloomberg Estimates)

  • Rates Weekly Agenda
  • 8:30am: Empire State Manuf., Sept. est. -2 (prior -5.85)
  • 11am: Fed to buy $4.5b-$5.5b notes due 11/15/2020-8/15/2022
  • 1am: Fed to sell $7b-$8b in notes 12/31/2014-5/31/2015
  • 11:30am: U.S. to sell 3-mo, 6-mo bills
  • 4pm: USDA crop-condition reports 


    • House, Senate in session
    • U.S. Defense Secretary Leon Panetta begins China visit


  • Homebuilding probably climbed with sales: U.S. eco preview
  • China home sales fall 4.7% in week ended Sept. 14: CEBM
  • Obama administration to announce trade complaints against China in Ohio
  • Ford picked by Canadian auto union as target in labor talks; current labor contact expires at 11:59pm tonight
  • Finance industry warns of “cliff effect” in ECB bond plan
  • Russian central bank starts $5b sale of Sberbank shares
  • India’s central bank unexpectedly cuts cash reserve ratio to 4.5%; holds key interest rate at 8%
  • BAE/EADS merger may flush out other suitors, Moody’s says
  • U.S. junk-bond yields fall below 7% for fist time: index data
  • Shell won’t drill for oil in Alaska this year after dome damaged
  • Emanuel promises suit to end Chicago strike as teacher balk on contract
  • Rosh Hashanah/Jewish New Year begins



COPPER – China down, Copper down almost 1% here this morning, after taking a vertical 3wk leap at its Feb/Mar highs; lower-long term highs remain intact.

  • Bullish Wagers at 16-Month High as Citi Sees Gains: Commodities
  • Hedge Funds Boost Bets as QE3 Pushes Oil to $100: Energy Markets
  • U.S. Hooked on Russian Crude Amid Shale Boom: Chart of the Day
  • Copper Falls on Speculation Rally to 4-Month High Was Overdone
  • Oil Trades Near Four-Month High on Signs of Improving Economy
  • Gold Seen Gaining in London as Stimulus Boosts Investor Demand
  • Wheat Drops as Rains Improve Crop Prospects in U.S., Australia
  • Coffee Rises in New York on Brazil Quality Concerns; Cocoa Falls
  • Ex-Touradji Trader Crone Starts Citrine Commodity Hedge Fund
  • Low Prices May Keep Aluminum Surplus Manageable in Near Term
  • Fed’s QE3 Signals Gold Rise to $2,000 by March: Chart of the Day
  • Rebar in Shanghai Declines on China Economic Slowdown Concern
  • Blackouts Spur $18 Billion Power Grid Upgrade: Corporate India
  • Piracy Fight Goes Awry as Nations Fail to Stop Killing Fishermen
  • Myanmar Gets Record Investment After Years of Isolation: Energy
  • Producer Destocking Balances Higher Exchange Aluminum Inventory













CHINA – Chinese stocks got smoked for a -2.1% drop, snapping my immediate-term TRADE line of 2107 support on the Shanghai Comp again overnight after China refuses to deliver on stimulus expectations (Food/Oil and Hong Kong property bubble up is not what they want more of via Qe3). Japan vs China heating up the headlines too.


SINGAPORE – We may have had the 3wk central planning rip in asset inflation wrong, but that’s making us more right on #GrowthSlowing, globally. Singapore just printed a bomb of a non-oil Export report at -10.6% y/y for AUG. That’s an important Global Macro leading indicator as we head into a very low growth rev/eps season.










The Hedgeye Macro Team


Anna is back from Macau and Singapore and we’ve got some takeaways exclusively for you



Relative to sentiment, we are more positive on Macau following Anna’s trip there and our Singapore view remains unchanged.  We still think September will be up potentially in the mid teens but there are a few more catalysts than previously expected.  We also expect LVS and the market to get a nice boost from the opening of Phase 2 at Sands Cotai Central which even the competition seemed to acknowledge.  On the margin, the VIP outlook is probably a little better and we’re getting closer to some real infrastructure improvements that could boost Mass.  While Singapore still appears to be a slow growth market over the next year or so, investor sentiment is already there.


LVS and MPEL continue to be our favorite names with Macau exposure.  Here’s a summary of our updated thoughts on Asia gaming:




  • Although there are several theories surrounding the slowdown in Macau’s VIP market, we believe it’s a combination of several factors:
    • Europe is the top destination for Chinese exports, and economic trouble in Europe and the US are impacting the Chinese economy and hence VIP demand
    • Given what’s going on in the economy, many junkets, especially smaller ones have been more prudent in extending credit
    • Given the change over in the government that is about to occur, there is likely heightened uncertainty and sensitivity to being flashy so some players are likely waiting on the sidelines
  • Most market participants believe that the change in government in early 2013 will be a catalyst for improvement in the VIP volumes
    • New governments like to look good during their first year in power and tend to pump stimulus into the economy
    • New governments will likely announce new infrastructure projects
  • Existing infrastructure projects opening soon will help stimulate growth
    • Guangzhou Zhuhai intercity mass rapid transit:  Trial runs of the trains on the Zhuhai section could begin as soon as October.  The railway is expected to be fully operational by the end of 2012, connecting Gongbei to Guangzhou.  This should help boost tourist numbers to Macau.
    • Gongbei port expansion opening at the end of 2012
    • Bottom line is that the combination of the light rail and the border expansion are expected to shave off 4 hours round trip for visitors to Macau.  This could increase length of play by 30% for many day trippers.




While the rooms at Conrad and Holiday Inn are quite nice, after visiting “Site 5,” it’s hard not to notice that what’s currently open lacks the “wow factor.”  Put less nicely, Site 5 lacks a draw factor.  That said, the property is only partially open at the moment and “Site 6” is a lot more impressive than what’s currently open.  Moreover, the opening of Site 6 will also be followed by opening of the covered bridge connecting SCC to Four Seasons/Venetian which should greatly increase traffic between LVS’s Cotai Corridor.


Will the vanilla offering at SCC cause it to be a flop? We don’t think so.  Why?

  • The opening of Site 5 didn’t really do much to boost LVS’s market share and expectations are fairly low
  • Macau is still massively under-supplied on the room front
  • Holiday Inn brand offers compelling value since the rooms are a lot nicer than the moniker suggests and Chinese tend to like a good deal.  So worst case scenario, SCC can serve as a dormitory for Venetian which should drive Mass revenues.
  • LVS has finally begun advertising the amenities of SCC this week



  • Seems to be stable
  • While junket commissions have increased, this seems more of a function of junket consolidation and large players reaching higher volumes and therefore, getting a larger revenue share percentage. 
  • The other reason for an uptick in commissions is that for a while now, more and more junkets are moving to a revenue share compensation plan from a RC compensation plan.  Given that market hold in Macau averages around 2.95%, revenue sharing agreements with volume targets allow junkets to achieve higher compensation thresholds then just getting paid 1.25%


  • While many casinos operators have gotten more savvy on their Mass rewards program, we saw no evidence that anyone aside from SJM was providing rebates on Mass (SJM has been providing rebates for several years now).  Operators are getting to know their premium mass players and in an effort to retain their loyalty, they offer free rooms, F&B comps and transportation.  



  • Mass hold percentages can vary significantly between those properties that include chip redemption at the cage as drop and those that only include markers
  • Recent higher Mass hold percentages look sustainable (CoD, Galaxy Macau)



  • Noticeably more popular than a few years ago.  Hybrid Stadium seating games where there is a live dealer and four different games played are quite popular at many casinos (Galaxy, LVS, MGM, MPEL).  Other electronic table games were also popular.



  • The government’s desire to drive tourism vs. gaming is abundantly clear.  While RWS and MBS couldn’t be more different, they are both similar in the respect that the casinos are discretely placed amongst a vast array of non-gaming attractions.  It’s entirely possibly to stay at RWS and not even see the casino.  The same is true of MBS – there was a massive high end mall, and lots of other attractions at this cavernous complex to keep non-gaming visitors intrigued.
  • The government is keen on protecting the countries’ residents from evils of gaming.  They have recently passed legislation including invention programs for patrons perceived to be gambling “too” much and have a fairly long list of factors that put Singaporean residents on the exclusion list.  There are also extension restrictions on casinos being able to promote gaming in Singapore, as evidenced by the recent fine on RWS. Given that about 50% of slot play and likely about 1/3 of mass play come from the local population, the 2 IRs will have a tough time growing this mature market. Any material growth of Singaporeans gambling will also likely bring further operational restrictions
  • International mass growth is constrained by the lack of hotel inventory in Singapore, and there likely won’t be much relief on that front for a few years
  • VIP play seems to be dominated by a small group of super high rollers. We believe that growth on this front will be dominated by the economic health of Asia and likely correlated to resumption of growth in Macau.  Bottom line, no one really knows what the growth profile of this market will look like.
  • The good news is that both IRs are generating a lot of cash, expectations for growth are low to non-existent from US investors, and the probability of additional gaming licenses seems extremely unlikely.

GIL: Why We Can’t Support Shorting It Here

Takeaway: There are too many factors helping out $GIL revs and margins to get bearish…at least not yet. But watch the CEO’s stock sales…he’s good.


Conclusion: There are too many factors helping out the top line and margins to get bearish…at least not yet. But watch the CEO’s stock sales…he’s good.


Keith pinged us yesterday on GIL, as it started to look like a short based on his models. True to our process, we re-evaluated the fundamental case to see where it stands vis/vis price (they’re often two very different things).  This is one of those times where we told him to focus short efforts elsewhere, as it is likely another two quarters before the fundamentals will likely line up with a  bearish stock call.

Here’s a quick review of the primary financial drivers – Revenue, Margins, and Cash Flow.


Revenue:  The setup is getting easier near term. Just as GoldToe anniversaries, Anvil revs layer on and will manufacture double-digit revenue growth alone. After the upcoming quarter, the setup is very favorable with GIL up against devaluation discounts of last year. Post FQ1, organic revenue growth will be more challenging to manufacture with the company now representing over 71% of the U.S. Distributor market forcing them to rely more heavily on building Branded Apparel, which is uncharted territory and away from management’s core expertise. Barring another acquisition (which we wouldn’t put past them) following FQ2, revenue growth should slow meaningfully as the benefit of recent deals will have passed, and the share gain from Hanesbrands jettisoning its screenprinting business will have ebbed.


GIL: Why We Can’t Support Shorting It Here - GIL Revs


GIL: Why We Can’t Support Shorting It Here - GIL Org Revs


Margins: This setup is also very favorable near-term as GIL starts to lap cotton prices as well as manufacturing downtime and inventory devaluation that will add 300-400bps of margin alone. GIL also posted a positive Sales/inventory spread in 3Q for first time in six quarters, which is gross margin bullish near term.


GIL: Why We Can’t Support Shorting It Here - GIL Margins

Cash Flow: Favorable. CapEx coming down after two years of higher spending to grow retail, open a new DC, another manufacturing facility, and revamp several existing manufacturing facilities to lower operating costs. Increased spending over the last two years at 9%-10% of sales should ease CapEx requirements for the next 2-3 years


GIL: Why We Can’t Support Shorting It Here - GIL Inv


GIL: Why We Can’t Support Shorting It Here - GIl S

Sentiment: Definitely mixed signals here, with short interest down to 3% of float (it’s been as low as 2%) and the sell-side generally positive as well. But on the flip side, CEO Glen Charmandy recently filed a 10b5-1 plan to sell up to 2.75mm of his 9.8mm shares of GIL stock.  While these 10b5-1 plans are ‘at arm’s length’ and are executed by a third party, it’s usually a wise move to pay attention when the CEO of a company registers an intent to sell 28% of his stock – especially when it’s a CEO that has had such a great track record in capital preservation on stock sales.


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Weekly European Monitor: The Draghi-Bernanke Show!

Takeaway: European markets are trading on policies, not fundamentals. We caution that there’s risk in simply riding Draghi’s coattails.

-- For specific questions on anything Europe, please contact me at to set up a call.


Positions in Europe: Long German Bonds (BUNL); Short EUR/USD (FXE)


Asset Class Performance:

  • Equities:  The STOXX Europe 600 closed up +1.3% week-over-week vs +2.3% last week.  Top performers:  Cyprus +17.8%; Russia (RTSI) +7.4%; Greece +7.1%; Ukraine +7.0%; Hungary +4.8%; Finland +4.7%; Austria +4.3%; Sweden +4.1%; Poland +3.7%. Bottom performers:  Denmark -1.6%; Slovakia -1.5%; Estonia -0.7%. [Other: France +1.8%; UK +2.1%; Germany +2.7%].
  • FX:  The EUR/USD is up +2.37% week-over-week.  W/W Divergences:  RUB/EUR +1.50%; HUF/EUR +1.14%; PLN/EUR +0.81%; CZK/EUR +0.79%; DKK/EUR -0.06%; CHF/EUR -0.48%; GBP/EUR -0.98%; NOK/EUR -1.67%; SEK/EUR -1.78%; TRY/EUR -2.15%.
  • Sovereign CDS:  Sovereign CDS followed yields with all main countries we track down on the week. On a week-over-week basis Portugal fell the most, down -72bps to 464bps, followed by Italy -148bps to 315bps, Portugal -133bps to 536bps, Ireland -97bps to 343bps, and France -25bps to 115bps. 
  • Fixed Income:  The 10YR yield for sovereigns fell dramatically across the board for peripheral countries, while the core gained on the week, for a second straight week.  Greece saw the largest decline, -83bps to 20.79%, followed by Portugal’s -16bps move to 8.09%; Italy fell -15bps to 4.97% and Spain dropped -11bps to 5.64%.  Germany was up +8bps to 1.70% and France gained +2bps to 2.26%.

Weekly European Monitor: The Draghi-Bernanke Show! - aa. yields


Weekly European Monitor: The Draghi-Bernanke Show! - aa. cds   a


Weekly European Monitor: The Draghi-Bernanke Show! - aa. cds   b



Central Bankers Make Waves


The last two weeks of market trading have been dominated by the policy moves of Draghi and Bernanke. Period.  Draghi’s “unlimited” bond purchasing program, named Outright Monetary Transactions (OMTs), and Bernanke’s further monetizing of MBS and push of the zero interest rate bound out to 2015 have stoked most global markets and the EUR (see price moves above), irrespective of the underlying fundamentals.


Specific to Europe, Germany’s Constitutional Court decision on Wednesday to uphold the ruling on the ESM and fiscal union added a further boost to capital markets, however we remain very cautious on the underlying weakness of these regional economies, and firm in our belief that a transition, if it is possible at all, to a united Europe (or at least Eurozone) under a monetary and fiscal union, is a long, challenging road.


A few broader challenges that stand in the way of a fiscal union are:

  • The unevenness of economies.
  • The strong cultural differences (namely language) that prevent frictionless labor moment.
  • The inability of states to willingly give up their fiscal sovereignty to Brussels or Frankfurt. Example: this week Spanish PM Rajoy, in response to talk about his country taking bailout monies said: “I will look at the conditions. I would not like, and I could not accept, being told which were the concrete policies where we had to cut.”

This week there was much talk about the formation of a European banking union. The European Commission (EC) delivered its proposal on a “single supervisory mechanism” of all banks in the Eurozone supervised by the ECB. Importantly, Germany is reluctant to cede control of its banking sector and wants the new regulator to concentrate only on the region's biggest banks, perhaps an estimated 20-25 banks.


While Germany's private-sector banks, including Deutsche Bank, have embraced the commission's proposal, the country's public-sector banks oppose it, saying their lower-risk business models should allow them to avoid the new layer of pan-European supervision. Certainly creating an FDIC of the Eurozone is an important step in the path to a fiscal union, however we see challenges arising from striping existing national supervisors to a new ECB supervisory board.


Taken together, we are fully aware of the powers of Central Bankers to drive markets. That said, the fundamental data keeps us grounded in our opinion that despite best efforts from Eurocrats to craft rescue programs, we think the structural flaws inherent in creating a Eurozone will continue to present challenges that should negatively impact markets; we expect the biggest challenge to be a protracted period of slow growth that misses expectations as Europe works through the debt trap it has amassed over the last ten years.  Finally, in the near term, the impact of high commodity prices as well as sticky to rising inflation (broadly), will add further negative economic pressures.



Call Outs:

France - The French 2013 budget is to be introduced on September 28th.  French Finance Minister Pierre Moscovici said that it needs to find €30-€35B in additional revenue from spending cuts. It plans to seek as much as €20B from new taxes (including the 75% on annual income over €1M, which President Hollande said this weekend could be dropped after around two years in place) and €10B from spending cuts to meet its pledge of reducing the budget to 3% of GDP next from a projected 4.5% in 2012. He also said that the government expects GDP to be 0.8% in 2013, down from its earlier forecast of 1.2%.  


Portugal - Troika agreed to ease Portugal’s deficit goal from 4.5% to 5% of GDP this year.


Italy - Prime Minister Monti hinting that he would be open to remaining in his position after elections next year.


Eurozone Banks - JPM sees another 15% upside in the group.


Netherlands - The Liberal Party of caretaker Prime Minister Mark Rutte was headed to victory in the Dutch parliamentary vote. The Liberals took 41 of the 150 seats (up from the 31 in the last vote in 2010); the Labor Party of Diederik Samsom won 40 seats (up from 30); D66 rose to 12 from 10; the Christian Democrats lost eight seats to 13; and Geert Wilders’ anti-immigrant Freedom Party lost 11 seats to 13. It appears likely Rutte, with the strongest international profile, will remain premier.


Spain - Cinco Dias, citing unidentified sources at the Budget Ministry, reported in its Wednesday Internet edition that the Spanish government is planning to increase the tax rate on short-term capital gains to as much as 52% in 2013. The paper pointed out that the highest tax rate on short-term capital gains currently stands at 27%. It added that move is intended to boost tax revenues and dampen market speculation and volatility.





Our immediate term TRADE range for the cross is $1.27 to $1.30. In the second chart below we look at CFTC data for net contracts of Euro non-commercial positions. Interestingly, since a high in short position in the Euro on 6/5/12 (-213.060 contracts), investors have been less bearish (and covering). Week over week, contracts are 10% less bearish, -95,080 as of the most recently reported data on 9/11 versus -105,433 as of 9/4. 


Weekly European Monitor: The Draghi-Bernanke Show! - aa. eur


Weekly European Monitor: The Draghi-Bernanke Show! - aa. CFTC



Data Dump:


Eurozone Sentix Investor Confidence -23.2 SEPT vs -30.3 AUG

Eurozone Industrial Production -2.3% JUL Y/Y vs -2.1% JUN

Eurozone CPI 2.6% AUG Y/Y vs 2.6% JUL   [0.4% AUG M/M vs -0.5% JUL]


Germany CPI Final 2.2% AUG Y/Y (UNCH)

Germany Wholesale Price Index 3.1% AUG Y/Y vs 2.0% JUL   [1.1% AUG M/M vs 0.3% JUL]


UK ILO Unemployment Rate 8.1% JUL vs 8.0% JUN

UK Jobless Claims Change -15.0K AUG vs -13.6K JUL


France CPI 2.4% AUG Y/Y vs 2.2% JUL

France Q2 total payrolls -0.1% Q/Q (exp. -0.1%) vs -0.1% in Q1

Bank of France Business Sentiment 93 AUG vs 90 JUL

France Industrial Production -3.1% JUL Y/Y (exp. -3.7%) vs -2.5% JUN

France Manufacturing Production -2.8% JUL Y/Y (exp. -4.2%) vs -2.9% JUN


Italy Q2 GDP Final -0.8% Q/Q (exp. -0.7%) vs -0.7% initial   [-2.6% Y/Y (exp. -2.55) vs -2.5% initial]

Italy Industrial Production -7.3% JUL Y/Y vs -7.9% JUN

Italy CPI Final 3.3% AUG Y/Y (initial 3.5%) vs 3.6% JUL


Spain CPI Final 2.7% AUG Y/Y (UNCH)

Spain House Transactions -2.5% JUL Y/Y vs -11.4% JUN

Spain House Prices -14.4% Y/Y in Q2 vs -12.6% in Q1


Portugal CPI 3.2% AUG Y/Y vs 2.8% JUL

Switzerland Producer & Import Prices -0.1% AUG Y/Y vs -1.8% JUL

Austria CPI 2.2% AUG Y/Y vs 2.1% JUL


Netherland Retail Sales -4.0% JUL Y/Y vs 1.0% JUN

Denmark CPI 2.6% AUG Y/Y vs 2.1% JUL

Norway CPI 0.5% AUG Y/Y vs 0.2% JUL

Finland CPI 2.7% AUG Y/Y vs 2.9% JUL


Sweden Q2 GDP Final 1.3% Y/Y (initial 2.3%) vs 1.3% in Q1

Sweden Unemployment Rate SA 7.8% AUG vs 7.5% JUL

Sweden CPI 0.7% AUG Y/Y vs 0.7% JUL

Sweden PES Unemployment Rate 4.8% AUG vs 4.6% JUL

Sweden Industrial Production -0.4% JUL Y/Y vs 1.2% JUN


Ireland CPI 2.6% AUG Y/Y vs 2.0% JUL

Ireland New Vehicle Licenses 5341 AUG vs 7944 JUL


Greece CPI 1.2% AUG Y/Y vs 0.9% JUL

Greece Unemployment Rate 23.6% in Q2 vs 22.6% in Q1


Poland CPI 3.8% AUG Y/Y (exp. 3.8%) vs 4.0% JUL

Czech Republic CPI 3.3% AUG Y/Y vs 3.1% JUL

Czech Republic Unemployment Rate 8.3% AUG vs 8.3% JUL


Estonia Exports 12% JUL Y/Y vs 8% JUN

Estonia Imports 14% JUL Y/Y vs 14% JUN


Hungary CPI 6.0% AUG Y/Y vs 5.8% JUL

Romania CPI 3.9% AUG Y/Y vs 3.0% JUL

Romania Industrial Output 1.9% JUL Y/Y vs 1.4% JUN

Slovakia CPI 3.7% AUG Y/Y vs 3.7% JUL


Turkey Q2 GDP 1.8% Q/Q vs -0.1% in Q1   [2.9% Y/Y vs 3.3% in Q1]

Turkey Industrial Production 3.4% JUL Y/Y vs 3.1% JUN



Interest Rate Decisions:


(9/13) Switzerland SNB 3M Libor Target Rate UNCH at 0.00%

(9/13) Latvia Refinancing Rate CUT 25bps to 2.50%



The European Week Ahead


Sunday: Sep. UK Rightmove House Prices


Monday: Jul. Eurozone Current Account, Trade Balance; 2Q Eurozone Labour Costs; Jul. Italy Trade Balance


Tuesday: Sep. Eurozone ZEW Survey Economic Sentiment; Aug. Eurozone New Car Registrations; Sep. Germany ZEW Survey Current Situation and Economic Sentiment; Jul. UK ONS House Price; Aug. UK CPI, Retail Price; Jul. Greece Current Account


Wednesday: Jul. Eurozone Construction Output; BoE Minutes


Thursday: Sep. Eurozone Consumer Confidence – Advance, PMI Composite, Manufacturing and Services; Sep. Germany PMI Manufacturing and Services - Advance; Aug. Germany Producer Prices; Sep. UK CBI Trends Total Orders, CBI Trends Selling Prices; Aug. UK Retail Sales; Sep. France PMI Manufacturing and Services – Preliminary; Jul. Italy Industrial Orders and Sales


Friday: Aug. UK Public Sector Net Borrowing, Public Sector Finances; 2Q France Wages – Final; Jul. Spain Mortgages-Capital Loaned, Mortgages on Houses, Trade Balances



Matthew Hedrick

Senior Analyst

QE3? Yah You Know Me

Takeaway: The Fed pulling the trigger on QE3 is bullish for gasoline and, historically, prices north of $4 per gallon have led to equity sell-offs.

This note was originally published September 13, 2012 at 14:35 in Macro

It seems 99% of Wall Street was correct as QE3 was extended.  Usually fading consensus is a great strategy, although perhaps not as it relates to the Fed, at least yet.  But for starters, let’s look at the Fed’s statement from earlier today, the key points are as follows:


“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.”


That’s actually not a key point, although it does emphasize, as we will touch on shortly, the mandate that the Fed has struggled to fulfill.


First on QE, the Fed effectively, as Keith would say, extended QE to infinity and beyond with this statement:


“If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”


On a basic level, this will start with increasing purchases of longer-term securities by about $85 billion each month through the end of the year, included in this will be $40 billion of mortgage paper.  As it relates to interest rates, the Fed indicated that a zero to 0.25% federal fund rate is likely to be warranted at least through mid-2015.


In the chart below, we show the aggregate growth of the Federal Reserve balance sheet.  The first chart shows the massive growth in the Fed balance sheet since 2008 with close to $3 trillion dollars being printed over the course of that period.  As a ratio of nominal GDP (just shy of 20%), this is a meaningful quantity as the following chart highlights.  Unfortunately, we have not seen a corresponding increase in economic activity.


QE3? Yah You Know Me - 2


The broader issue with extending QE is that it has been largely ineffective at fulfilling the Fed’s dual mandate.  Ironically, or not, the key economic data out this morning before the Fed’s statement enforced this.  On price stability, August’s producer price index came in at +1.7%, versus last month’s +0.3%.  This is near a three year high in terms of MoM acceleration.  Jobless claims also came in higher than expected at +382K versus +370K consensus, and +367K in the prior month.


QE3? Yah You Know Me -


While the employment data is only marginally bearish, the PPI data point is far more critical.  At +1.7% MoM growth in producer prices, this is the largest increase in PPI since June of 2009.  Our key issue with QE / money printing is that it is bearish for the dollar, which conversely inflates key commodities that are priced in dollars.  As Keith noted in the Early Look today, the CRB index currently has a -0.94 correlation to the dollar over the past month.


Obviously, the most relevant commodity to the U.S. consumer is crude oil and the derivative price of gasoline.  Given that there are 254 million registered vehicles in the U.S., the relevance of gasoline costs to consumer spending and growth should not surprise anyone.  That question, as always, though, is when does increasing commodity inflation start to matter? 


In the chart below, we show that prices at/north of $4 per gallon at that the pump have had a definitively negative impact on growth and the stock market over the last few years. Gasoline exceeded $4 per gallon in mid-2008, mid-2011, early 2012, and now.  In each instance there was a corresponding sell off in equities.  Perhaps this time is different, though we have our doubts.


QE3? Yah You Know Me - 1


Daryl G. Jones

Director of Research

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