This note was originally published at 8am on October 17, 2013 for Hedgeye subscribers.
“By definition, a government has no conscience. Sometimes it has a policy, but nothing more.”
With the debt ceiling and government shutdown behind us (at least for a few months), we can now all go back to focusing on doing investment research. Well, not so fast, now we actually have to focus on the Federal Reserve. The key question there is, of course, will they taper or not taper.
Yesterday, we wrote in the Early Look about an interesting study from the San Francisco Fed, which showed that the Fed’s program of quantitative easing had a de minimis impact on the real economy. We would actually take it a step further and suggest that with the inflation of commodities due to printing more dollars, QE may have even eaten into the real economy.
In that regard, we were trying to think of an analogy from the animal kingdom that best represented the impact of QE on the real economy and very naturally the tape(r) worm came to mind. For those that didn’t know the following is a description of a tape worm (emphasis mine):
“Tapeworms, or cestodes, are intestinal parasites; they are worms that are flattened like a tape measure. A tapeworm cannot live freely on its own - it survives within the gut (intestine) of an animal, including a human.”
To be fair, my assessment that QE effectively eats into its host, the real economy, has led to some push back. As my colleague Christian Drake rightfully pointed out to me earlier this week, while QE may not have an impact on the real economy, it does have an impact on asset prices. As an example, in the Chart of the Day we show the S&P 500 index with and without the twenty-four hour pre-FOMC returns.
The implication of this chart is quite astoundingly that the Fed may be responsible for almost all returns of the SP500 since 1994. Further, if QE truly does inflate asset prices, as the correlations suggest, then there is likely a wealth impact that ultimately does impact the economy by the way of increased consumption.
As we stand here today though, it seems much easier to argue that some easing of stimulus is likely to strengthen the U.S. dollar and deflate oil, which is probably the most important consumer stimulus the Fed could implement over the coming quarters and years. Hopefully, Mrs. Yellen gets the memo on this point. Let’s face it, if oil were at $50, we’d all be buying jelly doughnuts for the office.
Back to the global macro grind . . .
As noted, the government is back to work and the debt ceiling is averted, so now the global equity markets should be rallying hard. Well, that’s not quite how it is working out this morning. U.S. futures are down, Europe is off 25 – 80 basis points, and Asia is up, albeit small. So much for the party!
As we, and people much smarter than us have often said, markets don’t like uncertainty and our fine elected officials have now created more uncertainty with a number of looming deadlines, specifically:
- December 13th – the date when a House-Senate committee will report back on negotiations on a longer term budget deal;
- January 15th – the date on which the government is now open until subject to another budget agreement being reached; and
- February 7th – the next debt ceiling.
Now of course, Washington is changing this morning. Former Newark Mayor (although we understand he didn’t actually live there) Cory Booker is the newly minted Senator from New Jersey. We knew Cory when we were undergrads at Yale and he was in law school and he can be persuasive, but we aren’t sure even he can resolve this mess of catalysts that Congress will be dealing with in the next three months.
So, speaking of the real economy, what impact does this massive amount of uncertainty have? According to Gallup, the economic confidence index has fallen off a cliff in the last month from -15 (a range it had been in for awhile) to -40. With such short term and potentially negative catalysts on the horizon, it is unlikely this confidence improves meaningfully.
Luckily, as global asset allocators, we have the choice to be underweight the U.S. and our view on Europe is looking very compelling on a comparative basis as we highlighted in our recent Q4 theme - #EuroBulls. The euro, a currency we do have longer term issues with, is breaking out on our quant models and is up another 70 basis points this morning to $1.3629 versus the U.S. dollar.
Increasingly, the recent data from Europe is also supportive of being a #EuroBull. Some examples include:
- Greek 10-year yield down 206 basis points month-over-month to 8.4%;
- Eurozone September CPI benign at 1.1%;
- European new passenger car registrations up the most in two years at +5.4% year-over-year in September;
- European ZEW economic expectations at 59.1 in October, a sequential improvement from September; and
- U.K. ONS house price index +3.8% in August which beat expectations and increased sequentially.
To be fair, all is not great in Europe. But, in global macro markets, change happens on the margin, and on the margin the European economy is improving.
Our immediate-term Risk Ranges are now:
UST 10yr yield 2.66-2.73%
Good luck out there today.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research