Here's Why The Fed's Statement Is Roiling Markets

Stocks and bonds are selling off as the dollar strengthens in the wake of the release of the statement from the FOMC's October policy meeting.

In other words, the market is interpreting the statement as "hawkish" — meaning the Federal Reserve now seems closer than previously to tapering its quantitative easing program.

This was not what was expected by most on Wall Street. Many economists figured the FOMC would insert language in the statement to address the weight the government shutdown and ongoing fiscal crisis in Washington, D.C. was putting on the economy.

The FOMC did just the opposite in the October statement. Here's the key sentence: "Taking into account the extent of federal fiscal retrenchment over the past year, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program as consistent with growing underlying strength in the broader economy."

Because market participants have been coming around to the view that the potential damage to the economy from the fiscal crisis in D.C. means the Fed is unlikely to taper QE before March, today's statement comes across as "hawkish" on balance, because it leaves in play the possibility of tapering before then despite Washington-induced turmoil.

So, there exists the possibility that the FOMC could still spring a tapering announcement at the December or January meetings, as Miller Tabak chief economic strategist Andrew Wilkinson suggests in a note:

Emerging from the fiscal mist hovering over Washington, the FOMC’s October statement is remarkably and somewhat surprisingly similar to the prior monthly note. The committee left the taper-window wide open for any forthcoming meeting. The statement noted that “fiscal policy is restraining growth,” but took the issue no further. It also noted that the recovery in the housing market had slowed somewhat in recent months. We suggest that this is entirely on account of resurgent summer time yields, which played a role in the September statement yet has been dropped from the latest summary.

The message from the Fed is that the economy remains on course for recovery and that it sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall. The Fed is on hold, but the tone of the statement and the failure to bend on account of the government shutdown is very likely to bring forward the market’s timetable of tapering from March where we feel the pendulum has swung too far. It would seem the Fed’s approach is extremely balanced and that members are taking a level-headed view of the impact of interruptions to the economy. We believe that the central bank does not want to confuse the market by chopping and changing its view at a micro level. A bigger change might come for example should their be failure to agree on budget measures that would threaten further the ability of the government to remain open.

"This is 'dovish' I suppose but I don't suppose there is a single economist, strategist, journalist, trader or barman who expected anything less dovish," says Société Générale strategist Kit Juckes. "But honestly folks, this is the most dovish [central bank] out there simply failing to surpass expectations."

Read more: http://www.businessinsider.com/why-october-fomc-statement-is-hawkish-2013-10#ixzz2jEY6WXqE

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This Is The Only NYSE Margin Debt Chart That Matters

Much has been made in the press about how NYSE margin debt is at an all-time high, suggesting that investors are excessively bullish.

However, stock markets themselves are also at all-time highs — so perhaps the level of margin debt doesn't really tell us much that we don't already know.

A post on the blog Philosophical Economics (flagged by Josh Brown) explains the mechanism whereby increases in the stock market translate to increases in margin debt:

Now, why does total margin debt rise with the level and total capitalization of the market? There is a simple, intuitive answer.  In any environment, a certain percentage of investors borrow against their portfolios.  They borrow for a number of reasons.  Examples include: (1) They may be engaged in investment strategies that hedge and pare risk by applying leverage to uncorrelated assets. (2) Margin debt might be the cheapest type of debt they have access to, and therefore they may use it to pay off other more expensive debts. (3) They might be waiting for money to arrive at a broker, and need temporary liquidity to fund purchases. Or (4), they might just be really bullish and really reckless.

We should expect the amount of margin debt that these investors take on to vary with the size of the portfolios they are borrowing against.  Thus, we should expect the total quantity of margin debt in existence to vary with the total capitalization of the stock market (the sum of the value of all equity portfolios).  That is roughly what we see.

That brings us to the only margin debt chart that matters: NYSE margin debt as a percentage of stock market capitalization, which shows how the use of margin is growing relative to the pace of the rise in stock prices.

Why has this measure been rising? Philosophical Economics chalks it up to the evolving investment landscape:

Hedge funds have grown dramatically since the early 1990s.  The strategies they employ to smooth out and optimize their risk-adjusted returns involve more leverage than the rest of the market has traditionally used.

Additionally, the cost of borrowing against a portfolio has fallen significantly since the early 1990s.  Borrowing on margin is cheaper now than it has ever been, not only because interest rates are at record lows, but also because brokerage competition has produced an outcome where clients are offered much better terms.

Finally, with the development and mass expansion of online trading, portfolios are easier to monitor and quickly adjust.  This reduces the stress of being on margin.

Read more: http://www.businessinsider.com/only-nyse-margin-debt-chart-that-matters-2013-10#ixzz2j3EsZ3ng

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It Sounds Like The Euro Has Become One Of The Hottest Topics On Wall Street

All of a sudden, everybody is talking about the euro.

The currency has risen 8% against the U.S. dollar since July 9, when selling induced by Federal Reserve chairman Ben Bernanke's June 19 press conference — in which he hinted at tapering quantitative easing, causing strength in the dollar — culminated.

Today, the euro trades just below $1.38.

Steven Englander, global head of G10 FX strategy at Citi, just returned from client meetings in South America, and he said the thing everyone was asking about the most was the euro.

"The bulk of questions received were on EUR/USD, and our views were into year end," he writes in a note. "Most clients were happy to see it lower, but conviction was low as to the timing of the move. Views for significant EUR/USD upside were again also limited. Several accounts were buying EUR/USD presently, but discussions of the trade tended to lack medium-term justifications, although several clients cited technical reasons. The dominant view was EUR/USD could rise to 1.40, although investors in European assets were looking to establish hedges on their underlying exposure."

Société Générale global head of economics Michala Marcussen also says the number-one question from her clients is about the euro.

In a note, she writes:

TOP CLIENT QUESTIONS

WHY IS THE EURO SO STRONG?

Investor inflows is the most common answer

Hitting a two-year high against the U.S. dollar last week of just over $1.38, euro strength appears to be defying the traditional fundamental explanations of the relative monetary policy stance, external balances and growth differentials. Foreign investor inflows - attracted by abating tail risks, attractive valuations and green shoots of recovery – now appears the most common answer. There is an obvious, if undesirable, self correction mechanism to this logic, should foreign investors ultimately be disappointed by the euro area recovery. A scenario that becomes more likely, the longer euro strength continues. 

SocGen global strategist Kit Juckes penned a note in response to Marcussen's, expanding on the reasons for the higher euro:

I have been bandying around ultra-simple two-factor models of EUR/USD for a while. They help me to think about what kind of currency move I can expect from the two big drivers of the euro’s fortunes – rate spreads, and risk aversion as shown by the 3-year Spain/German spread. The one below suggests that if the 'neutral' Spain/German spreads is 200 basis points, and 2-year swap rates are identical in the U.S. and euro area, EUR/USD will be at 1.34.

That 'feels' high to lots of people, but when you run a current account surplus and employ a central bank in which Germany has a voice, it's what you get. Today, we are at 1.38, about 1% above the simplistic 'fair value'. The reason the fair value is so high is that 3-year Spain/German spreads have fallen to 165 basis points, the lowest level in 2 ½ years, and 2-year euro rates are above U.S. ones. This is 'why' we are here.

Juckes says the reason this caught everyone off guard is that "we didn’t expect that the market would be more hawkish about ECB than Fed policy at a time when the euro area economy is barely growing, nor did we expect to see the endless grind of Spanish bond out-performance go quite this far."

In the week ended October 23, investors poured $5 billion into European equity funds, marking the biggest weekly inflow ever into the asset class.

These funds have seen nothing but inflows for the past 17 weeks — since the beginning of the second quarter, when PMI surveys suggested the eurozone was finally emerging from recession.

Investor sentiment toward eurozone assets seems to have been spurred by recent improvements in the currency bloc's economic picture.

"Why won't the euro go down when everyone says it will?" says Neville Hill, head of European economics at Credit Suisse. "The euro area's current account has skyrocketed to a record 2.5-3% of GDP...we think that's why euro shorts are consistently disappointed!"

Read more: http://www.businessinsider.com/euro-has-become-hot-topic-on-wall-street-2013-10#ixzz2j3DmV33H

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NORDEA: EUR On A Short Leash, GBP Struggles, & JPY Gets Boring

The following is the key outlook for the FX market this week as provided by Aurelija Augulyte, a senior FX analyst at Nordea Markets. 

Where is EURUSD headed? What is fair value? The amount of fear and anxiety suggests the move above 1.40 will be painful for the complacent USD bulls. If you take the pre-crisis “normal” at face value, normalization will ultimately lead the EURUSD to above 1.40…

Is ECB worried? - No, if you ask Germans. But PMIs came out softer last week, and inflation is reported this week, with the consensus for unchanged (1.1%) against our expectation for downside risks. Also, excess liquidity in the interbank has fallen to below EUR 200bn, calling for some ECB concern. A bit of a déjà vu with early this year, where in February meeting (previous EURUSD highs) Draghi said: “we will certainly want to see whether the appreciation is sustained and will alter our risk assessment as far as price stability is concerned. In any event, next month we will have the new projections. “. November 7th. Tic-tac. Not only sustained but also broad EUR strength would worry ECB, especially against key trading partners. Previous few weeks were about mostly weak USD story, but last week the EUR gained more broadly – a flashing sign, and scope for reversal.

The FOMC meeting this Wednesday will be silent, with some 0.001% chance of a taper – but the effect would be mind-blowing. If QE doesn’t help – less QE shouldn’t hurt, right? In fact, now any indication of taper earlier than March 2014 would do to help the USD.

Technically speaking, the USD (DXY) index held the 79.00 toward the end of last week despite the softer data, suggesting potential for a bounce here – or else, 78.60.The 1.3830 is THE level (61.8% retracement of the May’11-Junly’12 move), also upper channel of the recent upward run. And yet my key concern: looks like many are expecting the EURUSD to hold here – so wouldn’t be very surprised to see a final squeeze toward 1.40, which would hit the downtrend from 2008 and would be exactly in line with the September move up

The GBP struggles…Technically same situation as last week, GBPUSD failed to breach the October 1 highs 1.6260 and still capped by it. But there is another chance, and this week’s PMIs may serve, by coming down from the unusual highs in previous months (56.7 latest), as various indicators (e.g. new orders) suggest slower momentum in the final months of 2013. Consumer confidence hints stronger retail sales…but legs are short, more decent wage growth pending.

JPY has become boring… The BoJ meeting this week, but there is nothing they should do now. Inflation is moving as projected – even faster – and could move more, to reflect JPY weakening and consumer inflation expectations picking up. But the JPY, to be fair, now is not so much about domestic events but rather global – USD yields and stock market. The fall of both would bring the USDJPY lower. I see first signs that US Treasury yields getting support, so hopes for the USDJPY shorts (like me) is the correction in stock markets which may still take some days to develop. Patience is virtue.

Tactical positioning, mostly unchanged: long USDCAD has been best performer over the past few weeks, still holding some for a move above 1.05. Short USDJPY and added short AUDUSD last week. Short GBPUSD before we go to above 1.6260. The good old NOKSEK short is still in place. Neutral on EURUSD, but short term bias to sell with a stop and reverse at above 1.3840.

Read more:http://www.efxnews.com/story/21391/eur-short-leash-gbp-struggles-jpy-gets-boring-nordea

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It Will Be An Unusually Heavy Week For The Economy — Here's Your Complete Preview

Economists and traders will be very busy digesting tons of fresh information on the economy.

"Next week’s data release calendar is heavier than usual because it contains reports that were postponed due to the government shutdown," said Credit Suisse's Jay Feldman.

"October consumer and business surveys should be hit with government shutdown headwinds, but a gain in October vehicle sales should indicate consumer resilience. We look for another modest gain in September retail sales, moderate increases in September industrial production, and contained and subdued September CPI and PPI inflation reports. In addition, the questionable quality of the October official jobs report places a higher premium on next week’s October ADP employment report."

That questionable October jobs report release has been delayed to November 8 from its originally scheduled release date of November 1.

Here's your Monday Scouting Report:

Top Story

• It Feels Like We'll Never See The Fed Taper:  Economists and traders are increasingly talking about how the Federal Reserve may have missed its chance to taper its large-scale asset purchase program (aka QE). Last week, bond traders passed around a report from Medley Global Advisors titled "Fed: Ctrl-Alt-Delete."  Medley analysts Regina Schleiger and Jeremy Torobin write that, "more than simply standing pat, the Federal Open Market Committee has effectively hit the reset button and is back where it was six months ago — at the very start of a long process of building the case for a downward adjustment to the Large-Scale Asset Purchase program.
  
  
  "The witch's brew of a labor market that was weaker even before the shutdown and debt-ceiling drama, growth that has disappointed and which was supposed to be accelerating already, and price gains so persistently meager that disinflation could soon take on a central role in the FOMC conversation, mean the bar for any change is higher than it has been for some time."

Economic Calendar

• Industrial Production (Monday): Economists estimate that production grew 0.4% in September. "Auto assemblies pulled back slightly after surging to a six-year high in August, and manufacturing payrolls and hours were little changed in the employment report, so we look for only a 0.1% uptick in factory production," said Morgan Stanley's Ted Wieseman. "A rebound in utility output after substantial weather-related weakness in recent months and another good gain in drilling should boost headline IP."
• Pending Home Sales (Monday): Economists estimate that sales were flat month-over-month in September. "The gradual rise in interest rates likely played a role in slowing sales in August and likely will keep the bounce back in pending sales restrained in September," said Wells Fargo's John Silvia. "Going forward, many analysts will be watching the existing housing market indicators now that interest rates are beginning to drop again. The short-term pull back in rates could help to support slightly better sales numbers in the coming months."
• Dallas Fed Manufacturing Activity (Monday): Economists estimate that the regional index fell to 9.0 in October from 12.8 in September.
• Producer Price Index (Tuesday): Economists estimate that PPI inflation climbed 0.2% in September, and 0.1% excluding food and energy prices.
• Retail Sales (Tuesday): Economists estimate that sales were flat in September, but up 0.5% excluding autos and gas. "Core details should look better than the headline, which should be held back by a drop in auto sales," said Credit Suisse's Alex Lebwohl. "On the upside, we look for a pick-up in food sales and a rebound in both building materials and clothing after declines last month."
• S&P/Case-Shiller Home Prices (Tuesday): Economists estimate that home prices climbed 0.6% in September.
• Consumer Confidence (Tuesday): Economists estimate that the Conference Board's measure fell to 75.0 in October from 79.7. "Our expectation is that consumer confidence fell again in October as the federal government shutdown and debt ceiling fight began to weigh on consumers," said Wells Fargo's Silvia. "This erosion in consumer confidence would be consistent with the drop in confidence after the last debt ceiling debate in August 2011. Over the next few months we expect the pace of consumer spending to downshift slightly given the gradual erosion in consumers’ expectations about future conditions."
• Monthly Budget Statement (Tuesday): Economists forecast a budget surplus of $67.0 billion.
• ADP Employment Change (Wednesday): Economists expect ADP to report a 150,000 increase in private payrolls in October.
• Consumer Price Index (Wednesday): Economists estimate that CPI increased by 0.2%, and also 0.2% excluding food and energy prices. "Gasoline prices at the pump were little changed and should not be a swing factor," said Credit Suisse's Lebwohl. "Core should round up to 0.2%, as in recent months, supported by rents, firmer used vehicle prices, and a turnaround in hotel rates and airfares after a recent soft run."
• Federal Open Market Committee Meeting (Wednesday): The FOMC updates us on monetary policy at 2:00 p.m. ET. Economists expect no change in rates and no tapering of its $85 billion large-scale asset purchase (LSAP) program. There is no post-meeting press conference or forecast updates scheduled.
• Initial Unemployment Claims (Thursday): Economists estimate jobless claims fell to 340,000. "As the partial federal government shutdown ended in the third week of October, we anticipate few if any additional claims from non-federal workers and contractors," said Citi's Peter D'Antonio. "Claims may still be at the mercy of the California backlogs, which have plagued the data since early September – inflating the four-week moving average."
• Chicago PMI (Thursday): Economists estimate the regional PMI reading for October slipped to 55.0 in October from 55.7. "We look for the Chicago purchasing managers’ index to remain roughly unchanged in October, in a relatively solid range," said Citi's D'Antonio. "However, we are well aware that the Chicago index tends to jump around a lot. This year the swings have been enormous (and seemingly unrelated to actual changes in activity)."
• Markit U.S. PMI (Friday): Economists estimate U.S. PMI registered at 51.1 in October.
• ISM Manufacturing Index (Friday): Economists estimate that the ISM index fell to 55.0 in October from 56.2. "We expect the index to pull back slightly in October to 55.2, as the government shutdown, along with fears around the debt ceiling debate, begin to weigh on business confidence and thus new order activity," said Wells Fargo's Silvia. "While we still expect industrial output to increase in the current quarter, the upside potential likely has been limited by the fiscal policy uncertainty of the past few weeks. This uncertainty is expected to continue given the short-term nature of the deal to end the federal shutdown."
• Vehicle Sales (Friday): Economists estimate the pace of vehicle sales accelerated to 15.4 million units at an annualized rate. "[I]ndustry surveys indicate that increased consumer caution during the government shutdown led to weak sales results in the first half of the month," said Morgan Stanley's Wieseman. "Retail demand appears to have improved significantly after the shutdown ended, and fleet sales picked up, but with the weak start only a modest rebound in sales for the month as a whole is expected."

Market Commentary

The stock market established new all-time highs last week. And for the most part, Wall Street's top strategists are still bullish.

"We remain comfortable being “slow buyers of equities” even as the market remains close to all-time highs," said JP Morgan's Tom Lee.

"Despite the doomsayers the worriers and those calling curtains on the rally, our clients continue to believe, as do we, the bias is to the upside for now," said BTIG's Dan Greenhaus. "If the central bank stays accommodative and earnings keep doing what they’re doing, why not?"

Read more: http://www.businessinsider.com/monday-scouting-report-oct-28-2013-2013-10#ixzz2ixRhe2IX

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RICHARD KOO: I Can't Find Anyone To Refute My Argument That America Is In A 'QE Trap'

The Federal Reserve shocked market participants in September with its decision to refrain from tapering quantitative easing, as many felt that the central bank had signaled the move at its June meeting.

Fed chairman Ben Bernanke sparked a sharp rise in long-term interest rates at the June press conference by suggesting that tapering could happen later in the year.

The September decision raised questions among observers over whether talking about tapering ended up eventually precluding tapering, because the rise in long-term interest rates sparked by the signal weighed on the economy such that the Fed then felt it couldn't ease up on the bond buying it does under its QE program.

Nomura

Richard Koo calls it the "QE trap," a concept he explained in a note following the September FOMC decision.

Koo has been meeting with clients and officials in the U.S., and he says he hasn't been able to find anyone to refute the theory that the U.S. economy is currently ensnared in the "QE trap."

"At the Fed I hoped to hear a refutation of the QE 'trap' argument presented in my last report and which I presented using Figure 1," writes Koo in a note to clients. "However, the official I met with was unable to say anything to ease my concerns."

The QE "trap" happens when the central bank has purchased long-term government bonds as part of quantitative easing. Initially, long-term interest rates fall much more than they would in a country without such a policy, which means the subsequent economic recovery comes sooner (t1). But as the economy picks up, long-term rates rise sharply as local bond market participants fear the central bank will have to mop up all the excess reserves by unloading its holdings of long-term bonds.

Demand then falls in interest rate sensitive sectors such as automobiles and housing, causing the economy to slow and forcing the central bank to relax its policy stance. The economy heads towards recovery again, but as market participants refocus on the possibility of the central bank absorbing excess reserves, long-term rates surge in a repetitive cycle I have dubbed the QE "trap."

In countries that do not engage in quantitative easing, meanwhile, the decline in long-term rates is more gradual, which delays the start of the recovery (t2). But since there is no need for the central bank to mop up large quantities of funds, everybody is no more relaxed once the recovery starts, and the rise in long-term rates is far more gradual. Once the economy starts to turn around, the pace of recovery is actually faster because interest rates are lower. This is illustrated in Figure 2.

Nomura

In essence, Koo says the idea hasn't caught on yet.

"I sensed the Fed’s full attention is now devoted to the question of whether and when to 'taper' its purchases of longer-term Treasury securities, leaving officials little time to think about long-term costs and scenarios," he writes. "The same could be said for the market participants I met with in New York and Boston, where the typical response was 'we haven’t thought that far ahead' or 'it’s tomorrow’s problem.'"

Koo says one way to avoid the "QE trap" is for the Fed to come out and argue that QE never worked to begin with, thereby downplaying concerns over its withdrawal, but it's unclear whether this would be effective, and he admits that it would be "difficult to implement."

"Current chairman Ben Bernanke, who unveiled the policy of quantitative easing, appears to want to at least begin dismantling it before his term expires," writes Koo, "but the reluctant QE 'trap' threatens to weigh on the economy for several years via elevated long-term interest rates."

Read more: http://www.businessinsider.com/koo-says-no-one-can-refute-the-qe-trap-2013-10#ixzz2il8s6ItJ

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Bonds Send A Worrisome Signal About Growth

NEW YORK (MarketWatch) — The sigh of relief felt in the U.S. bond market as Congress temporarily shelved its fiscal standoff is giving way to a more worrisome market signal: the economy isn’t as strong as we thought it would be by now.

The Treasury market has been on a tear in recent days, beginning in earnest as Senate leaders announced a deal Wednesday to reopen the government through January and allow the Treasury to continue borrowing through February. The benchmark 10-year note 10_YEAR +0.04%   yield, which falls as prices rise, is down roughly 15 basis points from its close on Tuesday, on track for its lowest closing yield since August. Strategists say yields are likely to stay in this range in the near term, in contrast to the sharp yield climb that characterized much of the summer.

“We’re pretty comfortable saying the 10-year won’t see 3% this year. At this stage, the September yield peak will be the high of the year,” said Ian Lyngen, senior rates strategist at CRT Capital Group.

Treasury yields, which serve as benchmark rates, push lower when economic and political uncertainty prompt investors to buy into the security of the government debt market. When the Congressional standoff came to a close this week, strategists thought yields would rise as the abating political uncertainty turned investor attention away from Treasurys and back toward riskier assets. But yields made a U-turn and moved in the opposite direction, catching many market participants by surprise. It’s one sign that the debt ceiling debate had simply masked, and possibly contributed to, a slowdown in economic growth.

“Since the end of the debt ceiling conflict, the focus has shifted in financial markets to what the economic implications would be,” said Jeffrey Rosenberg, chief investment strategist for fixed income at BlackRock. “And it came at a time when the economy had been slowing down, when there was disappointment in what was at the time heightened expectations of better second half growth.

Rosenberg puts the turning point in economic growth around the beginning of September, when the nonfarm-payrolls report missed expectations. Since then, many indicators have begun to slip.

The government shutdown also had the dual effect of taking a bite out of economic growth as well as delaying, and potentially skewing the way the Federal Reserve measures growth. Data releases were delayed during the 16-day shutdown as federal workers who produce them were furloughed.

“That all has turned market expectations from the ‘escape velocity growth is around the corner’ [mentality] to ‘maybe here we go again,’” Rosenberg said.

Since the government shutdown, a number of research houses have revised their fourth-quarter projections for U.S. economic growth downward. Macroeconomic Advisers shaved 0.5% off its estimate, now 2.1%. IHS Global Insight is now forecasting 1.6%, versus 2.2% previously. And Capital Economics now projects 2% growth, down from 2.3%.

Further, many participants assume that fights in Congress will replay themselves when the government reaches the budget and debt limit deadlines it set for itself early next year. That uncertainty has pushed back projections of when the Fed will begin winding down its $85 billion in monthly bond buying. Expectations of withdrawing the stimulus that had held interest rates down in turn pushed yields sharply higher over the summer.

Many analysts expect Janet Yellen — who has been nominated to lead the Federal Reserve — will continue on a dovish policy path. As a result, some market participants are now honing in on a March time frame as the earliest possible time to begin the so-called taper.

“Tapering will be off the table until 2014,” said Matt Duch, portfolio manager at Calvert Investments. He added: “It’s getting bumpier and bumpier and you’re better off in a conservative investment.”

Strategists stopped short of saying bonds were set to rally. The Fed will inevitably have to scale back its bond purchases, but in the meantime, the pause in the benchmark interest rate’s climb may present opportunities. BlackRock, for one, upgraded some of its interest-rate sensitive sectors, such as Treasury and agency bonds to neutral from underweight at the beginning of the month. 

Ben Eisen is a MarketWatch reporter based in New York.

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