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Federal Reserve Leaves Door Open for June Rate Increase

Published: 08:35 28 Apr 2016 BST

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Federal Reserve Leaves Door Open for June Rate Increase
Here is the opening of this report on the Fed’s announcement from Bloomberg:

Federal Reserve policy makers left open the door to raising interest rates in June by nodding to improvement in global financial markets and downplaying recent weakness in the U.S. economy.
The Federal Open Market Committee omitted previous language that “global economic and financial developments continue to pose risks,” instead saying officials will “closely monitor” the world situation, according to a statement released Wednesday following a two-day meeting in Washington. The Fed left its benchmark interest rate unchanged.
“Their removal of the line on risks is pretty significant,” said Carl Tannenbaum, chief economist at Northern Trust Corp. in Chicago and a former Fed official. “That might reflect increased comfort on the committee that global influences appear more manageable.”
The yield on 10-year U.S. Treasury bonds dropped by about 0.06 percentage point while U.S. stocks fluctuated with the dollar. Fed Chair Janet Yellen wasn’t scheduled to hold a post-meeting press conference.
The Fed’s assessment of how economic conditions have evolved since the committee last met in March was mixed. Officials acknowledged recent weaknesses while adding dashes of optimism over what’s ahead for the labor market and consumer spending.
“Labor market conditions have improved further even as growth in economic activity appears to have slowed,” the FOMC said. “Growth in household spending has moderated, although households’ real income has risen at a solid rate and consumer sentiment remains high.”
The committee reiterated that it will probably raise rates at a “gradual” pace. The central bank’s next meeting is June 14-15.
Extending a hold since raising interest rates in December from close to zero, the committee said that inflation has continued to run below the Fed’s 2 percent target, and market-based measures of inflation compensation remain low.


David Fuller's view
The US Federal Reserve has as Dual Mandate: stable prices and maximum employment.  They will not mention countries by name but reading between the lines we can assume that they are less concerned about China and commodity producers, and not without some justification.  In other words, negative deflation is slightly less of a risk and they do not yet see the ‘whites of the eyes’ of inflation.  Meanwhile, the trend of US employment is generally favourable, even though we can quibble about the quality of jobs on offer.  
Consequently, the Fed is on course for a quarter-point rate hike in June, provided there are no shocks between now and their next meeting on June 14-15.  However, there will still be a wild card which they have not had to consider previously.
 

Confused by Brexit? Here is Why Voting Remain is the Sensible Option, for Now
Here is the conclusion from this interesting article by Ben Wright for The Telegraph:

The risks posed by the two options in this summer’s referendum are therefore asymmetric. If we leave, we leave. But a vote to remain keeps the country’s options open – it is like being allowed to make an each-way bet on a two-horse race.
This is an especially important consideration for undecided voters. To the extent that normal people are paying any attention to the debate whatsoever, they may by now have concluded that the UK economy is likely to suffer a hit if the country votes to leave the EU (a fact that is conceded by even ardent Brexit supporters). But they will have no idea how extensive or lasting the damage might be.
They have been told that it is better to be inside the European Union agitating for much-needed reforms, but also that there is a lack of democratic accountability in Brussels where Eurocrats turn deaf ears to the UK’s pleas.
They have heard that European countries won’t be willing to agree favourable trade deals with a post-Brexit UK for fear of giving succour to anti-EU parties within their own borders. But they have also heard that Brits eat too much brie and drive too many Volkswagens for the EU to shut them out.
They may have noticed that a range of foreign politicians, economists, companies and supranational organisations have urged against Brexit, but might have been persuaded that this is a sophisticated propaganda blitz organised by an elite cabal hellbent on safeguarding its own existence.
In short, British voters, who have been bombarded with opinions (often masquerading as facts), will be unsure about who to trust and probably find themselves torn between the two sides of the argument – between pragmatism and patriotism; between head and heart.
Those who are should comfort themselves with the knowledge that the choice is not binary. There is absolutely no reason why the UK can’t vote to remain a member of the EU this summer and, if the benefits of that relationship deteriorate (which is certainly not beyond the realms of possibility), hold another referendum in five, 10 or 20 years’ time.
It's clear that the timing of this vote is far from ideal. The global economy is not looking so hot right now. The UK is running a peacetime record current account deficit, which can only be funded through foreign investment. And that money may very well start to dry up during the protracted negotiations that will follow a Brexit vote.
Some might describe such caution as cowardly. I think it fits Michael Oakeshott’s description of a small “c” conservative, who prefers “the familiar to the unknown … the tried to the untried, fact to mystery, the actual to the possible … the convenient to the perfect”.
It’s true that this philosophy benefits the status quo and sometimes things need to be shaken up. But that puts the onus on reformers to lay out a compelling alternative. If the British public is being told to take a running jump, it seems only fair to ask what we’ll be landing in. The Leave camp has failed to persuade me that it won’t be brown and sticky.
Yes, the UK’s membership of the EU may become less beneficial over time; it may reach the point where the decision to quit becomes compelling. But we’re not there yet.
Given that, there’s only one logical course of action for the undecided come June. It’s not stirring but it is sensible: Vote Remain (For Now).


David Fuller's view
I find this view persuasive, under difficult circumstances.  While I think EU officials are the architects of its probable destruction, assuming they stay on their present course, I do not like the real possibility that the UK would be blamed for triggering an even worse crisis.
I also think many currently undecided voters will find Ben Wright’s view persuasive.
A PDF of Ben Wright's article is posted in the Subscriber's Area.

One Regulation Is Painless. A Million of Them Hurt.
Here is the opening from this is a most welcome article by Megan McArdle for Bloomberg:

“In one year,” wrote Warren Meyer in 2015, “I literally spent more personal time on compliance with a single regulatory issue -- implementing increasingly detailed and draconian procedures so I could prove to the State of California that my employees were not working over their 30-minute lunch breaks -- than I did thinking about expanding the business or getting new contracts.”
Meyer is the owner of a company that runs campgrounds and other recreational facilities on public lands under contract from the government. It doesn’t seem like regulatory compliance should be eating up so much of his time; he is not producing toxic chemicals, operating a nuclear facility, or engaged in risky financial transactions that might have the side effect of sending our economy into a tailspin. He’s just renting people places to pitch a tent or park an RV, or selling them sundries. Nonetheless, the government keeps piling on the micromanagement lest some employee, somewhere, miss a lunch break.
I know what you’re going to say: Employees should have lunch breaks! My answer is “Yes, but.…” Yes, but putting the government in charge of ensuring that they get them, and forcing companies to document their compliance, has real costs. They add up.
An economy with but one regulation -- employees must be allowed a 30-minute lunch break, and each company has to document that it has been taken -- would probably not find this much of a drag on growth. But multiply those regulations by thousands, by millions, and you start to have a problem.
A new working paper from the Mercatus Center attempts to document the cumulative cost of all these regulations. It finds that the growth of regulation between 1977 and 2012 has shaved about 0.8 percent off the rate of growth, costing the nation a total of $4 trillion worth of GDP.
Stories like Meyer’s are the tangible face of the economic theory. As is the fact that in the annual small business survey by the National Federation of Independent Business, taxes and government red tape are far and away the biggest issues that business owners cite as their most important problems. Forty-three percent of those surveyed cited one of the two as their top issue.


David Fuller's view
I have heard similar stories over and over in recent decades.  In the USA, where it is fashionable to be patronising about former President Ronald Reagan’s abilities, I believe he would have lifted the dead weight of overregulation.
Excessively burdensome regulation is most frequently introduced by left of centre governments, with the intention of protecting workers, while actually reducing their prospects.  Governments too often ignore this while taking pride in the number of white collar regulatory jobs they have created.
The EU is the gold mine of regulatory jobs.  

Email of the day
On Markets Now presentations:
Good morning David, Gillian and I thank you once more for an interesting evening. The presentations and the dialogues were enlightening. I have downloaded a copy of your power point presentation but could not find those from Iain and Charles. I would appreciate if you would forward them to me or direct me towards the place where I can find them. Best regards also from Gillian, Erich


David Fuller's view
You are very welcome, and thank you for travelling all the way from Switzerland.  Your comments in discussions were also greatly appreciated.
To avoid overwhelming email systems and winding up in a ‘Spam’ folder, I release the PowerPoints over three days, in the sequence in which they were delivered.  Here is Charles Elliott’s excellent presentation: Investing in Technology.


How Argentina Settled a Billion-Dollar Debt Dispute With Hedge Funds
This article by Alexandra Stevenson for the New York Times may be of interest to subscribers. Here is a section:

After several frantic meetings and heated discussions over conditions, including that the hedge funds continue to have a say in Argentina’s future domestic market fund-raising, NML, Aurelius, Davidson Kempner and Bracebridge signed a deal on Feb. 28. In the agreement, Argentina agreed to pay $4.65 billion to the hedge funds, which included bond principal, interest and “certain legal fees and expenses incurred.”

Two days earlier, Mr. Pollack, the mediator, requested that Judge Griesa sign an order summoning Mr. Pollock and Mr. Singer of Elliott to his offices.

On Friday, Argentina paid all of the holdout creditors who had agreed to deals — a total of $9.3 billion, the economy ministry said. Elliott received $2.4 billion, a 392 percent return on the original value of the bonds, according to the ministry.


Eoin Treacy's view
Mauricio Macri is likely to be someone we hear a lot more from in future. Since his inauguration late last year he has come through with what he said he would do during the election campaign. In terms of the improving governance we look for to justify a medium-term bullish argument Argentina didn’t have it and now it does.


Email of the day on inflation expectations and rates
You've drawn attention to the 12 month T-bill rate a couple of times over the past week. Additionally, it is also very instructive to monitor inflation expectations to gauge what is discounted in terms of the future direction of interest rates. The five-year “breakeven” rate, a market measure of inflation expectations derived from comparing the yield of Treasury Inflation protected bonds (Tips) and conventional Treasuries, has climbed from a low of 0.95% in early February, to 1.56% now. It peaked at 2.4% in October 2012 after reaching an unprecedented minus 0.9% in 2008.

Movements in Tips have tended to reflect investor expectations about future consumer price inflation, and these have been stoked by the recent rise in oil prices and a weaker dollar, which means higher import prices. In fact, the breakeven rate has been rising in tandem with oil prices since February. Interestingly, the “core” US inflation rate, which strips out the impact of volatile components such as energy and food, has also been rising. The current buying of Tips reflects a view that the cycle of dollar strength and commodity weakness has come to an end.

Like you and David, I also think that commodities have bottomed. However, there are no signs of strong underlying demand and inflationary pressures from the real economy at the moment. Furthermore, Janet Yellen, the Fed chair, has cast doubts on the durability of the recent pick-up in core inflation and inflation expectations, arguing that the case for moving cautiously on interest rates was still strong. It is not surprising that she would say that given that the Fed has reduced the likely number of rate rises this year.

My view is that the US breakeven rate will rise with commodity prices which will push conventional yields up and stock markets down but I don't believe that oil prices, for example, will get anywhere near the previous peak for the reasons discussed by this Service. Thus bond yields too will peak at a much lower level. The collapse in commodity prices in the last few years has distorted valuations in various markets and there will be a ripple effect across the other asset classes.


Eoin Treacy's view
Thank you for this thoughtful email and for highlighting breakeven rates which I have not looked at in a while. I watch the 12-month yield because if gives us a good indication of how the bond market is pricing the risk of the Fed raising rates.


The forgotten but enduring emerging markets opportunity
Thanks to a subscriber for this report from Deutsche Bank which may be of interest to subscribers. Here is a section:

As GDP goes, so does consumer products consumption
In these volatile times, the relationship between commodities, currency, pricing and consumption is as pronounced as ever, with inflationary pricing to offset f/x transaction driving bulk of EM growth as benign commodities and modestly improving macro drives modest growth in developed markets. As we discuss in this report, GDP growth is the primary industry consumption driver, with multiples tracking this growth trajectory. For instance, in 2010, when EM growth was solid and commodities high, US and EM-centric CPG companies traded at roughly the same 12% PE premium to the market; by 2015, US centric names jumped to a 40% premium versus 22% for the EM exposed names. With commodity complex still depressed and geopolitical risks omnipresent, we understand the consensus negative views on emerging markets but several stocks in our coverage have substantial leverage to improving trends in these demographically privileged markets.

BRIC by brick
Noting clear cultural, geopolitical and demographic differences across Brazil, Russia, India and China, in addition to myriad other developing markets, the per capita consumption opportunity is significant for branded consumer packaged goods manufacturers. Despite the recent malaise, emerging markets are still growing at least 3x faster than demographically challenged developed markets, with often cited but still powerful dynamics of younger, upwardly mobile populations, urbanization, female workforce participation and shift from agrarian to services jobs supporting sales, margin and cash flow growth for those who have already built the critical infrastructure.

Valuation supports market perform view on group
Group is trading above average relative to the market on historical P/E multiples; and industry DCF, which we use to derive our target prices and assumes 2.5% sales growth and 0.6 pts of margin expansion per year through 2023 (7% WACC, 1.5% TVG) suggests group is about 2% undervalued relative to its cash flow. Downside risks include cost inflation, rising rates, dollar strength, consumption declines and EM slowdown. Upside risks are US recovery, M&A rational pricing, flat commodities and f/x, accelerated restructuring, EM stabilization, and cost savings, and aggressive balance sheet redeployment.


Eoin Treacy's view
A link to the full report is posted in the Subscriber's Area.

The Consumer Staples and Consumer Discretionary sectors have been consistent outperformers over the course of the medium-term bull market from the 2009 lows. Part of the reason for this is because they offer exposure to the rise of the global middle class but also because they dominate their respective niches and often have reliable cash flows.


The Chart Seminar 2016


Eoin Treacy's view
Thank you to everyone who has expressed interest in The Chart Seminar this year. Our plans are to hold a webinar sometime in June and I will share details of this as we firm up how best to conduct it. The timing of the seminar will be catered to where the majority of delegates sign up from but we’ll try to pick a time when the most possible people can tune in live.

We also plan to hold two seminars in physical locations this year. From some subscriber feedback I was thinking of holding one in Los Angeles during the summer and another in London during the fourth quarter. If you would like to express interest in any of our events please message Sarah Barnes at sarah@fullertreacymoney.com.

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