February 2019 – Monthly Commentary

February 2019

It would appear that economic pundits believe that the U.S. economy is either sustainably robust or faltering and on the verge of recession.  Certainly, Central Bankers around the globe are suspiciously reassuring that economic growth is just right and in case things go awry, they stand ready and able to act.  Much as Fed Chairman Powell did in his speech last month, European Central Bank President Mario Draghi gave a sobering assessment of the European economy, recognizing that business activity in the region has slowed materially.  In response, he vowed to not raise interest rates in 2019 and to reimplement the Targeted Long-Term Refinancing Operation for the third time (TLTRO III).   TLTRO is the program in which the ECB issues low cost loans to European Banks with the idea that the banks will turn around and relend the cash to borrowers, thereby stimulating growth.  At least that is the stated goal of the program.  In reality, the reimplementation is being put in place because the previous TLTRO is rolling off and the ECB needs to head off a funding crisis of their own creation.  Despite the dovish turn in policy, we doubt that it will result in anything more than tepid growth in the region.  As we’ve discussed on several occasions, we think that the problem with economic growth in Europe is structural.  Monetary policy can provide a short term burst to activity but the socialist tendencies and high consumption tax will keep the economy from growing rapidly.

Also during the month, Bank of England Governor Mark Carney reversed his opinion of the consequences to the economy should the United Kingdom leave the European Union without an agreement on trade.  In November, Carney opined that should a no-deal BREXIT come to pass, the economy could contract as much as 7% and the exchange rate for the Pound Sterling could fall as much as 25% against the Euro and the U.S. dollar.  On Thursday he tempered that forecast saying that the economic impact would only be about half of what he originally forecast.  Nonetheless, a contraction of economic activity on the order of 3% in the U.K. is likely to have repercussions for U.K. as well as continental Europe.  At the time of this writing, with two weeks until the so called divorce date, no solution for an amicable split from the European Union exists.  Ironically, the FTSE 100 is 5% higher, with interest rates and the value of the Pound Sterling marginally unchanged over the first two months of the year.  One can only guess at the value of those markets one month from now.

Turning to the U.S., despite the “full court press” of dovish comments by the various members of the FOMC, economic growth continues to impress.  On the last day of February, Q4 2018 GDP was released, showing 2.6% quarter-over-quarter growth, annualized.  That outcome was surprising given that consensus was expecting at 2.2%.  Even more impressive, when compared to the Q4 2017, growth for the period registered 3.1%.  Moreover, that growth was achieved despite an abysmal month for stock prices and concern the economy was on the verge of recession.  Despite that gloomy end to year, stocks have demonstrated impressive resilience, rallying 11% in the first two months of this year.  That comes on the back of solid growth in fourth quarter earnings.  Equity investors are again “climbing the wall of worry” investing in stocks despite the government closure that started the year and the on-again off-again trade negotiations between the U.S. and China.  The big question is how investors will react when the U.K. and the Europe Union finally split.

Copyright 2019, Halyard Asset Management, LLC. All rights reserved.

January 2019 – Monthly Commentary

January 2019

The January Federal Open Market Committee (FOMC) meeting yielded no rate hike and a dovish outlook for interest rates, as expected.  Chairman Powell concluded this meeting with a press conference as will be the convention following every FOMC meeting going forward.  The standard to date had been to have a press conference every other meeting.  Our guess is that he would have preferred to skip this one given his marked about-face on interest rates.  Typically, the Chairman is lobbed “softball” questions in a tacit understanding that the media doesn’t want to embarrass him.  Such was especially the case with the thin-skinned previous Chairs Bernanke and Yellen.  However, in a break from that understanding, Chairman Powell was bluntly asked pointed questions such as, “is the Fed at the end of rate hike cycle, what would it take for interest rates to rise, has the risk of recession increased, and is trade policy influencing the FOMC decision making.”  Those are all questions the Chairman would prefer not to answer since they directly affect the capital markets and pose the risk of him being wrong again.  He is now clearly perceived as having been wrong back in September when he said the Fed Funds rate was nowhere near the neutral rate.  What’s worse, one questioner asked if there was now a Powell equity put in place.  The insinuation, of course, is that’s now the conventional wisdom.  The idea of a FOMC put originally came into play when Alan Greenspan cut rates sharply in the wake of the 1987 stock market crash.  With each subsequent large market correction, the Fed would ease monetary policy conditions.  The more severe the correction, the more severe the easing of monetary policy.  Until it reached the absurdity that we’ve witnessed in the wake of the 2008 financial panic with 0% interest rates and the Fed buying more than $4 Trillion in government debt. 

Chairman Powell’s hawkish tone and December rate hike panicked investors and resulted in the sharp fall in stock prices.  He reacted by reversing his hawkish rhetoric and assessment of interest rates.  We think there’s a very good chance that reversal will come back to haunt him later this year.  The economy continues to demonstrate robust strength.  The January employment report showed that 304,000 new jobs were created in the month; a shocking amount of job creation given this stage of the cycle.  In addition, average hourly earnings rose 3.2% over last year’s reading, down 0.1% from last month but the highest rate of change since 2009.  It wasn’t that long ago that economists were bemoaning that wage grow couldn’t break above 2%.  To be fair, consumer confidence and softer measures of economic activity such as manufacturer surveys are portraying a slowing in economic activity, but we argue that it’s self-inflicted damage from the White House and Congress.  Despite the stories about government workers who were unable to pay the mortgage, put food on the table and purchase necessities for the family, the shutdown effected a very small subset of the population.  However, it had the collateral effect of depressing the general confidence of the country as a whole.  Whether in agreement with the strategy or against, it’s hard to argue that it didn’t have a negative impact on consumer sentiment.

Similarly, the trade battle with China has gone back and forth from being close to resolution to seeming likely to drag on for a very long time.  The effect on the U.S. economy so far has been muted, at best, but a number of companies that operate on a global scale have reported that tariffs are impacting their business.  If the two countries are able to arrive on a solution in the near-term, either real or perceived, that would bode very well for market sentiment and consumer confidence.  If unable to reach a compromise, the earnings of global companies will come under pressure.  The worry is that the contraction in those companies could have a contagion effect to domestic business and the consumer as a whole.  In that instance, economic growth would be at risk. 

Copyright 2019, Halyard Asset Management, LLC. All rights reserved.