US 5y yields have been in a rising triangle formation since mid 2013. Yesterday’s close was the highest since the one print a year ago, and today’s close seem destined to settle about multi-month resistance:
Most of the move has been driven by real yields – inflation breakevens have actually fallen 30bps from the June highs. The currency market has actually moved ahead of the rates market – the Dollar index notched up is fastest gain from early July to now since last summer, although how much of that was due to the ECB and oil prices is up for debate.
The charts certainly suggest an imminent breakout, but does the move in yields make fundamental sense? The data suggests yes, but perhaps it is a bit early. Economic surprises (white below) are at the strongest levels since early 2012, which is supportive. But a breakdown of the components shows that the strongest contributors are the survey components rather in the hard data. While the surveys are historically strong leading indicators for the data, the Fed has historically wanted to see the strength reflected in the hard data before moving.
And that segues to the crux of the issue – market expectations for the FOMC next Wed. Many participants have noted the possibility that the Fed removes the ‘considerable period’ language in the statement. Given that Yellen let slip in her first press conference as chair that ‘considerable period’ means around 6 months, such a change without further qualifiers would cause the market to price in a strong possibility of a hike by March of next year. But the price action suggests that despite the chatter, markets are actually fairly sanguine about such a shift, as the April 2015 Fed Funds future shows: (FOMC meets on 3/18/15 and 4/29/15) This suggest the possibility of an interesting, asymmetric bet.
Buffet on Market Valuation, via the Brooklyn Investor: (and why Buffet probably thinks that equity valuations should be notably higher than the historical average)
From the 1981 Berkshire Hathaway letter:
- The economic case justifying equity investment is that, in aggregate, additional earnings above passive investment returns – interest on fixed-income securities – will be derived through the employment of managerial and entrepreneurial skills in conjunction with that equity capital.
- Several decades back, a return on equity of as little as 10% enabled a corporation to be classified as a "good" business – i.e., one in which a dollar reinvested in the business logically could be expected to be valued by the market at more than one hundred cents. For, with long-term taxable bonds yielding 5% and long-term tax-exempt bonds 3%, a business operation that could utilize equity capital at 10% clearly was worth some premium to investors over the equity capital employed… Investment markets recognized this truth. During that earlier period, American business earned an average of 11% or so on equity capital employed and stocks, in aggregate, sold at valuations far above that equity capital (book value), averaging over 150 cents on the dollar.
- That day is gone. But the lessons learned during its existence are difficult to discard. While investors and managers must place their feet in the future, their memories and nervous systems often remain plugged into the past. It is much easier for investors to utilize historic p/e ratios or for managers to utilize historic business valuation yardsticks than it is for either group to rethink their premises daily. When change is slow, constant rethinking is actually undesirable; it achieves little and slows response time. But when change is great, yesterday’s assumptions can be retained only at great cost. And the pace of economic change has become breathtaking.
- RBNZ kept policy rates unchanged but used aggressive language on the exchange rate:
- The exchange rate has yet to adjust materially to the lower commodity prices. Its current level remains unjustified and unsustainable. We expect a further significant depreciation, which should be reinforced as monetary policy in the US begins to normalise.
- In light of these uncertainties, and in order to better assess the moderating effects of the recent policy tightening and export price reductions, it is prudent to undertake a period of monitoring and assessment before considering further policy adjustment. Nevertheless, we expect some further policy tightening will be necessary to keep future average inflation near the 2 percent target
AU Employment jumped to +121k vs +15k expected, at 36 year high, driven by part time employment. This is obviously something of an outlier, but even after revisions, the results are likely to be stronger than consensus expectations.
France CPI declined to 0.5% YoY as exp vs 0.6% prev
US Jobless Claims rose to 315k vs 300k exp and 304k prev
China August CPI printed +2% y/y versus +2.2% expected, a four month low. PPI -1.2% y/y versus -1.1% expected. Vegetable and oil prices were some of the drivers.
- Thu: NZ PMI
- Fri: Kuroda Speaks, US Retail Sales, U Michigan Confidence
- Mon: China Retail Sales, IP, US Empire Manufacturing,
- Tue: UK CPI, PPI, German ZEW, US PPI
- Wed: BoE Minutes, UK Employment, US CPI, NAHB Housing Index, FOMC, NZ GDP
- Thu: UK Retail Sales, US Jobless Claims, Housing Starts, Philly Fed