The Debate Raging within the Federal Reserve

There’s a debate raging within the Federal Reserve as to what to do about the “Evans Rule.” This was guidance adopted by the Fed, at the urging of Chicago Fed President Charles Evans, as to what specific metric would cause the Fed to raise short-term interest rates. The Fed said that it would use an unemployment rate of 6.5%. Previous Fed Chairman Ben Bernanke was careful to warn that this was a threshold and not a trigger.

The problem is that unemployment has already declined to 6.6%, and no one’s even close to raising interest rates. Most FOMC members don’t see a rate increase happening until 2015 or 2016. There are even some folks who say that low rates are here to stay and the Fed’s use of Quantitative Easing will become its primary tool to fine-tune the economy. That’s probably too extreme, but it’s being talked about.

The minutes released this week covered the Fed’s January meeting. Interestingly, the Fed`s members were surprised at the economy’s strength. That obviously contributed to the decision to gradually pare back their massive bond-buying program. But what’s interesting is that the central bank is showing no signs of backing away from taper plans, even though the last two jobs reports weren’t so hot.

Strangely, the Fed is as undecided about when to raise short-term rates as it is stubborn about tapering,. In fact, the Fed may even back away from using a specific number, like Evans had suggested, and fall back on using garbled econo-speak. On the one hand, this doesn’t lead the markets to false expectations. Some FOMC members favor this direction but it adds a layer of opaqueness to the Fed’s deliberations.

The Fed may elect to lower the threshold. Narayana Kocherlakota, the president of the Minneapolis Fed, wants to go down to 5.5%. I think some voting members want to get rid of a precise number altogether. As I said, markets will find something to fret about. Of course, all of this is complicated by the Fed`s having a new boss in Janet Yellen. The Fed’s next meeting, and the first one under Yellen, will be on March 18 and 19.

What this means for investors: The Fed is still clearly on the side of investors. Quantitative Easing is with us, and will be for several more months. The pace of stimulus, however, will gradually decline. The curveball about QE is that it impacts the long end of the yield curve, while traditional Fed stimulus is at the short end. Higher long-term rates could impede sectors like housing, but I doubt we’ll see much impact, although we’ve seen mortgage financing take a hit. The simple fact is that housing inventory is lean, and the market needs more homes. Bad weather may delay that fact, but it won’t change it.

This is good news for the economy and the stock market in general. I think it’s very likely that 2014 will be one of the strongest years for economic growth in a long time. I won’t go so far as predicting a bond market sell-off, but I do think the long-end of the curve is a bad place for investors. The yields are just too measly, and the math is squarely on the side of stock “longs.” Continue to focus your portfolio on high-quality stocks such as our Buy List. If the Evans Rule is altered or dropped, it could propel the market much higher. Now let’s look at some of our Buy List earnings from this week.

Watch for a Taper Time-Out

Good luck to new Fed Chair Janet Yellen and her expectation that the Fed can continue to taper back its QE stimulus at the current pace until it is completely gone by summer.

The economic reports say it is not going to happen.

In her optimism regarding the economy, expressed in her testimony before Congress this week, Yellen pointed to GDP growth hitting an average annual rate of 3.5% in the last half of last year, compared to only 1.7% in the first half.

Regarding the negative consequences tapering seems to be having on emerging markets she said in effect that the Fed is only worried about the U.S.

She shrugged off the recent dismal jobs reports, saying weather may have played a factor, only agreeing that employment is still far from satisfactory conditions.

[Hear More: Dr. Peter Warburton: Disinflationary Trend Continuing – But Fed’s QE Policy Ultimately Leads to Higher Inflation]

However, the problems are not showing up only in the jobs picture.

As I noted in previous columns, it has been the unexpected widening of the U.S. trade gap, as exports decline and imports rise. It has been in the huge plunge of the ISM Mfg Index, and in Durable Goods Orders, factory orders, home and auto sales.

This week is was the negative surprise of retail sales being down 0.4% in January, and previously reported sales for December revised down from a gain of 0.2% to a decline of 0.1%. It was also not encouraging that within the report, online sales, which should be boosted by bad weather that keeps shoppers away from the malls, also fell in January, down 0.6%.

The Federal Reserve reported Friday that U.S. industrial production fell 0.3% in January, versus the consensus forecast for a rise of 0.2%. The production report would have been even worse except for a 4.1% surge in utilities output due to increased heating demand.

 The initial estimate from the U.S. Bureau of Economic Analysis (BEA) was that the economy (GDP) grew at an annual pace of 3.2% in the 4^th quarter, a number also noted by Fed Chair Yellen. However, the BEA subsequently revises the number monthly for several months as new information regarding the quarter comes in.

While Janet Yellen remains sanguine about the future, major Wall Street firms have slashed their economic estimates quite dramatically again this week, particularly after the disappointing retail sales report for January. They are continuing to cut their expectations not only for this quarter, but also for the fourth quarter of last year.

Barclay’s bank says the downward revision this week of previous reported retail sales in December subtracted another 0.4% from the firm’s already declining estimate for the fourth quarter, which now suggests a probable downward revision by the BEA to 2.2% “a full percentage point below the first official estimate of 3.2%”.

Michelle Girard, chief economist at RBS, says, “Our running tally of probable revisions for fourth-quarter GDP point to a downward revision to 2.3%”.

Jan Hatzius at Goldman Sachs cut his 4^th quarter estimate of GDP growth to 2.4%, and his estimate for the current quarter to 1.9% (it was at 3.0% just three weeks ago).

This week Credit Suisse economists reduced their estimates for the current quarter in 2014 from their previous estimate of 2.6% to just 1.6%.

It may not be good news for the economy. However, the stock market loves it.

After declining for five straight weeks in January and into early February on concerns about the negative effect the Fed’s tapering was having on economic reports, the stock market has rallied for eight of the last ten days, now celebrating each additional negative report.

What happened to its concerns?

The deteriorating economic outlook has now reached the stage where each additional negative report becomes difficult for the Fed to shrug off, or blame on weather, and adds pressure for it to at least pause the tapering back of its QE stimulus.

In her testimony before Congress this week, Fed Chair Yellen did say the Fed is “staying the course unless the data turns decidedly negative.”

It is doing so, and the stock market probably has it right that Fed stimulus will remain on the table for longer than expected. Whether that would be enough to reverse the U.S. economic slowdown, and global economic problems, particularly if the Fed waits until their next FOMC meeting in mid-March to make the decision, may be a question markets have to face later.

Russell: “An hour before the close (on Friday), the Dow was up 120 points, with substantially less volume.  This told me that institutions were selling into the rally.  The Dow closed slightly off its high.  I call this a poor day, accented by institutional selling.  Gold had its best day since last August, closing at a new high for the move.  

I think gold is overbought now, with many Johnny-come-latelies belatedly advising positions in gold.  Today there was a full-page ad in the New York Times advertising “bargain gold.”  This too suggested that gold, after its excellent rally, is now overdue for a rest.

In the big picture, I continue to believe that we’re in a world depression.  This will be followed by frantic activity by the Fed, as it prints new trillions of dollars.  Which I’m certain, by the way, is why gold has been rising.  I think we’re at the inflection point where the primary bear trend is overcoming the frantic action of the Fed.  

For years the Fed has been trying to establish its objective of 2% inflation.  But the global deflationary pressures have thwarted the Fed.  The dollar is key here.  If or when the dollar index closes under 80, I think we will see fireworks in gold.” 

More:  “Despite government Fed lies and propaganda, I will repeat my take on the present situation.  The world is in a continuing depression, and only the vanishing US middle class is aware of it.  The Fed and the government are feeding an unending parade of lies to the American people.  

Once the actual facts emerge to the newspapers, I expect Janet Yellen to buy Treasuries at a greater rate than we’ve seen so far.  And at the same time, she will be creating new trillions of dollars without end.  Rising gold is anticipating these future Fed moves.  But rising gold will be a red flag for all to see.  I look for the dollar index as a first sign of the Fed’s helplessness in the face of the ongoing world depression. 

So far, the dollar index has clung to a price of $80 plus.  I believe a break of the $80 support level for the dollar will be a sign that the Fed is losing its battle.  The powerful performance of gold for weeks and weeks is a subtle sign that the Fed has already lost its grip.  A position in gold is a position against the Federal Reserve.  

Unfortunately for the Fed, gold is traded across the face of the planet.  And currently gold is telling us the truth about the Fed’s money creation.  I continue to like CEF as a security beyond the reach of the Fed and the government.  As noted yesterday, most gold items are now in the process of breaking out of their bases.  A vote for gold is a vote against central bank planning.  Gold will forever be a hated item in the eyes of central planners.”

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“With mayonnaise, cookies, and coffee leading the way”

US Products Lead the Way; Currency Devaluations Hit P&G Earnings.

Prices of many goods in Argentina soared in the past two weeks. US brands are at the forefront of the action. Via translation from Lanacion, In two weeks, Warehouse Prices Rose 30%, with mayonnaise, cookies, and coffee leading the way. Officially, prices are up 3.3%. In reality, prices are up 30%.

According to official data, the price of food and beverages was up 3.3%. A tour of various supermarkets in the city of Buenos Aires, found escalating inflation is much higher in stock products, perfumery and milk.

Here are some price increases from the article. Please use relative price increases. They use the $ symbol for pesos.

• Hellmann’s mayonnaise in late January was on the shelves at $10.40 is now $13.55.
• A can of peaches last month cost about $20 and yesterday were above $26.
• Coffee 500g [about 1.1 pounds] rose 16% from $33.69 to $38.99.
• Express cookies went from $15.39 to $20.39.
• Hamburger buns increased from $13.06 to $14.19.
• Sancor yogurt went from $15.25 to $ 17.99
• La Serenissima Long life milk went from $10.7 to $11.59.
• Shampoo went from $15.77 to $19.
• Colgate Triple Action toothpaste 180 grams [6.3 ounces], went from $15.70 to $19.96. 
• Two-liter bottles of water rose from $8.25 to $9.43

Currency Devaluations Hit P&G Earnings

Inquiring minds may be wondering how this affects earnings of US multinational corporations.

Forbes explains Venezuela, Argentina Currency Devaluations Hit P&G Expected Sales And Earnings. 

Retail investors aren’t the only ones suffering from the woes of the emerging markets: Procter & Gamble PG +2.06% is feeling the pain of foreign currencies, too. Due to devaluations in currencies like the Venezuelan bolivar, Argentine peso and Turkish lira, to name a few, the consumer product giant said that it is lowering its outlook for its full-year 2014 sales and earnings.

P&G, which in January announced second quarter earnings results that were already feeling the ill effects of foreign exchange rates, said Tuesday afternoon that it would incur a charge between $230 million and $280 million, or 8 cents to 10 cents per share, a one-time charge resulting from revaluing its Venezuelan balance sheet in the wake of a change in the way the Venezuelan bolivar is valuated. Venezuela uses a de-facto dual-exchange rate system, but policy changes recently enacted by the Venezuelan government are affecting the way that certain imports — i.e, certain P&G products — are exchanged. 

Specifically, the policy changes dictate that the state-run currency rate between the bolivare and the dollar is now 11.4 bolivares per one U.S. dollar; P&G, meanwhile, had calculated the value of its foreign transactions using the other, 6.3-bolivare-per-USD rate, thus the near-$300 million charge P&G now expects to incur on its third quarter balance sheet.

In reevaluating its outlook, P&G also took into consideration the recent devaluation of the Argentine peso, Turkish lira, South African rand, Russian ruble, Ukrainian hryvnia and Brazilian real. Of the group, the Argentine peso has proven the biggest problem, declining 20% to 8 pesos per dollar.

All told, P&G’s full-year sales growth forecast is 2%, down from a prior range of 3% to 4% for fiscal year 2014. The company also lowered its earnings-per-share growth forecast to 3% to 5%, down from prior guidance of 5% to 7% growth.

Mike “Mish” Shedlock

also:

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Immigration Debate Rages in US and Europe; EU Strikes Back at Switzerland

http://globaleconomicanalysis.blogspot.com