FOMC, ECB and Jobs - A Trifecta Of Potential Disappointment
The coming week is chock full of data that is likely to move the markets - unfortunately it is not likely to be higher. The problem for market participants who have been elevating the markets over the last few weeks in the face of deteriorating fundamentals, earnings and economics, in anticipation of more stimulative support from the Fed, is that they may have set themselves up for disappointment. As we laid out in this past weekend's missive the announcement by Mario Draghi last week sent the markets surging higher in anticipation of further stimulative support - the problem for the ECB is that while "talk" is cheap being able to "act" may be an entirely different matter.
This week there are three key items that are likely move the markets this - the FOMC meeting which concludes on Wednesday, a potential ECB announcement on Thursday and Employment data on Friday. As I will explain - all three of these are not likely to be positive market events.
FOMC - "No QE3 For You!"
The Federal Open Market Committee meets on Tuesday and Wednesday of this week and the markets are fully expecting Bernanke to announce an initiation of a third round of bond buying or Quantitative Easing (QE3). The markets will likely be disappointed by a regurgitation of recent Capitol Hill testimony where Bernanke stated that he is aware of the weakness in employment, and the economy, and stands ready to act if necessary but that it is imperitive that Congress acts with fiscal measures soon as the limit of monetary policies are showing the effects of diminished returns.
The last part of the previous statement is the most important. When the first round of QE was launched in early 2009 the market and economy were struggling with a potential depressionary dive. The initial program worked well at stabilizing markets and supported an inventory rebuilding cycle which comprised about 3/4th's of the economic growth seen. However, in 2010, as QE ended the economy and the markets began to fade just as quickly showing the Fed the need for further action. At the time that QE 2 was launched the markets had declined from a 9% gain for the year to an 8% loss and the economy was quickly headed towards a potential recession. QE 2 succeeded in staving off the recessionary pull in the economy and again created an asset rally, which as Ben stated, was needed to spur consumer confidence.
Alas, as QE 2 ended so did the rally. As the economy showed renewed signs of a lack of organic growth the markets slid from an 8% gain to a 10% loss for the year. Again, the Fed intervened with further support through a program that became known as "Operation Twist."
If you take a look at the chart you can see the problem that Fed faces this week. The economy is not completely collapsing, with the first estimate of 2nd quarter GDP, coming in stronger than expected at a weak, but not disastrous, 1.5%. The reason that the Fed launched both QE 1 and QE 2 was to "push asset prices higher" in order to create an artificial wealth effect to boost consumer confidence. With the markets already up 10% for 2012 - the majority of any potential impact from a QE program is already priced in.
The Fed has been able to effectively, like the ECB, use "talk" to get the desired action from a market that has become dependent on Fed monetary policy as an investment tool. For Bernanke, very much like Pavlov, he no longer has to "ring the bell" for the dogs to begin salivating - he only needs to walk towards it. Therefore, with the markets already significantly higher over the last month, and the economy somewhat stable, there is a very high probability that the Fed will announce "no action" of consequence with the exception of possibly extending the current ultra-low interest rate policy into 2015.
With the market participants piling into stocks with the full expectations of QE 3 on Wednesday - there is likely to be disappointment.
ECB - More Talk
On Thursday, the ECB is set to announce its interest rate policy decision. During this announcement it is expected by the markets that Mario Draghi will announce his "big bazooka" to follow up on his rather ambiguous statement "to do whatever is necessary to save the Euro." The markets are already anticipating everything from the ECB re-engaging in a bond buying program, an initiation of QE, deeper cuts in interest rates, further relaxation of credit quality as collateral, or accepting losses on Greek debt.
While it is certainly likely that that the ECB will lower interest rates further on Thursday it is highly unlikely that the ECB will move further without support from Germany. Draghi has already made clear previously that direct bond buying by the ECB was not a favorable route and that it would be the EFSF and ESM funds that would shoulder the weight of the burden. However, the problem for the ECB is that Germany is unlikely to move any sooner than September on the ratification of the ESM - if ever.
The problem for the ECB is that without Germany on board there is little action that can feasibly be undertaken. This leaves the markets exposed to a "non-event" announcement on Thursday with more "talk" to try and keep the markets drooling for more action down the road. However, there is a potential, given the run up last week, that this could be a bitter disappointment.
Currently, estimates for this Friday's employment report have risen above 100,000 new jobs given the recent outsized drops in the Jobless Claims reports as shown in the chart. However, these outlier events have been caused by the seasonal adjustments that typically account for automakers shutting down plants during the summer months to retool for the new lines. This has not been the case this year.
However, early in the month of July we saw a 247k jump in regular state claims which has not been reported in any of the employment reports. It is possible that this Friday's employment report could be materially worse than current expectations. Weak employment data has been the "siren's song" to Bernanke to institute more stimulative action. However, Ben will not be working with this information during the FOMC meeting earlier in the week. Therefore, with a fresh announcement of "No Q.E." on Wednesday, no ECB action on Thursday and poor employment on Friday - the risk of disappointment is elevated.
Anything Is Possible
These are just my observations from the flow of the data and historical precedent. However, I do not dismiss the fact that central bankers around the world can take irrational positions and make illogical decisions. We have seen it before. Currently, central bankers have been able to get the desired effect by "jawboning" the markets higher temporarily. However, talk is cheap and eventually action will have to be taken. The problem is that the reality of continuing to bail out broke countries by borrowing money from other broke countries to lend to countries that can not possibly afford to pay it back - is a logic that only makes sense to the central bankers.
However, this chase to find new and creative ways to prop up the debt bubble continues with the never ending "hope" that somehow, and in someway, it will resolve itself with no one having to pay the tab - except the billion, or so, taxpayers. Consequently, it is those very taxpayers that have come to the realization of Hayek's "Road To Serfdom", in which he warned of the danger of tyranny that inevitably results from government control of economic decision-making through central planning, has become a reality. As Hayek stated: "The abandonment of individualism, classical liberalism, and freedom inevitably leads to socialist or fascist oppression and tyranny and the serfdom of the individual." Welcome to the "New World."