The Daily Shot And Data - March 17, 2016

By Walter Kurtz

Thursday, March 17, 2016 11:58 AM EDT

Greetings,

We start with the United States where the Federal Reserve struck a dovish tone. While nobody expected a rate hike at this FOMC meeting, many viewed the latest pickup in inflation (discussed later) as potentially prompting the Fed to begin preparing the markets for more rate increases shortly. That didn't seem to be the case, however.

The FOMC's forecasts removed 2 rate hikes from 2016 and 2017 (table below shows median Fed Funds rate projections at different FOMC meetings).

Source: Natixis

The chart below shows the downshift in the median rate projections (dot plot).

Source: @fastFT

Moreover, the long-run fed funds rate projection was downgraded again by the FOMC.

Source: @SoberLook

The central bank also sharply cut the 2016 inflation forecast but left the core inflation figure unchanged.

Source: Natixis

It was interesting to see the FOMC cut the longer-run unemployment rate again (first chart below). The Committee seems to be of the belief that the unemployment rate can remain relatively low without igniting significant inflation (we see that in Japan for example). The second chart below shows the so-called "natural rate of unemployment" (NAIRU), reported by the US. Congressional Budget Office. It is a theoretical "equilibrium" measure of unemployment. Janet Yellen suggested that the declines in FOMC's long-run unemployment forecast are driven by lower NAIRU.

Finally, the FOMC downgraded the long-run GDP growth forecast below 2%. What does that say about the Fed's confidence in the US economy over the long-term?

Why has the FOMC turned more dovish? To a large part, it is the fact that as most major central banks are easing or remain dovish, the Fed's policy is increasingly out of synch. That means that even a small rate hike packs a punch in tightening policy by pushing up the US dollar. And the FOMC has finally accepted just how damaging a strong dollar can be to the economy - both in the US and globally.

Here is a quote from the statement.

Source: FRB

This next chart shows the US policy out of synch with much of the world, prompting the Fed to take a more dovish stance.

Source: @JohnKicklighter

Markets reacted sharply to the FOMC communication, turning a cautious morning into a full-fledged "risk-on" day. Short-term rate expectations fell, with the 2-year treasury yield falling below 0.9%.

The Jan-17 Fed Funds futures jumped, shaving 13.5bp from the implied 2016 hikes.

Source: barchart

To be sure the markets still expect rate hikes this year. According to Bloomberg, the probability of at least one hike in 2016 is now 66%.

Source: @M_McDonough

Note: the yellow bars represent 12/16/2015 ("2016" is an error).

Here is what happened in other major markets.

1. Treasuries jumped across the curve, with the shorter and intermediate maturities most impacted. Below is the 5yr note futures contract.

Source: barchart

2. The euro rallied sharply - now for the second time in 5 days. This must be really frustrating for Mario Draghi whose bazooka stimulus should have weakened the euro.

Source: barchart

3. Gold jumped 2.4% in response to the FOMC.

Source: barchart

4. Coffee futures rallied on weaker dollar.

Source: barchart

5. Crude oil was already higher before the FOMC announcement, rallying almost 6% on the day.

Source: barchart

6. The Russian ruble rose 2.35% on stronger crude oil prices, risk-on sentiment.

Source: Yahoo.com

7. There was a decent size one-day jump in the yuan in response to the FOMC/weaker dollar.

8. Bank shares sold off on lower rate expectations (therefore lower interest margins) and concerns about weaker long-term growth (the FOMC's below-2% projections for US growth does not instill much confidence). Regional banks underperformed.

Source: Ycharts.com

9. The Dow Jones US real estate index jumped on the FOMC announcement, outperforming the broader market.

Source: Ycharts.com

10. Related to the above, lumber futures rose sharply.

Source: barchart

Australia's unemployment rate unexpectedly fell but so did the labor force participation (a familiar story for those in the US). South Australia unemployment jumped to 7.7%.

The currency markets took the jobs report as a positive, boosting the Australian dollar for the second time in a day.

Turning to the US economy, offshoring to China is no longer as cost-effective as in the past. US unit labor costs in manufacturing remain relatively low compared to global levels.

Source: @AnsteyAsia

Foreign official accounts sold quite a bit of US treasuries as the FX reserves declined. China is one of the biggest sellers. From the performance perspective, that's poor toming.

Source: @valuewalk, @GaveKalCapital

Here are a couple of updates on US housing.

1. US single-family housing starts are the highest since the recession - but still at 45% of the peak level.

2. New US mortgages for house purchase continue to rise steadily.

We continue to have reminders that the US economy is not out of the woods yet. Year over year, industrial production dropped 1% in February - here is an updated chart.

Now let's take a look at some inflation trends in the US.

1. The detail behind US core CPI shows a broader upward move in inflation. The overall increase was the highest in the post-recession period (the chart below shows rounded numbers).

2. Here is the US sticky CPI (less volatile component of the CPI) moving above 2.5%.

3. Medical care CPI rose as expected.

4. Shelter CPI continues to rise, now firmly above 3% per year.

4. Goldman is bullish on US inflation. Here is the service inflation trend. Goldman and many others believe the Fed will adjust its near-term inflation forecasts higher over the next couple of meetings.

Source: Goldman Sachs

5. Goldman's internal model shows longer-term swap-based inflation expectations significantly mispriced (too low). Are inflation expectations about to rise significantly?

Source: Goldman Sachs

Next, we have a couple of observations on the energy markets.

1. US crude oil production is gradually declining (short and longer-term chart shown below).

2. US gasoline demand picks up on warmer weather.

Following up on yesterday's comment on Ukraine, here is YTD Ukraine trade balance (each year is reset to zero). Imports have collapsed together with the currency. The nation's activity has flatlined - "no pulse"...

Also following up on yesterday's Valeant summary, the firm's collapsing shares have negatively impacted the Sequoia Fund which is seeing persistent large redemptions.

Source: @stephenfoley, @FT, h/t Jake

Finally, in recent years, activist investors have pushed public firms into boosting share price via financial engineering (extra dividends or share buybacks). 2015 was a record year for such activity.

Source: @FactSet, h/t @chartoftheday

Turning to Food for Thought, we have 5 items this morning:

1. The use of solar power is on the rise thanks to cheapening solar panels and tax incentives.

Source: @BloombergBrief

2. President Obama nominated Merrick Garland to the Supreme Court and the odds of vote/approval jumped in the betting markets. Markets view Garland as having a decent chance.