Monday October 5

Stocks rise on expectations for accommodative monetary policy around the world. The S&P500 and the Dow Jones both rose 1.8% to 1,987 and 16,776 respectively. The possibility that the Fed might push back tightening expectations was a source of optimism. Similarly there are hopes for further Bank of Japan and European Central Bank easing. Japan recently turned into another deflationary period. Markets are pricing in virtually no chance of a rate hike in October and only 31% in December. The probability of a rate hike does not go above 50% until March of 2016. The VIX returned to a level below 20 for the first time since August. The USM ISM non manufacturing index missed expectations but is still at a level that is indicative of above average GDP growth. Accounting for the non-manufacturing index, these two reports indicate that GDP will be in the 2.5-3% range for the remainder of the year according to an analyst from Capital Economics. The 10 year yield rose 7 basis points from Friday’s lows to 2.06%. Similarly the two year yield rose 3 basis points to 0.61%. The dollar rose against the euro and the yen to $1.1183 and Y120.43 respectively. These gains are a sign of easing expectations abroad.

The downside surprise in Friday’s data may alter the Fed’s plan to raise this calendar year. Previously Janet Yellen spoke of optimism for the US recovery and the health of the labor market which were both factors in her expectation to raise by the end of 2015. Traders are discounting the Fed’s guidance which may be a sign that markets are losing faith in the Fed’s guidance and credibility. The Fed kept rates on hold due to global concerns, but officials have since been very vocal that they still expect rates to rise in 2015. Fridays data undermines these expectations. Only 142k jobs were created compared to an expected 201k and there were sharp downward revisions to previous month’s readings. The unemployment rate held steady at 5.1% although labor force participation fell. The ten year yield fell to the lowest level since April, and expectations that the Fed won’t tighten have supported markets ahead of earnings season. The Fed is more optimistic than the market.
Goldman Sachs forecasts high inflation in emerging markets over the next six to twelve months. The report cites stabilizing commodities and depreciating currencies which is the primary driver of their forecast. This call comes in spite of deflationary fears across Asia. Potential inflation could encourage central banks to raise interest rates or at least stop cutting rates so dramatically. Goldman expects disinflationary pressures from oil declines to be overcome by effects of currency weakness. Central banks will be tasked with the challenge to balance higher rates to prevent inflation yet not too high to destabilize already weak economies. The three factors in Goldman’s model include currency movements, oil prices (which Goldman expects to stay at current levels through 2016) and the output gap (difference between actual and potential output. Given that inflation is a sign of too much money chasing too few goods, a large output gap is a sign that not enough is being produced given the potential. The report highlights that purchasing manufacturing indexes are down in countries such as Russia, S. Africa, Turkey, S. Korea, China, Indonesia, Singapore, and Brazil all reflecting contraction. This is a sign that the output gap in these countries may be widening and therefore contributing to inflation in the future.
Monday October 5

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