DOWN, DOWN. HOW LOW CAN FORECASTS GO?

As they say, one swallow does not make a spring.  But markets may well be thinking the same over forecasts. In early February, the Atlanta Fed posted a possible econometric growth forecast of about 5.4%. This forecast was always going to be revised down.  That’s the nature of the Atlanta Fed’s methodology for forecasting growth.

As more information is received, that information is then inputted into the model. In the early stages, the model is extremely inaccurate. However, a delighted Trump then tweeted the forecast as if it were fact.

The only problem is,  the current forecast is now much lower and other forecasters are having a race to see who can predict the lower forecast. Simply put, the tax cuts have not boosted the economy or had the impact that Trump’s team expected.

Currently, growth for the January-March period looks to be on track to grow at less than 2.5%. If it does, this would mark the third year in a row where the economy has started slower. Moody’s forecasters, for example, have cut growth forecasts to 1.7%, citing weather events as the reason for growth in the second half of 2017.

The Fed still remains optimistic and has a growth number of 3% and several more hikes projected. However, many analysts are now starting to question the growth forecasts and are concerned that Trump’s tariffs will slow growth and increase inflation. Not the sort of thing an economy wants.

The problem for Kudlow, Trump’s new economic salesman, is that he has to sell an agenda that only two weeks or so ago he vehemently opposed. The problem for Trump’s administration is that the economy is receiving mixed signals and all the time the deficit is growing.

At some point, the bond market will awaken from its slumber and question how the deficit will be reduced and what policies are required to reduce the deficit. At the moment, interest costs are around 5% GDP.

However, a spike in rates would significantly alter that ratio. Capital will be needed.  That means either interest rates rise significantly, or the currency weakens significantly or that the U.S. economy is stimulated to grow in excess of 4%.

Given the political uncertainty and the likely impact of tariffs, a significant increase in economic growth appears unlikely especially as U.S. manufacturing capacity is a but a shadow of its once mighty self. Social media won’t grow an economy.  Real stuff will.  And the U.S.,  in many cases,  has lost its will by not investing in capex and R&D but rather spending its capital in share buybacks and dividend increases, neither of which adds to productivity increases.

For equity markets, their time is possibly coming to picking winners. The easy times have now gone.  Most of the growth in the share market over the last few years has come from the FANG stocks.  This will make the task more difficult. The FANG stocks contributed something in the order of 25% of the total growth during the last 3 or so years.

U.S. stocks ended the week higher led by energy stocks as crude spiked. Investors were buoyed by positive factory output and a strong consumer sentiment report. Stocks rallied ahead of the Fed meeting.   Friday also was the day when futures and options contracts expired so we had an afternoon of quadruple witching.

Bonds greeted the mixed messages of economic activity with a shrug and sold a little. Industrial production was up 1.1% and consumer sentiment is at a 14-year high.  However, homebuilding plunged.

The bond market, however, is now starting to focus on the cracks appearing. The TED spread is now starting to widen to 44, the Libor-OIS spread is now at 52, the widest since 2011 and the currency is jittery.

What bond investors will have to decide is when the deficit is too much. That point will be reached when it appears growth won’t get past the magical 3% level and may even look to decline. And if and when that point is reached markets could then turn sour.

 

Recap.

Equities: The S&P 500 rose 0.1%. The Dow fell 0.08% and the Stoxx 600 rose 0.2%. The Vix closed at 15.8.

Currencies: The Bloomberg Dollar Spot Index gained 0.5%. The euro fell 0.5%.

Bonds: The ten-year closed around at 2.844%. The 2-year closed at 2.295% and the 30-year closed at 3.077%. The ten-year bund closed at 0.57 and the UK gilt closed at 1.43% and the OAT closed at 0.817%. The U.S. curve closed 2/10 at 54.9 bp, 2/30 at 78.20 bp and the 10/30, closed at 23.1 bp. The U.S. 5-year closed at 2.64.

Commodities: The WTI rose 1.8% gold fell 0.2%.

Bitcoin is trading around $7,500, that’s down 27% for the month and up 91% for 6 months and down 47% yoy.

 

Aussie Market Today.

The Aussie equity market should be stronger on the day. However, with the possibility of a rate hike in the U.S. later this week (94% probability) and a possible retracement, equity markets won’t advance too far.

Bonds should be steady on the day. With a looming rate hike in the U.S., bonds may soften later in the week.