December 19, 2018
Welcome back to the second special weekly edition of Axios Markets. Dion Rabouin joins us this week to lead our markets coverage and kicks off analysis of Fed day. Your friends can sign up for Axios Markets here.
Breaking: As expected the Fed raised interest rates 25 basis points. Chairman Jerome Powell speaks to reporters at 2:30pm. Axios' Courtenay Brown will be in the room to ask if he "feels" the market. Check the stream on Axios.com for updates.
1 big thing: The Fed is walking Trump's tightrope
The Fed's "dovish lite" rate hike today is a key moment in chairman Powell's balancing act.
- This interest rate increase was expected, protests from President Trump notwithstanding, because one had been telegraphed for months and the Fed rarely surprises.
Why it matters: The Fed signaled today two more hikes next year instead of three while reiterating that "risks to the economic outlook are roughly balanced," but for the first time noted it will "monitor global economic and financial developments and assess their implications for the economic outlook."
Between the lines: Having worked as an investment banker at Dillon Read & Co. and The Carlyle Group, Powell is much closer to the markets than his predecessors. And Wall Street has been clamoring for the Fed to slow down.
- That's why there was such an outsized reaction to his November statement that U.S. interest rates were now "just below" rather than "a long way" from neutral. It was a sign that Powell heard the so-called Dow vigilantes and was ready to delay further hikes in 2019 should the equity market downturn persist.
Powell learned from former Fed chairs Ben Bernanke and Janet Yellen, who both faced hostility from Congress and the public, to keep a low profile.
- He's done everything he can to avoid a confrontation with Trump. He started by effusively praising the economy after taking over as chair and has gone out of his way to avoid commenting on Trump and congressional Republicans' expansionary fiscal policy, or the federal deficit.
He's also made it a major point to woo Congress, with 60 personal visits and one-on-one phone calls to lawmakers, according to his most recent public calendars from February to August.
"He wants as strong a political base as he possibly can, and he also wants to not be blamed for stuff. The way you don’t get blamed for stuff is to not make promises about your future actions."— Vincent Reinhart, a former Fed official and now chief economist at Standish, a division of BNY Mellon, told Dion
What's next: Don't expect Powell to kowtow to Trump's tweets, but the awful performance of the stock market in December has to have changed his thinking somewhat. His strategy appears to be endearing himself and the U.S. central bank to Wall Street and Capitol Hill.
- The futures market sees zero rate hikes in 2019, ignoring the Fed's previous dot plot, which showed three rate hikes next year.
2. Why the Fed was right to hike
The Fed's dual mandate — delivering both maximum employment and low inflation — requires a balancing act, Axios' Felix Salmon points out: Low interest rates help to bring down unemployment, but according to economic theory, they also risk causing inflation. In reality, thanks largely to China, inflation has not been a problem for decades.
- The Fed's preferred inflation measure, PCE, has been below 3% for more than 25 years.
- Unemployment, on the other hand, has been a tougher problem to solve: It reached 10% in late 2009.
The temptation, then, is always to keep interest rates very low, as President Trump desires.
- But when interest rates stay very low for an extended period of time, that has the effect of creating asset bubbles like the credit and housing boom of the mid-2000s. Since 1995, the ratio of U.S. assets to GDP has risen from 4.6 to 6.8.
- To put it another way: If your stocks, bonds, and real estate holdings were worth the same today, relative to GDP, that they were worth in 1995, they would have to crash in value by 33%, or $43 trillion. That's more than enough to trigger another financial crisis. (The stock market right now has lost about $4.1 trillion, compared to its all-time high in September.)
- "Asset bubbles have been a far greater source of economic disruption over the past 25 years than any increase in inflation," says David Kelly of JPMorgan Funds. "While the Fed has kept policy tight enough to restrain general inflation, this has not been enough to slow a too-fast increase in asset prices."
The only way to prevent another catastrophic asset bubble is to allow interest rates to revert to something much more normal. That's what the Fed is doing today.
- The rate hike also gives the Fed some much-needed ammunition for when the next recession arrives. Cutting rates to zero is easy; then, you run into difficulties.
- By hiking rates, the Fed also does what it said it was going to do. Making sure that the Fed delivers on its promises is the best way for Powell to preserve the Fed's credibility in the face of onslaughts from the president.
The bottom line: In the 50 years before the financial crisis, the real Federal Funds rate was positive more than 80% of the time. Its recent return to positive territory, for the first time in over a decade, is something to be welcomed.
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Bonus chart: Today's interest rate in perspective
3. Quote of the week
"I'll just conclude by saying most of the issues that we're dealing with today are induced by bad political choices ... I mean, making a bad decision about a new tax, creating a tremendously difficult situation with Brexit, the immigration crisis in Germany, the mercantilism and state-owned enterprise initiatives in China, the tariffs that the United States put in unilaterally. So you just go down the list, and they're all the things that have created macroeconomic slowdowns."— FedEx CEO Fred Smith on an earnings call yesterday
4. The "smocking" hot labor market
There are 7 million unfilled job openings in the U.S. and the unemployment rate is below 4%.
Our thought bubble from Dion: This theoretically gives the Fed a lot more room to raise before there will be employment impact. The labor market today is tighter than in 2006 when the Fed funds rate was 5.25% and 2000 when the rate was as high as 6.5%. Former Fed chairman Alan Greenspan said in October that this was the "tightest labor market [he'd] ever seen."
5. The S&P target waiting game
Unlike its peers on Wall Street, Oppenheimer is putting off its 2019 S&P 500 forecast until this bout of volatility runs its course.
- Why? "If you're trying to set a target for the S&P 500, you want to get as close as you can to the low point. And if you're in a rising market you want to get as close to the high point," John Stoltzfus, Oppenheimer's chief investment strategist, tells Courtenay.
Considering Credit Suisse has already cut its S&P target for next year to 2,925 from 3,350, Oppenheimer's approach makes sense. But it also speaks volumes about analysts' eagerness to win the S&P 500 target contest.
- For the record, Oppenheimer said the S&P would end this year at 3,000 (as did several other firms) — 17% above yesterday's closing price.
6. A floor for oil prices...
The commentary atop the IEA's monthly oil market report a week ago was headlined "A floor under prices?" That question mark is doing lots of work, writes Axios energy reporter Ben Geman.
- Our thought bubble from Axios Future Editor Steve LeVine: "As soon as you call something a floor it turns into a ceiling."
Where it stands: Prices plummeted several dollars per barrel this week despite the OPEC+ efforts to stabilize the market.
- Brent crude fell to roughly $56 per barrel, while WTI, the U.S. benchmark, dropped sharply into the $46-per-barrel range.
- Brent has come down from a 4-year high of $86 in early October, while WTI has dropped by around $29 since then (though both benchmarks regained some ground today).
The big picture: Concerns about slowing economic growth and trade battles are eating into demand. The robust amount of crude sloshing around and broader market woes are creating downward pressure on prices.
- Here's Bloomberg: "The plunge in U.S. oil prices has wells in some parts of the Permian Basin below break-even levels, threatening to put the brakes on the record flow from the prolific field."
What they're saying: “The market is experiencing price carnage, maximum pain and considerable downside pressure,” Robin Bieber of the brokerage PVM oil tells Reuters.
7. Situational awareness
- Altria is close to a deal to buy 35% of Juul Labs at a $38 billion valuation (more than double Juul's value a few months ago), the WSJ reports. The deal shows "Altria’s desire to find growth outside its shrinking cigarette business."
- Facebook gave partners even wider access to more user data (including private messages) for a longer time than previously known, according to the New York Times. Axios chief technology correspondent Ina Fried calls the revelations a "shock." #BREAKING: Facebook shares down as much as 6% on word of a suit by the D.C. attorney general.
- U.S. home sales fell 7% from a year ago "amid growing affordability pressures," the AP reports. Rising mortgage rates "have caused sales over the past 12 months to plunge at the steepest pace since May 2011 ... [t]he average 30-year mortgage rate was 4.63 percent last week, up from 3.93 percent a year ago."
- Pfizer and GlaxoSmithKline intend to combine their over-the-counter products and separate the merged company into its own publicly traded entity, Axios healthcare business reporter Bob Herman reports. This deal would heavily consolidate common health products — ranging from Pfizer's Advil and Nexium to GSK's Aquafresh toothpaste, Excedrin and Tums — into one $13 billion drug giant.
- Uber lost its appeal in the U.K.'s second-highest court against two drivers who allege they are employees of the company, not independent contractors, CNBC reports. Being classified as an employee would guarantee certain perks like a minimum wage and holiday pay. Uber says it will appeal.
- Softbank's telecom unit flopped on its first day of trading in Japan, thanks in part to concerns about its exposure to Chinese tech-firm Huawei, Reuters reports. It was the world's second-biggest IPO ever, behind Alibaba.
8. 1 Elon thing
“We’re not saying stop all other solutions, but we think this is the only solution that will actually work.”— Elon Musk repurposing a Tesla as the world’s smallest passenger train
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