Financial Review

Absent a Smackdown

….G7 summit mess. Trump Kim summit next. Fed on Wednesday, with a possibility for change in direction. ECB on Thursday. Net neutrality is dead, for now. AT&T on the hunt. Burgers?

Financial Review by Sinclair Noe for 06-11-2018

DOW + 5 = 25,322
SPX + 2 = 2782
NAS + 14 = 7659
RUT + 2 = 1674
10 Y + .02 = 2.96%
OIL + .33 = 66.07
GOLD + 1.00 = 1301.00


Stocks opened modestly higher and managed to hold on for modest gains. Trading was confined to a fairly narrow range.


After a weekend that featured a kerfuffle at the G7 meeting, attention turned to Tuesday’s summit between Trump and North Korea’s Kim Jong Un, which actually starts in a couple of hours (Singapore is 12 hours ahead of Washington DC, so in Singapore 9 AM tomorrow is 9 PM East coast time today) And then, attention will shift to the Federal Reserve FOMC policy meeting, which wraps up on Wednesday.


The G7 economic summit ended without the US signing on to the communique. Trump disowned the agreement hours after leaving the gathering, launching a personal attack on the Canadian prime minister and accusing other countries of “robbing” the US. The communique said the leaders of the US, Canada, Britain, France, Italy, Germany and Japan agreed on the need for “free, fair and mutually beneficial trade”, and the importance of fighting protectionism. “We strive to reduce tariff barriers, non-tariff barriers and subsidies,” the statement said. But there was no announced change in steel and aluminum tariffs imposed against our allies. Then there is concern that the bickering with Trudeau could lead to a breakdown of NAFTA negotiations, which have not been showing much progress. Perhaps there is method to this madness, but any evidence was not on display at the summit. Today, investors dismissed the G7 as not much more than a kerfuffle, which can be resolved. And if it is not resolved, we will look back on the past few weeks as the beginnings of a trade war. Time will tell, but the G7 summit ruffled more feathers than it smoothed.


Next up, the US-North Korea summit. Do not expect any great breakthroughs. The issues that have plagued the Korean Peninsula for decades will not be resolved in a one-day meeting. North Korea is looking for assurances of its security. The US is looking for de-nuclearization. Such negotiations would typically go into great detail but that won’t happen tomorrow; instead, Trump will try to get a “feel” for Kim’s intent. Brushed aside as these high-profile photo-ops unfold are Pyongyang’s gulags, deliberate mass starvation and other crimes against humanity — the true indicators of regime nature and goals. By now it should be clear that a smiling Kim does not reform or denuclearization denote. Still, anything short of a wrestling match smackdown will be hailed as a victory.


So, for now Wall Street traders looked past geopolitics as so much fluff and puffery. And that brings us to Wednesday’s Federal Reserve FOMC policy meeting. The Fed is almost certain to raise the target on short-term interest rates by a quarter of a percent, or 25 basis points. And there might be a surprise. The Fed might announce a chance to its quantitative tightening program – the operation to shrink the amount of bonds the Fed owns that would have run well into the next decade could be wrapped up next year, or early 2020 at the latest. Instead of reducing the balance sheet from its peak of $4.5 trillion to $2.5 trillion or so as some Fed officials indicated, the impact could be far less — perhaps, some suggest, to $3.5 trillion or even a little more.


It all depends on how tight financial markets get. Tightening in the money markets, and an unexpected push of the fed funds rate toward the high end of its target range, would be key factors in prompting the Fed to re-examine its policy normalization efforts from financial crisis extremes. If the balance sheet runoff ends sooner than anticipated, investors probably can expect that the rate-hiking cycle could wrap up a bit earlier as well. I don’t expect a change to be announced Wednesday but look for an announcement that they are considering a change. The Fed is slow and deliberate, and the markets loath surprises. The upcoming deliberations will give investors a window into how the Fed will unwind the stimulus it injected to help pull the economy out of the financial crisis, and ultimately how the market will react.


In October, the Fed began allowing a set amount of proceeds from its bond holdings to run off each month, while reinvesting the rest. Since that operation began, there has been a $102 billion reduction in Treasury debt and mortgage-backed securities on the balance sheet. Concurrent with that has been a gain in interest rates, as the Fed also has raised its funds level; meanwhile, some upward pressure has built on government bond yields as the central bank has reduced its role in that part of the market.


Most recently, the funds rate has risen to near the top of the 1.5 percent to 1.75 percent target range the FOMC set after March’s hike. Specifically, the benchmark is at 1.7 percent, just 0.05 points away from the interest on excess reserves the Fed pays to banks that store cash at the central bank. The interest rate on excess reserves (IOER), as it is known, historically has served as a guide for the funds rate, and usually runs a bit above the Fed’s benchmark. According to minutes from the May meeting, FOMC officials are concerned that the funds rate is rising a bit more quickly than anticipated, causing a tightening in money markets that would make a more aggressive unwind of the balance sheet problematic. A solution suggested at the meeting was that the Fed raise the rate paid on reserves by 0.2 percent while it hikes the funds rate 0.25 percent. Doing so would be expected to hold back the funds rate from getting too close to the target ceiling. It might also be a response to reserve scarcity. The Fed can encourage more money market reserves by raising the rate paid on reserves.


The wild card is inflation. Today, the New York Fed published a survey showing inflation expectations were flat in May after several months of gains, while Americans grew more pessimistic about income and spending growth. If we don’t see much inflation, if the tight labor market does not result in wage push inflation, then the Fed could back away from selling off its balance sheet and back away from more rate hikes – and just settle into a nice groove and take a breather to look at the implications of policy on life, the universe and everything. That is all subject to change – depending upon the data.


Meanwhile, a Thursday meeting of the European Central Bank could result in a timetable for eventually winding down its monthly bond-buying program. The ECB might offer the scope for the most in terms of surprise or disappointment. Investors are looking for the central bank to offer an outline of how it intends to go about winding down its program of asset purchases, which are currently scheduled to run at least through September. The ECB could announce it will ratchet down the size of its purchases beginning in October, ending them in December and then delivering a rate increase some time in 2019. Or, the ECB could stick to its quantitative-easing program in the wake of softening data. A downbeat assessment of eurozone economic prospects could potentially dent investor sentiment. There are also developments in the U.K.’s Brexit process and a Bank of Japan policy meeting to round out the mix.


Last December the Federal Communications Commission repealed the 2015 net neutrality rules. The 2015 order subjected internet providers to strict regulations by the FCC, arguing consumers needed protection from internet provider practices, essentially regulating internet service providers as if they were a public utility. About 80% of the American public supports the idea of net neutrality. Today, the repeal of net neutrality went into effect, giving internet service providers (ISPs) sweeping power to slow, block or offer “paid prioritization” to some websites as long as they disclose the practices. Don’t expect any noticeable changes to the internet, at least not now, as the possibility of legislation and litigation looms. There is still a chance the repeal could be repealed, but the window is getting smaller.


Comcast will formalize its all-cash offer to acquire most of Twenty-First Century Fox on Wednesday if a federal judge approves AT&T’s deal for Time Warner on Tuesday. Comcast, which owns NBCUniversal, has already publicly acknowledged its plans to compete with Disney on an acquisition of Fox assets, including Fox’s movie studio, the Nat Geo and FX networks, regional sports channels, and stakes in Hulu, Star India and Sky PLC. Comcast has been preparing to raise $60 billion in a deal for Fox while simultaneously pursuing a $31 billion offer for the 61 percent of Sky that Fox doesn’t already own.


Home Depot plans to spend $1.2 billion over the next five years to speed up delivery of goods to homes and job sites; adding 170 distribution facilities across the U.S. so that it can reach 90% of the U.S. population in one day or less. The new sites will include dozens of direct fulfillment centers for next-day or same-day delivery of commonly ordered products, as well as 100 local hubs where bulky items like patio furniture and appliances will be consolidated for direct shipment to customers.


Well, now we know. IHOP, the International House of Pancakes, has changed its name to IHOB. The “B” stands for burgers. The name change is temporary, which means it was nothing more than a marketing trick without longer-term ramifications.

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