Without a mandate, Janet Yellen would surely go ahead and raise rates in September, if only to weed out some excess from the market. Yet the Fed’s stated goal of stable prices and full employment will make it very difficult to justify tightening monetary policy in the next two months. While the Fed has been closely monitoring economic indicators, hoping to understand the economy’s direction, data driven monetary policy is not forward looking, it is inherently backward looking.
Instead of reading tea leaves, Yellen and Co. should be paying attention to what markets are saying. WTI oil prices have fallen 21% since July 1, which has major ramifications for both consumer prices and employment. Thus far gasoline prices have held up relative to oil, but they will come under pressure in the coming weeks, and it will surely impact CPI. Again, the problem with CPI as a gauge of prices is that it operates on a significant lag – often several months. But the gold/silver ratio mirrors these moves in real-time, giving you a new price every day.
The chart below shows extremely tight correlation between lagged CPI and gold/silver. If this correlation holds, and there’s no reason to believe it won’t, US CPI will be -1.5% Y/Y by December.
Oil’s impact on the job market is equally troubling. Oil-field services providers that help drill wells have quietly revealed job cuts that were deeper than initially announced, and warned of more layoffs to come. Halliburton (HAL) and Baker Hughes (BHI), two big service companies that plan to merge, disclosed last week that they have cut 27,000 jobs between them, double the 13,500 they announced in February. Chevron (CVX) cut its workforce by 2% this morning.
Nearly 50,000 energy jobs have been lost in the past 3 months on top of 100,000 layoffs since oil starting falling last summer. To be clear, the jobs data has been reasonably strong for some time. The unemployment rate is rapidly approaching the Fed’s technical definition of “full employment” and initial jobless claims are near an all-time low. However, there is little sign of higher wages, which would typically be associated with a robust recovery. Average hourly earnings are still stagnant at 2.0% Y/Y despite the minimum wage hikes across several states and corporations.
The market, which is inherently forward-looking, seems to understand the current economic conditions. At the moment, LIBOR rates show investors are betting on the first hike to come around January 2016. Yet countless speeches from various Fed officials suggest a September hike is still on the table. Whether it’s September, December or 2016, at some point the backwards-looking Fed will collide with the forward-looking market, and we should expect volatility.
The Cup & Handle Fund is up around 3.5% on the year, and +18.0% since August (inception). Next week my YTD returns will reset to zero, and I’ll have to start from scratch. I sent out my investment letter for July two weeks ago and it’s already moved 3% in my favor. I’m now starting to think about themes for August. If you’d like to start receiving these letters click here.
Today’s letter will cover several topics, including:
With that I give you this week's letter:
As always, if you have any questions or comments or just want to vent, please send me an email at email@example.com.
Until next time, tread lightly out there,
Managing Editor – Cup & Handle Macro