Central Banks Steal the Spotlight Once Again
Markets March Forward
The Dow Jones Industrial Average (DJIA) closed the week up 1.8%, finishing the week just below 15,000. The S&P 500 finished the week up 2.0%, above the 1,600 mark, while the Nasdaq finished 3.0%.
Equity gains were driven by news abroad and data from home. Equities started the week strong on Monday as Italy formed a government nearly two months after its national election. Yields on Italian bonds dropped to their lowest level in two years as center-left Prime Minister, Enrico Letta, was sworn into office. In a speech to parliament Monday, Mr. Letta expressed the need to stimulate growth and create jobs. “Without growth and without cohesion, Italy is lost.” He also reiterated that Italy could not borrow its way out of trouble.
Milan’s benchmark index gained 2%, outperforming its European peers, making it the strongest of all major European markets over the past month. Italian 10-year bonds were sold at a yield of 3.94%, down nearly 80 bps from a month ago.
Equity markets experienced a mid-week slump in light of a below forecast rise in ADP private sector employment. However, stocks rebounded on European Central Bank (ECB) news and an improving US unemployment rate. On Thursday, the ECB announced that it will cut its main policy rate from 0.75% to 0.5%. Thursday was also witness to an unexpected drop in initial jobless claims. Initial jobless claims fell 18,000, following a 13,000 decline in the prior week.
Equity markets experienced large gains going into the weekend as the April unemployment rate beat expectations. Labor markets continue to show signs of improvement with employers adding 165,000 workers to nonfarm payrolls in April. The unemployment rate continues to decline steadily, dropping from 7.6% in March to 7.5% in April. This beat expectations as the unemployment rate was forecast to stay at 7.6% with nonfarm payrolls expected to rise by only 140,000 jobs. Professional and business services led the way adding 73,000 jobs. Leisure and hospitality followed, as food services and drinking places added 38,000. Retail trade added 29,000 jobs and healthcare increased by 19,000.
Perhaps the brightest spot in the jobs report came from prior month revisions. March job growth was ratcheted up from 88,000 to 138,000 while February was revised to 332,000 from 268,000.
Not all news for the week was encouraging, with negative reports from both ISM indices. The manufacturing sector continues to slow with the ISM Manufacturing Index trending down from 51.3 in March to 50.7 in April. Positives in the report included accelerated new orders and a back-to-back build in backlogs. This was offset by a drop in inventories. The ISM Non-Manufacturing Index followed suit, declining to 53.1 from 54.4. Both still remain in expansionary territory, but continue on a steady downward trend.
Consumer confidence and consumer sentiment came in mixed for the month of April. The Consumer Confidence Index as measured by The Conference Board came in positive, jumping from 61.9 to 68.1. The 6.2 point increase was largely due to recovery in expectations, which swung lower in March during sequestration cuts and has rebounded subsequently. The University of Michigan’s Consumer Sentiment Index came in negative, dropping 2.2 points from 78.6 to 76.4.
In the bond markets, Treasury yields rose modestly for mid- and long-term maturities. Yields held constant for most of the week with Wednesday and Friday being the exceptions. Rates eased Wednesday on the disappointing ADP private employment report coupled with the belief of added language surrounding the possibility that the Fed may shift its stance on quantitative easing.
On Friday, rates jumped following a slightly down Thursday. This was due to a better-than-expected April jobs report that led to increased risk appetite by investors. For the week, the 10-year note was up 8 bps while the 30-year note was up 10 bps.
The week was another positive one for equities as seen by the increases in the DJIA, S&P, and Nasdaq. This was buoyed by news abroad and the better-than-expected April jobs report. With the labor market continuing to show positive gains and central banks remaining accommodative, investors are happily reallocating to equity markets.
Central banks steal the spotlight once again
Central banks around the world continue to provide increased stimulus to their respective economies. Increased conviction over pro-stimulus policies comes in light of recent flaws found in the Reinhart & Rogoff January 2010 paper, which suggested that government debt of more than 90% of GDP is detrimental to economic growth. The latest week brought another round of news in the world of central banking, although it seems the number of options left on the table is running short. What central bankers hope for now is that economies will finally enter recovery mode.
Since the start of the year, central banks have implemented 168 policy decisions, with 20% of those resulting in interest rate cuts, according to Central Banks News. Not surprisingly, with developed interest rates already near 0%, most of the changes this year are in emerging market economies.
Last week, however, the European Central Bank (ECB) became the latest to reduce rates, cutting its main policy rate by 25 bps to 0.5%. Such moves are unlikely to be impactful across the European Union in light of news that inflation fell to 1.2% in April, the lowest since February 2010. Unemployment also remains high at 12.1% across the EU and does not appear to be near an inflection point.
Source: Thomson Reuters
ECB President Mario Draghi reiterated that the ECB remains “ready to act if needed,” even welcoming the possibility of a further 25 bps rate cut in the months ahead. Given current levels of unemployment and growth, it is hard to see the efficacy of such small changes.
Officials at the U.S. Federal Reserve also met last week, but it was an uneventful affair. The main policy rate remained at 0-0.25% and intended asset purchases remained unchanged at $85 billion. Market participants most closely paid attention to a line saying, “The committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.” For some, this is an indication the Fed is at least considering the possibility of ceasing asset purchases in the near future.
In the current environment, the most recent and most important central bank may turn out to be Japan. Following decades of stagnant growth, the Bank of Japan embarked on a plan to purchase government bonds in an effort to pop inflation up to 2%. The Japanese Yen sold off sharply surrounding the news and at first glance, one might believe Japan’s actions are occurring in isolation. Unfortunately, that is not the case. Trade partners and competitors to Japan will bear the brunt of the pain. Germany, in particular, is facing an uncertain future. After benefitting from the creation of the Euro, Germany never looked back, exporting goods around the world. Recently, manufacturing and other sectors began to show signs of weakness, partially due to the Eurozone recession, but partially due to competitiveness concerns against Japan.
Source: Pragmatic Capitalism
The days of boring central bankers are no longer, and despite some improvement in the overall economy, central banks globally remain as active as ever. Traditional interest rate policy is running out of room, opening the door to more and more creative maneuvers. Actions by central banks through the remainder of this year will continue aplenty and play a large role in the direction of the markets.
the week ahead
Central banks continue to be in the spotlight, as a number of Fed officials will speak this week on economic policy outlooks. Fed Governor Stein will speak on Wednesday at the Chicago Fed conference on “dollar funding and the lending behavior of global banks.” Richmond Fed President Lacker will speak on financial stability with his speech titled “Ending too big to fail is going to be hard work.”
Central banks expected to meet this week include Australia, New Zealand, Malaysia, Korea, Egypt, and the Bank of England.
Earnings season continues with a few notable earnings reports coming out this week. Sysco, Disney, Toyota, and Apache are the main companies to watch.
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