US Dollar Outlook, Week Ending 11/3

I'm making a post strictly for the U.S. Dollar this coming week because it seems we're approaching a possible inflection point for the currency. Technical indicators suggesting the dollar's recent rally is looking a bit hot, combined with a week of important economic data, suggest a selling opportunity for the dollar may be imminent.

Source: investing.com

A look at movements in the dollar index futures suggest some further strengthening in the currency is seen for the first day of the workweek, with Asian/Pacific trading starting to rev up as I type this (8:10pm Central Time). Since a relative nadir on October 11th, the dollar index has risen by nearly two index points, from 92.83 to 94.75. The biggest day of gains came on October 26th, with a jump of 1.01 index points. Needless to say, we've been in a bit of an uptrend over the last couple of weeks.

Source: investing.com

From a technical vantage point, the recent dollar rally has flipped the script from what we saw over the summer and earlier this fall, when the dollar was encountering one of its weakest periods in years. Both the pound and euro are starting to look a little too weak against the dollar right now, especially with EUR/USD dipping just barely below 1.16 in early trading to start this workweek.

Source: tradingeconomics.com

In terms of economic data, this week is looking to be a pretty significant one for the U.S. Seen among the high-impact data releases this coming week are a FOMC decision on Wednesday, where expectations are for the benchmark federal funds rate to be held steady at a range of 1.00% to 1.25%.

Source: CME Group

The big question for this meeting is going to be how policymakers view the likelihood of a December rate hike. As shown to the right, market participants view the probability of a rate hike at this week's FOMC meeting as practically nonexistent, but are pricing in a 97.2% chance of a 25 basis point hike in December. In other words, markets are viewing a December rate hike as all but certain, which leaves little room for any big upside dollar moves from this meeting. Instead, any hint of a more dovish shift in FOMC thinking on a December rate hike could hit the dollar and put an end to this recent uptrend.

The Federal Reserve has indicated they are taking into account the behavior of financial markets in their decisions- of course, to what degree is uncertain, but I would be surprised if there was to be any dovish shift. By historical valuations, stocks are indeed expensive, and I personally see the Federal Reserve as willing to turn a blind eye towards soft inflation and hike rates once or twice more to keep a very strong labor market and a frothy stock market in check. This was put on display a bit in the last few months when traders saw Federal Reserve chair Janet Yellen point to a December rate hike as more likely than previously thought.

The fun doesn't stop there, however. The employment report hits the newswires on Friday, 11/3, and everyone will be watching both the unemployment numbers and any hints of wage gains. Similar to last month, job gains numbers (currently forecasted at or over 300,000 jobs) could be volatile as businesses likely bounced back strongly in October after being hit hard in September from two major hurricanes.
Since this could be another volatile report, it wouldn't surprise me to see this week's USD direction be established by the midweek FOMC meeting. As that last sentence implies, though, the potential volatility of the report could also be a scene-setter, but we'll have to wait and see if that actually ends up being the case.

To summarize:

- Watch the 11/1 FOMC report for hints of a more dovish approach to monetary policy- market participants are nearly fully pricing in a December rate hike and USD could become vulnerable in a change of thinking.
- The possibility of another NFP report missing or beating forecasts by a large margin, like last month, is a source of uncertainty and will likely help set the tone for the week's performance of the dollar.

Andrew

Economic Data Continues to Suggest Late-Stage Business Cycle

A review of economic data continues to suggest the United States is in the late stages of the current economic expansion of the broader business cycle. We'll begin analysis of the economic data with monthly job openings for total non-farm jobs.

Source: FRED of St. Louis

Shown above are total non-farm job openings for the United States since just before the recession that began at the turn of the century. Increasing job openings indicates increasing opportunities for the unemployed to find a job, and thus signals a healthy (or at least improving) economy. This phenomenon is seen in the aftermath of both the dot-com bubble recession and the 2007-2009 recession (shaded gray areas).

I input a trend line (red), from the nadir in job openings after the 2007-2009 recession to around the value reached in April 2017. This is to show the general slope of job openings so far, and can be used practically by watching for any sudden deviations from the trend line, for example if the number of job openings were to suddenly skyrocket or plummet.
I also input a shorter-term trend line (green), which begins January 2015 and ends May 2017, the last recorded data point. Note how the slope of this new line is notably lower than the slope seen throughout the entire economic expansion. While we can visually see the values still oscillate around that red slope line, the recent trend has been to see momentum in job openings slow. The green trend line is meant to show that while the number of job openings still appear to be expanding, indicating some slack in the labor market, the momentum of this upward trend may be beginning to falter, a typical symptom of the late stage of an economic expansion of the business cycle.

One data set is not nearly enough to validate such a claim, of course, so we'll now expand our view into a few more parameters.

Source: FRED of St. Louis

To broaden the scope of parameters that generally track the business cycle, I created a graph composed of total non-farm job openings, levels of commercial and industrial (C&I) loans from all commercial banks, total vehicle sales, and the unemployment rate. These parameters are shown in the lines colored blue, red, green and purple, respectively. Additionally, note that these lines do not use the raw data numbers (e.g. job openings in thousands of people or unemployment rate in percentage), but instead are made into an index. In other words, I have set each parameter to show an index value of "100" at their respective nadirs during or immediately following the 2007-2009 recession. By using this index format, we are better able to track slowing momentum and potential turning points in these business cycle-sensitive parameters.

Commercial and Industrial Loans, All Commercial Banks
Since the total non-farm job openings parameter has been analyzed above, we now take a look at commercial and industrial loans created by all commercial banks, as aggregated by the Federal Reserve. For this parameter, the index value of "100" was set for October 2010, the lowest point in C&I loans resulting from the 2007-2009 recession.

Loan growth was originally negative following the end of the recession, as seems to generally happen following economic recessions (see a similar phenomenon occur following the early-2000s recession). Loans picked back up around 2011, and has been on the uptrend since. While I have not drawn out a trend line, you can see the relatively steady upward slope in C&I loans from ~2011 to the start of 2016. From 2016 until today, however, we note that the level of commercial and industrial loans given by commercial banks has plateaued. It is possible this stems from businesses not needing any further credit, having had the last eight years to enjoy economic growth. It is possible loan growth has slowed as businesses are no longer as confident about the future to significantly invest in long-term plans via loans. There is a wide variety of possible triggers for this plateau, but no matter the true reason(s), C&I loan growth has indeed appeared to hit a plateau.
This is similarly symptomatic of a late-stage economic expansion, as companies (again, for unknown reason(s)) begin to curb their loans. Should this be a protracted phenomenon, the lack of strong investment in long-term growth plans could hamper the current economic expansion.

Total Vehicle Sales
Vehicle sales are seen as another indicator of the business cycle, for their widespread usage by consumers but also their position as a durable good. As a durable good, vehicles will generally be purchased when consumers are upbeat about the economy and have ample funds. Consequentially, vehicle sales track the business cycle. For this parameter, the index value of "100" was assigned to February 2009, the nadir of sales amidst the recession.

Similar to C&I loans, it is not difficult to visually draw a line from February 2009 to roughly mid-2015 where the growth / slope line of vehicle sales was stable and strong. While 2015 and 2016 both saw record vehicle sales, the years also saw the emergence of a plateau as vehicle sales jumped from 16.9 million in 2014 to 17.8 million in 2015, followed by 17.9 million in 2016. Analysts have noted poor vehicle sales numbers so far in 2017, at least relative to the prior record-setting year. The apparent retreat of consumers from vehicle purchases may suggest less confidence in the economy, a preference to save money, or other reasons. Again, the reasoning may be unclear, but the data once again shows a characteristic of a late-stage economic expansion.

Unemployment Level
This parameter isn't shown here to be scrutinized for a plateau so much as a slowing in momentum. Note in the early-2000s recession and the 2007-2009 recession that the unemployment rate only began rising notably in roughly the middle of each recession. Consequentially, the unemployment rate appears to be a bit of a lagging indicator. Thus, to identify a late-stage economic expansion, we would be seeking continued downward movements (signaling lower unemployment) but at a slower clip than before. The unemployment rate index was set to "100" for October 2009.

It's not difficult to see that we have entered a lower grade of momentum for a decreasing unemployment rate, the expected signal of a late-stage economic expansion. Since this is more of a lagging indicator, analysis is somewhat less clear than C&I loans or vehicle sales, but we can still see here that the labor market is approaching full employment, which would likely signify the peak of the economic expansion.


We've now gone over a handful of broad economic indicators and seen that there are some red flags pointing towards the United States currently in the ending stages of the economic expansion. A personal favorite of mine is to look at delinquency rates for various types of loans, as delinquency rates typically increase prior to the official start of a recession, as defined by the NBER. Once again, I have set the parameters to indexes and set the index value of "100" at each parameter's respective nadir during or immediately following the 2007-2009 recession.

Source: FRED of St. Louis

In this chart, I have shown a number of delinquency rates:

• Delinquency Rate on All Loans, All Commercial Banks (dark blue, index=100 at 2010 Q1)
• Delinquency Rate on Loans Secured by Real Estate, All Commercial Banks (red, index=100 at 2010 Q1)
• Delinquency Rate on Credit Card Loans, All Commercial Banks (green, index=100 at 2009 Q1)
• Delinquency Rate on Commercial and Industrial Loans, All Commercial Banks (purple, index=100 at 2009 Q3)
• Delinquency Rate on Consumer Loans, All Commercial Banks (turquoise, index=100 at 2009 Q2)

These various delinquency rates cover a rather broad area of delinquent loans (e.g. the Delinquency Rate on All Loans), but also on more focused portions of the economy (e.g. Delinquency Rate on Credit Card Loans). I won't go into detail on each individual parameter here because they're all not too dissimilar from each other, but it's quite apparent that prior to the last two recessions, we have seen delinquency rates across the board first lose downward momentum, and then begin rising in the months before the recession's official start. 

This trend of a trough, followed by rising delinquency rates prior to the official start of a recession is seen across the board for the five delinquency rates graphed above. In recent months, we have seen mixed indicators. For instance, the Delinquency Rate on All Loans and the Delinquency Rate on Loans Secured by Real Estate are exhibiting some slowing downward momentum, but the delinquency rates on credit card loans, C&I loans, and consumer loans appear to be rising. With these mixed signals not allowing us to say that a recession is definitely on the horizon, these delinquency rates do appear to show a late-stage expansion.

There are other economic data we could observe that both support and deny the assertion that we are in a late-stage expansion of the business cycle, but with the consensus seeming to revolve more around the confirmation that we are in a late-stage economic expansion, it's worth more to see if that is indeed the case than to decide otherwise and potentially be burned by that ignorance.

In sum, I do believe we are in the late stage of this economic expansion- an accusation that has been made before to no avail, but this time supported by economic data. 

Andrew

Yellen's 'High-Pressure Economy' May Pressure Stocks

Janet Yellen laid out her take on current monetary policy in Boston on Friday at a luncheon, describing how a "high-pressure" economy may be necessary in order to boost growth. The speech comes at a time when the Federal Reserve is divided on whether to raise benchmark interest rates this year, or keep them steady at their historically-low levels. (More information on her speech can be found in this link from Reuters).

I have a few concerns about letting inflation run temporarily hot.

FRED - Federal Reserve Bank of St. Louis

Shown above is the civilian unemployment from January 1948 to the most recent data point, September 2016. Shaded gray areas indicate economic recessions. There are two main take aways from this graph:

1. When looking at past economic expansions, a common signal that the expansion is coming to an end is when we start to see the slope of the unemployment rate line go to zero. This was seen prior to the recessions of 1970, somewhat in 1973-1975, again in ~1979 and ~1981, and notably just before the early 1990s recession, the early 2000s recession, and a bit before the Great Recession back in 2008. While one could nitpick and say the slope never did get to zero, merely eyeballing it shows that before recessions, the unemployment curve generally becomes flat, if not close to flat, as the economy reaches full employment.
Taking a look at our current position on the curve, we're right around (if not at) that point where the unemployment line's slope hits zero-ish. The table below illustrates this quite well:

The attached table shows civilian unemployment data from FRED, compared year-over-year for September of each year during the current economic expansion. We began the economic expansion in September 2009 with a change of -0.3% from then until September 2010. The YoY change in the unemployment rate from September 2015 to September 2016 was the smallest change throughout the entire economic expansion when looking at September YoY changes. I haven't run the data for all the months' YoY change, but going through a few more data points, it appears this could very well be the smallest YoY change throughout the entire expansion, including all months' YoY changes.
What does that tell us? Right now, the only thing we can plausibly assert is that the labor market is near full employment, based on how the slope of the unemployment line is getting closer and closer to zero. I don't believe this shows that a recession is barreling our way, primarily because the Fed is keeping monetary policy extremely accommodative and investor sentiment remains more-or-less high, though we saw an unexpected drop on the Consumer Sentiment Index on Friday. However, given the Consumer Sentiment Index is a lagging indicator, and by most other measures the domestic economy is still chugging along, I don't believe a recession is pending in the short-term.

2. Despite claims that the labor market is not yet at full employment, recent recessions indicate it could be. Referring back to the FRED unemployment rate chart, note how the minimum unemployment rate, or at least the point when the slope of the curve begins to flatten to zero, has been creeping up ever since April 2000, when it hit an expansion-low of 3.8%. The expansion-low prior to the Great Recession was 4.4%, hit multiple times from Fall 2006 to Summer 2007. Our expansion-low in our current economic expansion is 4.7%, from May 2016. The gradual uptick in apparent minima with respect to the unemployment rate could be a signal that our labor market is at full employment, in addition to the signal from the flattening slope of the curve.

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My other main concern resides in the fact that the stock market is already near record highs, and broke record highs this past summer. Allowing inflation to run hot could create a bubble, if one hasn't already been formed.

Big Charts - Marketwatch

The chart above reflects the DJIA's history through early 1988 or so, on a weekly scale. Note how we are currently just below record highs reached earlier in the summer. Record stock prices generally come about around the peak of a bull market, and it's been my belief for some time that we are either at the peak or just past the peak of this current expansion's bull market. But that's not my primary point of discussion relating to the stock market.

Extraordinarily-accomodative monetary policy in the U.S. for the last many years, and expectations of continued accommodative policy, has led to prolonged risk-on sentiment, as reflected in the record highs for all three major equity indices this past summer, and the near-record-high valuations at present date. Many financial analysts promote the idea that this accommodative policy has led to the 'Central Bankers' Bubble', named after central banks' continued enforcement of such monetary policy that some believe has blown a bubble in more than just one specific asset. To be sure, this is by no means a prevailing opinion, as far as I can tell, and the theory that we are mid-bubble does not stand for all financial analysts. However, I do personally believe that this is the case, at least to some degree, and this is where my concerns over a 'high-pressure economy' come to light again.

In a general sense, inflation is bearish for the stock market. When inflation begins to ramp up, typically the Federal Reserve will act to tighten monetary policy by hiking interest rates, thus placing a more risk-off sentiment across financial markets as investors leave stocks and seek safer investments, like bonds. However, if the Federal Reserve were to maintain low interest rates while allowing inflation to rise, the 'lower-for-longer' concept (the idea that interest rates will stay lower for a longer period of time) that has boosted stock prices over the last few years would persist. Inflation would begin to eat away at the stock market, and at that point the Fed would begin tightening monetary policy, but until then it would be a continuation of low interest rates and more-or-less tepid inflation, until the 'high-pressure economy' kicks in and inflation rises.
Why the worry? With inflation expectations so low, we could be talking about a number of years in a low interest rate, low inflation environment, which would almost certainly blow an equities bubble, if one hasn't already begun forming. Consequentially, if/when inflation reaches a point that the Fed deems as conducive to hiking interest rates, the pullback in stock markets would be far sharper than it would be if the Fed were to hike rates today.

In my eyes, the Fed has dug itself into a hole by maintaining interest rates for so low. To be fair, this was a good choice when you see how steadily the unemployment rate fell. However, good cases could have been made for a rate hike in the last few FOMC meetings, particularly after some FOMC members began taking far more hawkish viewpoints. Then, when they didn't hike, the Fed began losing credibility, but that topic is for another write-up. By allowing a low-inflation, low-interest rate environment to persist, possibly for a prolonged time period (longer than Ms. Yellen believes, as the FOMC is notorious in recent history for being too aggressive in their inflationary expectations), equities would almost certainly enter into a bubble, and if other assets also enter into bubbles as ultra-accommodative monetary policy continues, the pullback if/when tightening occurs could be nasty.

Lucky for us, all of this is hypothetical, and assuming the FOMC goes along with Yellen's ideals. While she posed the high-pressure economy as a 'question that needs more research', it's quite frank that she is looking for every excuse to not hike interest rates, and it's entirely plausible that the chairwoman is able to convince the FOMC to follow suit.

Andrew