The taper is coming. That much is certain. Recent reporting indicates the Federal Reserve may move ahead as early as September.
“It looks like they are probably turning the corner,” said Mike Englund, principal director and chief economist for Action Economics.
Three Fed officials all over the U.S. map spoke up in recent weeks about the taper. Dallas Fed President Robert Kaplan told CNBC that it’s time for the Fed to taper in the fall, starting the actual program’s end in October. Richmond Fed President Thomas Barkin said “we are closing in on tapering” though he wasn’t more specific. San Francisco Fed President Mary Daly said a few weeks before her colleagues that the taper could come “later this year” or in early 2022.
Interviewed on CNBC earlier this week, Boston Fed President Eric Rosengren said he could be ready next month to begin.
Many market watchers feel that the Fed has been so much more communicative this time around that the taper, when it starts, will be a “ho hum” event for investors, and that is the way the market is acting so far. Stocks continue to sit near records, even though they’ve been weak in recent days, and bond yields remain depressed. But there is a lot the economy and markets still don’t know about the Fed’s taper plans, and the ripple effects. Here are a few of the major issues.
1. Consumer prices may have hit peak inflation, but that does not go for housing rentals
Last week there was a lot of focus on the Consumer Price Index coming in cooler than expected and hot areas like the used car price index declining into August. There was relief, to be sure, in the latest CPI.
“We had good news from CPI in the topping of the most volatile components,” Englund said.
But housing rentals — and the broader issue of housing affordability — remain a major pain point for the average American. It also reflects a housing market that remains majorly imbalanced between supply and demand.
“People want more residential real estate and less commercial, and you can’t just convert it. We have partially filled skyscrapers and a large number of people who now work from home, so the demand for residential has gone through roof compared to the existing stock,” Englund said.
In July, rents nationally rose 7% year over year for one-bedroom apartments and 8.7% for two-bedroom apartments. The multifamily rental industry set a record in July, with rents rising 8.3% year over year and single family rentals up 12.8%, according to Yardi Matrix data.
The problem in housing rentals is not one created by the pandemic, and dates back to at least the financial crisis. The U.S. housing market has been used to adding 1 million to 2 million units a year in terms of supply, and when you look at the recent housing starts numbers, the industry is struggling to get to 2 million.
“Now with supply constraints for carpenters and electricians, and everyone else, we are probably at our capacity of what we can build,” Englund said. “We have 100 million homes but you can only build 1 million to 2 million a year, and people need 10%-15% more housing.”
The National Association of Realtors estimates that it is a two-year construction shortage, and that’s why rents are being pushed up.
The pandemic has added to pressures in the housing market. While the eviction moratorium is necessary for the hardest-hit Americans, it also has the effect of lowering the supply of available housing for rent on the market.
But what is unaffordable to most people works to the advantage of those most financially secure. “Cash purchases of homes are going up even as we see double-digit price increases in homes,” Englund said, driven by people at the very high end of the income distribution.
“Looking at the data since the turn of the year you could have thought that maybe the Fed should have accelerated the tightening process. These policies don’t shift spending from underspent areas. People buy more of what they already have. A handful of us bidding prices of homes upwards,” he said. “It’s not clear how the problems associated with the pandemic were helped by driving up asset prices and almost everything looks like a bubble,” he added.
It is worth noting that shelter (the CPI parlance for housing) is the largest component of the index by weight, but it is equally important that it is not the inflation measure the Fed is likely to focus on in policy decisions, according to experts like Englund, especially compared to wage inflation and the labor market. And the housing market is one where no single Fed decision on the taper timeline is going to solve the supply demand challenge.
2. Inflation is still running very hot among producers
As the CPI declines, big gains continued last week in the latest Producer Price Index. Shortages in supply chains, such as the chip shortage rattling auto production, could last into the end of the year.
The latest PPI numbers show that the wholesale side of the economy continues to be under a lot of pressure with producers still facing broad price increases.
That is not a surprise. Economists started the year arguing there would be bottlenecks, but even those like Englund are surprised by how deep the bottlenecks are.
“These shortages have been maintained in doorknobs and everything else you bought on Amazon,” he said.
Englund said when comparing the latest CPI and PPI numbers, it is the latter that are more notable. “The PPI was more significant because of the numbers, because of the sheer size of not seeing cooling at the wholesale level, but the CPI was encouraging for some topping,” he said.
Sam Stovall, chief investment strategist at CFRA, said the PPI data, which remains hotter than expected, keeps inflation concerns alive, but monthly gains are expected to start to edge lower as we head towards year-end.
3. The stock market seems okay with inflation
Stovall said the CPI number ended up being a market driving event to the upside, with inflation still high but the slight tick downwards from last month leading investors to assume that at least from the consumer inflation perspective it is manageable, and maybe the Fed has more, not less, flexibility about waiting a little longer to announce when the taper will take place.
“They are pretty certain they are going to announce and enact tapering by the end of this year and what slightly softer CPI data might allow them not to say in August or September, to delay, would just be statement rather than intent and action.”
The record stock market is saying inflation is good for stocks, according to Stovall. “It is an indication that the economic recovery is occurring and because much of the inflation is likely to be transitory, that means economic expansion and earnings improvements will outpace inflation,” he said. “In other words, you end up with more money left over at the end of the month.”
4. PPI might speak for the Fed hawks, but maybe not Powell
The continued inflation in the supply chain could lend an argument to the Fed hawks who want to pull back right away, but Powell speaks for the center and he hasn’t shown much of indication he wants to tighten, at least not yet.
“Whether these numbers change it, is unclear,” Englund said.
Englund isn’t convinced the taper timeline will begin formally in September because of the “center” that Powell represents.
“They’ve probably talked it to death, but I don’t think they want to tell us in September,” he said. And if there is not enough momentum to move the center, the Fed may stick with its “closing in on tapering,” advance the ball messaging, but not go so far as to give a timetable in September.
“If you are focusing on the economic problems of inner cities you want to delay tightening as long as possible, even if you know you will have a bigger inflation problem. If all you have is a hammer, everything looks like a nail,” Englund said. “But the broad macroeconomy, clearly 80% is bursting at the seams,” he added.
The Fed also has “the cover” of the delta variant, right now, as a reason to move more slowly, though so far it’s hard to see its effect on the economy, Englund said. Recent consumer sentiment and retail sales numbers did experience big declines. But once the Fed starts the conversation about the taper, it is harder to stop.
“They may have gotten over their skis when they start signaling the timing of taper because it is hard not to progress the conversation once they start it,” Englund said. “If they can get through the September meeting without giving the market a timeline that pushes the timeline back to November, which is where they would have wanted it anyway.”
Action Economics continues to think Powell will want more evidence of “substantial further progress” beyond the recent data.
“I certainly wouldn’t want to wait any later than December. My preference would be probably for sooner rather than later,” Rosengren told CNBC this week.
The latest clue from the Fed will come on Wednesday afternoon when minutes for its July FOMC meeting are released.
5. The Fed’s trial balloons could be misinterpreted by market
Stovall sees the recent comments from regional central bank presidents as “the Fed floating trial balloons, trying to be as transparent as possible and dissipate a potential taper tantrum like we saw in 2013.”
It’s working so far, though not all investment experts are convinced there won’t be more volatility in markets ahead, with Wells Fargo Securities head of macro strategy Michael Schumacher telling CNBC on Tuesday that he remains concerned about a market that is treating the taper as a ho-hum event. He doesn’t think the taper is fully baked into bond and stock markets.
Stovall said the more the Fed talks about the possibility of tapering, the more that conversation continues into the September meeting and an announcement tapering will start by the end of this year is what Wall Street now expects, and Wall Street will not react as negatively as it might have otherwise.
“My best guess is they message it in September and announce the taper in November, but they may not even wait until 2022. It may be December,” Stovall said of when the Fed formally starts easing its bond purchasing.
6. Once the taper is set, it’s onto rate hike timeline and the impact on stocks
Once the taper timeline is clear, there’s the next big Fed watch to move onto, which is the first rate increase. Stovall said investors may not need to worry as much as they would think.
Historically, going back to 1945, in the six months after the Fed starts raising rates, the Dow Jones Industrial Average fell, but only by an average of 0.2%. Over 12 months after a first rate hike, the average gain in the Dow is 2.5%. There is no doubt, though, that a cutting cycle is better for stocks than rate hikes. In the first six months after a rate cut, the average gain in the Dow since 1945 is 11%, and 17% over a full year.
There is reason to believe a more communicative Fed, if it can taper without causing a market selloff, can also lower the risk of a major market surprise when it raises rates.
Stovall said the current stock market reminds him of the late 90s, in that the market “just does not want to go down,” driven by large-cap tech and consumer discretionary giants.
That means the Fed timing on the taper and hikes, and the pace of those policy shifts once started, will loom large for the markets.
“Between now and December it will be tapering along with inflation and employment, and as we go into 2022, it’s the speed of the tapering and the timing of the first rate increase, and then the number and magnitude of those rate increases,” Stovall said.
Rogers, Shaw formalize planned Freedom sale to Quebecor – BNN Bloomberg
Rogers Communications Inc., Shaw Communications Inc. and Quebecor Inc. announced Friday they reached a definitive agreement for the previously-announced proposed sale of Shaw’s Freedom Mobile wireless business.
The three companies said that the terms of the definitive pact are “substantially consistent” with their original announcement on June 17, when they said Montreal-based Quebecor agreed to pay $2.85 billion to purchase Freedom. Originally, July 15 was the target to reach the definitive agreement.
“We are very pleased with this agreement, and we are determined to continue building on Freedom’s assets,” said Quebecor president and chief executive officer Pierre Karl Péladeau in a release Friday. “Quebecor has shown that it is the best player to create real competition and disrupt the market.”
The transaction is conditional on Rogers receiving final regulatory approvals for its planned $20-billion takeover of Shaw, which was announced in March 2021.
The road to regulatory approval has become more treacherous for Rogers after Competition Commissioner Matthew Boswell stated his objections to the plan, warning it would diminish competition in the telecom market, notwithstanding Rogers’ long-stated intent to divest Freedom Mobile.
Rogers’ legal counsel has argued vociferously against Boswell’s claims, saying in a June 3 filing with the Competition Tribunal that Boswell’s stance “is unreasonable, contrary to both the economic and fact evidence presented to the Bureau, and not supportable at law.”
The Competition Tribunal is currently scheduled to begin a hearing on the matter Nov. 7.
Rogers also has to clear another regulatory hurdle: its planned acquisition of Shaw requires approval from Innovation, Science and Industry Minister François-Philippe Champagne, who has previously said he won’t allow the wholesale transfer of Shaw’s wireless assets to Rogers.
The process became more complicated for Rogers after a national network outage knocked out service to its customers in early July.
Champagne subsequently said the outage would “certainly be in [his] mind” when weighing the merit of the Shaw sale.
For its part, the Canadian Radio-television and Telecommunications Communications announced its conditional approval of the transaction in March.
Shaw investors have consistently demonstrated skepticism that the deal will go ahead as planned, as evidenced by its shares never once attaining the $40.50-per-share takeover offer from Rogers since the takeover was announced last year.
Investors refuse to accept higher rates are here to stay – and that's a problem for financial markets – The Globe and Mail
With interest rates rising, and rapidly so, the driving force that dictated decision making in financial markets for the past fifteen years is dying out. In a flash, disoriented investors have been exposed to a new world, one that demands dramatically different expectations for what constitutes a decent return.
Yet for all that’s changed, it can be tough to accept the era of ever-lower rates is truly over. Deep down there may be a tacit acknowledgment of changing winds, but it is often coupled with denial about what this all means.
The hope, it seems, is that the damage has already been done. Technology stocks have been clobbered, and house prices have finally started falling in Canada. But the undertow generated by rising rates is hard to contain, and for that reason it will likely ripple through financial markets, hitting everything from private equity to blue-chip stocks.
Such a sea change can be hard to grasp. Since the 2008-09 global financial crisis, investors of all stripes have grown accustomed to ever-falling interest rates. By July, 2020, the yield on the 10-year U.S. Treasury bond, a benchmark for financial markets, had dropped to a paltry 0.52 per cent.
The trend was so absurd, such a deviation from historical norms, that it even spawned a new mantra: “lower for longer.” Investors learned to accept that rates would stay low for longer than once thought imaginable – and it lasted for so long that it became the norm.
And now, in just seven months, it’s all changed, after scorching inflation and geopolitical earthquakes forced a paradigm shift. In July, the Bank of Canada raised its benchmark rate by a full percentage point, something not seen since 1998. The Federal Reserve hiked its own by 0.75 percentage points a few weeks later.
The reaction since has been quite bizarre. The Nasdaq Composite index for one, a barometer for growth stocks, is up 23 per cent from its June low. Investors seem to think the worst is behind us, and they’re happy to return to the way things were.
The reality: It is highly likely that there is no going back, at least not for quite some time.
“Many economists, strategists and investors are thinking the world hasn’t changed – that we’re in a normal cycle,” said Tom Galvin, chief investment officer at City National Rochdale, a subsidiary of Royal Bank of Canada with roughly US$50-billion in assets under management. He disagrees. “We are in a new era.”
This summer, Mr. Galvin put out a paper that spelled this all out, explaining why the new mantra must be ‘higher for longer.’
“Inflation will be higher for longer than we anticipated, interest rates will be higher for longer, geopolitical tensions and uncertainty will be higher for longer and high volatility in the economy and financial markets will be higher for longer,” he wrote.
Of course, Mr. Galvin is only one voice, and everything in economics and finance is so chaotic right now that it’s near impossible to call anything with 100 per cent certainty. In Canada, inflation is at its highest level in nearly 40 years, yet unemployment is at a record low. That isn’t supposed to happen.
But in the past two weeks a spate of Federal Reserve officials have given public interviews saying much the same.
The day after stock markets rallied this week on the back of news that month-over-month U.S. inflation was flat in July, Mary Daly, president of the San Francisco branch of the Federal Reserve, told the Financial Times that investors shouldn’t be so giddy. While the data was encouraging, core prices, a basket that strips out volatile items such as energy costs, still rose. “This is why we don’t want to declare victory on inflation coming down,” she said. “We’re not near done yet.”
Diane Swonk, chief economist at KPMG, can’t quite understand why investors are forgetting what scares the Fed the most: inflation. One of the central bank’s biggest failures in the past 50 years was allowing U.S. inflation to grow out of control – or ‘entrenched,’ in economics parlance – in the 1970s, forcing the Fed to eventually take drastic action to bring it back in line.
“This is a Fed that remembers the seventies,” Ms. Swonk said. “Most people operating in financial markets don’t.” Especially not the twenty- and thirty-something retail traders who sent stock markets soaring in 2021.
Fed officials can’t say outright they’ll tolerate a recession as a trade off for squashing inflation, but the eighties is proof they have and they will. “They’re going to raise rates and hold it for a while to grind inflation down,” Ms. Swonk predicts.
Despite the history, there is still speculation in certain corners of the financial markets that the Fed will change course. And there are some recent precedents of doing so. Twice over the past decade, the Fed and the Bank of Canada signalled they were ready to take action to cool the economy, but both times the central banks ultimately backed off. They did so first in 2013, after bond investors freaked out, and then again in 2019.
The big difference between now and then is inflation. Even Mike Novogratz, one of the most popular investors in cryptocurrencies, the mother of all speculative assets, warned in the spring that rates won’t be falling any time soon. “There is no cavalry coming to drive a V-shaped recovery,” he wrote in a letter to investors after the crypto market crashed, referencing the quick stock market rebound after the pandemic first hit. “The Fed can’t ‘save’ the market until inflation falls.”
Predicting precisely how financial markets will be impacted by higher rates is hard, but just like unprofitable technology stocks, the asset classes that benefitted the most from the low rate world are those most susceptible to tremors. Private equity and private credit, to name two, are near the top of the list.
When debt was ultra cheap, private equity funds could fund their buyouts for next to nothing. At the same time, passive investing was gathering steam, taking the shine off hedge funds and mutual funds. Private equity, then, became a vehicle for outsized returns.
Earlier this year, Harvard Business School professor Victoria Ivashina wrote a paper predicting a shake out in the sector, arguing that these tailwinds aren’t there anymore. “As the flow of funds into private equity stabilizes and as the industry growth slows down, the fee structure will compress and compensation will shift to be more contingent on performance,” she wrote.
Already there are signs that major investors are moving away from private equity. Earlier this month, John Graham, chief executive of Canada Pension Plan Investment Board, one of the world’s largest institutional investors, disclosed that CPPIB saw more value in public markets than private ones for now. And in a July report, Jefferies, an investment bank, wrote that major money managers, including pension and sovereign wealth funds, had sold US$33-billion worth of stakes in buyout and venture capital funds in the first half of the year, the most on record.
Private debt funds, which lend money to higher risk borrowers, are also vulnerable in the current environment. Money poured into the sector over the past five years because these investment vehicles tend to pay 8-per-cent yields, but that return looks much less rosy now that one-year guaranteed investment certificates pay nearly 4.5 per cent.
By no means are these asset classes dead in the water. The same goes with stocks and so many others. Rates have jumped, and quickly, but they are still low by historical standards.
However, there are many reasons why investors of all stripes should not be expecting a quick return to lower for longer. The latest inflation data is encouraging, but it’s a single data point. Who knows what type of energy crisis Europe and the United Kingdom will face this winter, and what that will do to oil and gas prices.
Inflation also isn’t known to disappear quickly. “It’s easy to get from 6-per-cent core inflation to 4 per cent,” Ms. Swonk, the economist, said. “It’s really hard to get from 4 per cent to 2 per cent.”
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German Chancellor Olaf Scholz coming to Canada to meet with Trudeau, business leaders
OTTAWA — The Prime Minister’s Office says Justin Trudeau will accompany the chancellor of Germany, Olaf Scholz, on a brief Canadian visit later this month that will include stops in Montréal, Toronto and Stephenville in western Newfoundland.
In a statement released Saturday, the PMO confirmed the Aug. 21-23 visit starts in Montreal, where meetings will be held with German and Canadian business leaders, and a tour is scheduled at an artificial intelligence institute.
The two men will then head to Toronto, where Trudeau will take part in the virtual summit about Russia’s annexation of Crimea, followed by an appearance at the Canada-Germany Business Forum.
The trip will conclude with a stop in Stephenville, N.L., where Trudeau and Scholz will attend a hydrogen trade show.
The statement says the two men intend to talk about clean energy, critical minerals, the automotive sector, energy security, climate change, trade and Russia’s “illegal and unjustifiable invasion” of Ukraine.
The prime minister and chancellor last met in June at the G7 Summit in Germany.
This report by The Canadian Press was first published Aug. 13, 2022.
The Canadian Press
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