Overview:
- Markets bleeding lower on Greek and Fed rate hike fears
- Current breadth readings at levels marking prior short-term bottoms
- Trends in 52-week highs and credit measures troubling and need to be monitored
It has been a slow grind this year as the markets grapple with the ongoing Greek debt saga as well as anticipating the Fed’s first rate hike in nearly a decade. A major component of inflation, wage growth, is picking up as the U.S. employment backdrop continues to improve. The current level of wage inflation has been trending sharply higher the last few months and now rests at levels seen in 2004 when the Fed first began the last rate raising cycle.
Source: Atlanta Fed
While Q1 GDP came in well below expectations the trend level of growth for the economy remains in positive territory and well above recessionary levels. For example, the Philadelphia Fed’s State Leading Index growth rate rests at 1.12 currently after falling to the lowest level in years but still remains well above recessionary warning levels (0.50) and well above outright recession levels (0.00).
Source: Bloomberg
Given the underlining growth trend of the economy the Fed appears bent on raising rates sometime this year. Former Fed Governors like Charles Plosser call for a sooner but slower hike rather than a fast and destabilizing pace as described in the following article.
‘I am jealous of the ECB’: Ex-Philly Fed’s Plosser
"Why do we continue to have monetary policy that is calibrated at the same level that we had in the depths of the financial crisis? That just doesn't seem quite right to me. We need to adjust. We need to be responsive to the economy. As the economy improves, policy ought to change," he told CNBC.
His comments came after the International Monetary Fund said earlier in the day that U.S. rate increases could destabilize markets when they finally occur.
Plosser was unimpressed by the warning, telling CNBC, "I should be careful what I say about the IMF, but they want to be central bankers—and they are not."
He added that delaying a hike could prove problematic, because it increases the risk of the Fed being forced to raise rates more steeply than ideal.
"My own view is that the longer they wait to begin rate hikes, the greater risk that they will have to raise rates faster. That will create volatility. Better to start sooner and give us a better chance to do it smoothly. If the markets get ahead then we are going to have to chase rates up and that would not be a good situation," Plosser told CNBC, from the annual Goldman Sachs global macro conference in London.
Echoing the call to go early and gradual came from former Fed Board of Governors member Lawrence Lindsey this week who spoke on CNBC’s “Squawk Box.”
Fed needs to take away the punch bowl: Lindsey
The Federal Reserve is increasing risk to the U.S. economy by putting off an interest rate increase, and it's time to take away the punch bowl, former Fed Board of Governors member Lawrence Lindsey said Monday.
"Risks are necessarily two-sided, and by delaying action, what that'll mean is when they have to move, they're going to have to move much more quickly. And to me, that's a much more destabilizing type of risk than a gradual adjustment upward in rates," the Lindsey Group CEO said on CNBC's "Squawk Box."
Lindsey said current rates are not appropriate in the grand scheme, noting that unemployment is at 5.5 percent, the economy is growing at about 2 percent and inflation is roughly 1.5 percent.
The twin anxieties of Greece and a Fed rate hike have seen the markets bleed lower with the S&P 500 falling just under 3% from its all-time high of 2134.72 set on May 20th. While the present pullback has been shallow, there has been a larger retrenchment beneath the surface. As seen below, breadth measures have declined and are now near levels that have marked short-term lows in the S&P 500.
Source: Bloomberg
If we do begin to advance over the coming days and weeks, special attention needs to be paid towards the market’s breadth. This has been a narrowing advance to new highs last month in which fewer and fewer troops (stocks) are following the general (index) up the hill. This can be seen by looking at the spikes in new 52-week highs on the S&P 500, which have been declining with each move to new highs this year, and indicates vulnerability to further declines should breadth not improve.
Source: Bloomberg
What also needs to be watched closely are the global credit markets. One such tool for doing so is the BofA Merrill Lynch IRisk Index (description provided below), which has been trending higher since 2014. Large spikes in the IRisk were seen during the 2010/2011 Europe debt crisis and U.S. debt ceiling standoff with a smaller spike seen during the 2013 taper tantrum. Risks of a market correction will rise materially should the IRisk Index begin to advance higher and I’ll alert readers should the development occur.
Source: Bloomberg
Summary
Markets are bleeding lower without any significant news and the common reasons attached to the weakness have been concerns over resolution of the Greek debt standoff with its creditors as well as anticipation of the first Fed hike. Rising wage inflation is putting further pressure on the Fed to raise rates with many former Fed governors recently arguing for an early and slow pace to hiking interest rates rather than a delayed and fast pace that could destabilize markets.
While these two issues remain for the markets to grapple with, current breadth measures argue that the recent slide over the last few weeks may be nearing an end and we are likely at or near a short-term low.
The strength of any ensuing rally needs to be watched closely given market breadth has been weakening all year and measures of global financial stress are rising, indicating the market is on its weakest foundation in some time. Should breadth and global credit markets deteriorate materially ahead I’ll be sure to let readers know with an update.
