- China prepares to start buying more U.S. products
- FOMC minutes will show steady Fed policy
- U.S. housing starts expected to drop back after Dec’s surge
- U.S. PPI report expected to strengthen
China prepares to start buying more U.S. products — China’s Ministry of Finance on Tuesday published a list of about 700 American products that can qualify for tariff exemption applications including soybeans, pork, beef, corn, wheat, crude oil, and LNG. The Chinese government must provide waivers for its penalty tariffs on American products, or China will have no hope of meeting its promise to buy an extra $200 billion of U.S. products in 2020-21.
Meanwhile, Bloomberg News reported that China is considering making some purchases of U.S. ag goods in late February or early March to demonstrate its intention to meet its promise to buy U.S. goods, even in the face of the challenges posed by the coronavirus. The markets are watching Chinese purchases of U.S. products very carefully because President Trump might launch a new round of tariffs if he thinks China isn’t living up to its promises in the phase-one trade deal, which officially went into effect last Friday.
FOMC minutes will show steady Fed policy — The minutes of the Jan 28-29 FOMC meeting will be released today but are somewhat obsolete since the Fed at that time was only about two weeks into the coronavirus crisis.
Fed Chair Powell, in his Jan 29 post-meeting press conference, said that the current stance of Fed policy was “appropriate,” although he said that if developments cause a “material reassessment of our outlook,” the FOMC will respond. Mr. Powell said, “There is likely to be some disruption to activity in China and globally” from the coronavirus, and he said the virus is “very serious.”
In a slightly dovish comment, Mr. Powell also said that he FOMC is “not comfortable” with inflation persistently under 2%, suggesting that the FOMC will maintain its easy monetary policy as long as necessary to allow inflation to rise above 2%.
The FOMC reiterated its guidance that its T-bill purchase program will continue into Q2. The Fed began its program of buying $60 billion of T-bills per month on October 1 in order to boost the supply of reserves available to banks and reduce the need for the Fed to supply liquidity through large repo operations. The markets are generally expecting the FOMC to end its T-bill purchase program by June. The FOMC will likely end the program with some tapering in the last 2-3 months of the program so that the markets do not get cut off cold-turkey from the reserve injections.
The Fed has so far boosted its balance sheet via T-bill purchases by $423 billion from the 6-year low in August 2019, thus reversing 56% of the overall balance sheet drawdown seen during 2015-19. If the Fed continues its T-bill program through June (i.e., 4-1/2 more months at $60 billion per month), then the balance sheet should rise by about another $270 billion, resulting in an overall rise of about $700 billion.
That would mean that the T-bill purchase program by the time it ends will have reversed about 90% of the 2015/19 drawdown and put the Fed’s balance sheet only about $50 billion below the record high of $4.52 trillion posted in Jan 2015. The Fed is essentially admitting that it woefully underestimated the banking system’s need for reserves and never should have drawn down its balance sheet in the first place.
The stock market is likely to show some caution when the Fed ends its T-bill purchase program since the stock market will no longer have the headwind of $60 billion of reserves being permanently injected into the banking system every month. It does not seem to be a coincidence that the S&P 500 index started its current up leg just a week after the Fed started its T-bill purchase program on October 1, 2019.
In more recent comments, Mr. Powell, in his semi-annual testimony to Congress last Tuesday, said the coronavirus presents a downside risk that the Fed will be watching, but that the virus doesn’t change the Fed’s view that monetary policy is currently at the appropriate level. He said, “we are closely monitoring the emergence of the coronavirus, which could lead to disruptions in China that spill over to the rest of the global economy.” He added, “We know that there will be some, very likely be some effects on the United States,” and the question for the Fed will be whether the impact is “persistent” and “material.” He added, “It’s just too early to say.”
The market is currently expecting 1.6 Fed rate cuts by the end of this year. Specifically, the Dec 2020 futures contract on Tuesday closed at 1.225%, indicating expectations for a 40 bp rate cut by year-end from the current 1.625% target midpoint for the funds rate. The Fed dots, by contrast, are predicting no more rate cuts in 2020 and then a 25 bp rate hike in 2021 and a second rate hike in 2022.
U.S. housing starts expected to drop back after Dec’s surge — The market consensus is for today’s Jan housing starts report to show a -11.4% decline to 1.425 million, giving back the majority of Dec’s +16.9% surge to 1.608 million. The warm winter weather is likely to give housing starts a boost, as well as continued low mortgage rates. The current 30-year mortgage rate of 3.47% is only 2 bp above 3-1/4 year low of 3.45% posted in early February.
U.S. PPI report expected to strengthen — The consensus is for today’s Jan final-demand PPI to rise to +1.6% y/y from Dec’s +1.3%, and for the Jan core PPI to rise to +1.3% y/y from Dec’s +1.1%. The PPI is likely to drop back in February as the coronavirus took its toll on the global manufacturing sector and commodity input prices. U.S. inflation remains tepid with the core PCE deflator in December at only +1.6% y/y and the 10-year breakeven inflation expectations rate at only 1.66%, both well below the Fed’s +2.0% inflation target.
