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U.S. Labor Market Seriously Injured

Note: Also posted on Seeking Alpha. It can be found here.

April FOMC Meeting Minutes: “It likely would be appropriate for the Committee to increase the target range for the federal funds rate in June.”

Last Friday: 38K jobs created in May, the fewest since September 2010. Way way lower than 123K jobs gained (that number is revised….hold your breath) in April. Way way lower than 159K gain expected.

Labor market was seriously injured in May. The United States added only 38,000 new jobs, the fewest in almost six years. Things get worse. Prior two months reading were revised lower by 59,000. There were 123,000 jobs added in April down from initial estimate of 160,000. Nonfarm payroll for March was revised to 186,000 from 208,000.

Total Non-Farm Payrolls - Monthly Net Change (In Thousands) — Total Non-Farm Payrolls – Monthly Net Change (In Thousands)

Yet, unemployment rate surprisingly dropped by 0.3% to 4.7%, the lowest since November 2007. Hold on a second. How can unemployment rate drop so much if employment decreased so much? More people left the labor force, as confidence in the labor market is cooling down.

The labor force participation rate decreased by 0.2% to 62.6%, near 38-year low, unwinding about two-thirds of the rise between last September and March. A record 94,708,000 Americans were not in the labor force in May, 664,000 more than in April.

Unemployment Rate and Labor Force Participation Rate "Death Cross" — Unemployment Rate and Labor Force Participation Rate “Death Cross”

The report has evaporated the chance of a rate-hike this month from the Federal Reserve. Before the report, the federal funds futures were pricing in 55% chance of a rate-hike. Now, that is less than 5%.

Federal Funds Futures Source: @MktOutperform (Twitter) — Federal Funds Futures
Source: @MktOutperform (Twitter)

The next probable rate-hike prediction is December. As I mentioned in early January, the Federal Reserve will lower back rates this year. Let’s dig deep into the jobs report.

About 35,000 job losses can be connected to a 45-day Verizon strike, which began on April 13. The workers returned to work on Wednesday, June 1st, after unions reached a deal with the telecommunications company on compensation and job security.

Since they were not working and was on a strike, they were counted as unemployed. Without the “Verizon strike effect,” May nonfarm payroll would have shown 73,000 gain, still way below from the prior month and expectations.

Information services employment, which Verizon workers would fall under, declined by 34,000 jobs in May, the first decline since November 2015. The Bureau of Labor Statistics (BLS) even highlighted the impact of the strike, “employment in information decreased due to a strike.” “About 35,000 workers in the telecommunications industry were on strike and not on company payrolls during the survey reference period,” said BLS in the report.

This is not the first time Verizon workers went on a strike. In both 2000 and 2011, information services employment dropped as Verizon workers demanded more benefits. The month after the strikes, the sector’s employment numbers rebounded.

Verizon Strikes & Information Employment Source: @M_McDonough — Verizon Strikes & Information Employment
Source: @M_McDonough (Twitter)

These 35,000 Verizon workers will be added back to the June’s nonfarm payrolls.

The agreement between the unions and the company gives Verizon workers 10.9% increase in pay over four years (contract expired on August 3, 2019), as well as other benefits. That pay raise is way more than stagnant wages across the country.

Average hourly earnings rose by 5 cents (0.2%) to $25.59, following 9 cents (0.4%) increase in April. On a year-over-year (Y/Y) basis, the wage growth was flat for two months, growing by 2.5%.

Average Hourly Earnings and 12-Month Percentage Change "Death Cross" — Average Hourly Earnings and 12-Month Percentage Change “Death Cross”

Unemployment at 4.6% is within the range the Fed considers “full employment.” The average unemployment rate from 1948 (oldest data I could find) to last month is 5.8%. This leads me to believe the unemployment rate is below its natural rate, 5.8%. Then, why is not inflation higher?

According to Phillips curve, inflation should be higher. Inflation has been hovering around 0% and 1% since the end of 2014. So, why is the Phillips curve not really working?

Phillips Curve (Inflation and Unemployment Rate)

If there’s a recession later this year or next year (as some people are forecasting) and the inflation rate is the same as now, we will have a deflationary problem. This time, the deflationary problem will be much worse than they were before. At this time, I am not forecasting anything on recession. If there is one, it will be very interesting how the central banks react to the deflationary pressures, considering the fact that they are running out of ammunition.

I believe Phillips curve is not really working today due to unemployment engineering (like companies do with non-GAAP) and globalization. Workers should not be counted as unemployed because they didn’t look for work in the past four weeks. Instead, it should be three months or more. It gives them more time to think and flush out their savings, if they even have one. Such discouraged workers should be included in the calculation process of unemployment.

Mostly important, globalization has played a big part in the crisis of Phillips curve. Since the financial crisis and light-speed innovation of technology, many companies found ways and more ways to reduce the costs. Since they are battling for customers, they are reducing their prices, keeping inflation low. The trade agreement, Trans-Pacific Partnership (TPP), will keep or even lower inflation further.

The countries included in TPP (China is excluded) account for 36.2% of global economic output and 25.6% for world trade. By eliminating taxes on exports, companies with intense competition, will reduce their prices further. For example, TPP eliminates import taxes up to 70% on U.S. automotive product exports to TPP countries.

The prices of drugs, on the hand other, will continue to increase. TPP increases the protection of drug patents and copyrights, reducing the availability of cheap generics.

Back to the jobs report. Private sector added only 25,000 jobs, the fewest since February 2010. April’s private sector gain was revised down to 130,000 from 171,000. March’s gain was slightly revised down to 167,000 from 184,000. Constructions payrolls dropped by 15,000, the most since December 2013 and the second consecutive month of decline.

The goods producing sector, which includes mining, manufacturing, and construction, shed 36,000 jobs, the most since February 2010. Mining employment continued its downward trend as plunging oil prices penetrated the operations of energy companies, shedding 10,000 jobs in May. Mining employment have dropped by 207,000 since peaking in September 2014, with three-quarters of the losses in support activities.

Temporary-help service jobs shrank by 21,000 and are down by 64,000 so far this year.

Employment and Earnings by Industrial Sector. Percentage of Labor Force sorted: From the highest to lowest. Green colors: Highest in the column Red colors: Lowest in the column — Employment and Earnings by Industrial Sector.
Percentage of Labor Force sorted: From the highest to lowest.
Green colors: Highest in the column
Red colors: Lowest in the column

Retail employment rose 11,400 (Shopping for summer?) after losing jobs in April for the first time since December 2014. Health care added the most jobs, with 45,700. Over the year, health care jobs jumped by 487,000 (Thanks, Obamacare?).

Diffusion index – which measures the breadth of employment across the private sector – collapsed to 51.3%, the lowest since February 2010. A reading of 50 represents that as many industries gained employment as lost employment. If it’s 0, employment of all industries decreased. If it’s 100, employment of all industries increased. That is down from 53.8% in April and 56.3% in March and from the recent peak of 71.2% in November 2014.

Total Private Employment: 1-Month Employment Change and 1-Month Diffusion Index

Further, the number of people employed for part time for economic reasons (involuntary part-time workers), climbed by 468,000 to 6.4 million, the highest since August and the largest jump since September 2012. This level, in addition to other numbers above, suggests slack still in the labor market. It is still high by historical standards.

Part-Time Employment Level for Economic Reasons

These workers are included in the alternative measures of underutilization (U-6) that remained unchanged at 9.7% in May.

There are nearly 1.9 million workers who have been unemployed for more than 26 weeks, down from 2.1 million in April. It’s the lowest since July 2008, but is still high by historical standards.

Three-month average of total nonfarm is down to 116,000 from 181,000 in April. It’s the lowest since July 2012 and is down from 203,000 three-month average during he same period last year. The three-month average of total private is nosedived to 107,000 from 173,000 in April.

The Federal Open Market Committee will meet on June 14-15. They will keep rates on hold, unless they don’t listen to the market like in December. Again, I continue to believe the Fed will lower back rates this year.

The labor market remains in hospital with serious injuries.

Reactions to the jobs report:

U.S. Dollar (greenback):

U.S. Dollar ("/DX" on thinkorswim) — U.S. Dollar (“/DX” on thinkorswim)

Gold:

October Jobs Report Strong: It Is Just One Report

On November 6 (Friday), jobs report for October had the winds of 120 miles per hour and blew everyone away. Non-farm payrolls showed 271,000 jobs were added in October, the most gain since December and a huge beatdown on expectations of about 185,000. It’s the best month for job growth so far this year. The report follows two consecutive months (August and September) of weak jobs growth below 160,000.

The total job gains for August and September were revised 12,000 higher. August was revised 17K higher to 153K from 136k, and September was revised -5K lower to 137K from 142K. Over the last 12 months, employment growth had averaged 230K per month, vs. 222K in the same-period of 2014. In 2014, average monthly payrolls was 260K. This year, it is 206K. Not only jobs gains for October were strong, but also unemployment and wages.

Total Non-Farm Payrolls – Monthly Net Change

The unemployment rate dipped 0.1% to 5%, its lowest level since April 2008. Average hourly earnings rose by 9 cents an hour to $25.20. It rose 2.5% year-over-year (Y/Y), the best level since July 2009. For most of the “recovery”, wages has been flat. The increase in earnings is significant for two reasons. More money for employees means more spending (don’t forget debts), which accounts two-thirds of the economy. Second, wage growth might suggest that employers are having trouble finding new workers (should I say “skilled” workers) and they have to pay more to keep its workers and/or to get new skilled workers. This could draw more people back into the labor market, increasing the participation rate. Without the right skills, good luck.

Average Hourly Earnings and Average Weekly Hours

The labor force participation rate remained unchanged at a 38-year (1977) low of 62.4%. The long-term decline in the participation rate is due to the aging of the baby-boom generation and loss of confidence in the jobs market. There hasn’t even been a rebound in participation rate of prime-age Americans (between the ages of 25 and 54).

Unemployment Rate + Labor Force Participation Rate

More than 122 million Americans had full-time jobs at the end of October, the highest since December 2007 (121.6 million).

Immediately after the jobs report, the probability of a rate-hike in December lifted. Fed funds futures currently anticipates about 65% chance of a rate hike next month vs. about 72% immediately after the report and about 55% before the report.

Federal Reserve Chairwoman, Janet Yellen, lately has been saying that December’s Federal Open Market Committee (FOMC) meeting was “live” for a potential rate-hike. While this jobs report is positive, I believe it is too early to jump in on conclusions.

The policymakers should not be too quick to act on one report. In September, the Fed left rates unchanged mainly due to a low inflation. Inflation is still low and we will get a fresh look on Tuesday (November 17) when Consumer Price Index (CPI) is released.

In March, the Fed expressed worries about the strength of the U.S. Dollar, just after the greenback hit above $100 mark. The greenback then tumbled and has never recovered back to $100….yet.

US Dollar ("/DX" on thinkorswim platform) - Daily — US Dollar (“/DX” on thinkorswim platform) – Daily

Right after the jobs report, the dollar skyrocketed and was 40 cents away from hitting $100 mark. It’s currently at $98.88 and there is a very high chance it will go above $100 until December 15, the first day of FOMC meeting.

If the November job numbers does not surprise to the upside (released in December 4), inflation stays low, and the dollar keeps strengthening, I do not believe the Fed will hit the “launch” button for a rate-hike liftoff.

Market Reactions:

US Dollar ("/DX" on thinkorswim platform) - Hourly — US Dollar (“/DX” on thinkorswim platform) – Hourly

S&P 500 Index ("SPX" on thinkorswim platform) - Hourly — S&P 500 Index (“SPX” on thinkorswim platform) – Hourly

Repulsive Jobs Report

Last Friday (October 2), jobs report for September came out way weaker than expected. Non-farm payrolls report shows 142K jobs were added, vs 200K expectations. Unemployment rate stood unchanged at seven-year low of 5.1%. Not only that, but wage gains stalled, labor force shrank, and July and August gains were revised lower.

July job gains were revised lower to 223K from 245K (-22K) and August job gains were revised lower to 136K from 173K (-37K), totaling downward revisions of 59K. Average jobs gains for third quarter is now at 167K, lower than the 2014 average of 260K. So far, job growth has averaged 198K a month this year, compared with an average gain of 260K a month the previous year.

Unemployment rate stayed at 5.1% only because people stopped looking for work. In other words, they lost confidence in the labor market. 350K people dropped out of the labor force which took labor force participation rate fell to 62.4%, the lowest in 38 years (1977), from 62.6% in the previous three months.

Labor Participation Rate (Source: @ReutersJamie)

Wages also showed weakness. Average hourly earnings fell by a penny to $25.09 after rising 9 cents in September. The average workweek declined by 0.1 hour to 34.5 hours.

There are increased worries that global slowdown is weighing on the domestic economy. The repulsive jobs report knocked down the chances of a rate-hike for this year. Federal Funds Rate (FFR) shows less than 10% and less than 35% chance of rate hike in October and December, respectively. Regardless of weak jobs growth, I still expect 0.10% rate-hike this month. But, I don’t expect 25 basis points for the year. If 0.25% were nothing, the Fed would have raised it already. The Federal Open Market Committee (FOMC) will meet on Tuesday-Wednesday, October 27-28.

Weak jobs report seems to point out a weak third quarter GDP growth following a strong rebound in the 2nd quarter. According to final GDP report released on September 25, second quarter grew at an annual pace of 3.9%, vs previous estimate of 3.7%. Advance (1st estimate) GDP report for the third quarter will be released on Thursday, October 29.

In the first quarter, the economy grew only 0.6% because of strong U.S. dollar, low energy prices, West Coast port strike, and the bad weather. Well, winter is approaching. Who’s not to say that the weather will hamper the growth again? The dollar is still strong and the energy prices are still low.

Energy sector continues to struggle. The mining industry – which includes oil and natural-gas drillers — lost 10K jobs last month, totaling 102K losses of jobs since December 2014. Energy companies continue to layoff workers since low energy prices are hurting companies. Energy companies like Chesapeake Energy and ConocoPhillips continues to reduce its workforce and its operations, and cut capital expenditures to offset higher costs.

Earlier in September, the Job Openings and Labor Turnover Survey (JOLTS) report showed that there were 5.8 million job openings in July, a series (series began in December 2000) record and higher than 5.4 million in May, as employers cannot find qualified workers.

It’s likely to get worse in the longer-term because of higher minimum wages. If employers pay higher wages, more people, especially teenagers, are likely to drop out and work. If states and companies continue to raise minimum wages, jobs that require skills such as programming, etc, will not be filled in the United States, but in countries with higher amount of education. That’s why recent minimum wage increases will batter, not help, the U.S. economy in the longer-term.

Reactions to the jobs report:

US markets fell immediately after the report, but rebounded later. 10-year Treasury yield fell below 2%, to the lowest level since April. US Dollar plunged, but recuperated about half of the losses later.

Standard & Poor 500 ETF ("SPY") - Hourly — Standard & Poor 500 ETF (“SPY”) – Hourly

10-Year Treasury Index ("TNX") - Hourly — 10-Year Treasury Index (“TNX”) – Hourly

US Dollar ("/DX") - Hourly — US Dollar (“/DX”) – Hourly

Another Quantitative Easing In The United States?

Last Thursday (September 17), the Federal Reserve left rates unchanged due to low inflation, recent turmoil in financial markets and in economies abroad, particularly China.

Markets were pricing less than 30% chance of rate-hike and most people in the financial markets were not expecting rate-hike. Well, not me. I was actually expecting ~~0.25%,~~ 10 basis points rate increase, as I stated in my previous post.

“Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.” Federal Open Market Committee (FOMC) said in statement. They are referring to events that took place in August, that can be described in one word; uncertainty.

Before we go any further, let’s compare the last two Fed statements.

Statement Comparison in PDF

Federal Reserve "Dot Plot" - September 2015 Meeting — Federal Reserve “Dot Plot” – September 2015 Meeting

According to the Fed’s famous “Dot Plot” – that is where committee members think interest rates are going – one committee member, for the first time ever, thinks the U.S needs to move to negative interest rates until the end of 2016.

During the press conference, Janet Yellen – the chairwoman of the Fed – indicated that negative rates were not “seriously considered at all today” and that the policymaker in question was “concerned by the inflation outlook”. The Fed looks at a model “Phillips Curve” which states that inflation and unemployment have a stable and inverse relationship. It hasn’t been working lately.

We know, as of today, both employment and inflation is low, likely due to the fact that many people are not in labor force and they are not included in unemployment calculation and due to low energy prices.

She said something that I found very interesting, “That’s something we’ve seen in several European countries. It’s not something we talked about today. Look. If not– I don’t expect that we’re going to be in the path of providing additional accommodation but if the outlook were to change in a way that most of my colleagues and I do not expect and we found ourselves with a weak economy that needed additional stimulus, we would look at all of our available tools and that would be something that we would evaluate in that kind of context.” This shows that even the Fed is uncertain about the future and another quantitative easing is a possibility.

If you want to see the body language from Yellen as she said it, go watch the press conference video. It can be very interesting. Any body language experts here?

The Fed also raised growth forecast for the year and cut unemployment projection.

Federal Reserve Economic Projections - September 2015 Meeting — Federal Reserve Economic Projections – September 2015 Meeting

Yellen expressed that some countries other than China are also danger to the U.S, “…we saw a very substantial downward pressure on oil prices and commodity markets…significant impact on many emerging market economies that are important producers of commodities, as well as more advanced countries including Canada, which is an important trading partner of ours that has been negatively affected by declining commodity prices, declining energy prices….important emerging markets have been negatively affected by those developments. And we’ve seen significant outflows of capital from those countries, pressures on their exchange rates and concerns about their performance going forward. So, a lot of our focus has been on risks around China but not just China, emerging markets, more generally in how they may spill over to the United States.”

Back to “wait and see” mode again. Weak start in the year hammered the chances of rate-hike in June. Now, outsiders hammered the chances of rate-hike in September. Next stop?

If the current situation stays unchanged, I expect rate increase of 0.10% (again) in October (FOMC press conference will be called if the Fed decides to change rates). But, the current situation might get much worse. The bad news might come from China again.

Xi Jinping, China’s president and Communist Party chief, will arrive in the U.S next week to meet President Obama and business leaders. After the meeting when Mr. Xi is back in China, unpredictability arrives.

China would not want to create tension with the U.S before they meet face-to-face. Thus, unpredictability comes in two or three weeks. China might devalue their currency again, by 5% or more. They might even dump much more U.S Treasuries again.

It’s reported that China dumped U.S Treasurys of $83 billion and $94 billion in the month of July and August, respectively. Why would China sell U.S Treasurys? China is in dire need of cash. Capital outflows are increasing substantially and their stock market are declining substantially. China would want to cut its holdings of treasurys to support the yuan.

According to latest data from the U.S Treasury Department, China’s holdings of U.S Treasuries was $1.240 trillion in the end of July (is probably much less now), the smallest since February 2015. In end-June, China held $1.271 trillion. China remains the world’s largest holder of U.S debt. What does that mean for the U.S?

If U.S’s #1 lender stops supporting or stops buying U.S debt, the cost of everything that depends on Treasury rates could rise, putting pressure on the Federal Reserve and prevent the Fed from raising rates. Treasury yields (inverse relationship with prices) are the benchmark that sets the cost of borrowing.

China’s abandonment of U.S Treasury debt is a warning.

Imagine if China’s major trading partner, Japan, joins China in selling U.S Treasuries. Japan is the second-largest holder of U.S. Treasuries, with $1.197 trillion in July. The devaluation of Yuan will make Japanese exports less competitive. Japan’s economy is still suffering despite Abenomics. As I stated in my post “Global Markets Crash + Asian Crisis Part 2“, Abenomics has failed. Soon enough, Japan might also be in dire need of cash and they might start cutting their holdings of U.S Treasuries.

Recently, Standard & Poor’s slashed its ratings on Japanese debt from AA- to A+ because of weak economic growth, blaming Abenomics “…we believe that the government’s economic revival strategy–dubbed “Abenomics”–will not be able to reverse this deterioration in the next two to three years.” According to Standard & Poor, Japan’s Debt/GDP ratio currently stands at 242.4%, a dangerous level for developed country.

I believe Bank of Japan (BoJ) will increase its purchases of government debt to cover the danger of Japan’s Debt/GDP ratio and will sell portion of U.S Treasurys.

We can conclude everything will probably get much worse. The Fed will have no other choice, but to start another round of quantitative easing. In other words, debt monetization, a process of buying Treasury and corporate debt on the open market, increasing money supply. When increasing money supply, interest rates should fall.

The Fed is being held hostage by outsiders, such as China and Brazil. It probably won’t end well for the U.S, promoting another round of Quantitative Easing.

Markets’ reactions to the Fed report:

Gold ("/GC") - Hourly Chart — Gold (“/GC”) – Hourly Chart

EUR/USD - Hourly Chart — EUR/USD – Hourly Chart

Fed Will Hike The Rates By…(Hint: Not 0.25%)

Last Friday (September 4, 2015), non-farm payrolls AKA jobs report for August came out little bit stronger. 173,000 jobs were added in August and the unemployment rate decreased by 0.2% (5.3% in July) to 5.1% (The Fed considers unemployment rate of 5.0% to 5.2% as “full employment”), lowest since April 2008.

Employments numbers for June and July were revised higher. June was revised from 231K to 245K (+14K) and July was revised from 215K to 245K (+30K). With these revisions, employments gains in June and July were 44K higher than previously reported.

Average hourly earnings increased 8 cents or 0.32% (biggest rise in 7 months) to $25.09, a 2.2% gain from a year ago. The average work week increased 0.1 hour, to 34.6 hours. Increasing income will lead to increased spending (demand increases) which leads to increase in Consumer Price Index (CPI) (As demand increases, suppliers will increase the prices of goods and services) which then leads to an increase in inflation, getting closer to Fed’s 2% inflation target (or inflation rockets to the moon, damaging the economy).

Lower oil prices may be holding back wage increases, especially in the energy sector.

While average hourly earnings are slowly growing, recent “positive” changes in the minimum wages – higher minimum wages – will not help earnings/income, but will only mutilate the US economy. While the minimum wage increases may sound like a good thing, but it isn’t. When businesses are forced to pay higher wages to their workers, they may have to increase prices for their goods/services, leading to increase in inflation. Some businesses might lose their market share to low-paying businesses aboard. After businesses adjust their prices to offset wage increases, there’s no actual change in the “buying power” of consumers.

It’s better to let US companies make their own decisions regarding wages. Let the markets lead. Laissez-Faire.

The labor force participation did not move at all, at 62.6% for a third straight month.

So, unemployment decreased and labor force participation stayed unchanged. Here’s the dark side:

261K Americans dropped out of the labor force, pushing total US workers who are not in the labor force to a record of 94 million. The government only counts people as unemployed if they are actively looking for jobs. Those who dropped out of the labor force are not actively looking for jobs. Therefore, real unemployment rate can be and is much higher.

This report was the latest jobs report before the Federal Reserve meets this month to answer “million-dollar” question, rate-hike or not? The Fed will meet on September 16 and 17 to decide whether to raise interest rates for the first time since June 2006.

Rate-hike in June 2015? Well, that did not happen. Rate-hike in September 2015? Well, expectations for the rate-hike were lowered due to uncertainty about China and the health of global economy. But, Yes, there will be a rate-hike this month. ~~No, not 0.25% (or 25 basis points).~~ The Fed will raise the rates by…

…10 basis points or 0.10%…

Q2 GDP revision: 3.7%. Exp. 3.2%, First estimate 2.3%

I still stay with my rate-hike forecast of 0.10% in Sept. https://t.co/u3KUdSGLeE

— Khojinur Usmonov (@Khojinur30) August 27, 2015

0.10% is very reasonable.

On August 27, Preliminary (2nd estimate) Gross Domestic Product (GDP) showed that the US economy grew faster than initially thought in the second quarter. GDP expanded at 3.7% annualized rate instead of the previous estimate (advance estimate) of 2.3%.

This clearly shows a sharp acceleration in US economic growth momentum following a weak start in the year.

Personal Consumption Expenditures (PCE) (Consumer spending), which accounts for two-thirds of US economic activity, grew at a 3.1% in the second quarter following 1.8% growth in first quarter.

Real GDP and PCE- Quarterly % Change (2012 Q1 - 2015 Q2) — Real GDP and PCE- Quarterly % Change (2012 Q1 – 2015 Q2)

PCE price index (inflation measurement) increased at 2.2% annualized rate after declining by -1.9% in the first quarter. Core-PCE (excluding food and energy) increased at 1.8% annualized rate after increasing only 1.0% in the first quarter.

Further revisions for the second quarter are possible when the Department Of Commerce releases its final (third) GDP update on September 25.

Market reactions to the economic reports:

S&P 500 ("SPX") - 15 Min. Chart — S&P 500 (“SPX”) – 15 Min. Chart

Global Markets Crash + Asian Crisis Part 2

Global markets crash. Currency wars. What’s next? Good buying opportunity?

US markets: Markets plunged dramatically on Friday. The Dow Jones Industrial Average fell 530.94 points (3.12%), the worst one-day loss since November 2011 (on a % basis). The index is now down 10.2% (correction territory) below the May 19 closing and all-time high of 18,312, for the first time since 2011. For the week, the index is down 5.8%, the steepest decline since September 2011.

S&P 500 fell 64.84 points (3.19%), the worst one-day loss since November 2011 (on a % basis) and falling below 2,000 level for the first time since February. For the week, the index is also down 5.8%, the steepest decline since September 2011.

NASDAQ fell 171.45 (3.52%). For the week, the index is down 6.8%, the biggest weekly decline since August 2011.

European Markets: European stocks fell into correction territory on Friday. The Stoxx European 600 1.3% to 368.59. The index is down 11% from April 15 closing and all-time high of 414.06. For the week, the index is down 4.6%, the worst weekly performance since December. Other indexes fell into correction territory also. Germany’s DAX Index is down 18% from its highs. So far, 13 out of 18 western-European markets have lost 10% or more from their highs.

US oil prices fell just below $40 for the first time since February 2009, due to demand concerns and increasing supplies. US oil prices fell for their 8th consecutive week, the longest losing streak since 1986.

The CBOE Market Volatility Index (VIX) (also known as “Fear Index”) jumped 46.45% to $28.03 on Friday. For the week, the index rose 118.47% (from $12.83 to $28.03), largest % move ever in a week.

Three factors driving the free-fall of the global markets:

Growing concerns (or uncertainty) about China’s economy
US rate-hike uncertainty. Uncertainty is the market’s worst foe
Plunging oil prices

There are concerns about slowing growth in emerging economies, particularly China. Economic data from China showed manufacturing PMI in China fell to a 77-month low of 47.1 in August, down from July’s final reading of 47.8. A reading below 50 represent a contraction. About two weeks ago, China’s trade data showed that July exports declined by 8.3% year-over-year (Y/Y) due to a strong yuan and lower demand from its trading partners. Exports to the Japan, European Union, and United States fell 13%, 12.3%, and 1.3%, respectively. Exports are China’s strongest growth machine. The weakness in the fundamentals started (still is) putting pressures on policymakers. Then, a surprise move came.

On August 11 (days after the exports data), the People’s Bank of China (PBOC) made a surprising move to devalue its currency (so called “one-time” move), the renminbi (RMB) (or yuan), against the US dollar (greenback) by 1.9%, the biggest devaluation since 1994 and first devaluation since the yuan was de-pegged from the dollar in 2005. PBOC decided to lower daily reference rate – which sets the value of yuan against the greenback – to make yuan more market-oriented exchange rate.

Three reasons behind China’s move:

Weak fundamentals, including exports
Desire to be included in IMF SDR basket
Impending US rate-hike

China’s move increased concerns over the health of its economy (second largest economy in the world) and shocked the global markets which continues today. China’s devaluation signaled that the economy there must be worse than what everybody believes. Continuous slowdown as it shifts from an export-led economy to a consumer-led economy has led Chinese government (or PBOC) to help stimulate economic activity. Over the past year, they cut interest rates four times and cut RRR (Reserve Requirement Ratio) several times. The goal is to combat slowing growth by strengthening liquidity and boosting lending (so far, unsuccessful). The recent devaluation will make imports expensive and help boost exports (reminder: exports fell 8.3% Y/Y in July).

Another reason behind China’s recent move is its desire for the yuan to be included in the International Monetary Fund’s (IMF) Special Drawing Rights (SDR), a basket of reserve currencies, in which the US Dollar, Euro, Japanese Yen, and British Pound are part of. Earlier this week, IMF decided to extend its scheduled revision of SDR basket (revision takes place every five years) by nine months (to September 30, 2016), giving China more time to make yuan (or Renminbi ) “freely usable”, a key requirement join the SDR basket.

Last reason behind China’s recent move is impending rate-hike in the US, which would support the greenback and would have consequences for China. The recent devaluation ended the era of Yuan appreciation which began in 2005 (reminder: yuan was de-pegged from the dollar in 2005). Ever since “Strong Yuan” policy began in 2005, Yuan (CNY) appreciated 28% against the US Dollar (USD), 30% against the Euro (EUR), and 65% against the Japanese Yen (JPY)

Rise of Yuan against most of its trading partners’ currencies has made its trading partners exports attractive. US rate-hike would have made China’s export rivals even more attractive. Now that China devalued its currency in the wake of falling exports (reminder: exports fell 8.3% Y/Y in July), its trading partners would want to protect their exports share. Therefore, China has fired the first shot to start currency wars.

Consequences of China’s actions:

Countries like Australia, Thailand, New Zealand, Malaysia and Canada are likely to suffer from China’s devaluation. These countries are largest exporter to China. Don’t also forget that these countries can affect other countries. Basically, it is “Domino Effect” economically.

Earlier this week, Kazakhstan – whose top trading partners are China and Russia – switch to a free float (which means that the central bank stopped managing the exchange rate), causing its currency, the tenge (KZT), to fall 25%. The move comes due to three reasons; crude prices (Kazakhstan is central Asia’s biggest crude exporter) fell 55% in the past year, Russian has allowed its currency (ruble) to depreciate significantly as commodity prices plummeted, and due to the yuan devaluation. The motivation for the move is to preserve its export competitiveness.

Vietnam has also allowed its currency, the dong, to weaken further due to the recent devaluation by its biggest trading partner, China. Who will be next to devalue their currency in this crisis; Asian Crisis Part 2.

Commodities denominated in US dollars will become more expensive to buyers in China, the world’s largest consumer of raw materials. When China’s economy slows, demand for raw materials, such as copper, Iron-ore, etc decreases and the lower demand puts downward pressure on commodity prices.

China, second-largest oil consumer, is causing oil prices to drop non-stop, which will hurt oil exporters, such as Canada (possibly leading to another rate-cut).

Falling commodity prices mean one other thing; deflationary pressures.

Slow growth and lower commodity prices most likely will lead other central banks, especially large commodity exporters to maintain their easy monetary policies for longer. Countries with large current account deficits and/or corporations with large amount of debt denominated in US dollars could see their economic/financial conditions worsen, causing them to further increase/expand their easy monetary policy (rate-cuts, for example). Not only commodity exporters and emerging countries will suffer, but also US companies.

US companies with significant exposure to China will suffer from China’s devaluation. Such companies are Wynn Resorts, Micron Technology, Yum Brands, and Apple, accounting for China sales exposure of 70%, 55%, 52% and 30%, respectively.

When I noticed China economic getting worse earlier this year, I knew Apple depended on China a lot, so I said that Apple was overvalued as more competitors were emerging and China’s economy was about to get worse. Even though Apple’s earnings came out better than expected, I went ahead on twitter and responded to Carl Icahn’s comments on the Apple and the market. He expected (maybe still expects) Apple’s stock price to double, which I did not (and I still don’t). More competitors are starting to emerge and China’s economic conditions are getting worse (debt bubble coming).

Mr. Icahn believed the market was extremely overheated and expected market bubble. I have to agree with him. I preferred (still prefer) to use the term “correction”. At this time, I believe current market sell-off is temporary and the dust will be settled in a month (good-buying opportunity). I expect “market bubble” after the Fed raises interest rates to the range of 0.70% and 0.80% (early 2017?). That’s when market sell-off will be much worse than the current situation.

$AAPL is too expensive….market buble? more like correction https://t.co/4IItxdliAg

— Khojinur Usmonov (@Khojinur30) June 24, 2015

No… $AAPL is expensive https://t.co/5mBNIV7QSX

— Khojinur Usmonov (@Khojinur30) June 24, 2015

I’m calling Mr. Icahn to respond to my questions; how do you think China’s action will affect global economies (or markets)? Do you still think Apple could double in price?

Now, let’s get back to how else China can affect global economies (deflationary pressures). I expect Europe’s economy and Japan’s economy to slow down.

Europe’s economy will slow down due to export demand decreasing and the uncertainty created by Greece (Yes, they did get a bailout deal, but it’s not over). That’s why I believe European Central Bank (ECB) will either lower interest rates even further or they will increase current Quantitative Easing (QE) program, pushing Euro currency lower. Current falling prices in the European markets are a golden opportunity. Lower interest rates and/or increased QE program will send European equity prices higher>>>all-time highs will be made.

Japan, China’s largest trading partner, will also suffer due to export demand decreasing. The devaluation of yuan (or, Renminbi) will make Japanese exports less competitive. Japan’s economy is still suffering despite Abenomics (similar to QE). Recent data showed GDP (Gross Domestic Product) falling at annual pace of 1.6% in 2nd quarter, due to slowing exports and lack of consumer spending. Abenomics has failed. Additional monetary easing coming? If the economy does not get any better in the next several months, I expect additional monetary easing by the Bank of Japan (BoJ).

I don’t believe the Federal Reserve will stop its plan to hike the rates, but it will slow the pace of it. On Wednesday (August 19), Fed minutes of July meeting (leaked earlier) showed that Federal Open Market Committee (FOMC) members “…judged that the conditions for policy firming had not yet been achieved, but they noted that conditions were approaching that point.” They also said that “…the recent decreases in oil prices and the possibility of adverse spillovers from slower economic growth in China raised some concerns.” US dollar has been falling ever since the release of fed minutes, as expectations for September rate-hike decreased.

Now more troubles emerged, I wonder what the Fed will say or do. There are many US economic reports that will come until the Fed’s September meeting. The reports will decide the fate of rate-hike for September. At this time, I expect the Fed to hike the rates in September by 10 basis points (or 0.10%).

If the current China situation (or Asian Crisis Part 2) gets out of control, there will be no rate-hike for the rest of year even if there’s strong US economic reports.

All comments welcomed. Thank you.

Disclaimer: The posts are not a recommendation to buy or sell any stocks, currencies, etc mentioned. They are solely my personal opinions. Every investor/trader must do his/her own due diligence before making any investment/trading decision.

U.S. Rate-Hike Impending – Tick Tock

Last Thursday (July 30, 2015), the Bureau of Economic Analysis (BEA) released its advance (1st estimate out of 3) of Gross Domestic Product (GDP) for the second quarter (April, May and June) of the year. It was positive enough to increase the chance of rate-hike in September significantly.

Before we go any further, let’s review what two types of GDP, nominal-dollar terms and real-dollar terms. Current (or nominal-dollar) GDP tallis the value of all goods and services produced in the U.S. using present prices. On the other hand, Real (or chained-dollar) GDP counts only the value of what was physically produced. To clarify the point, suppose a hat-making factory announces that it made $1 million selling hats this year, 11% more than last year. The $1 million represents nominal company sales (or current dollar). However, something is missing. From this future alone, it’s unclear how the factory achieved the extra income. Did it actually sell 11% more hats? Or did it sell the same number of hats as the year before but simply raised prices by 11%? If the factory made more money because it increased the price tag by 11%, then in real (constant-dollar) terms, the true volume of hats sold this year was no greater than last year, at $900,000.

It’s vital to know if the economy grew because the quantity of products sold was greater or whether it was largely the result of price hikes, or inflation. (Source: “The Secrets of Economic Indicators” by Bernard Baumohl)

Real GDP increased at a annualized rate of 2.3%, vs expectations of 2.5%. This is a major acceleration from the first quarter when real GDP increased 0.6% (expansion), revised from -0.2% (contraction). The economy bounced back after a slow start in the beginning of the year.

Real GDP - Quarterly (1Q 2011-2Q 2015) — Real GDP – Quarterly (1Q 2011-2Q 2015)

In the beginning of the year, US economy was hurt, or “walked backwards” due to unfavorable weather, lower energy prices, West Port strike, and stronger dollar. While, the economy has moved beyond the weather and west port strike, – a strong dollar, and lower energy prices will continue to limit growth.

While first quarter was revised upwards, 2011-2014 was revised lower. The economy grew 1.6% in 2011, down from the 2.3% initial reading; 2.2% in 2012, up from the 1.5% initial reading; 1.5% in 2013, down from 1.7%; and 2.4% in 2014, down from 2.7%. From 2011 to 2014, growth was essentially weaker. The economy expanded by an average annual rate of 2%, below initial reading of 2.3%.

Real GDP - Annual (2011-2014) — Real GDP – Annual (2011-2014)

Growth in the second quarter was boosted by consumer spending. Consumer spending grew at a 2.9% rate from a 1.8% in the first quarter. That is a very good sign because real personal consumption expenditures (PFE) AKA consumer spending, accounts for 70% of total GDP. If people are not spending, it spells serious trouble for the economy.

Real exports increased 5.3% in the second quarter, compared to 6% fall in the first quarter. First quarter’s significant drop was due to west port slowdown. The strong dollar has hurt exports but its effects have eased recently…for now. Port delays in the first quarter freed up exports and temporarily increased exports.

Business investment fell 0.6% in the second quarter, from previous 1.6% increase in the first quarter, as energy companies continue to scale back projects amid low oil prices.

Recently, crude oil prices have fallen back to the Earth. On Monday, August 3, crude oil prices hit just above $45 (currently below $45). It will continue to hurt energy companies, causing them to scale back projects and lay-offs. Low gasoline prices, however, would lead consumers to spend money. It’s better to pay off debts first before spending money on “wants”.

Crude Oil ("/CL" on thinkorswim) - Daily — Crude Oil (“/CL” on thinkorswim) – Daily

On Friday (July 31, 2015), Employment Cost Index (ECI) report for the second quarter was released and it was disappointing.

ECI, a broad measure of workers’ wages and benefits, increased 0.2%, smallest gain since records began in the second quarter of 1982, following 0.7% increase in the first quarter. Wages and salaries, which accounts of 70% of compensation costs, also increased 0.2% in the second quarter, the smallest gain on record.

Employment Cost Index (ECI) - Bloomberg Terminal — Employment Cost Index (ECI) – Bloomberg Terminal

The report suggests that slack remains in the labor market. The unemployment rate fell to 5.3% in June – the lowest level since April 2008 – close to the Fed’s target of 5% to 5.2%, which the Fed policy makers consider consistent full employment.

S&P 500’s reaction to both GDP and ECI reports.

S&P 500 ("SPX" on thinkorswim) - Hourly — S&P 500 (“SPX” on thinkorswim) – Hourly

Dollar’s reaction to both GDP and ECI reports.

US Dollar ("/DX" on thinkorswim) - Hourly — US Dollar (“/DX” on thinkorswim) – Hourly

The Federal Reserve are counting on rising wages to boost both the economy and inflation (2% target). On Wednesday, July 29, the Fed said it won’t start lifting rates until there is “some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”

The Fed is monitoring employment, inflation, and wages closely as it moves to closer to raising interest rates from near zero, for the first time since the recession. Raising rates too soon or too late can have its consequences.

The Fed will meet on September 16 and 17. I still believe the Fed will raise rates. If employment, inflation and wage reports are not very strong until September meeting, the Fed might raise the rates by little as 0.10% (10 basis points), instead of 0.25%.

I believe the disappointment of ECI is temporary as more companies are starting to increases wages and more people are slowly entering jobs market. I also believe that GDP continues to be strong. In fact, I believe current Q2 GDP will be revised higher. Preliminary (2nd estimate) of Q2 GDP will be released on Thursday, August 27.

On Friday (August 7), important reading data of US economy will be released, non-farm payrolls AKA jobs report. My guess for employment and unemployment rate is 285K and 5.4%, respectively. I believe wages will stay flat at this time and accelerate in the next few months.

I will take advantage of any pullback in the greenback (US Dollar). Greenback has a room to strengthen more. Currency pairs such as USD/JPY, USD/CAD, I would be long, and I would be short EUR/USD. If you have any questions, feel free to contact me and/or leave comments below. Thank you.

Fed removes “patient”, and adds twists

Last Wednesday (March 18, 2015), the Federal Reserve released its statement on the monetary policy and its economic projections. The The Fed dropped from its guidance “patient” in reference to its approach to raising the federal funds rate. It was largely to be expected to be removed, which would have send U.S Dollar higher and U.S market lower. However, the opposite happened because of two twists; they lowered their economic projections, and Chair of the Board of Governors of the Federal Reserve System, Janet Yellen’s words during the press conference.

According to the “dot plot”, the Fed lowered median “dot” for 2015 to 0.625% from 1.125% (December). What is “dot plot”? The Dot Plot is part of the Federal Open Market Committee (FOMC)’s economics projections and it shows what each member thinks the federal funds rate should be in the future. It is released quarterly. Sometimes, it might be released more than that, depending on economic circumstances. It gives you a perspective of what each member of FOMC thinks about economic and monetary conditions in the future.

Again, the Fed lowered median “dot” for the end of 2015 to 0.625% from 1.125% in December (-0.50%). The Fed also lowered the “dot” for end of 2016 and 2017. For the end of 2016, it is at 1.875% from 2.5% in December (-0.625%). For the end of 2017, it is at 3.125% from 3.625% in December (-0.50%). Besides, the “dot”, Yellen said one thing that took a toll on the U.S Dollar.

Even though the Fed removed “patient” from the statement, Yellen had “patient” tone during the press conference. Yellen said ““Just because we removed the word “patient” from the statement does not mean we are going to be impatient,”. This sentence alone halted US Dollar from rebounding after it dropped on the statement. There are other things that complicates the timing of the rate-hike.

It’s now more complicated to predict the Fed’s next move because of three reasons; very strong US Dollar, low inflation, and economic crisis in Europe and Japan, if not United Kingdom too. US Dollar is too strong, hurting U.S exports. Inflation has declined due to falling energy prices. The struggling foreign countries economically can also hurt U.S economy. I believe two majors factor of the Fed’s next move are the strong US Dollar, and the low inflation. When both of them are combined together, it makes imports cheaper and keeps inflation lower. I believe Europe will start to get better–as Quantitative Easing (QE) fully kicks in–money starts flowing in Europe. European stocks will probably hit new highs in the coming years because of QE program. Once, the Fed raises the rates, the money will probably flow into Europe from the U.S because of negative interest rates. Low rates have been a key driver of the bull markets in the U.S stock market the past six years. Lower rates makes stocks more attractive to the investors.

Since, the “dot” has dropped harshly, I believe this could be a sign of late delivery of rate hike. They might hike the interest rate in September, not June. However, if non-farm payrolls number continue to be strong, average wage (indicator for inflation) lifts and oil prices rebound, then the door for rate-hike for June might still be open. For now, there is no sign of oil rebounding since it has dropped sharply this week. We will get the next non-farm payroll, which also includes average wage, on April 3.

In the statement, FOMC stated “The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term. This change in the forward guidance does not indicate that the Committee has decided on the timing of the initial increase in the target range.”

The Fed want to be cautions before raising the interest rates. They want more time to be sure; “further improvement in the labor market” and “reasonably confident that inflation will move back to its 2 percent…” Although, non-farm payrolls have been strong lately, inflation is too low. The inflation is low because of the stronger dollar and the plunge in oil prices.

The Fed is in no hurry to increase the interest rate. The Fed said it would definitely not act on rates at “…April FOMC meeting.” and might wait until later in the year. I believe September has higher chance than June, from the rate-hike.

It looks to me that the Fed planned to send US Dollar lower. They probably wanted the US Dollar to be weaker before raising the rates, which could send the US Dollar a lot higher. Their plan worked. The US Dollar dropped so much that it sent EUR/USD (Euro against US Dollar) up 400 pips (above 1.10). U.S market rose after they were down ever since the release of non-farm payrolls for February. Dow gained over 200 points, as well as other indices.

Dow Jones (DJI) - 30 Mins — Dow Jones (DJI) – 30 Mins

US Dollar - 30 Mins — US Dollar – 30 Mins

Feel to contact me and/or to leave comments. Don’t forget to follow my twitter account @Khojinur30. At any moment, I might post my view on certain things. Thank you.