Auto Sales Weak In Beige Book
The Fed’s Beige Book report was released Wednesday. That’s where the Fed gives its update on how it sees the economy now and where it might be going in the future. The key term was that there is modest to moderate growth which Steve Liesman says means 2% growth. This makes sense because the economy has grown about 2% this year and this entire recovery. Even though the current quarter and past quarter did better than this long run rate, it’s best not to get overly optimistic since the effects from hurricane Harvey haven’t been estimated yet. I’m looking forward to seeing tomorrow’s unemployment claims report because that will have the first effects from the hurricane.
The Beige Book includes economic analysis from the 12 Federal Reserve banks from early July into August. The weakest portion of the report was the auto sector with Cleveland seeing a 16% decline in year to date in production at auto assembly plants. The Beige Book said, “contacts in many Districts expressed concerns about a prolonged slowdown in the auto industry.” This is the worst part of the economy, but the cars which were destroyed in the storm will need to be replaced, so we’ll see if there’s an uptick in September and October. This catalyst came at a great time as Autodata reported August sales declined to the worst rate in over 3 years and inventories are rising.
Cohn Takes A Hit
There was news out of Washington on Wednesday that Gary Cohn won’t be the next Fed chairperson. Personally, I thought he had very little shot at being picked because he has no monetary policy experience. However, the reason President Trump won’t be picking him has nothing to do with his qualifications. It’s because of Cohn’s criticisms of President Trump’s Charlottesville response. This is understandable because the President doesn’t seem to want to appoint people who aren’t on his side. However, it also makes this pick very uncertain because any of the potential candidates can criticize one of his actions. Weirdly, Yellen is the top candidate on this PredictIt list even though her entire Jackson Hole message was against President Trump’s proposed repeals of financial regulations. The main reason why she’s on top is because the last time President Trump spoke of her, it was positive. Also, Fed chairs are routinely reappointed. Finally, there isn’t a clear replacement, so bettors just go with the easiest choice.
Kevin Warsh is second on this list because he is a good fit. He’s a renegade like President Trump who doesn’t hesitate to criticize the Fed. Candidate Trump would have picked him, but President Trump is now more hesitant to criticize the central bank because he’s on the inside. He doesn’t want the Fed to mess up the economy, hurting his chances at re-election.
Kevin Warsh being the Fed pick is probably the biggest risk the market faces in the next 6 months because he doesn’t care about the stock market when making decisions and he hates QE. I could see him unwinding the entire balance sheet instead of leaving the terminal value near $3 trillion. That would cause massive volatility on Wall Street. Because President Trump knows this, he might not want to take that risk. As you can see, the conflict is between going with what he campaigned on or going with what gives the economy the best shot at doing well in the next 2 years to help him get re-elected. Ordinarily, you’d expect politicians to always go with the pick that gives them the best chance of being re-elected. The problem lies in the optics of picking someone who he criticized during the campaign. It would also be tough to get the Yellen pick passed the Senate because some Republicans would balk at the idea. Even if the pick passed with majority support from the Democrats, it would look bad to his base.
Whenever you’re trying to find alpha to get your portfolio to do well on a risk adjusted basis, you try to find things that aren’t already priced in to the market. That’s what a Warsh pick would be. Even though PredictIt gives him 19% odds, the market clearly doesn’t see this coming. There’s a 45.2% chance the Fed doesn’t raise rates by August 2018. If Warsh is consistent with his life’s work, he will raise rates which is currently not expected.
The final piece to the puzzle is if Warsh follows through on his previous public statements. President Trump might negotiate with Warsh to tamper down his hawkishness for a promise to be picked. Secondly, the President can surround Warsh with doves to prevent too many rate hikes. The Fed’s number two person, which is vice chairman Stanley Fischer, announced he will step down in mid-October. This gives President Trump another spot to fill.
Fischer stepping down might be a signal that President Trump is about shake things up at the Fed. Even though Yellen’s odds went up 12% to 32%, I still think this is bad news for her odds of being re-appointed. Sometime in mid-October to December President Trump will make his feelings more well known opposed to leaks which say who he won’t pick.
Conclusion
Yellen’s odds of being the next Fed chair increased on Wednesday which is bullish for stocks. However, she’s still below 50%, so nothing is certain. Saying there’s a 32% chance the market has the chances of rate changes correct, doesn’t sound consoling. Saying there’s a 19% chance there will be a Fed chair who doesn’t care about what the stock market thinks sounds downright terrifying after years of Bernanke and Yellen.
One of the parts of the economy which will benefit from the hurricanes is autos because cars will need to be replaced. This comes at a great time because auto sales have been a big drag on the economy Construction should also pick up in the next few weeks as the rebuild in Houston starts.
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