Markets are not prepared for a government shutdown / December 13

Date:  December 6, 2017Author:  kenzocaspi

BY JAMES RICKARDS

AWARE

December 5, 2017

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Do the Republicans and Democrats agree on a budget and avoid a government shutdown after midnight Friday?

I'd say the odds are 50/50. Actually, I put the odds of closing about 55%. Certainly there is enough substance here to be cautious.

The government could shut down due to disagreements over defense spending, funds for the wall Trump with Mexico ,  deporting illegal immigrants brought to the United States as children  (the "Dreamer Law" also known as "DACA"),  funds for Planned Parenthood ,  funding for Obamacare  (called "SCHIP"),  disaster relief and more.

There is not much middle ground between Democrats and Republicans in many of these hot topics.

How would a closure plans the Fed to raise rates on  day 13 ?

If you can not reach an agreement and the government shuts down, it is very difficult to imagine that the Federal Reserve will continue with its planned hike interest rates on December 13.

Meanwhile, markets are almost certain that the Fed will raise rates. They are already "baked cake."

The euro, the yen, gold and Treasury notes have a full price to raise rates. If it happens, these instruments will not change much because the event is priced.

But we could see a backlash on the market if Janet Yellen stays and does not raise rates.

If the Fed does not raise rates, gold could skyrocket as the Fed approves their best chance to raise rates and the markets perceive that the easy money is here to stay. Euro, yen and Treasury notes also skyrocket.

Of course, say that the government could shut down is different from saying that the government will close.  Again, I give it a 55% probability at this point.

And there are many ways for things to go wrong.

At the end of last week, the Commerce Department released data PCE core inflation of October. This is important because that is the number that the Fed observed. There are many other readings of inflation (CPI, PPI, core, non-core, trimmed mean, etc.), but year after year Core PCE is used by the Fed to compare their performance in terms of its inflation target. .

The goal of the Fed PCE Core is 2%. October reading was 1.4%. For weeks I've been saying that a reading of 1.3% would put the rate hike on hold, and a reading of 1.6% would make the rate hike was a fact. Then, the actual reading of 1.4% was in the soft easy medium range forecast.

Interestingly, the previous month was also 1.4%, so the new number has not changed since September. That's not what the Fed wants. They want to see progress towards its target of 2%.

On the other hand, 1.4% of September was a revised. It was previously reported 1.3% (the same number as in August).

You can read this in two ways. If you see the 1.3% August at least, then we can say that the readings of 1.4% for September and October were a step towards the target of 2% of the Federal Reserve. It is a thin tongue, but Yellen could use this to justify their view that the weakness of a year in Core PCE is "temporary".

On the other hand, these movements 0.1% month are really statistical noise and may even be due to rounding. The bigger picture is that PCE Core is weak and is not close to the target of the Federal Reserve. Another rate hike in December could be a big mistake if the economy slows down even more and leads to further weakness in PCE Core.

In short, the number of Core PCE probably enough (just) to justify an increase in the rate. I increased the likelihood of a rate hike in December 30% to just over 50% - 55%. That's what analysts should do; forecasts updated continuously based on new data. You can not be stubborn with your analysis.

I'm not trying to be "consensus" or "out of consensus." I just want to do well, and that means sometimes be in consensus. Other times, I will not be.

But you must forget how the market is valuing the outcome. The futures market funds the Federal Reserve has been turned off by orders of magnitude before. In mid-February 2017, the futures markets given the possibility of a rate hike in March to 30%.

He was giving 80% chance.

Within three trading days in late February, the odds of the market changed from 30% to 80% before converging at 100% for the March meeting.

That does not mean I did it right this time. But it illustrates that the futures market does not always have this right, not even close.

And the markets are gearing up for a fall.

Bull markets in stocks seem unstoppable until the moment they stop. Then comes a rapid phase of shock and burns.

Are there ever any warning that a collapse is going to happen?

Of course there Analysts warn him all the time and provide mountains of data and historical evidence to support its analysis.  The problem is that all ignored.

You can talk about  the dangers represented by CAPE ratios, margin levels, computerized trading, persistent low volatility and complacency all you want, but nothing seems to slow this bull market.

However, there is one thing that can stop a bull market on its way, and that corporate profits are.

The simplest form of stock valuation is projected profits, implement a multiple and, voila, you have an assessment. Multiples are already near record levels, so there is not much room for expansion there.

The only variable that remains are projected profits and that is where Wall Street analysts are having a field day increasing stock prices. Earnings grew significantly in 2017 on a year-over-year basis, but that is mainly because profits were weak in 2016, so the annual growth was relatively easy.

Now comes the hard part.

How profits expand again in 2018 when 2017 was such a strong year?  Wall Street just use a simple extrapolation and says that next year will be like this year, we just better!  But there are many reasons to doubt that extrapolation.

Earnings likely not meet expectations,  which can lead to a correction. Once that happens, multiples can also be reduced. Soon you will be in a bear market on a large scale with stock prices down 20% or more.

Without considering that a war with North Korea and all the dangers that others have mentioned.  This may be your last clear chance to lighten the exposure to listed shares before it explodes the bubble.

Markets are creatures manipulated by changes in Fed policy,  statements, guidance and other forward sleight of modern central banks . That's what you get after 10 years of ZIRP, QE, tuning, QT, orientation forward, currency wars and reflections on NIRP.

Off or off, the Fed has cornered with no way to escape the room.

That is the greatest to consider as we approach the Dec. 13 history.

Tune the current sideshow and keep that in mind.

Regards,

Jim Rickards 
for The Daily Reckoning