Sound bites: US banking insider sentiment crumbles ahead of key Yellen speech

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There are more warning signs for a US market that spent has spent the summer hitting new all-time highs. Over the past few weeks we have been watching broad insider sentiment sink as stocks have moved higher. Banking insiders were the one group that offered some comfort to the bulls with our Banking Indicator remaining above the 100% mark, meaning there were more stocks in the group with key insider buying than there were with selling. However, in advance of Janet Yellen's Friday speech at the Kansas City Federal Reserve's end-of-summer symposium at Jackson Hole, the banking insider comfort zone is crumbling.

Our banking indicator as of Tuesday has dropped to 77%, a level not seen since November 19th of last year. The plunge in the banking indicator last time around foreshadowed a retreat in banking shares with the SPDR KBW Bank ETF (KBE*US) falling more than 20% over the ensuing three months. Just like last fall, the Fed is making noises about raising interest rates even as it continues to fail to meet its 2% inflation target. In fact, you have to go back to spring 2012 to find the last time the Fed's preferred measure of inflation, the PCE Price Index, was at 2%. The inflation target had been met on the back of a combination of zero interest rates and QE 1 and 2. However, "Operation Twist" and QE 3 subsequently failed to deliver on the inflation mandate. Indeed, perceptions may now be that inflation will remain below target permanently as inflation expectations have tumbled on a number of measures over the past few years.

Given recent comments from Fed officials, including FOMC member William Dudley, the Fed now seems to be more focused on the timing of its next rate increase than the timing of achieving its inflation target. While we are no great fans of a 2% inflation target, it is nevertheless a core policy objective clearly set by the Federal Reserve. The willingness of the Fed to, on the one hand, keep the target but, on the other hand, be content with failing to achieve it may well be at the root of current anxiety among many market participants, including insiders.

 

On Friday, Janet Yellen has the opportunity to reset policy expectations with her Jackson Hole speech. Will the Fed "do what it takes" to hit 2% or will it continue to hope that investors buy its sales pitch that inflation just needs a bit more time to get there? But, therein lies the danger. There is no basis to believe that the Fed will ever reach its inflation goal with the status quo.

If the Fed chair reaffirms the latter "trust us" approach, she will be seen as sticking to a path of future rate increases after more-or-less succeeding at the Fed's labour market objectives while essentially throwing the inflation mandate under the bus.

 

Will Janet Yellen through the Fed's inflation target under the bus on Friday? Image source: Oran Viriyincy

Such a posture could well firm up the US dollar, pressure commodities, and push down PCE inflation further, boosting short-term real rates in the process. Such a scenario for banks would, at best, keep the yield curve where it is today and, at worst, flatten it further. Furthermore, as well intentioned as Fed policy makers may be, sticking with the "rate hike soon" mantra would highlight a stunning degree of wishful thinking that they can tighten monetary conditions even as just about every other country on the planet is in loosening mode. Moreover, when US consumer prices are calculated on the same basis as they are calculated in Europe using a harmonized index, US inflation is not only lower than European inflation, it is close to zero!

 

Monetary policy divergence between the US and the rest of the world at this point can be nothing more than a dream. Eventually the Fed and the US rate hawks on the FOMC may figure that out. Until they do, the American economy and stock market are at risk for a setback.

No wonder banking insiders are nervous.

Listen to Ted Dixon on Roundhouse Radio FM 98.3 every Thursday for his weekly financial markets commentary at 7:30 am Pacific Time. If you missed the live broadcast, catch the replay here. This post includes material from the US Market INK Report sent to INK subscribers on August 23rd.

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