The emerging market crisis spread to Brazil and infected Italy this week. Even though Italy is not an emerging market, the country holds a disproportionate amount of emerging market debt. Furthermore, Italian President Sergio Mattarella blocked two anti-establishment parties, the 5 Star Movement and League parties, from taking power, effectively denying Italian voters their chosen political leaders from the March 4 election.
These new political parties are not friendly to the European Union (EU), reflecting the fact that Italian voters are increasingly hostile to the EU leadership. However, on Thursday, the 5 Star Movement and League struck a deal to form a new government, raising hopes of forming a coalition.
In the meantime, Carlo Cottarelli has been named Italy's new Prime Minister to lead a "caretaker" government if a coalition cannot be formed. Spain's leadership is also under siege, since Prime Minister Mariano Rajoy faces a no-confidence vote in Parliament. Between the chaos in Italy and Spain, the euro hit a six-month low against the U.S. dollar, which is causing the 10-year U.S. Treasury rates to retreat.
The Emerging Markets Crisis is Boosting the U.S. Dollar
Just to recap the status of the overall Emerging Markets crisis, there has been a growing currency crisis in Argentina, Burma, Cambodia, Indonesia, Iran, Paraguay, Turkey, Uzbekistan, Venezuela, Vietnam, and some other emerging market countries, which is also accelerating the exodus from emerging market investments. When there is an international currency crisis, the oasis currencies are the U.S. dollar, British pound, the Chinese yuan, the euro, and Japanese yen, since these currencies have tremendous liquidity. However, the Chinese yuan and euro are not as strong as they once were, plus the British pound and Japanese yen have slipped a bit, leaving the U.S. dollar to carry the burden of global capital flight.
The good news is that this capital flight is causing the 10-year Treasury bond yield to decline, which means that the Fed will likely be hesitant to raise key interest rates further after its widely anticipated June 13 rate hike next week. The Treasury yield curve is now the flattest in over a decade, which is bad for the financial stocks that typically profit from the spread between short- and long-term interest rates. I am a former banking analyst and am proud that financial stocks are largely absent from my growth portfolios, so I'd say one of the keys to beating market averages is to avoid financial stocks, especially major banks.
In the meantime, a trucker's strike over high diesel prices has crippled Brazil's economy. A decline in fuel taxes is putting pressure on the Brazilian government to end its payroll tax breaks, which may in turn instigate more strikes. Despite a concession to cut diesel prices for 60 days, many truckers remain on strike, so there are acute fuel and food shortages nationwide. Many Brazilian businesses remain closed due to a lack of raw materials and the inability to deliver essential products. Approximately one billion chickens and 20 million pigs are at risk of not being fed adequately. So overall, Brazil's GDP is expected to take a major hit, and chaos has become the "new normal" in Brazil.
Lowest Jobless Rate Since 1969 Highlights Upbeat Economic News Week
Naturally, the big economic news last week was Friday's payroll report, where the Labor Department reported that 223,000 payroll jobs were created in May, much better than economists' consensus estimate of 190,000. The March and April payrolls were revised up by a cumulative 15,000 jobs to 155,000 and 159,000, respectively. The unemployment rate in May declined to 3.8%, its lowest level since 1969 and tying a reading from April 2000. Average hourly wages rose by 8 cents or 0.3% in May to $26.92 per hour. In the past 12 months, wages have risen at a 2.7% annual pace. I should add that on Wednesday, ADP reported that 178,230 private payroll jobs were created in May. ADP significantly revised its March and April private payrolls lower to 198,470 and 162,990, respectively. Overall, the job market remains very healthy, with hiring in construction, healthcare, and manufacturing industries especially strong.
The other economic news was equally positive last week. On Tuesday, the Conference Board's consumer confidence index for May rose to 128, up from a revised 125.6 in April. The present situation component rose to a 17-year high of 161.7 in May, up from 157.5 in April. Overall, consumer confidence is near a 17-year high, which bodes well for retail sales as well as second-quarter GDP growth.
The Fed's Beige Book survey, released Wednesday, stated that all 12 Fed districts grew "moderately." The Beige Book survey was especially positive on U.S. manufacturing, citing a strong construction sector. All this economic activity boosted loan demand, which is also a good sign. Despite higher prices for crude oil, steel, and other commodities, the Beige Book survey said that inflationary pressures appear subdued. Overall, the Beige Book survey painted a "Goldilocks" view of the U.S. economy, where growth and inflation are neither too hot nor too cold. Essentially, the Fed is on track to raise rates in June and then will monitor inflation and market rates before deciding if it wants to raise rates later this year.
Finally, I should add that the Energy Information Administration (EIA) reported on Thursday that crude oil output rose by 215,000 barrels per day to 10.47 million barrels per day in March, a record for U.S. oil production. Production in Texas rose by 4% to almost 4.2 million barrels per day. The spread between WTI crude oil and Brent light sweet crude is now over $11 per barrel, which means the refiners I prefer should be able to make a lot of money on the spread!
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