Friday, August 31, 2012
Capital Markets Update
By Louis S. Barnes Friday, August 31st, 2012
At the end of each August, the world’s central bankers gather in Jackson Hole, Wyoming. Sit around the ol’ campfire singin’ sad songs, goin’ fishin’ in pin-striped suits, and tellin’ tales about the big trout that got away. This year, most of ‘em.
Despite the risk of feeding conspiracy theorists, it’s good to know that these people talk with each other constantly. The People’s Bank of China comes to Jackson. Money is money everywhere, the problems different but the same, and today are tightly linked. Mangled policy in Europe creates risk in China, and makes it all the more difficult for China to adjust its own severe imbalances.
One central banker is missing: in the midst of widespread expectation of ECB bond-buys, its chairman Mario Draghi 48 hours ago cancelled his scheduled Jackson speech. One thing is certain: if you’re afraid to leave town, you don’t have a deal.
Perfesser Bernanke spoke today shortly after smoky Wyoming sunrise. Markets hoped for immediate announcement of new QE, and didn’t get it. They did get a defense of QE dismissive of its critics: It seems clear, based on this experience, that such policies can be effective, and that, in their absence, the 2007-2009 recession would have been deeper….” Then, “Monetary policy cannot achieve by itself what a broader and more balanced set of economic policies might achieve.”
Markets held breath, fearful the Perfesser was backing out of the game, but got the clincher: “The stagnation of the labor market is in particular a grave concern… The Federal Reserve will provide additional policy accommodation as needed….”
There are four basic views of central bank policy: 1) these monetary authorities create more trouble than benefit and should be locked to rules or gold, or closed; 2) they may be active in deep emergencies but should quickly return only to maintaining stable prices; 3) they should be as active as necessary without risking inflation; and 4) if economies are dangerously slow, create inflation.
All but the first (which appeals only to those ignorant of 1930-32) involve “printing money” — merely a question of how much. Option two is the prescription of the bureaucrat: “Who, me… do something?” Option four is the darling of the Left, championed twice-weekly by disgraceful Paul Krugman.
Option three is the only game, and no financial matter more confuses the public (and most policy makers) more than how to print money without inflation.
Here in the US we still have a broken credit system. We have taken most losses and significantly re-capitalized, but credit is choked in circular fashion by a poor economy, low values of assets (houses), and weak employment. The worst damage: we’ve been doddfranked, the new-age synonym for arbitrary and self-destructive over-regulation.
The Fed’s QE “prints” into a banking system with no outlet. Thus its result is limited to pulling down long-term interest rates and forcing cash from ultra-safety into risk. The link between inflation and credit is very strong: can’t ignite anything with soaked kindling, and it’s the Fed’s duty to offset the credit shortage.
The ECB’s problem is entirely different. Euro-zone banks have not taken losses, especially on sovereign paper, and have not recapitalized. The ECB has done some printing, but injected cash only versus collateral. If it begins to print to buy bad bonds outright, directly funding the budget deficits of the weak, cumulative and new… there is nothing more inflationary. Thus it must force an offset: a guarantee of austerity among the weak. Circularity is a plague common to central bankers. We can ease your transition to sound fiscal affairs, but not by free money inducing inflation: you must do your painful part.
That is a fair deal, much like the UK’s policy. However, the UK has one government. The ECB has no means to enforce austerity, and dare not print in volume only to discover that the weak have slipped the hook once again. The UK has made more progress than it gives itself credit, and here in the US a great deal more. Europe, three years into crisis… none at all.
At the end of each August, the world’s central bankers gather in Jackson Hole, Wyoming. Sit around the ol’ campfire singin’ sad songs, goin’ fishin’ in pin-striped suits, and tellin’ tales about the big trout that got away. This year, most of ‘em.
Despite the risk of feeding conspiracy theorists, it’s good to know that these people talk with each other constantly. The People’s Bank of China comes to Jackson. Money is money everywhere, the problems different but the same, and today are tightly linked. Mangled policy in Europe creates risk in China, and makes it all the more difficult for China to adjust its own severe imbalances.
One central banker is missing: in the midst of widespread expectation of ECB bond-buys, its chairman Mario Draghi 48 hours ago cancelled his scheduled Jackson speech. One thing is certain: if you’re afraid to leave town, you don’t have a deal.
Perfesser Bernanke spoke today shortly after smoky Wyoming sunrise. Markets hoped for immediate announcement of new QE, and didn’t get it. They did get a defense of QE dismissive of its critics: It seems clear, based on this experience, that such policies can be effective, and that, in their absence, the 2007-2009 recession would have been deeper….” Then, “Monetary policy cannot achieve by itself what a broader and more balanced set of economic policies might achieve.”
Markets held breath, fearful the Perfesser was backing out of the game, but got the clincher: “The stagnation of the labor market is in particular a grave concern… The Federal Reserve will provide additional policy accommodation as needed….”
There are four basic views of central bank policy: 1) these monetary authorities create more trouble than benefit and should be locked to rules or gold, or closed; 2) they may be active in deep emergencies but should quickly return only to maintaining stable prices; 3) they should be as active as necessary without risking inflation; and 4) if economies are dangerously slow, create inflation.
All but the first (which appeals only to those ignorant of 1930-32) involve “printing money” — merely a question of how much. Option two is the prescription of the bureaucrat: “Who, me… do something?” Option four is the darling of the Left, championed twice-weekly by disgraceful Paul Krugman.
Option three is the only game, and no financial matter more confuses the public (and most policy makers) more than how to print money without inflation.
Here in the US we still have a broken credit system. We have taken most losses and significantly re-capitalized, but credit is choked in circular fashion by a poor economy, low values of assets (houses), and weak employment. The worst damage: we’ve been doddfranked, the new-age synonym for arbitrary and self-destructive over-regulation.
The Fed’s QE “prints” into a banking system with no outlet. Thus its result is limited to pulling down long-term interest rates and forcing cash from ultra-safety into risk. The link between inflation and credit is very strong: can’t ignite anything with soaked kindling, and it’s the Fed’s duty to offset the credit shortage.
The ECB’s problem is entirely different. Euro-zone banks have not taken losses, especially on sovereign paper, and have not recapitalized. The ECB has done some printing, but injected cash only versus collateral. If it begins to print to buy bad bonds outright, directly funding the budget deficits of the weak, cumulative and new… there is nothing more inflationary. Thus it must force an offset: a guarantee of austerity among the weak. Circularity is a plague common to central bankers. We can ease your transition to sound fiscal affairs, but not by free money inducing inflation: you must do your painful part.
That is a fair deal, much like the UK’s policy. However, the UK has one government. The ECB has no means to enforce austerity, and dare not print in volume only to discover that the weak have slipped the hook once again. The UK has made more progress than it gives itself credit, and here in the US a great deal more. Europe, three years into crisis… none at all.
Friday, August 24, 2012
Capital Markets Update
By Louis S. Barnes Friday, August 24th
“It’s quiet out there — too quiet.”
That line appeared again and again in 1950s horse operas, and we Western kids practiced daily the eye-squinted and growled delivery. We also worked at whistling the call of the meadow lark, the way the Native-Americans in those oaters signaled each other before their attacks. In our games, the short straws were the cowboys; our Sioux and Cheyenne always won in thrilling slaughter.
It is August, traditionally void of news, but this is really quiet. Eerie quiet.
Europe has fallen silent. Even the European Union no-content boys in Brussels have paused posturing. Monti, Rajoy, Hollonde… so quiet you could hear a euro drop in the Rhine. Draghi at the ECB after his excursion into bluster has corked himself altogether. Today Ms. Merkel broke her speaking fast to announce foursquare support for Greece and how much she wants it to stay on the euro (she may be a master of Europe on the order of Metternich and Bismarck, or an all-time blockhead, the power of her purse pushing her forward beyond talent — and I can’t find anyone who knows which).
The still-sealed tomb of a Chinese emperor is noisier than China’s current leadership. Japan is an exercise in origami in which paper is folded until it disappears altogether. And here a Presidential campaign which would be improved by silence.
You hear a meadow lark out there, wherever you are, best keep your head down.
Formal governments are paralyzed, and markets and the “leaders” themselves all turn now for rescue to hybrid, un-elected star chambers: the central banks. The Fed, the ECB, the PBOC, and the BOJ.
When one speaks, even without doing a thing, markets shake. The shock is still rippling from Wednesday’s release of month-old Fed meeting minutes. They sound as though they’ll ease again in some form, but no one knows how, or when, or to what effect. Stocks and other “risk assets” usually take off on new presumption of Fed easing, but not this time. 10-year Treasury yields did fall back to the center of their May-August range, but hardly an exuberant response. Suspicion is building that any new Fed operation will just buy time until fiscal and economic reckoning. Meanwhile, federal tax revenue in 2012 is running 15.7% of GDP versus 24% spending, and versus 2007 revenue at 18.5%.
Everyone assumes the ECB is collecting final political approval for its own QE, trying to suppress borrowing costs for the euro-wrecks. However, neither the ECB nor any European authority has a solution to the stimulus-austerity conundrum, so long as all are bolted to the euro.
In the best-by-far English language China blog, www.mpettis.com, Dr. Pettis asserts that a new round of PBOC stimulus will signal panic, more credit and investment making things worse, and marking aversion to desperately needed re-balancing of China’s economy away from state industries and toward consumers.
Many expect the BOJ to print Japan out of deflation. That would make 23 years of expecting, still counting.
Those who meditate find clarity in silence, and so this August we have it. The convergence of expectations of all four major central banks — results beyond their means — says with considerable clarity what comes next. In varying ways and times, in all four regions — US, Europe, China, Japan — economic deterioration will force dealing with their actual headwinds. The toughest part: to sort those who can support their debt from those who cannot, and to proceed with their assisted default. One or more may temporarily embark on the last mirage of the central bank, to print enough to induce inflation, but the ensuing catastrophe would caution the others.
Here in the US we enjoy the improbable position of having the best chance to act of the four. Either now or soon, we will be the only one with positive GDP. We may be the only one still with the capacity to deal with our existing debt and budget gap. How we do it will be disorderly beyond imagining, but that’s how we do things.
Saturday, August 18, 2012
Capital Markets Update
By Louis S. Barnes Friday, Augfust 17th, 2012
Two things this week: explain the sudden rise in Treasury and mortgage rates, and then provide a simple tool for understanding budget issues in the election. Nuthin’ to it.
In the last two weeks the 10-year T-note has run up from 1.45% to 1.85%, taking many mortgages from below 3.50% to above 3.75%. Explanations offered by sharpies: the economy has turned for the better, no longer sliding toward recession. Or because the Fed will not soon begin QE3 more bond-buying, either because the economy is better, or because it won’t do any good, or because of the election, or because of internal politics. Or rates have risen because Europe might save itself.
Put all that eyewash in a bucket. Then dump the bucket. July’s 0.8% up-wobble in retail sales is not a “turn” — not with the Philly and NY Feds’ indices sinking, not with small-biz NFIB returning to recession threshold, not with euro-zone GDP going negative, and not with China verging on distress. The Fed may not act now, but inflation is tipping again below the Fed’s target, and a solid majority at the Fed does not want to risk deflation or a run up in long-term rates.
When there is no “fundamental” economic explanation, look to “technical” — chart patterns reflecting the emotional condition of the herd. For nine months prior to April, the 10-year traded 2.00% (mortgages 4.00%-4.25%). Then 10s fell in a straight line to 1.50%, wandered at 1.60% in June, and then spent July in the 1.40s. At yields like these, nobody makes money on the rate; you make money when bond prices rise (yields falling more). A month with no buyers to take prices higher, and a few in the herd began to take profits, then many, and so prices will fall (rates rising) until low enough that they can rise again. 10s might go all the way back to 2.00%, might stop here, but rates are not going all the way back down until something ugly happens.
From that complexity to something simple. The budget. (Note: in the long run, the yield on 10s and the budget are linked. Heh-heh.)
Democrats say the Republicans are cruel, want to rob the poor to benefit the rich, and that Medicare and Social Security will be fine if rich people pay more taxes. Republicans say the nation is broke, Democrats will never stop spending and taxing, and besides, we’ve got ours. Each party offers to play a shell game with no pea.
We have to pay money for all the social goodies, and yet have to pay a social cost if we cut the goodies. Today we borrow $.41 of every $1.00 we spend, and we spend $80 billion each day. Something has to give, but what?
Any time you hear a pol’s pitch this fall, here’s the pea to put under all the shells: what’s the pol’s proposal as a percent of GDP?
Since WW II, federal spending has run about 20% of GDP, and revenue about 18%, a perpetual but modest deficit. Until the Great Recession. Spending is now 24% of GDP, and revenue 15%. The revenue decline is partly the result of the recession; reversal of the Bush tax cuts would not get revenue past 17% of GDP. That recession shortfall is the reason recovery is so desperately important. Rather worse, social-goody spending will take total spending over 30% of GDP in the next decade, health care doing 85% of the damage. Worse yet, our borrowing ability will be tapped out in a very few years. At the current pace… two years. If that. Then markets will pull our plug.
Many of my friends on the Left are soaked in European tax-rate propaganda, 35%-50% of GDP, but are blind to nationalized healthcare, railroads and so on, all requiring higher taxes and spending, and with intractable deficits. Republicans envisage a dinky government, 18% of GDP, but are utterly dishonest about the social cost, and are resistant to deep cuts in defense. Democrats refuse to consider any upward limit on GDP, or a budget deficit smaller than 3% of GDP.
The Bowles-Simpson www.fiscalcommission.gov “Co-Chairs Proposal” caps spending at 22%, eventually 21%, and raises revenue to 21%. Please read it.
Mr. Politician, don’t tell me what’s wrong with the other guy’s deal. Please do tell me what you want to do, and your GDP metric, and consequences. Then compromise.
Friday, August 10, 2012
Capital Markets Update
By Louis S. Barnes Friday, August 10th, 2012
In the absence of meaningful US data, ECB rattling of the printing press has taken away some of the fearful bidding for Treasurys (10-year T-note in four days from 1.49% to 1.72%), and mortgage rates have risen a little as well. For us to return to interest rate lows or set new ones requires Armageddon over there or recession here.
Instead, odds have risen for a new European can-kick, held for the moment by a new standoff: Spain and Italy need a lot of money, but those with the money will not offer it until asked. Spain and Italy will not ask until they know what strings will be attached. (No, I am not making this up.)
Italy is the less weak of the two, and thus expects its promises alone will do, no strings. Spain already has strings: to cut its 8.5% of GDP budget deficit to 6.5% this year, to 4.5% next year, and to 2.8% in 2014. It’s chances are about even with a six-legged, eight-eyed critter snapping an Instamatic at Curiosity. New strings would force Spain to give control of its budget to the euro Gestapo. The next inadequate and temporary can will be kicked as soon as Spain decides to the right thing: lie.
Here at home, genuine good news, adding to the up-push on rates, and to the Fed’s evident wish to defer more easing: housing really is turning. We get housing data in a constant stream from dozens of sources, none definitive because “housing” is an a aggregation of a gazillion micro-markets, and measuring national trend is an art form. The sources range from the imaginary (Zillow), to permanently loopy (NAR), to perma-bear (Gary Shilling), and financial analysts have an especially hard time grasping a market so different from theirs (no exchanges, no uniformity, no mobility…).
One of the best sources: mortgage-insurer MGIC’s quarterly Market Summary, notable for descriptive adjectives on a single page, no numbers or percentages, and the right balance of detail. 73 metro areas are rated strong-stable-soft-weak, and further by change underway, softening-improving. In the best ratio in a half-dozen years, 12 are improving versus two softening, and in markets changing rating in the last 90 days the score is 9-0. MGIC also dropped its credit redlines of Arizona, Florida, and Nevada.
However, the MGIC measure of how far we have to go: 20 metro areas are weak, 25 soft, and 28 stable. Not one is rated “strong.”
To grasp the difficulty ahead, the policies that have hurt, and the ones that would help, nothing beats NYFedPrez Bill Dudley’s speech on January 6. One of a volley of papers delivered by the Fed that week, not one idea in it or the others has been adopted or advocated by the administration, by either party in Congress, or by any Republican Presidential contender. (Exception: HARP underwater refis are happening in volume, but based on frequent client testimony I am suspicious of overcount by inclusion of non-HARP loans, possibly intentional by lenders looking for gold stars.)
On the essence of housing as cause of this weak economy Dudley says, “Since home values peaked in 2006, homeowners have lost more than half their home equity — about $7.3 trillion. At present roughly 11 million households are in negative equity with the aggregate amount of negative equity estimated to be roughly $700 billion.”
Credit is too tight. “70% of new prime conforming loans go to borrowers with Fico scores 760 or above, versus 30% before the crisis.” The response of lenders to the crisis has been punitive and self-defeating: “Fees for new purchase mortgages should be based on the expected losses on these mortgages — not the realized losses on loans of earlier vintages.”
Dudley also called for more loans to investor buyers. And for an end to open-season loan-buyback demands, to be replaced by requirements for material defect, imposition of time limits, and to give buyback relief for loans defaulting after job loss.
And an equitable means of principal reduction: “The borrower could be given an open-ended option to pay off the loan at an LTV of 125 percent, and the right to pay off the loan at an LTV of 95 percent after three years of timely payments.”
Of all the policy mysteries today, how advice like this can be ignored is beyond me.
Friday, August 3, 2012
Capital Markets Update
By Louis S. Barnes Friday, August 3rd, 2012
This bizarre time resembles a sci-fi epic involving three alternate universes, one real and two political, at each change of scene each universe moving more distant from the others.
Reality first. Today’s reported 163,000-job net gain in July has surprised markets expecting more bad news, and thus triggered a short-covering rally in stocks and a dumping of safety-bought bonds, market moves magnified by thin attendance during vacation season. The job gain was half-again the forecast, but other aspects of the report were as weak as prior months: more part-time workers unable to find full-time jobs, and fewer people in the workforce able to find any work at all.
The ISM reports for July were on the cusp of weakness, manufacturing shrinking slightly at 49.8, the service sector at 52.6 a hair better than hoped. June personal income grew .5%, spending not at all. June factory orders were expected to rise and instead fell .5%; excluding a nice month for aircraft, orders tanked 1.8%.
Mohammed El-Erian, CEO of bond-fund-giant Pimco, reviewing global data: “A serious slowdown is underway.” Nothing off-table, all in slow motion, but nothing evident to stop it.
The much-anticipated Fed meeting this week brought… nothing. Possible internal discord, possible internal doubt about what-when-how to act, but politics for certain. As any Presidential election approaches, the Fed seeks invisibility for fear of accusation of favoritism. The Left universe wants a free-money rescue, and the Right wants a good-ol’-days cash-’n-gold economy. And everybody should have a horse. And cave.
Even more dramatic expectations for the ECB meeting yesterday ended with something: universal contempt for its president, Mario Draghi. All talk, no walk. Resume item soon: “Second and last president of the ECB.”
The UK Telegraph says that Germany would support a rescue of Spain if it surrenders control of its fiscal affairs and graciously accepts Grecian assisted-suicide. Universes moving apart. The Telegraph’s Ambrose Evans-Pritchard has for years been in front of the euro mess, and said this week that Italy’s un-elected academic Mario Monti is “the de facto prime minister of the Latin bloc, working hand in glove” with the White House and all-think no-do Tim Geithner. Possibly because nobody else in Europe wastes time with them.
The deepest and longest-running weakness in the world has been rising Asia undercutting Western wages. Right behind it: the Western accumulation of ruinous debt in a desperate effort to maintain its standard of living. Some of those accumulators can make it, and some cannot. The longer we go pretending that all are going to make it, the greater the damage to all economies and the larger the ultimate losses.
The Left everywhere wants a central banking miracle: in a reverse of loaves-and-fishes, make the debt disappear. The Right reflexively resists, but offers nothing except to pull everyone’s plug at once.
Central banks can hose cash to put down bank runs, and they can be used as bridge lenders or temporary guarantors during extended recessions. They do not however, have transporter rooms in which debt can be sent to Zircon 22.
Every finance-type I know is slack-jawed at the sight of it all. One wise and tough Scot, retired international executive Neil Palmer: “If I were back at it… would I invest in new capacity? Hire? Of course not.” Every one is trying to calculate the moment of breach, and has given up on leadership, just trying to identify the market or economic tension that would trigger the break. And going deeper into cash.
Here is a paradox: as the universes fly apart, Left-Right-Real each red-shifting away from the others, the ultimate outcomes are converging on two singularities. Either some leadership rises to manage an orderly kind of global bankruptcy triage, softening the consequences of default, restructuring, and devaluation, or one day physical forces will overtake all voluntary options.
The good news is questionable.
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