Holding Steady For Now

Capital Markets

Friday July 26, 2013*********************************************By Lou Barnes Fun week! New data were soft, but not enough by miles to break Fed-fear and so interest rates stayed put. The entertainment lay in the politics of US economic and financial governance, making progress in our uniquely wacky way. June sales of existing homes fell 1.2%, dismissed as a quirk by those who believe housing will accelerate the economy. They think low inventory is key, but no matter how low, to get economic oomph we have to sell more. Sales of new homes jumped 8.3% but were overstated by May’s negative revision. It is too soon for higher rates to have done harm; we are still working off pent-up demand undeterred by price or rate. June orders for durable goods were flat, no gain at all ex-transportation, and the Chicago Fed’s national index recorded another month in mild positive ground. The University of Michigan confidence survey put in another post-’08 high, most likely boosted by home prices and liquidity — maybe not a locomotive, but a genuine relief. Spinners have Europe and Japan turning corners. Not. Auto sales in Holland fell 31% in the last year. Any improvement in Japan is the beggar-thy-Asia result of yen devaluation. China’s PMI fell again, now 47.7, halfway between no-growth and outright recession. The US is the bright spot. Brace yourselves for next week: Wednesday to Friday a Fed meeting, fresh data from July, and a new set of the almighty payroll numbers. The new Chairman of the SEC, Mary Jo White, was held in suspicion as too close to Wall Street. Forget that. This week’s filings against SAC (so modestly named after its tycoon, Steven A. Cohen) remind me of the SEC’s old days, when we still remembered the Great Depression and the financial shenanigans that got us into it. Clear through the 1970s if you walked near the edge of propriety and refused to retreat, you’d find yourself the object of an SEC press conference. If you were caught walking on the edge, you woke to read your name in a lawsuit. Conviction was not important; indictment is incompatible with staying in business. The SEC in those days understood that overdoing the thunder was a beneficial risk and warning, especially as there are very few innocents on the Street. In that SEC climate, nobody even considered walking over the edge. Then, in a Dodd-Frank correction, it looks as though an overdone aspect will be reversed. Its wild-swinging effort permanently to prevent mortgage abuses codified “skin in the game” retention of a part of mortgage production, and attempted a bright-line description of “safe” mortgages (“QRM” for Qualifying Residential Mortgage). A consensus is forming now: the provisions would be anti-competitive, expensive, and supply-choking, and plenty of other regulation will do the job. In other entertainment just beginning, the bank-hunters in Congress and at the NYT this week asserted that major banks had taken control of large parts of the commodity business and jacked prices to their benefit. They may be right, and then again they may not understand what banks do, or should do, or how markets work. Either way we win: banks get caught being bad, or hysterics are self-exposed. Could not be better. Our top political leadership is disengaged (the kindest possible term). In the 100th anniversary year of Pickett’s Charge, John Boehner intends another battle over the debt ceiling. Republicans fought that sort of action in California until finally thrown out. On Wednesday the President appeared from wherever he has been to speak on the economy, delivering eight-and-a-half pages of single-spaced 12-point type worthy of the Leonid Brezhnev Prize For Inducing Coma. Mr. Obama is a fine speaker who could enliven a reading from the dictionary, but this hour-long exhortation had not one specific for action, except to threaten five more speeches on the economy. Next week is a big deal. The Fed has prematurely tightened and can’t retreat, although doing more harm overseas than here. The long knives are out in the battle for Perfesser Bernanke’s replacement, and current policy will affect how the nominee fares in Congress — doctrinaire extremes dominating, as in far too many issues.

A Full Point Better

Capital Markets

Friday July 19, 2013**************************************** By Lou Barnes Relax, everybody. The Fed follies are over for now, for weeks and maybe months. Interest rates won’t do much until we get a stream of data either confirming or denying the Fed’s relatively rosy forecast. The economy is in no danger of “overheating” into inflation, and the greater risk is still on the stall side. Give yourself a soft summer moment to look backward, not in anxiety, but to mark the ever-so-gradual transition toward normality — and the period we have survived. Normal… in normal times the 10-year T-note yield has tended to be about 2% over inflation, and/or about the same as nominal GDP (not inflation-adjusted). “Core” inflation today is running about 1%, which would lead to a 3.00% 10-year, and the Fed’s Aunt Blappys in the last 60 days have gotten us almost there, right or wrong. GDP is trickier (a lot): the Fed forecasts 2.6% real GDP for 2013, plus 1% inflation would equal a 3.6% 10-year. The IMF has US GDP one full percent below that, therefore the 10-year fully corrected right now. If GDP accelerates, then we can afford higher costs of borrowing. Only higher inflation is trouble, forcing the Fed to lean against the breeze. Where is normal for inflation? Perfesser Bernanke has insisted it will soon return to 2%, but offered no supporting analysis for a trend which no one else sees, inflation now headed down. The anti-QE yappers and their “Debasement! Money-printing! Inevitable inflation! Buy gold!” have been as wrong as wrong can be. One road to inflation is excessive credit; we don’t have enough. Another is cost-pushed, as in an energy-price shock; Gasland gasbags aside, fracking is an anti-inflationary boon likely to last decades. Perhaps the most reliable source of inflation is a wage-price spiral. That’s the great bugaboo left over from the ’70s. By 1990 foreign wage competition began to cap and then drive down US wages. The Lefties insist that the 1% did it, and the Righties claim wages would rise if we removed government, both totally mistaken. We might be at “risk” of too-fast wage growth when China reforms its economy away from excessive investment and production, or the whole emerging world closes on the US in productivity and wages. Good luck with those. We could enter new bubbles of some kind, requiring a period of Fed puncture. Some people are worried about a housing re-bubble, but it’s not in the numbers. We won’t know for months the damage brought by prematurely higher rates (my faith in Bernanke notwithstanding, “premature” is what this rise has been), and not for months beyond that if the housing spurt of the last year is more pent-up release than self-sustaining. Under current underwriting standards, the latter is impossible. Credit may improve faster than I think. Banks have been in a long process of re-capitalization, now in the second half. First the slow recognition of immense losses, then retaining earnings, then retaining earnings to new levels of capital, then forced to raise those levels. However, the political crimp on lending is going to last a long time — after the Great Depression it lasted 40 years. With crazy people like Jeb Hensarling (R, TX) and Elizabeth Warren (D, MA) in charge, ever-vigilant against government-assisted OR private lending, credit will not fuel inflation for a long, long time. You could spend a summer hour worried about other things. Syria, Egypt… but don’t. For the first time since Israel’s founding, other nations nearby are consumed by internal affairs. Hassan Rouhani is an unmistakable improvement and signal in Iran. You could worry about Detroit, and a series of municipal defaults. Don’t. I worked there 1972-73, and terminal decay was in plain sight. Worth studying, but not worry. You could worry about financial horrors in Japan and Europe, upon whose failure so many are betting so much. But anything that goes really wrong will just push more cash to the US 10-year and mortgages. Instead of all that angst, wish a victory lap for Perfesser Bernanke. He’s a great fan of baseball and deserves a tour like Mariano Rivera’s. Stop this market-dressing for your successor and take some high-fives, thanks for saving our sorry behinds.

A Little Improvement

Capital Markets

Friday July 12, 2013 ****************************************** By Lou Barnes Credit markets are still struggling to understand the Fed and to lay odds on its intentions, and failing, still on hair trigger for more selling and rate increases. The housing market is better, in some places a great deal better, and psychology even better than the markets themselves. It is a great relief to a lot of the nation just to be able to sell a home, let alone at a higher price. However, no one knows or can know how housing will fare with mortgages pressing toward 5.00%. The stock market is happily drunk (again), but — a positive indicator for the economy? Or just more computer gaming, the market’s principal source of trading? By comparison, this Fed business makes the stock market seem the soul of sobriety. The Fed’s newest flailing whipsawed markets all day Wednesday. First came the release of the Fed’s June 19 meeting minutes, which everyone scoured to try to understand the disastrous Bernanke press conference right after that day’s meeting. Did he have a bad day? Did he overstate the Fed’s intentions quickly to taper QE to zero? Did he mean to hint at raising the Fed funds rate next year? The bond market had improved slightly from last Friday’s sell-panic, but when it found in the minutes that half of those prNFIB Sesent at the meeting wanted to end QE by the end of 2013… sell again. Sell if you could, if your losses were not too deep to recognize. But briefly, clutching at hope for Bernanke’s speech two hours later, at the day’s market close. The speech was a snoozer (the last hundred years of banking zzzzzzz). Just as trading stopped, the Chairman again took questions. “Highly accommodative monetary policy for the foreseeable future is what’s needed in the US. It may well be sometime after we hit 6.5% unemployment before rates reach any significant level.” Traders who had gone short bonds on the minutes got clocked by the Q&A charm, and short-covering gave us the best rates of the week, but entirely artificial. The markers of something very odd underway: the 10-year T-note has not “retraced” from this epic spike. Any market gone vertical in either direction should have retraced the move by about one-third by now. The 5-year T-note looks the same, even mid-range traders self-protective. Only the 2-year indicates some relaxation in immediate Fed fear. The Fed’s minutes also contained this idiocy: “The staff viewed the uncertainty around the forecast for economic activity as normal relative to the experience of the last 20 years.” Normal uncertainty? Now? The forecast to which they refer, at the June 19 meeting, called for US GDP growth about 2.6% this year rising to 3.4% in 2014. This week the IMF revised down its US forecast, GDP to 1.7% this year and 2.7% next. The IMF: “Downside risks to global growth prospects still predominate.” I have never seen a gap between the IMF and Fed like this. Some international agencies have axes to grind and take extreme positions (BIS, Bundesbank…), but not the IMF. Its Managing Director, Ms. LaGarde, is a positive-spinner. Market participants learn quickly to shed confusing crosscurrents, to get to the heart of the matter, or face unintended and immediate career change. The heart of this matter: the Fed looks crazy. Not just a bad day, or a streak of ineptitude, but nuts. Which gives markets a sell bias, and pushes even serious people off into conspiracy theories. Will the confirmation of a new Chairman be blocked by wingnuts in Congress unless the Fed swears off QE? Have tightwads inside the Fed seized the asylum? At this moment, clarity of any kind would help. The Fed may be stuck in a transition from one Chairman to another, the retiring one having lost command. In a situation like this, we look to the rest of government for reassurance. Cue crickets chirping. Anybody there? Where is the President? Keeping Romney out of office had some merit as a second-term goal, but was that it? New Treasury Secretary Lew’s sole contribution is his signature on new currency. He makes Geithner look hyperactive. And with a vacant Executive Branch, Congress is at its awful worst. We have relied on the Fed alone far too long. Rise up, somebody.

A Wild Ride Indeed!

Capital Markets Update

By Lou Barnes****************************************Friday, July 5th, 2013 Today's sleepy, semi-holiday dawn was interrupted by news of a surge in new jobs, up 195,000 in June plus 70,000 in upward revisions of prior months. Every big shot is at the beach, heard the news through hangover fog and then barked or texted "sell," and went back to sleep. The 10-year T-note jumped almost a quarter-point to 2.72%, putting the most vulnerable mortgage borrowers close to 5.00%, gold in a new collapse to $1215, and stocks struggling to decide whether good economic news is worth a tightening Fed. Those of us who are little shots, working stiffs today, read on. The jobs were low-end: retail, hospitality, business services and health care. Construction added a piddling 13,000 and manufacturing shrank for a fourth month. "Involuntary part time" rose, the 25-54 age group weakened, and the unemployment rate stayed the same at 7.6%, new jobs a push versus new people trying to find work. The one legitimate bright spot: hourly wages gained ten cents in the month, so strong it looks like an error. No other fresh data took off with jobs except car sales, which are pushed by the only easy credit in the economy other than student-sharking. The twin ISM reports for June were shaky: manufacturing crawled back just above breakeven to 50.9, its employment component especially weak, and the service sector expected to grow in June to 54.4 from 53.7 in May instead tanked to 52.2, the poorest in three years. All economies have weevils and fleas. There is always a list of what's-wrong, if only in government policy. Groups of citizens always take turns in difficulty. The Fed's job is the aggregate, and no central bank has the ability to micro-spray the bugs. The Fed also has the horrifying obligation to look around invisible corners. An overriding central-banking assumption: whatever you do (or don't do), the consequences will not be apparent for six to eighteen months. The Fed must rely on whatever forecasting tools it has. Since the Great Bank Run began in July 2007 the Fed's forecasting has been awful. ("Then shut them down!" cry the cavemen. Appropriate reply: Stick to hoarding gold.) The forecasting errors have not been the Fed's fault. Imagine dropping the National Weather Service and a super-computer on a previously undiscovered planet. We have never been in this economic situation before, and we're guessing, all of us. No predictions, but some benchmarks: 1. The Fed sees an accelerating economy. Bill Dudley, NY Fed: "A strong case... growth will pick up notably in 2014." Okay, if you say so. However, the next sentence, "Growth prospects among our major trading partners have begun to improve," is nuts. 2. The Fed seems to give top importance to "reduced fiscal headwinds," lessening effects of the Sequester and Cliff tax increases, and to housing strength. 3. Our fiscal situation is extremely unstable, a new debt-limit fight ahead, and the health-care sinkhole widening. The NYT reported the average cost of childbirth in 2010: $37,341. The White House silently deferred key provisions of ObamaCare beyond next year's election. Three years after passage execution is in chaos. All through the Great Recession the one category of employment to add jobs every month: health care. 4. Nobody knows how healthy housing really is. We are enjoying a release of pent-up demand and an accumulated shortage of supply. Affordability is so strong that even a run above 5% mortgages is survivable. But credit is as scarce and tight as ever. 5. A new load of Basel III and total-leverage requirements are about to land on US banks, which can't generate credit now. 6. Every modern Fed tightening cycle has ended in recession, and long-term debt investors are on the run. The Fed paused in 1980 and 1998, and made every effort to prolong expansions, but outcomes are inevitable. The bond market is out in front of the Fed, but that's what it's supposed to do. We can hope for a few or even several years of expansion, but in this time without precedent the bond market may intercept a process the Fed would like to be gradual. The Fed funds rate is the overnight cost of money directly controlled by the Fed. Long-term rates often begin to rise before the Fed begins to raise the funds rate, but that event marks the beginning of tightening, even if the fed has not formally begun. The Fed then embarks on a middle stage, trying to extend recovery as long as possible while tamping risks of inflation. In the end stage the inflation threat has risen enough that the Fed pushes the funds rate above long-term rates (an "inversion"), and recession ensues. We have no modern experience with a long-rate-induced recession. That is, long rates running away from the Fed. During the Great Recession a primary purpose of QE has been to push down and/or control long-term rates. By jawbone alone since May 22, doing nothing, insisting the funds rate will stay at zero for a long time, the Fed has let go control of long rates. The odds still are that a zero funds rate will tend to anchor long rates at a level below serious damage to the economy. However, our cumulative fiscal excess is without precedent, and as the Fed lets go direct control the bond market can do some extreme things to indicate displeasure with excessive borrowing.