Don Vialoux: Miners Recently Outperforming Bullion (August 9, 2012)

Thursday, August 9th, 2012

by Don Vialoux, EquityClock.com

Upcoming US Events for Today:

1. Weekly Jobless Claims will be released at 8:30am. The market expects Initial Claims to show 375K versus 365K previous. Continuing Claims are expected to reveal 3290K versus 3272K previous.
2. Trade Balance for June will be released at 8:30am. The market expects -$47.5B versus -$48.7B previous.
3. Wholesale Inventories for June will be released at 10:00am. The market expects an increase of 0.3%, consistent with the increase reported previous.

Upcoming International Events for Today:

1. The ECB Publishes the August Monthly Report at 4:00am EST.
2. Great Britain Merchandise Trade for June will be released at 4:30am EST. The market expects –9.0B versus –8.4B previous.
3. Canadian Housing Starts for July will be released at 8:15am EST. The market expects 210K versus 222.7K previous
4. Canadian Trade Balance for June will be released at 8:30am EST. The market expects -$0.9B versus -$0.79B previous.

LIVE SEASONALITY GANTT CHART

The Markets

Equity markets traded flat on Wednesday with little to move the tape one way or the other. Volume was once again light as conviction appeared lacking. The two consumer sectors bookended the days activity with Consumer Staples showing the best sector performance with a gain of seven-tenths of a percent, while Consumer Discretionary showed the worst performance, succumbing to a loss of half a percent.

Investors continue to remain hopeful for further monetary stimulus from any one of the major central banks, a fact which is clearly showing up in inflation expectations. The ratio of the Treasury Inflation Protected ETF (TIP) over the 7-10 Year Treasury ETF (IEF) continues to trend higher following an almost five month decline. Even the 5 Year Breakeven Rate has pushed higher since ECB President Mario Draghi hinted of further central bank intervention. Increased inflation expectations are bullish for stocks and commodities, both of which are at multi-month highs.

Inflation is particularly conducive to strength in the price of Gold, which has shown moderate improvement over recent weeks. Seasonal investors are well aware that we are within the period of seasonal strength for the yellow metal, but thus far the price action of bullion has been rather subdued, at least compared to years past. The metal is hinting of a breakout above a descending triangle pattern, a pattern that has bearish implications should the price of Gold fall below $1525. Further evidence is required to confirm the breakout. Hesitation from investors to believe in the stimulus hype is suspected to be culprit for the shallow returns.

The framework for a strong move higher in Gold has become established. In addition to increased inflation expectations, the US Dollar index has also come under pressure over the course of the past month and a minor head-and-shoulders top can be spotted on the charts. The target of this topping pattern points down to 81, also the point at which the price action would intersect with the rising intermediate trendline. The long-term trend for the US Dollar continues to look positive as the upside target derived from a head-and-shoulder bottoming pattern is fulfilled. The US Dollar Index seasonally declines, on average, between now and September, supporting commodity prices, such as Gold.

Another positive for the Gold trade is the fact that the miners have recently shown outperformance compared to bullion, a typical precursor to a positive move in the commodity. The relative performance chart for Gold Miners versus Gold bullion has shown a declining trend for over a year and a half, just recently charting the lowest level since the 2008 low. However, a double bottom has become apparent on the chart, hinting of positive things to come as investors become content with equity valuations at current gold prices. A positive trend still needs to be established, which may not be able to be confirmed until the ratio breaks above the 200-day moving average (0.29 on the chart below). The seasonal trade in gold currently looks appealing given the positive backdrop, but keep in mind that the trade could easily break if stimulus expectations are not confirmed.

Sentiment on Wednesday, as gauged by the put-call ratio, ended bullish at 0.80. The ratio continues to hold within a declining range as bullish expectations flourish.

S&P 500 Index

Chart Courtesy of StockCharts.com

TSE Composite

Chart Courtesy of StockCharts.com

Horizons Seasonal Rotation ETF (TSX:HAC)

• Closing Market Value: $12.40 (up 0.40%)
• Closing NAV/Unit: $12.36 (down 0.02%)

Click Here to learn more about the proprietary, seasonal rotation investment strategy developed by research analysts Don Vialoux, Brooke Thackray, and Jon Vialoux.

Tags: 10 Year Treasury, 9b, Bullion, Central Bank Intervention, Central Banks, Consumer Sectors, Consumer Staples, Don Vialoux, Ecb President, ETF, ETFs, Half A Percent, Inflation Expectations, Initial Claims, Merchandise Trade, Seasonality, Sector Performance, Seven Tenths, Stocks And Commodities, Trade Balance, Weekly Jobless Claims, Wholesale Inventories
Posted in Markets | Comments Off

The Vanishing Treasury Yield

Thursday, August 2nd, 2012

by Neuberger Berman Research

July 2012 – Investment Strategy Group

Despite hitting record lows earlier in the year, the yields on U.S. Treasury bonds continue to tumble. The 10-year rate ended last month at 1.62%, materially below the long-time monthly record low of 1.95% set in January 1941. Yields for 10-year Treasury Inflation-Protected Securities (TIPS) have been persistently negative since the fourth quarter of 2011 and continue to trend lower, implying that investors are paying increasingly higher prices for the relative safety these investments are supposed to provide. In this edition of Strategic Spotlight, we consider why yields continue to decline and the implications for investors.

Download PDF

A Mystery, But Is It?
Yields on long-term Treasuries have been declining since the 1980s, when they peaked along with inflation. Since the financial crisis of 2008, the continued reduction in Treasury yields has at times perplexed even the most astute investors. One prominent bond guru famously avoided them in 2010 to the detriment of his portfolio, and pundits who prematurely declared the imminent “death” of bonds couldn’t have been more wrong. In recent years, yields have moved even lower even though inflation has held fairly steady.

Over the longer term, nominal yields for long-term Treasuries generally follow inflation levels and growth expectations. When inflation rises, nominal yields typically rise to compensate for the erosion in purchasing power and, similarly, if growth expectations rise, the increase in attractive investment opportunities in the economy tends to result in rising real (after inflation) interest rates (see Figure 1). Oddly enough, inflation expectations (as implied by the difference between the nominal 10-year Treasury yield and TIPS yield) have held steady at around 2% and the decline in nominal rates has been driven mostly by declining real yields—all in the face of a positive, albeit slow, growth environment.

REAL YIELDS AND GDP TEND TO MOVE TOGETHER

Source: Factset.

So, what explains this somewhat unusual phenomenon? Since the onset of the financial crisis, bond purchases by the Federal Reserve have increased as it has implemented unconventional monetary policies, specifically quantitative easing and maturity extension programs (known to most as Operation Twist). Through these measures, which have tended to lower long-term interest rates, the Fed has sought to stimulate the economy and reduce unemployment at a time of low inflation. Another pressure on rates has come from foreign demand for Treasuries, which has generally been very strong, especially during periods of heightened market anxiety. In recent months, slowing purchases by emerging market central banks have been offset by flight-to-quality demand from European investors, who have also driven the nominal rates on certain German, Dutch and Danish bonds to negative levels. Meanwhile, U.S. investors have shown a lack of appetite for risk as flows to bond mutual funds have outpaced those into equities.

How Low Can Rates Go?

In theory, there is no bottom for bond yields. Declining inflation and continued risk aversion have historically caused nominal rates to fall. Real yields have been significantly negative in certain time periods, although admittedly when inflation was higher than today. Figure 2 shows that there have been two key periods since the 1920s in which real rates where very negative—during the Great Depression and World War II era, and in the 1970s when inflation spiked along with oil prices. Should global economies falter in the coming months, it’s possible that interest rates could move In theory, there is no bottom for bond yields. Real yields have even been significantly negative in certain time periods. lower (even turning negative on the short end), especially if the Fed engages in another round of asset purchases.

REAL RATES HAVE ‘GONE NEGATIVE’ IN THE PAST

Source: Factset.

Better Opportunities Elsewhere

It should be noted, however, that there are major risks in holding Treasuries with little to no yield. An end to the continued bull run in Treasuries would imply a reversal of some factors supporting it now, such as low inflation, deteriorating growth expectations and worsening prospects for the eurozone debt crisis. With global central banks launching unprecedented levels of monetary easing, potentially higher levels of inflation could hamstring the Fed’s ability to continue asset purchases – causing both inflation expectations and real yields to go higher. In addition, investors may realize that Treasuries might not be as “risk-free” as they assumed, particularly as the debate over the U.S. federal budget deficit intensifies later this year.

While interest rates could still move lower in the short term, we believe that the return profile for the asset class is skewed to the downside, especially given our base-case assumption of low but positive growth. We advise caution in holding excess levels of Treasuries and believe that other assets, such as high yield fixed income and high-quality U.S. equities, could be more attractive in this environment. Similar to buying tech stocks in the late 1990s with no sales and earnings, buying today’s Treasuries with minimal yields could prove hazardous for investors.

*Source: Factset

This material is presented solely for informational purposes and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. The views expressed herein are generally those of Neuberger Berman’s Investment Strategy Group (ISG), which analyzes market and economic indicators to develop asset allocation strategies. ISG consists of five investment professionals who consult regularly with portfolio managers and investment officers across the firm. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Third-party economic or market estimates discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates. This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events may differ significantly from those presented. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.

This document is issued for use in Europe and the Middle East by Neuberger Berman Europe Limited which is authorised and regulated by the UK Financial Services Authority (“FSA”) and is registered in England and Wales, Lansdowne House, 57 Berkeley Square, London, W1J 6ER. Neuberger Berman is a registered trademark.

This document is being made available in Asia by Neuberger Berman Asia Limited (“NBAL”), a Hong Kong incorporated investment firm licensed and regulated by the Hong Kong Securities and Futures Commission (“SFC”) to carry on Types 1, 4 and 9 regulated activities, as defined under the Securities and Futures Ordinance of Hong Kong (Cap.571) (the “SFO”).

This document, and the information contained in it, is being made available in Australia by Neuberger Berman Australia Pty Ltd (CAN 146 033 801), holder of Australian Financial Services Licence No. 391401 (“NB Australia”), to a person defined as a “wholesale client” under section 761G of the Corporations Act 2001 (Cth) and applicable regulations, and other such persons to whom disclosure would not be required under chapter 6D and Part 7.9 of the Corporations Act 2001 (Cth) (“Wholesale Investor”), for informational and discussion purposes only. This document is intended only for the Wholesale Investor to which it has been provided, is strictly confidential and may not be reproduced or redistributed in whole or in part nor may its contents be disclosed to any other person (other than such Wholesale Investor’s agents or advisers) under any circumstances without the prior written consent of NB Australia.

This document, and the information contained herein, is not, and does not constitute, directly or indirectly, a public or retail offer to buy or sell, or a public or retail solicitation of an offer to buy or sell, any fund, units or shares of any fund, security or other instrument (“Securities”), or to participate in any investment strategy.

The Wholesale Investor who receives this document should not consider it as a recommendation to purchase any Securities mentioned in it. To the extent that information in this document constitutes financial product advice, it is general financial product advice only, and provided only by NB Australia to Wholesale Investors. This document does not take into account the Wholesale Investor’s investment objectives, financial situation and particular needs (including financial and tax issues) as an investor. Any Securities mentioned in this document will only be available to a Wholesale Investor to whom the provision of a disclosure document prepared in accordance with Australian law is not required. The Wholesale Investor to which this document is provided should not rely on the information contained in this document in making any future investment decision.

This document has been issued for use in Japan and Korea by Neuberger Berman East Asia Limited, which is authorized and regulated by the Financial Services Agency of Japan and the Financial Services Commission of Republic of Korea, respectively. Please visit https://www.nb.com/Japan/risk.html for additional disclosure items required under the Financial Instruments and Exchange Act of Japan.

The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC. Neuberger Berman LLC is a Registered Investment Advisor and Broker-Dealer. Member FINRA/SIPC.

Tags: Astute Investors, Attractive Investment Opportunities, Detriment, Financial Crisis, Growth Environment, Growth Expectations, Imminent Death, Inflation Expectations, Inflation Protected Securities, Investment Strategy, Neuberger Berman, Pundits, Purchasing Power, Record Lows, Relative Safety, Strategy Group, Treasuries, Treasury Inflation Protected Securities, Treasury Yields, U S Treasury, U S Treasury Bonds
Posted in Markets | Comments Off

From Negative 5Y/5Y To $2200 Gold?

Tuesday, June 5th, 2012

For the first time on record (based on Bloomberg’s data) 5-year / 5-year forward inflation expectations turned negative today. This kind of deflationary impulse has occurred twice in recent years and each time has been accompanied by dramatic Federal Reserve easing. The anticipation of the move by the Fed has caused Gold each time to surge higher on yet more expectations of the fiat-fiasco unwinding. Given the 5Y5Y inflation print currently, we would expect action from the Fed and one could argue that this would cause the price of Gold to rise to $2200 per ounce as the deleveraging continues.

The red arrows show the deflationary impulse (5Y5Y inflation is inverted) and the orange curve arrow shows the reaction function post Fed reaction to the blue arrow levels of the deflationary impulse.

Chart: Bloomberg

Tags: Anticipation, Blue Arrow, Federal Reserve, Fiasco, fiat, Gold, Impulse, Inflation Expectations, Nbsp, Orange Curve, Ounce, Price Of Gold, Red Arrows
Posted in Markets | Comments Off

The Economy and Bond Market Radar (May 7, 2012)

Monday, May 7th, 2012

The Economy and Bond Market Radar (May 7, 2012)

Treasury yields have had a slight downward bias the past couple of weeks and that trend accelerated this week as yields fell across the board. U.S. economic data continues to be a mixed bag. The unemployment report was released on Friday which was lackluster at best with non-farm payrolls growing a modest 115,000. The recent trend does not inspire a lot of confidence as can be seen in the chart below. The Federal Reserve remains in play and may enact additional quantitative easing or other stimulative policy measures if the economy does not improve.

Strengths

• The ISM Manufacturing Index rose to 54.8 in April, showing surprising strength amid weakening manufacturing data in many parts of the globe.
• The HSBC Purchasing Managers Index (PMI), which is a gauge of China manufacturing, also improved but still indicated contraction.
• Australia cut interest rates by 50 basis points as inflation expectations moved lower.

Weaknesses

• Non-farm payrolls only rose a modest 115,000 and the recent trend has been disappointing.
• April same-store sales have disappointed as the consumer appears to have slowed down after a several months of beating expectations.
• The European Central Bank indicated that additional easing is not likely.

Opportunity

• Bonds continued to grind higher and appear to be forecasting a benign inflation and slow growth.

Threat

• Europe remains a wildcard with austerity programs under pressure, creating significant uncertainty.

Tags: Austerity Programs, Basis Points, Bias, Bond Market, Contraction, Economic Data, Federal Reserve, Gauge, Inflation Expectations, Ism Manufacturing Index, Market Radar, Non Farm Payrolls, Parts Of The Globe, Pmi, Policy Measures, Purchasing Managers Index, Quantitative Easing, Treasury Yields, Unemployment Report, Wildcard
Posted in Markets | Comments Off

How Rising Rates Will Affect Stocks (Koesterich)

Wednesday, April 18th, 2012

by Russ Koesterich, iShares

While recent market weakness, and the accompanying bond market rally, has tempered fears of an imminent bond market meltdown, many equity investors are still concerned about the potential impact of rising rates on US and global stocks.

This year, I expect long-term rates to rise modestly as they appear too low. Assuming the US economy continues to stabilize over the course of the year, the yield on the 10-year Treasury will likely rise to around the 3% level, roughly where it was last summer.

However, in my opinion, this probable grind higher is not a major threat to US and global stocks this year for two reasons:

Low Starting Point: It’s important to put the current yield environment in context.  Excluding the period of unusually high nominal yields in the 1970s and 1980s, the long-term average nominal yield for the 10-year note is still 5.25%, more than twice today’s level. As such, any rise in rates will be coming from historically low levels. And a rise in rates from the absurdly low to the merely low has not, at least historically, hurt stocks. Equity valuations do contract when rates are rising, but this relationship typically breaks down when rates are this low.

The Driver of Rising Rates: In the past, the reason behind why rates rise has been as important for stocks as how much rates rise. Looking forward, the coming rise in rates will likely be driven by higher real rates, not by higher inflation expectations.

When interest rates are rising due to heightened inflation expectations, stock multiples tend to contract. However, when rising interest rates are due to a rise in real, or after-inflation, rates in the context of a strengthening economy, multiples have not been hurt. In fact, over the long term, there hasn’t been a statistically significant relationship between real yields and multiples. If anything, in recent years — which have generally been characterized by too little growth, rather than too much — stock multiples have risen with real rates.

To be sure, none of above suggests that equities have become impervious to higher rates. While higher real yields probably won’t hurt multiples, a high enough rise could dampen earnings. But in my opinion, any rate rise this year should be modest and likely won’t negatively impact valuations. Looking forward, the real threat to stocks in 2012 is weak economic growth, not higher rates.

Source: Bloomberg

Copyright © BlackRock, Inc. , iShares

Tags: 10 Year Treasury, 1970s, 1980s, Bond Market, Economy, Equity Investors, Fears, Global Stocks, Inflation Expectations, Inflation Rates, Ishares, Market Meltdown, Market Rally, Market Weakness, Nbsp, Nominal Yield, Relationship, Rising Interest Rates, Russ, Valuations
Posted in Markets | Comments Off

Emerging Markets Radar (March 12, 2012)

Sunday, March 11th, 2012

Emerging Markets Radar (March 12, 2012)

Strengths

• The Global Emerging Markets Fund (GEMFX) has benefited from a bias toward small-caps in 2012. On a relative basis, the fund has benefited from choosing stocks that pay more than twice the dividend yield of the Russell 2000 Index and those companies which have a low price-to-earnings ratio.
• China’s February Consumer Price Index (CPI) was up 3.2 percent in February, lower than the estimate of 3.5 percent and below January’s 4.5 percent figure. With inflation expectations tamed, the market expects the People’s Bank of China (PBOC) to further cut the reserve requirement ratio (RRR).
• China’s fixed asset investment (FAI) growth came in stronger than expected at 21.5 percent year-over-year during the first two months of 2012, up from 18 percent in December. Interestingly, residential FAI rose 27 percent, the same pace as last year. This indicates that the housing market may not collapse as many worried last year.
• New bank deposits rebounded strongly in February to Rmb 1.6 trillion, enabling Chinese banks to lend more in March. In addition, M2 money supply growth was near expectations, right at 13 percent.
• Philippine CPI rose 2 percent in February. This is well below the 3.2 percent increase that was forecasted.

Weaknesses

• China’s retail sales and industrial production growth came in weaker than expected. Retail sales rose 14.7 percent, down from 17.1 percent in 2011. Industrial production rose 11.4 percent, slowing by 1.4 percentage points from December. These data points indicate that China had probably over tightened its monetary and industrial policies and needs to loosen up these policies during the first half of the year.
• China has lowered the country’s GDP growth target to 7.5 percent this year, 50 basis points lower than in the past eight years. Many believe Chinese policymakers will try to slow down the country’s economic growth by curbing housing market growth and postponing some infrastructure growth. However, China has consistently beaten its own GDP target every year over the last decade and the country will still encourage growth in consumption and industrial enhancement.
• Malaysia’s exports grew 0.4 percent in January, the slowest pace in 15 months.
• After a good run, Turkish industrial production faltered in January. Industrial production was up by 1.5 percent year-over-year in January, weaker than the market expectations. Turkey’s Purchasing Manager’s Index (PMI) also deteriorated in February as a result of poor weather conditions.

Opportunities

• Droughts from Mexico to Argentina are shrinking corn stockpiles to a five-year low. This raises the prospect of a bull market in the U.S., as farmers are expecting to see the biggest crop ever.
• Corn demand in China, the biggest consumer after the U.S., may decline after Premier Wen Jiabao lowered the annual growth target to 7.5 percent. Prices fell 16 percent in the last four months of 2011 as the U.S. Department of Agriculture (USDA) predicted Brazil and Argentina would produce their biggest crops ever. The two countries currently account for almost 10 percent of global corn supply. While prices may keep rising for now, analysts anticipate declines by the end of the year as U.S. growers harvest the most acres planted since 1944.
• This chart shows China’s inflation has come down notably since July 2011. Food prices, the largest contributor to the rise in inflation last year, have come down since the fourth quarter after the supply chain and logistics were improved. The market expects the PBOC to cut RRR again in order to support economic growth and liquidity in the economy.

Threats

• While investment flows pour into most of the largest emerging markets, foreign investors are selling South African equities at the fastest pace in four years over growing concern that policy makers will seek a larger share of the nation’s mining profits. International investors sold $933 million of South African equities in the first two months of this year and are on track for the biggest first-quarter outflow since 2008.
• A study commissioned by President Jacob Zuma’s ruling African National Congress party proposed increasing taxes on the mining industry last month. In addition, the party’s youth wing has lobbied for a government takeover of gold and platinum mines to boost employment in Africa’s biggest economy.
• China’s February retail sales rose 14.7 percent, below the expectations of policymakers. In order to reach the stated consumption growth target near or above 18 percent, Chinese policymakers need to loosen the country’s monetary policy or begin a fiscal subsidy, such as a new home appliance incentive.

Tags: Agriculture, Asset Investment, Bank Deposits, Bank Of China, Chinese Banks, Consumer Price Index, Dividend Yield, emerging markets fund, GDP Growth, Gemfx, Growth Target, Index Cpi, Industrial Policies, Inflation Expectations, Infras, Money Supply Growth, Pboc, Price To Earnings Ratio, Relative Basis, Russell 2000 Index, Small Caps
Posted in Markets | Comments Off

Albert Edwards: JPY Devaluation Exacerbates Risk of China Hard Landing, Drags them into Currency war

Thursday, March 8th, 2012

by Daily Colateral

“What do people think will happen if another recession strides into sight any time soon? We are a hair’s breadth or, more exactly, one recession away from a market panic on outright deflation — a panic that will send the central banks into a printing frenzy that will make their balance sheet expansion so far seem like a warm-up act for the main show.” Albert Edwards in his latest note, taking a look at wage inflation (or lack thereof) in the United States:

Edwards calls the current environment the “Ice Age reality of ever lower nominal quantities” and references Lakshman Achuthan of ECRI’s recent interview in which he reaffirmed his call for a recession in the U.S. as well as John Hussman’s latest comment, which discusses the same.

Albert Edwards’ Soc Gen colleague Dylan Grice in his most recent note described the decision behind the Bank of Japan’s latest move to ease further, weakening the yen. Further, current inflation expectations remain below target in many DM economies, providing central banks further justification to continue printing.

Edwards notes that Asian currencies like the Korean won haven’t been taken down by the BoJ move yet due to the risk rally that’s played out so far this year, but sees that changing if markets reverse. Then, Edwards points out that “if the yen’s decline takes other Asian currencies lower, it would leave the renminbi as the anomalously strong currency in the region – much to the annoyance of the Chinese authorities,” like so:

This, of course, will not sit well with Chinese authorities, who are currently dealing with a renminbi at all-time highs in real terms, which is necessarily foreboding for the Chinese export situation:

Edwards on the inevitable consequences:

We have long stated that if the Chinese economy looks to be hard landing, as we believe it will, the authorities there will actively consider renminbi devaluation, despite the political consequences of such action. The renminbi devaluation option is widely ignored by the markets in the same way they ignore the likelihood that the Chinese economy is hard landing. The devaluation option should be seen as “in play” however unthinkable it is believed to be at present.

Tags: All Time Highs, Asian Currencies, Bank Of Japan, Central Banks, Chinese Authorities, Chinese Economy, Chinese Export, Colateral, Currency War, Devaluation, Ecri, Grice, Inevitable Consequences, Inflation Expectations, John Hussman, Lakshman, Market Panic, Renminbi, Target, Wage Inflation
Posted in Markets | Comments Off

Goldman’s Economists Score 7 Out Of 10 For 2011 (Retrospective)

Thursday, December 22nd, 2011

Since the 2012 Outlooks have now slowed to a drip, its appears retrospectives are the stocking-filler of choice for the week. Goldman’s economist group reflects on their ’10 Questions for 2011′, released at the end of December 2010, and finds they were correct seven times. The tricky thing about judging the ‘score’ is the magnitude of the error – or more importantly the magnitude of the question’s impact on trading views. Jan Hatzius and his team have had their moments this year, for better or worse, in economic sickness or health but they have largely been accurate at predicting Fed policy (or should we say ‘directing/suggesting’ Fed policy), but were significantly off (along with emajority of the Birinyi-ruler-based extrapolators from the sell-side) on growth (high) expectations and inflation (low) expectations. Nevertheless, the lessons learned from over-estimating the speed of healing from the credit crisis and the disin- / de-flationary effects of a large output gap (which BARCAP would argue is not as wide) when inflation is already low and inflation expectations well anchored are critical for not making the same overly-optimistic mistake into 2012.

US Daily: A Retrospective on “10 Questions for 2011″

Today’s comment reviews the 10 key questions for 2011 that we posed a year ago, our answers at the time, and what actually happened.

It has been a mixed year. On the positive side, our views on Fed policy have proven accurate. On the negative side, we were too high on growth and too low on inflation. Adverse supply shocks, including the upheaval in the Middle East and the Japanese earthquake in March, explain part of these misses. But we also overestimated both the speed of healing from the credit crisis and the disinflationary effects of a large output gap when inflation is already low and inflation expectations are well-anchored.

In the last US Economics Analyst of 2010, published on December 31, we posed “10 Questions for 2011.” In today’s comment, we review each of the questions, our answers at the time, and what actually happened.

Question 1: Will we finally see a “real” economic recovery?

Our answer: Yes.

Verdict: Incorrect. Ultimately, 2011 felt much like 2010. A strong performance in the winter was followed by a sharp slowdown in the spring, renewed recession worries in the summer, and some signs of reacceleration in the fall. From the perspective of our forecasts, the main difference was that we predicted the slowdown of 2010 but failed to predict the slowdown of 2011. In fact, we thought that growth would accelerate to a 3.5%-4% annualized pace in the course of 2011.

However, real GDP grew just 1.2% in the first three quarters of 2011 and our current activity indicator (CAI)–an alternative measure of growth that takes into account a broader range of data–grew 1.9% in the first eleven months of 2011. Depending on which of the two measures we use, this implies that growth has fallen short of our forecast by 2 to 2-1/2 percentage points.

What explains this miss? We see three factors:

1. Adverse supply shocks account for a 3/4-point miss. We estimate that the nearly 30% increase in seasonally adjusted gasoline prices between November and April–largely due to increased supply worries in the wake of the “Arab spring”–shaved 1-1/2 percentage points from real disposable income growth in the first half of the year. With little change in the saving rate at the time, most of the real income hit fed through into weaker consumer spending growth. In turn, with little change in net trade, most of the consumption hit fed through into real GDP. (Note that this implies a real GDP hit of about 1 percentage point, since the level of consumption is about two-thirds that of GDP.) The supply-chain disruptions following the East Japan earthquake of March 2011 also weighed on growth for a while. For the first three quarters of 2011, we believe that adverse supply shocks may have subtracted 3/4 percentage point from growth.

 

2. Fiscal retrenchment accounts for a 1/2-point miss. When Congress extended the 2001-2003 tax cuts for another two years and passed the temporary fiscal measures–especially the payroll tax cut–at the end of 2010, we thought that this meant a roughly neutral fiscal stance in 2011, with slight net stimulus from the federal government offset by slight net restraint from state and local governments. However, we now believe that fiscal policy has subtracted about 1/2 percentage point from growth in 2011 so far. The official GDP data show that a reduction in government spending, concentrated in the state and local sector, has subtracted 1/2 percentage point from growth; meanwhile, there seems to have been little change in overall tax rates after accounting for income, payroll, and sales taxes. Overall, this suggests that fiscal policy subtracted 1/2 points more from growth than we expected.

 

3. A longer “hangover” may account for the remaining 1-point miss. The preceding two points explain perhaps 1-1/4 points of disappointment, but this still leaves approximately another 1 percentage point. An obvious candidate explanation is the European crisis, which has intensified beyond most people’s expectations (including ours) this year. But we think that this explains only a small part of the miss. Instead, a more plausible story is that the “healing” in private domestic demand has simply progressed more slowly than we had expected at the end of last year, when measures of underlying final demand had started to pick up at a fairly impressive speed. In other words, the “hangover” from the bubble seems to be lasting even longer than we thought.

Question 2: Will the housing market recover meaningfully?

Our answer: No.

Verdict: Correct. Although housing starts and home sales did rise slightly through 2011, the increase has fallen short of what we would call “meaningful.” Moreover, house prices have fallen on net, and some measures show a reacceleration in the pace of decline in recent months. We expect a somewhat better performance in 2012, with starts and sales growing more noticeably and home prices stabilizing late in the year.

Question 3: Will the trade deficit shrink substantially?

Our answer: No.

Verdict: Correct. The trade deficit has been essentially unchanged in 2011, as both exports and imports have grown at impressive 10%+ rates through the year. We expect more of the same in 2012.

Question 4: Will the unemployment rate fall?

Our answer: Yes.

Verdict: Correct (but partly for the wrong reasons). The unemployment rate fell from 9.8% in November 2010 to 8.6% in November 2011, which is actually somewhat below the 9% we expected a year ago. The larger-than-expected decline occurred despite weaker-than-expected GDP growth, as the labor force participation rate fell by another 1/2 percentage point to 64.0%, the lowest since 1983. Going forward, we expect the unemployment rate to move sideways to higher as growth stays sluggish and participation stabilizes.

Question 5: Will inflation move back toward 2%?

Our answer: No.

Verdict: Incorrect. Both core and headline PCE inflation rose significantly in 2011 and now stand at 1.7% and 2.7%, respectively. Part of our error was due to the bigger-than-expected increase in the prices of oil and other commodities, as well as the surge in automobile prices following the Japan earthquake. But we also underestimated the upward pressure on rents in an environment of still high but gradually declining excess supply of housing; in particular, our expectation that excess supply in the owner-occupied sector would also hold down rents in the renter-occupied sector (via an arbitrage relationship between the two sectors) proved incorrect. More broadly, we probably overestimated the disinflationary effects of a large output gap at a time when inflation is already very low and inflation expectations are well-anchored. All that said, inflation now does seem to be slowing again, and we see the core PCE deflator back at 1.3% by the end of 2012.

Question 6: Will profit margins rise further?

Our answer: Yes.

Verdict: Correct. When measured as after-tax profits as a share of GDP, profit margins rose from 6.8% in the third quarter of 2010 to 7.3% in the third quarter of 2011. When measured as S&P 500 earnings per share in percent of revenue per share, margins rose from 8.3% to 9.0%. Going forward, we expect margins to flatten out both on a top-down and bottom-up basis.

Question 7: Will QE2 end on schedule, i.e., in June 2011 with total holdings of $600bn?

Our answer: Yes.

Verdict: Correct. Fed officials did stop the program on schedule at $600bn. Since then, they have embarked on “operation twist,” whose effects on financial conditions are similar to QE in our view, and we expect them to return to QE in the first half of 2012.

Question 8: Will Fed officials start to “exit” from their current policy stance by raising the funds rate or shrinking their balance sheet?

Our answer: No.

Verdict: Correct. Despite some hawkish signals early in the year, Fed officials ultimately embraced a “lower for longer” view and are currently indicating no rate hikes until “at least mid-2013.” With the short-term rate discussion settled for the time being, we moved to a view of further easing in August, which occurred in September via “operation twist.”

Question 9: Will the 10-year Treasury note yield end 2011 above the current level of 3.4%?

Our answer: Yes.

Verdict: Incorrect. Despite our bullish call at the front end of the yield curve, we predicted an increase in rates at the longer end (albeit a moderate one that was below the forwards at the time of our “10 Questions” note). At least part of this was due to the worse-than-expected domestic growth performance and the greater “flight to quality” in the wake of the intensifying European crisis.

Question 10: Will the state and local budget crisis derail the recovery?

Our answer: No.

Verdict: Correct. The widespread fears about state and local finances at the end of 2010 did not materialize. Municipal governments have not defaulted in large numbers, and municipal bonds outperformed most other sectors of the fixed income market in 2011. While continued fiscal tightening was responsible for much of the improvement, the negative impact on GDP growth from state and local spending has actually diminished a bit in the last few quarters and should continue to do so in 2012.

Tags: Birinyi, Credit Crisis, Disin, Drip, Economist Group, Fed Policy, Gap, Goldman, High Expectations, Inflation Expectations, Japanese Earthquake, Low Expectations, Outlooks, Output Gap, Retrospective, Ruler, Seven Times, Supply Shocks, Upheaval, Us Economics
Posted in Markets | Comments Off

Monetary Policy: Week in Review (October 30, 2011)

Monday, October 31st, 2011

The article below comes courtesy of Central Bank News, an authoritative source on monetary policy developments.

The past week in monetary policy saw 15 central banks announce interest rate decisions. Those that increased interest rates were: India +25bps to 8.50%, and Mongolia +50bps to 12.25%, while those that decreased interest rates were: The Gambia -100bps to 14.00%, Sierra Leone -300bps to 20.00%, and Georgia -25bps to 7.25%. Also announced was Angola’s central bank setting its new benchmark interest rate at 10.50%. The central banks that held interest rates unchanged were: Israel 3.00%, Canada 1.00%, Hungary 6.00%, New Zealand 2.50%, Japan 0-0.10%, Russia 8.25%, Namibia 6.00%, Sweden 2.00%, and Colombia 4.50%. Also in the news was the Bank of Japan announcing a 5 trillion yen addition to its quantitative easing program.

With just two months left in the year this week’s summary chart shows a good representation of monetary policy this year. The key word of course is diversity. On the one hand there is developed markets with unusually low interest rates (and low growth and low inflation pressures). While on the other hand is the emerging and developing markets with much higher interest rates (and relatively higher growth rates and inflationary pressures). Even within developing economies there is diversity in the trajectory of interest rates as some begin to feel the pinch of policy tightening, paired with the deteriorating outlook in western economies, and in particular the ongoing sovereign debt issues in Europe (short-term crisis-containment measures notwithstanding).

Some of the key quotes from the monetary policy makers are included below:

• Reserve Bank of India (increased rate 25bps to 8.50%): “both inflation and inflation expectations remain high. Inflation is broad-based, and is above the comfort level of the Reserve Bank. We expect these levels to persist for two more months. There are potential risks of expectations becoming unhinged in the event of a pre-mature change in the policy stance. However, reassuringly, momentum indicators, particularly the de-seasonalised quarter-on-quarter headline and core inflation measures, indicate moderation. This is consistent with the projection that inflation will decline beginning December 2011.”
• Bank of Japan (added 5 trillion to QE): “some more time will be needed to confirm that price stability is in sight and due attention is needed for the risk that the economic and price outlook will further deteriorate depending on developments in global financial markets and overseas economies. While steadily implementing its decision in August to enhance monetary easing, especially through the purchase of financial assets, the Bank deemed it necessary to further enhance monetary easing so as to ensure a successful transition to a sustainable growth path with price stability.”
• Central Bank of Russia (held rate at 8.25%): “Considering recent domestic and international macroeconomic developments and the effect of the monetary policy measures, implemented in recent months, the Bank of Russiajudged that the current level of money market interest rates is appropriate to balance the inflationary risks and the risks of economic growth slowdown in the nearest future”
• Bank of Mongolia (increased rate 50bps to 12.25%): “The rapid expansion of budget expense, cash hand-out from the Human Development Fund and the high increase in loans are contributing to higher demand. This sharp increase in demand builds the pressure on core inflation even the total supply and the real capacity of economy have not added on yet. The consecutive growth in prices of non-food products from the beginning of 2011 and the current stand in yoy 11.3% prove that the increase of total demand is bringing the growth of core price.”
• Riksbank (held rate at 2.00%): “The difficulties in resolving the public finance crisis in Europe has led to increased uncertainty regarding the future. In Sweden, growth is expected to be slightly weaker in the coming period. At the same time, inflationary pressure is low. The Executive Board of the Riksbank has therefore decided to hold the repo rate unchanged at 2 per cent and to wait to increase it until sometime next year.”
• Bank of Canada (held at 1.00%): “The global economy has slowed markedly as several downside risks to the projection outlined in the Bank’s July Monetary Policy Report (MPR) have been realized. Financial market volatility has increased and there has been a generalized retrenchment from risk-taking across global markets. The combination of ongoing deleveraging by banks and households, increased fiscal austerity and declining business and consumer confidence is expected to restrain growth across the advanced economies. The Bank now expects that the euro area—where these dynamics are most acute—will experience a brief recession.”
• Reserve Bank of New Zealand (held rate at 2.50%): “Given the ongoing global economic and financial risks, it remains prudent to continue to keep the OCR on hold at 2.5 percent for now. However, if global developments have only a mild impact on the New Zealand economy, it is likely that gradually increasing pressure on domestic resources will require future OCR increases.”

Looking at the central bank calendar, next week will be a very interesting week in central banking with the very important US Federal Reserve and European Central Bank both announcing monetary policy decisions. All eyes will be focused on whether the US FOMC announces or hints at any further quantitative easing; meanwhile people will be watching to see if the new ECB president, Mario Draghi, decides to cut the interest rate or provide any other supportive measures to aid the faltering Eurozone economies.

Source: Central Bank News, October 29, 2011.

Tags: Bank News, Bank Of India, Bank Of Japan, Benchmark Interest Rate, Canadian Market, Central Banks, Containment Measures, Debt Issues, Developing Economies, India, Inflation Expectations, Inflation Pressures, Inflationary Pressures, Interest Rate Decisions, Low Interest Rates, Outlook, Policy Developments, Reserve Bank Of India, S Central, Sovereign Debt, Sweden 2, Term Crisis, Western Economies
Posted in Canadian Market, India, Markets, Outlook | Comments Off

QE3 is Likely if Economy Slips – FOMC Minutes (Sept 20-21)

Thursday, October 13th, 2011

by Asha Bangalore, vice president and economist of The Northern Trust  Company.

The minutes of the September 20-21 FOMC meeting indicate that several members see significant downside risks to economic growth. They do not project a decline in GDP, but noted that the economy was “vulnerable to adverse shocks.” In this context, the sources of adverse shocks included “pronounced or more protracted deleveraging by households, the chance of a large-than-expected near-term fiscal tightening, and potential spillovers to the United States if the financial situation in Europe were to worsen appreciably.”

The FOMC views that risks are balanced with regard to inflation. Stable inflation expectations and a continued dissipation of the impact of the past increases in energy and commodity prices are factors that support members cited to support projections of both headline and core inflation settling close to levels consistent with the Fed’s dual mandate. The minutes indicate that despite these expectations, the “outlook for growth and inflation as more uncertain than usual.”

The September meeting included an extensive discussion of tools available to support the economy if economic conditions weaken. The deliberations were focused on three options. First, reinvest principal payments it receives on holdings of agency bonds in long-term Treasury securities. Second, purchases long-term Treasury securities and sell a matching amount of shorter-term Treasury securities in such a manner that reserves and the Fed’s balance sheet would not be affected. Third, the FOMC would purchase longer-term Treasury securities and increase the balance sheet size of the Fed. The minutes note that a “large number of participants saw large-scale asset purchases as a more potent tool that should be retained as an option in the event further policy action to support a stronger economic recovery was warranted.”

The FOMC chose the second option of the three, which is known as Operation Twist. The vote was 7-3 in favor of Operation Twist. The minutes reveal that two members would have preferred to take more aggressive steps compared with Operation Twist. They were willing to consider Operation Twist because additional future support was not ruled out. The implications of reducing interest on reserve balances (IOR) were also part of the discussion. A range of opinions were presented and it was noted that additional information would be necessary to assess the usefulness of this tool in the current economic environment.

The minutes also show that the Committee is examining modifications of its communications policy: “Most participants indicated that they favored taking steps to increase further the transparency of monetary policy, including providing more information about the committee’s longer-run policy objectives and about the factors that influence the committee’s policy decisions.” The Committee also looked into “ways to elucidate the economic conditions that could warrant raising the level of short-term interest rates.” Overall, it appears that the Fed is working on improving its communication about monetary policy changes with the public.

Source: Asha Bangalore, Northern Trust – Daily Economic Commentary, October 12, 2011.

Tags: Agency Bonds, Asset Purchases, Balance Sheet, Bonds, Commodity Prices, Core Inflation, Deliberations, Dissipation, Downside Risks, Dual Mandate, Economic Conditions, Economic Recovery, Financial Situation, Fomc Minutes, Inflation Expectations, Northern Trust Company, Outlook, Potent Tool, Principal Payments, Stable Inflation, Support Members, Treasury Securities
Posted in Bonds, Brazil, Markets, Outlook | Comments Off