Disappointing, but Not Terrible

Tuesday, July 10th, 2012

 
Disappointing, but Not Terrible

07/09/12

by Charles Lieberman, Advisors Asset Management

Job growth has slowed to a disappointing pace over the past three months, insufficient to bring down unemployment, but not so weak that recession is much of a threat. This mediocre performance also leaves the Fed in a quandary, neither making an obvious case to leave policy unchanged or a clear case to implement yet another form of policy accommodation.The economy added 80,000 net workers, the third consecutive month in which hiring remained so sluggish, following a first quarter in which hiring averaged 226,000 monthly. But other details in the report were more encouraging. The workweek rose by 0.1 hours, a seemingly small number, but equivalent to roughly 385,000 full time jobs. Hiring of temporary workers also advanced by 25,000, an important precursor to permanent hiring. A solid 0.3% increase was also reported for wage rates, which is important to finance household spending. With the housing sector beginning to gain some momentum, providing a new source of demand to support growth, a relapse into recession appears highly unlikely. So, the employment report was far from a disaster, but that’s hardly a ringing endorsement.

Fed officials are surely going to have quite a debate over the future direction for policy. Public statements suggests that they are quite divided over whether to implement more innovative initiatives to promote growth, although a number of them worry that reversing all of their efforts at the appropriate time may become more difficult. Certainly one possible new initiative may be to buy mortgage backed securities instead of U.S. Treasuries bonds. This would make reversing the Fed’s accommodative policies easier, since mortgage pay down principal every month. There is also concern that the Fed is running out of policy options. It is commonly accepted that the efficacy of policy is diminishing, although there is quite a bit of disagreement whether further initiatives would be worthwhile.

It is highly unlikely that any new fiscal policy initiatives can make it through Congress prior to the election, which is now less than four months away. So, the onus for any additional initiatives falls exclusively on the Fed. Even if there is no new policy implemented at the Fed’s upcoming meeting, it is likely they would feel obligated to do something if hiring remains disappointing. They may choose to act now to avoid complaints that they are acting out of political considerations as we get closer to the election.

Copyright © Advisors Asset Management

Tags: Clear Case, Disagreement, Efficacy, Employment Report, Fed Officials, Household Spending, Lieberman, Management Job, Mediocre Performance, Mortgage Backed Securities, Policy Options, Precursor, Public Statements, Quandary, Recession, Relapse, Time Jobs, Treasuries, Wage Rates, Workweek
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Bernanke: Be Humble!

Tuesday, May 1st, 2012

Bernanke: Be Humble

by Axel Merk, Merk Funds

“Humble” is typically not an attribute associated with the Federal Reserve (Fed), especially in light of the trillions of dollars recently printed. Yet, in his latest press conference Fed Chairman Bernanke called for humility: we must be humble in setting monetary policy! The problem is, Bernanke’s definition of the word “humble” appears to be something entirely different from what – in our humble opinion – common sense might expect.

We have previously argued that the only reason the Fed gets away with printing so much money is because that money doesn’t “stick”. Technically, the Fed doesn’t actually print money, but buys fixed income securities with ever-longer maturities (mortgage-backed securities and Treasury securities). To purchase those securities, money is literally created out of thin air; a simple computer entry is all that is required to credit the account of a bank at the Fed in return for the purchase of a security. These purchases are reflected as an increase in assets on the Fed’s balance sheet, with an offsetting increase in liabilities (cash in circulation – Federal Reserve notes – are a liability for the Fed). When proceeds from a maturing security are re-invested, no new money is being created, but the balance stays at an elevated level; as such, when QE1 or QE2 “ended”, the amount of money that had been printed was still in the system. Some economists argue that such policies don’t amount to “money printing” because banks haven’t done much with the money they received (the velocity of money has not shot up). Our response to that argument has been that if you were to give a baby a gun, just because the baby doesn’t shoot anyone, doesn’t mean it isn’t dangerous. So, to us, being humble should focus on being most concerned about the potential side effects of monetary easing.

A key reason why all the money that has been printed hasn’t made it to the real economy is because major deflationary forces are present, as a result of the financial crisis. In our assessment, in the run-up to the financial crisis, the Fed had lost control over the credit creation process. That is, consumers used their homes as ATMs, creating their own money. Similarly, financial institutions found ways to create their own money, e.g. increasing leverage by creating special investment vehicles (SIVs). In the goldilocks economy of much of the last decade, it was only rational for investors to take on more risk, to increase leverage. After all, house prices could never fall. However, starting in 2007, risk came back to the markets. As a result, it became similarly rational for investors to reduce leverage. Unfortunately for investment banks Bear Stearns and Lehman Brothers, they didn’t have sufficient liquid collateral to downsize. Similarly, many consumers buried in debt have been unable to downsize, causing elevated numbers of defaults on their obligations (mortgages, auto payments, credit cards…) It’s because policy makers initially lost control on the credit creation side that we are now witnessing a gargantuan effort to stem against deleveraging, deflationary forces. We believe this is a key reason why, with all the money spent and printed, the U.S. can only generate lackluster economic growth.

In this environment, it’s likely that the Fed can get away with just about anything in terms of monetary expansion. But should these policies work, should all the money that has been printed make it through to the real economy, the Fed may find itself in a tricky situation. Bernanke argues that he can raise interest rates in as little as 15 minutes to contain any inflationary fallout that might occur. In the early 1980s, former Fed Chair Paul Volcker raised rates to 20% to beat inflationary pressures. In those days, people complained, but because there was so much less leverage in the economy, it was bearable. In today’s environment, 6% appears to be the threshold for countries such as Spain before commentators believe the International Monetary Fund (IMF) has to come to the aid of the government. Wait. Paying 6% interest is considered unsustainable? What type of world are we now living in? More importantly, will the Fed have the will to potentially crush the economy in order to contain inflationary pressures? Anyone reading this and even considering that the Fed may hesitate proves that the Fed has lost credibility. Credibility requires the perception that the Fed will not hesitate to beat inflation.

Tags: Amount Of Money, Computer Entry, Fed Chairman, Fed Doesn, Federal Reserve, Federal Reserve Notes, Humility, Income Securities, Maturities, Monetary Policy, Money Printing, Mortgage Backed Securities, New Money, Qe1, Qe2, Simple Computer, Thin Air, Treasury Securities, Trillions, Velocity Of Money
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PIMCO Takes Record MBS Position Even Higher, Dumps Treasurys

Thursday, April 12th, 2012

The trend continues: as has pointed out here every month for the past five months, Pimco’s Bill Gross continues to layer into the “NEW QE” trade, only this time he is making it more clear than ever that he is certain that the Fed will have no choice but to monetize Mortgage Backed Securities. Indeed, in March the firm added another 100 bps in its MBS exposure, bringing the total to 54% of total, or a record $134 billion of the fund’s $253 billion in AUM. And while before Gross would buy MBS and TSYs pari passu, that is no longer the case. In fact in March, Gross dumped the most Treasurys since February 2011, cutting his net exposure from 38% to 32%, and likely is in part or whole responsible for the big bond dump in the middle of March, now long forgotten (that or he merely piggybacked on the negative sentiment: April holdings will be indicative of that). Other notable shifts: Gross continues to sell European sovereign exposure, with Non-US Development holdings down to 6%, the lowest since April 2011, and surprisingly even cutting Investment Grade holdings to just 14%, the lowest since October 2008: is Gross smelling a bond bubble (in both IG and HY) and is getting out while the getting is good? Sure looks like it.

And TRF’s maturity and duration distribution over time.

Tags: Aum, Bill Gross, Bps, Case In Fact, Cutting, Dumps, Duration, Five Months, Hy, Ig, Maturity, Mortgage Backed Securities, Negative Sentiment, Pari Passu, Qe, S 253, Treasurys, Trend, Trf
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Bond ETF Idea: Commercial Mortgage Backed Securities

Tuesday, March 6th, 2012

by Matt Tucker, Managing Director, Fixed Income,  iShares

ABS, MBS, CMBS.  Navigating your way around the various fixed income sectors can sometimes feel like a bowl of alphabet soup.  And with the proliferation of fixed income ETFs giving investors more ways than ever to slice and dice the bond market, now’s a great time to brush up on your acronyms.

Take, for example, commercial mortgage-backed securities (CMBS).  CMBS are fixed income securities that are backed by loans on things like office buildings, retail properties, and hotels.  The sector currently represents about 2% of the US fixed income market.

For investors who have a positive view on the commercial real estate market, CMBS are a way to gain exposure with less risk than real estate investment trusts (REITS).  Since its inception six years ago, the Dow Jones US REIT Index has experienced volatility of 30.1% and a return of 2.6%, whereas the Barclays Capital US CMBS Index experienced a volatility of 13.3% and a return of 6.63% during the same timeframe.  Keep in mind that REITS are equity securities, whereas CMBS are debt securities.

CMBS also have a compelling income component – compared to sectors that have a similar duration (a measure of bond risk), investment grade CMBS are currently offering a higher yield.  Note that in the chart below, CMBS is represented by the Barclays Capital US CMBS Index, which only includes investment grade bonds – there are no subprime bonds in the index.

Fixed Income Sector Comparison

With the recent launch of the iShares Barclays CMBS Bond Fund (NYSE Arca: CMBS), the first ETF dedicated solely to CMBS, investors now have the ability to gain diversified access to this sector in a single trade.  We expect to see clients using this fund in a few different ways.  One idea: if the investor prefers an overweight to CMBS, they can use it to complement a diversified bond index fund (such as the iShares Barclays Aggregate Bond Fund; NYSE Arca: AGG).  Or they may use it in conjunction with other bond index funds to build a customized fixed income portfolio.

Source: Bloomberg

Chart Source: Barclays Capital and iBoxx as of 2/21/2012. Past performance does not guarantee future results.  Fixed income sectors are represented by the following indexes –   Barclays Capital U.S. CMBS (ERISA Eligible) Index, Barclays Capital U.S. Agency Index, Barclays Capital 3-7 Year US Treasury Index, Barclays Capital U.S. MBS Index, Barclays Capital Intermediate U.S. Credit Index, iBoxx $ Liquid High Yield Corporate Bond Index, Barclays Capital U.S. Aggregate Index

Bonds and bond funds generally decrease in value as interest rates rise. In addition to the normal risks associated with investing, narrowly focused investments typically exhibit higher volatility. Commercial mortgage-backed securities (“CMBS”) represent interests in “pools” of commercial mortgages and are subject to credit, prepayment and extension risk, and therefore react differently to changes in interest rates than other bonds. Small movements in interest rates may quickly and significantly reduce the value of CMBS. Diversification may not protect against market risk.

Tags: Alphabet Soup, Barclays Capital, Bond Fund, Bond Index, Commercial Mortgage Backed Securities, Debt Securities, Diversified Bond, Dow Jones, Income Component, Income Securities, Index Fund, Investment Grade Bonds, Matt Tucker, Mortgage Backed Securities, Nyse Arca, Real Estate Investment, Real Estate Investment Trusts, Reit Index, Retail Properties, Risk Investment
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Gold Reacts as Quantitative Easing Becomes Fait Accompli

Friday, January 27th, 2012

I had proposed at the beginning of QE2, we are now in a QEn environment.  My working assumption is when QE2 ended last spring we’d have about a 6-8 month window before the desperate Federal Reserve began QE3.  I was thrown a curveball with Operation Twist instead – although my time frame was accurate; it was just a program of a different flavor.  But no worries, yesterday Bernanke kicked the door open and whispered songs of additional measures at every opportunity possible during his news conference.   This fits with my working theory that aside from LTRO this incredible strength in the market was similar to the “pre game” we saw ahead of the official QE2 announcement.  This is the “David Tepper” effect we saw fall 2010 where “if the economy improves, it is good for the market – buy stocks.  If the economy falters, it is good for the markets as the Fed will QE – buy everything.”

Hence, go forward we have to change our working assumption to one that includes another massive program of asset purchases (many believe these will be concentrated on mortgage backed securities to get mortgage rates even lower than their current record rates).  Whatever the case, gold (and silver) reacted accordingly….

……and we are in another round of global stimulus – this time with the ECB joining forces.  I’d also point out the UK printed a poor GDP figure yesterday and we certainly should expect a new round of quantitative easing out of the Bank of England shortly as well.   Of course, in the very short term this is now all “known” news, so we’ll see how long the market can continue the non stop ‘teflon’ rally without nary a resting point.

Via Reuters:

• Bernanke on Wednesday opened the door a bit wider for the Fed to return to buying securities in the months ahead to buttress a weak recovery and keep inflation from slipping too far below its newly adopted 2-percent target.
• “It sounds like the finger is on the trigger,” said Thomas Simons, a money market economist at Jefferies & Co.
• “Probably the main take-away from the press conference is the sense conveyed by Bernanke that it would not take much of a disappointment in growth or inflation to get the Fed to start another round of QE,” said Michael Feroli, chief U.S. economist at J.P. Morgan. ”In fact, from his answers it’s not even clear any disappointment would be necessary to see more QE,” Feroli wrote in a note, adding he was not forecasting another round of asset purchases even if the bar for action was low.
• “I think it could happen any time now, based on the language that we saw today,” said Eric Stein, a portfolio manager at Eaton Vance in Boston.
• Economists at 12 of 18 primary dealers, the large financial institutions that do business directly with the Fed, believe the central bank will undertake further quantitative easing, according to a Reuters poll after Bernanke’s news conference.
• The Fed has trained its sights on the stalled housing market in recent months, so any move to QE3 is most widely expected to involve buying mortgage securities to help bring down further already record-low mortgage interest rates.

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

Tags: Asset Purchases, Bank Of England, Buy Stocks, Curveball, David Tepper, ECB, Fait Accompli, Gold And Silver, Known News, Last Spring, Massive Program, Mortgage Backed Securities, Mortgage Rates, News Conference, Qe, Qe2, Resting Point, Reuters, Stimulus, Target
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On Playing Probabilities…

Sunday, January 22nd, 2012

At one level, the stock market is much about probability and statistics.  Of course there are many other levels as humans are involved, hence emotions, sentiment and the like are also keys.  If it were just about statistics and probabilities, the best stock pickers in the world would simply be computers who could analyze reams of data and discern patterns.

We’ve seen an impressive rally since mid December, and indeed all of 2012.  There has been no volatility and the market has either gone sideways or up nearly every session.  The S&P 500 has not even come down to test its 10 day moving average more than once during the entire move.  The big question on everyone’s mind has been is the European LTRO (info here and here) the new quantitative easing (“QE”)?  Why?  A lot of of probabilities and statistics go out the window during periods of massive central bank intervention as both psychology and arguably (temporarily) a different form of reality take over.  As the central bank’s balance sheet takes in huge amounts of inventory of product (whether Treasuries, mortgage backed securities, or whatever the ECB is currently willing to take as collateral in its LTRO program), funds are freed up to (temporarily) bid up other assets.   Aside from European LTRO the prospects of a new American QE are also on the table, and the market has learned to front run the official announcement.

Why does it matter?  Because going back to sentence one – at one level macro moves in the general market are about probabilities.  It’s the rubber band theory – once we get to extremes, the market eventually gets snapped back to a trend line.  However, the central bank interventions of the past few years have created even more extreme extremes (if you will), so one has to be cognizant of this.

I mention these things because right now the market is at a short term extreme on many (!) measures.  But what environment are we in?  The kind where extremes can stay so for a long period of time (i.e. during QE2?) or a more normal environment where a “rubber band” effect should be coming soon.  Obviously I don’t know the answer but if you go with probability you have to assume the rubber band snaps back to some degree – even if the longer term technicals of the market have improved.  That said, those assumptions of the rubber band working as normal proved painful to those on the bear side during periods of massive central bank intervention the past few years.

Let’s take a closer look both from a fundamental point of view and chart wise.  In this week’s Barron’s Mike Santoli’s weekly letter is titled “The Dangers of Complacency” and has a few interesting snippets:

• More worrisome is the fact that real-money indicators are hinting that equity investors are leaning out over their skis a bit too far for the immediate term. Short interest has shrunk severely in both exchange-traded funds and stocks. Volume in leveraged-upside ETFs versus bearish ones has reached the kind of extreme that recently has preceded market pullbacks, even as overall volume and technical momentum have been unimpressive.
• McMillan Analysis pointed out Friday that the Standard & Poor’s 500 was three standard deviations above its 20-day average, which tends to portend at least a short, sharp reversal.
• …the ratio of the 15-day volume of bearish puts on the S&P 100 Index to bullish call volume hit 2-to-1 last week. Traders of these instruments, known as OEX options, are proven smart-money actors, so their caution should be heeded. In the past decade, this ratio hit this level only in February 2007, February 2011 and April 2011; it also nearly reached 2-to-1 in late October of last year. Each instance foretold an imminent correction of some significance.

Let’s focus a bit on that last piece of data.  OEX is an index for the S&P 100 … if you believe option players are ‘smart money’ we are seeing a 2:1 ratio of puts to calls on a 15 day ratio.  That has only happened 4 times in the past decade.  Each instance preceded a meaningful correction.  Interestingly 3 of those 4 instances of the decade happened in the past year which I think reflects the ETF, HFT dominated “risk on, risk off” world we live in, where moves go in one direction without rest.  (prior to 2007 upside moves were generally slower in nature, whereas downside moves were fast – now upside moves are often as quick as downside moves)  I’ve posted a chart of the past year highlighting what happens after these OEX option extremes are hit: February 2011, April 2011 and October 2011.

Now beyond this Barron’s article, let’s look at another measure that shows a lot more secondary indicators at major extremes.  And what happened in the past… it will also highlight that “normally” X happens but during a central bank intervention “Y” happens.  So the question of if we are dealing with X v Y has important implications.

One of the other financial writers in the blogosphere uses a technical measure I was not that familiar with but have been studying for a few weeks – they are called Keltner Channels.  For those of you technically inclined they are similar to the much more familiar Bollinger Bands but with some key differences:

Keltner Channels are volatility-based envelopes set above and below an exponential moving average. This indicator is similar to Bollinger Bands, which use the standard deviation to set the bands. Instead of using the standard deviation, Keltner Channels use the Average True Range (ATR) to set channel distance. The channels are typically set two Average True Range values above and below the 20-day EMA.

There are two differences between Keltner Channels and Bollinger Bands. First, Keltner Channels are smoother than Bollinger Bands because the width of the Bollinger Bands is based on the standard deviation, which is more volatile than the Average True Range (ATR). Many consider this a plus because it creates a more constant width. Second, Keltner Channels also use an exponential moving average, which is more sensitive than the simple moving average used in Bollinger Bands.

Looking back on the S&P 500 the past few years, we have some very interesting data using Keltner Channels.  In almost every instance, when the S&P 500 breaks out over the top of the Keltner Channel (i.e. an extreme level) we’ve had a material correction – minimum 20 S&P points, and often much more.  Of course, the exceptions were…. wait for it… during QE2.  But even during QE2 we had two instance of this sort of indication that worked.  Let’s look at the multi year chart which I’ve started from the time QE2 was hinted at by Bernanke at Jackson Hole Wyoming in late August 2010, which I’ve also overlaid with Relative Strength and Full Stochastics.

Arrows with purple show this specific combination:

1. The index broke above the Keltner Channel
2. Relative Strength was near or at 70
3. Full Stoch was at or above 90

Arrows and lines in green are where we have the latter 2 conditions true, but the index continued to swim along at or slightly above the top of the Keltner Channel – all these instances were during QE2.

So what’s the takeaway here?  We have just broken over the top of the Keltner Channel again the past 2 sessions.  Relative Strength is at 69, and that is combined with a Stochastic reading of 99+.  In every non QE2 instance that this happened in the past few years, this led to at least a modest correction (sometimes much more than modest).  The few exceptions (green arrows) were during QE2 when obviously normal extremes are affected by ‘psychological’ (animal spirits) differences as speculators believe the Fed has their back no matter what.

Hence this leads us back to the title of this piece… and the question of what environment are we in?  With the ECB’s balance sheet exploding ala the Fed’s during previous quantitative easing, are we in an X or Y environment?  If X (non intervention environment) probabilities are extremely high for a pullback.  If Y (intervention environment) the probability is still there, but upside moves can continue for even longer as the rubber band gets pulled even farther back.

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

Tags: Balance Sheet, Band Theory, Best Stock Pickers, Central Bank Intervention, ECB, Impressive Rally, Interventions, Macro Moves, Mortgage Backed Securities, Probabilities And Statistics, Probability And Statistics, Qe, Reams, Rubber Band, Statistics And Probabilities, Stock Market, To Extremes, Treasuries, Trend Line, Volatility
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News That Matters (October 21, 2011)

Friday, October 21st, 2011

By www.thetrader.se

Ft.com

Saab Automobile’s chances of avoiding bankruptcy dwindled after the two Chinese companies that had agreed to invest in the company instead offered to buy it for a token sum. Citing people familiar with the discussions, http://ftalphaville.ft.com/thecut/2011/10/21/708181/saab-investment-plan…

The Cabinet of Japanese Prime Minister Yoshihiko Noda signed off on steps to deal with the soaring yen on Friday, the WSJ reports. Fleshing out proposals made last month, Tokyo’s plan aims to curb further http://ftalphaville.ft.com/thecut/2011/10/21/708101/japan-moves-closer-t…

Dexia, the stricken Franco-Belgian lender that has been at the centre of recent market turmoil, loaned €1.5bn of fresh capital to its two largest institutional shareholders which then used the cash to buy Dexia shares before 2008, http://ftalphaville.ft.com/thecut/2011/10/21/708106/e1-5bn-dexia-loans-u…

Daniel Tarullo, one of the five governors of the Federal Reserve board, says the central bank should consider large scale purchases of mortgage-backed securities if the economy does not improve, the FT reports. “A large-scale MBS purchase programme has many of the benefits associated with purchases of longer-duration Treasury securities, http://ftalphaville.ft.com/thecut/2011/10/21/708096/fed-urged-to-weigh-n…

European leaders will be forced to hold a second summit, perhaps as early as Wednesday, because of the inability of Germany and France to reach a deal on how to increase the firepower of the eurozone’s €440bn rescue fund. European leaders confirmed that a high-stakes summit on Sunday aimed at finalising a plan to shore up the eurozone would proceed.http://ftalphaville.ft.com/thecut/2011/10/21/708091/europe-forced-into-a…

China will allow local governments to issue bonds directly for the first time in almost 20 years as Beijing acts to prevent potential defaults by provincial and city-level governments that could wreak havoc in the country’s financial sector, http://ftalphaville.ft.com/thecut/2011/10/20/708031/china-municipalities…

Investment banks are exploiting gaps in global pay reforms to persist with some of their most contentious practices, including guaranteeing lucrative bonuses to employees regardless of their performance, industry data show. Guaranteed bonuses to new hires accounted for 8.5 per cent of the average bonus pool for 2010 at 51 top financial institutions, according to a study published by the Institute of International Finance (IIF), an industry lobby group. http://www.ft.com/intl/cms/s/0/ee686396-fa4f-11e0-b70d-00144feab49a.html…

WSJ.com

Asian stock markets were modestly higher in tentative trade Friday, as confusing signals from European leaders on plans to contain the euro-zone debt crisis kept most buyers at bay. Japan’s Nikkei Stock Average rose 0.1%, Australia’s S&P/ASX 200 added 0.4%, South Korea’s Kospi Composite climbed 1.1% and New Zealand’s NZX-50 was up 0.2%. Dow Jones Industrial Average futures were up 18 points in screen trade. Copper ticked up over 1.0% in early Asian trade after the red metal settled down 6.2% at a 15-month low in New York Thursday amid uncertainty over the European sovereign debt crisis, fears of slowing demand from China and the fallout from a Chinese government crackdown on metal-for-collateral. http://online.wsj.com/article/SB1000142405297020461870457664393297263281…

Standard & Poor’s Corp. said on Thursday that it would likely downgrade the credit ratings of France, Spain, Italy, Ireland and Portugal if the euro zone slips into another recession, which many economists say is likely. Bank ratings in the region would also take a hit under the two possible scenarios analyzed in the S&P report. “These stress scenarios are not our central expectation, but a simulation of the possible outcomes if such hypothetical events were to occur,” the ratings company said. http://online.wsj.com/article/SB1000142405297020448530457664329126863486…

Two years ago, a French banker flew to Washington on an emergency mission: Persuade International Monetary Fund chief Dominique Strauss-Kahn that his concerns about the health of the European banking sector were unfounded. The trip was a success. Mr. Strauss-Kahn agreed to keep his fears under wraps to avoid causing market panic, according to people familiar with the matter.http://online.wsj.com/article/SB1000142405297020448530457664156154026649…

Spanish banking giant Banco Santander SA frequently says that it doesn’t shuttle money among its far-flung units, a declaration meant to assure investors that its parent won’t raid those units for cash in a pinch. The bank has “a model of subsidiaries which are autonomous in funding and capital,” Chairman Emilio Botín said in a speech here last month. The same day, Santander’s chief executive delivered a slide presentation that said “Each subsidiary is responsible for its own capitalization and funding needs… no cross border funding.”http://online.wsj.com/article/SB1000142405297020375260457664301323491477…

Marketwatch.com

The head of Japan’s auto industry asked trade and industry minister Yukio Edano on Friday for a drastic response to the persistently strong yen, warning that Japan’s economy is already “hollowing out” due to the strong currency. In a meeting between Edano and executives of the Japan Automobile Manufacturers Association, JAMA president Toshiyuki Shiga said “fundamental countermeasures are needed against the strong yen.” http://www.marketwatch.com/story/japan-auto-group-head-need-major-respon…

French President Nicolas Sarkozy and German Chancellor Angela Merkel will meet Saturday night in Brussels to prepare for the summit meeting of European leaders set for Sunday, the leaders said in a joint statement Thursday. “The president and the chancellor have agreed to provide a comprehensive and ambitious response to the current crisis in the euro area,” which will include implementing a revamped euro-zone bailout fund, strengthening the capital of European banks and strengthening economic integration and economic governance, the statement said. http://www.marketwatch.com/story/merkel-sarkozy-to-meet-saturday-in-brus…

Reuters.com

ICE Brent crude for December rose $1.37 to settle at $109.76 a barrel, having traded from $107.31 to $110.17. The expiring U.S. front-month November crude fell 81 cents to settle at $85.30 a barrel. U.S. December crude fell only 22 cents to settle at $86.07 a barrel. Brent’s trading volume was 1 percent below its 30-day average and U.S. volume 13 percent under. Brent’s premium to its U.S. counterpart rose to $23.69. Brent’s recovery and a forecast for a cold winter helped push U.S. heating oil futures higher. U.S. gasoline futures also ended with a gain. http://www.reuters.com/article/2011/10/20/us-markets-oil-idUSTRE7922QH20…

“Prices appear to be consolidating within the range of $1,550 and $1,700.” Spot gold gained 0.4 percent $1,625.12 an ounce by 0253 GMT, but was headed for a drop of 3.2 percent from a week earlier, its biggest weekly decline in nearly a month. U.S. gold rose as much as 1.1 percent to $1,630.9, before easing to $1,626.90, on course for a 3.3 percent weekly decline. Technical analysis suggested spot gold could rebound to $1,650 during the day, said Reuters market analyst Wang Tao. http://www.reuters.com/article/2011/10/21/us-markets-precious-idUSTRE78M…

The ranks of the poor rose in almost all U.S. states and cities in 2010, despite the end of the longest and deepest economic downturn since the Great Depression the year before, U.S. Census data released on Thursday showed. Mississippi and New Mexico had the highest poverty rates, with more than one out of every five people in each state living in poverty. Mississippi’s poverty rate led, at 22.4 percent, followed by New Mexico at 20.4 percent. New Hampshire had the lowest poverty rate, at 8.3 percent, making it the only state with a poverty rate below 10 percent. Twelve states had poverty rates above 17 percent, up from five in 2009, while poverty rates in 10 metropolitan areas topped 18 percent, the data showed. http://www.reuters.com/article/2011/10/20/us-usa-states-poverty-idUSTRE7…

Plans to tackle the euro zone debt crisis have stalled with Paris and Berlin at odds over how to increase the firepower of the region’s bailout fund, French President Nicolas Sarkozy said on Wednesday. Sarkozy told French lawmakers the dispute was holding up negotiations and flew to Frankfurt to talk with German Chancellor Angela Merkel in an attempt to break the deadlock ahead of a make-or-break European leaders’ summit on Sunday. The two leaders left that meeting without speaking to waiting reporters. Asked if a deal had been reached, Jean-Claude Juncker, chairman of the Eurogroup of euro zonefinance ministers who attended the evening meeting, replied: “We’re still in meetings Saturday, Sunday.” http://www.reuters.com/article/2011/10/20/us-eurozone-idUSTRE79I0IC20111…

Bloomberg.com

European governments may unleash as much as 940 billion euros ($1.3 trillion) to fight the debt crisis, seeking to break a deadlock between Germany and France that is forcing leaders to hold two summits within four days. Negotiations on combining the European Union’s temporary and planned permanent rescue funds as of mid-2012, while scrapping a ceiling on bailout spending, accelerated this week after efforts to leverage the temporary fund ran into European Central Bank opposition and provoked the French-German clash, two people familiar with the discussions said. They declined to be identified because political leaders will have to decide. http://www.bloomberg.com/news/2011-10-20/eu-said-to-mull-wielding-1-3-tr…

Italian Prime Minister Silvio Berlusconi’s surprise nomination of Ignazio Visco to run the Bank of Italy sets up a possible clash with French President Nicolas Sarkozy over the composition of the European Central Bank’s Executive Board. Berlusconi chose Visco, a 30-year veteran of the Bank of Italy, to succeed Mario Draghi, who is to become president of the ECB when Jean-Claude Trichet’s term ends this month. The Italian premier had indicated he might choose ECB Executive Board member Lorenzo Bini Smaghi for the post, which would free up a seat on the ECB’s decision-making board for a Frenchman.http://www.bloomberg.com/news/2011-10-21/berlusconi-s-bank-choice-risks-…

Federal Reserve Governor Daniel Tarullo’s call for resuming large-scale purchases of mortgage bonds may boost chances the central bank will start a third round of asset buying aimed at reviving U.S. growth. Policy makers should move the tool “back up toward the top of the list” because it would help the economy through lower mortgage costs that would boost home purchases and spending by people who refinance their home loans, Tarullo said late yesterday in a speech in New York http://www.bloomberg.com/news/2011-10-20/fed-s-tarullo-says-central-bank…

India’s rupee dropped past the 50 per dollar level for the first time since May 2009 on speculation slowing economic growth and faster inflation will deter foreign investment. The currency was poised for its biggest weekly loss this month after China reported Oct. 18 that its third-quarter gross domestic product increased at the slowest pace in two years. Food inflation in India accelerated to 10.6 percent in the week ended Oct. 8 from a year earlier, the fastest pace since April, government data showed yesterday. Concern Europe’s debt crisis is worsening also sapped demand for emerging-market assets.http://www.bloomberg.com/news/2011-10-21/rupee-weakens-past-50-a-dollar-…

Dailyfinance.com

The economy appears slightly healthier than many had feared it was a few weeks ago, raising hopes that it can end the year on an upward slope. A raft of data Thursday show layoffs are trending down to a six-month low and factories in the Mid-Atlantic are growing again after contracting for two months. Nevertheless, home sales fell and the housing market is expected weigh on the economy deep into 2012. The outlook for the final six months of the year has improved from August, when many thought the economy was at growing risk of falling back into a recession. Other recent reports showed hiring picked up slightly in September and consumers boosted their spending on retail goods by the most since March.

http://srph.it/r7Qisa

Foxbusiness.com

The Obama administration and the regulator for Fannie Mae and Freddie Mac are expected to unveil new steps to help distressed homeowners in the next week or two, a senior congressional aide said on Thursday. The aide commented on the plan after Democratic Senator Dianne Feinstein said the Federal Reserve planned to send Congress “legislative recommendations” on housing. The aide said Feinstein “misspoke for a second” and meant the administration and the Federal Housing Finance Agency. http://www.foxbusiness.com/markets/2011/10/20/new-housing-plan-expected-…

USAtoday.com

Home sales are on pace to match last year’s dismal figures — the worst in 13 years. The average rate on 30-year fixed mortgages was nearly unchanged this week after rising last week. Freddie Mac says the average rate on 30-year loans edged down to 4.11% from 4.12% last week. The week before, it fell to 3.94%, lowest rate ever, according to the National Bureau of Economic Research. The average rate on the 15-year fixed mortgage ticked up to 3.38 percent from 3.37 percent. It hit a record-low of 3.26 percent two weeks ago. http://www.usatoday.com/money/economy/housing/story/2011-10-20/home-sale…

BBC.co.uk

EU leaders are to hold another summit by Wednesday, because they will not be able to agree a rescue plan for the euro on Sunday. French President Nicolas Sarkozy and German Chancellor Angela Merkel said a crisis strategy would be discussed on Sunday and adopted at the next meeting. EU leaders need to agree a second bailout for Greece, how to recapitalise banks and a stronger bailout fund. President Sarkozy also called for talks with the private sector. The private sector talks would be “to find an agreement allowing to strengthen the sustainability” of Greek debt. Previous disagreements between France and Germany about the bailout plans have centred on how much the private sector would have to contribute to any package. http://www.bbc.co.uk/news/business-15393260

Telegraph.co.uk

The ONS said sales volumes including petrol rose by 0.6pc on the month after a fall of 0.4pc in August, giving an annual rise of 0.6pc. Analysts had forecast flat sales on the month and an annual rise of 0.7pc. Excluding fuel, retail sales went up 0.7pc on the month and were 0.4pc higher on the year, above analysts’ expectations for the monthly rise. The figures offer a rare bit of good news for British retailers which otherwise have been struggling. http://www.telegraph.co.uk/finance/economics/8838002/Retail-sales-rise-o…

Independent.co.uk

European leaders were given a stark warning last night that Greece’s debt burden remains unsustainable, despite the €65bn (£57bn) in bailout funding the country has received since May 2010. The warning was contained in the draft text of the decision of the “troika” mission of officials – from the European Central Bank, the International Monetary Fund and the European Commission – on Athens’ progress towards stabilising its public finances. http://www.independent.co.uk/news/business/news/new-greek-bailout-cash-c…

The department store Debenhams and better-than-expected retail sales data have provided the UK’s beleaguered high street with some much-needed cheer ahead of the crucial Christmas trading period. Debenhams unveiled a 10 per cent rise in pre-tax profits to £166.1m for the 53 weeks to 3 September, a share buy-back and said it was “optimistic” about its prospects. The retailer also revealed extensive plans to grow its store numbers in the UK and overseas, as well as expanding online. http://www.independent.co.uk/news/business/news/the-uk-high-street-is-al…

Guardian.co.uk

Policymakers must consider how to stimulate lending to revive the economy, the City’s chief watchdog said, as he also conceded that regulators may never be able to prevent customers being “ripped off”. Lord Turner, chairman of the Financial Services Authority, told an audience at the Mansion House in the heart of the City on Thursday that current economic conditions meant the authorities should switch from imposing strict rules on banks to focusing on ways to make them lend more. http://www.guardian.co.uk/business/2011/oct/20/turner-fsa-regulators-ban…

Smh.com.au

The possibility of an interest rate cut is off the table as inflation is not expected to ease significantly in the September quarter, economists say. The Australian Bureau of Statistics will on Wednesday release the September quarter Consumer Price Index, the key measure of inflation. In recent weeks, some market observers have been predicting an interest rate cut before the end of 2011. The money market has been pricing in a series of rate cuts based on global growth worries, spiralling government debt in Europe and the weak non-mining sectors of the Australian economy.

Read more: http://www.smh.com.au/business/high-cpi-keeps-rate-cut-off-the-table-201…

Greek MPs have passed a deeply resented austerity bill that has led to violent protests on the streets of Athens, despite some dissent from one Socialist MP. The new measures include pay and staff cuts in the public service as well as pension cuts and tax hikes for all Greeks. The bill passed by majority vote in the 300-member parliament. Former labour minister Louka Katseli voted against one article that scales back collective labour bargaining rights. http://www.smh.com.au/business/world-business/greeks-pass-austerity-bill…

Xinhuanet.com

Chinese stocks fell to the lowest levels since March 2009 on Thursday, as mounting concerns over a slowing economy and a standstill of the European bailout talks continued to weigh on investors. The benchmark Shanghai Composite Index slumped 1.94 percent, or 46.15points, to close at 2,331.37, the lowest level since March 2009. The Shenzhen Component Index suffered heavier losses by plunging 3.06percent, or 309.51 points, to close at 9,796.23, breaching the key 10,000 mark and set a new low since June 2010. http://news.xinhuanet.com/english2010/china/2011-10/20/c_131202627.htm

China is expected to replace Japan as the world’s second-wealthiest country after the United States with total fortune shooting to nearly US$40 trillion by 2016, Credit Suisse AG said in a report yesterday.

However, the accumulation of fortune will be achieved along with an expanding wealth gap in China where the Gini coefficient, a commonly used measure of inequality of wealth, has already passed an extremely dangerous level. China, which has surpassed Japan as the world’s second-biggest economy, will soon also catch up with the neighbor in terms of total wealth.http://news.xinhuanet.com/english2010/china/2011-10/20/c_131202237.htm

Peru’s Finance Minister Luis Miguel Castilla said Thursday the coming months won’t see a recession, but warned that financial authorities should “be prepared” for a global economic slowdown as it would have repercussions on the Andean nation. Castilla said there are “remote” possibilities that a recession may hit Peru’s economy, but the ongoing effects of the international crisis are still difficult to assess. “It is not correct to speak about a crisis in Peru, because the country’s rates are growing dynamically and the inflation is showing a downward trend,” he said.http://news.xinhuanet.com/english2010/business/2011-10/21/c_131204245.ht…

Cs.com.cn

China’s social financing, a broad measure of funds raised by entities in the real economy, shrank 1.26 trillion yuan (194 billion U.S. dollars) from a year earlier to 9.8 trillion yuan in the first three quarters, the central bank said Thursday. All sub-indicators grew at slower paces from the same period last year, except foreign-currency loans which expanded by 184.9 billion yuan from a year earlier to 477 billion yuan, and entrusted loans which increased by 562.5 billion yuan to 1.07 trillion yuan, the People’s Bank of China said in a statement on its website. The yuan-denominated lending accounted for 58 percent of total social financing, up one percentage point from a year earlier, according to the statement. http://www.cs.com.cn/english/ei/201110/t20111021_3096128.html

Thehindu.com

Food inflation surged ahead to breach the psychological double-digit barrier at 10.60 per cent for the week ended October 8 against 9.32 per cent in the previous week, leaving no one in doubt that the Reserve Bank of India (RBI) will continue with its hawkish monetary policy stance on October 25. More disturbing is the fact that the fresh spurt in WPI (wholesale price index)-based food inflation does not suffer from the statistical anomaly of base effect as the food price spiral during the same week last year was also at a high of 15.72 per cent. http://www.thehindu.com/business/Economy/article2554825.ece

Even as the U.S. has continued to press India to undertake more investor-friendly reforms under the bilateral Strategic Dialogue, the World Bank on Thursday virtually congratulated India and 29 other countries for significant strides in making their regulatory environments more business-friendly. In a report titled Doing Business 2012: Doing Business in a More Transparent World the World Bank and the International Finance Corporation said that between June 2010 and May 2011, there were 245 business regulatory reforms worldwide, which was 13 per cent more reforms than in the previous year.http://www.thehindu.com/business/article2556115.ece

At a time when India Inc. is saddled with the twin problem of high inflation and low industrial growth, Prime Minister’s Economic Advisory Council (PMEAC) Chairman C. Rangarajan on Thursday pitched for roll back of the excise duty stimulus that was provided to the industry to combat the slowdown in the wake of the global meltdown in 2008. At an interactive session at the Economic Editors’ Conference here, Dr. Rangarajan made out a case for urgent rationalisation of subsidies along with roll-back of excise duties to the pre-crisis levels if the budgeted fiscal deficit target for 2011-12 is to be met. “Adjustment in subsidies will have to be done as early as possible. Otherwise, we will not be in a position to contain [the] fiscal deficit,” he said.http://www.thehindu.com/business/Economy/article2556047.ece

Economictimes.com

An amazing surge in India’s exports to the Bahamas has stoked the lingering suspicion that a slice of the country’s trades is sham transactions done to bring back money stashed in secret accounts with offshore banks. In just two years, exports to the Bahamas – best known as a tax haven – have shot up from $2.2 million in 2008-09 to $2.2 billion in 2010-11, according to commerce department data. The number in no way matches the data on the Bahamas’ global imports, which according to UNCTAD – the global trade and investments monitoring agency – was $2.8 billion in 2010.http://economictimes.indiatimes.com/news/economy/foreign-trade/sudden-su…

Yonhapnews.co.kr

The heads of South Korean banks expressed concerns Friday that the current turmoil in the global financial market may lead to difficulties in securing mid- and long-term overseas borrowing, the central bank said. The Bank of Korea (BOK) quoted 10 chiefs of local banks as saying that local banks have secured a large bulk of foreign exchange liquidity in advance in an attempt to fend off a potential liquidity squeeze. However, lingering concerns about the global financial markets may make it difficult for them to raise foreign borrowing in the mid-and long term, such as from bond sales. The remarks came when BOK governor Kim Choong-soo met with local bank heads in a monthly meeting. http://english.yonhapnews.co.kr/business/2011/10/21/46/0503000000AEN2011…

Themoscowtimes.com

Syria may start using the Russian ruble for banking transactions if the European Union bans it from operations in euros, central bank governor Adib Mayaleh said Thursday. As a first step, the Syrian central bank has begun posting the exchange rate for the ruble as well as the Chinese yuan on its daily bulletin, Mayaleh said in an interview with the Arabic-language Russia Today channel. “Don’t forget that we can carry out operations in rubles,” Mayaleh said, according to an e-mailed transcript of the interview. “In the nearest future we will agree on parameters for switching to close cooperation with Russian banks and using the ruble for international settlements.” http://www.themoscowtimes.com/business/article/syria-may-switch-from-eur…

Fin24.com

Washington – The International Monetary Fund and the World Bank have visited Libya and will return there in “coming weeks” to assess economic and financial needs, an IMF spokesperson said on Thursday. Officials from the IMF and World Bank visited Libya earlier this month to conduct a fact-finding mission on the economy and public financial management issues, IMF spokesman Gerry Rice told reporters. “Follow-up missions are planned to undertake a needs assessment,” he said but was unable to give dates for the next visits. http://www.fin24.com/Economy/World-BankIMF-to-assess-aid-for-Libya-20111…

Thetrader.se

Greece will eventually fall. Where to look for the next set of violence is probably Italy and the very “quiet” Spain. The problems Spain is facing are huge. Spain is also the only country with a property collapse, that is slowly collapsing further, while people enjoy the sun. With so many unsold homes, the balance sheets won’t look good for many years to come. Despite the political juice from Zapatero, austerity plans and talk of a brighter future, people are suffering, and getting poorer by the day. Spain just hit new alarming Poverty levels, and there is no leveraged EFSF to save Spain.http://www.thetrader.se/2011/10/20/remember-spain-pain/

Good summary of the Argentinian Default. What caused the collapse, and what lessons are to be learnt for the current Greek situation? In 1998, Argentina entered what turned out to be a four-year depression, during which its economy shrank 28 percent. Argentina’s experience has been cited as an example of the failure of free markets and fixed exchange rates, among other things. The evidence does not support those views. Rather, bad economic policies converted an ordinary recession into a depression. Three big tax increases in 2000-2001 discouraged growth, and meddling with the monetary system in mid 2001 created fear of currency devaluation. As a result, confidence in Argentina’s government finances evaporated. In a series of blunders that made matters even worse, from December 2001 to early 2002, succeeding governments undermined property rights by freezing bank deposits; defaulting on the government’s foreign debt in a thoughtless manner;http://www.thetrader.se/2011/10/20/argentinas-economic-crisis/

Tags: Avoiding Bankruptcy, Bonds, Chinese Companies, Crude Oil, Daniel Tarullo, European Leaders, Eurozone, Federal Reserve Board, Firepower, Gold, Havoc, India, Institutional Shareholders, Investment Plan, Japanese Prime Minister, Level Governments, Local Governments, Market Turmoil, Mortgage Backed Securities, News That Matters, Outlook, Saab Automobile, Thetrader, Treasury Securities, Wsj
Posted in Bonds, Brazil, Gold, India, Markets, Oil and Gas, Outlook | Comments Off

Twist and Pout (Brown)

Tuesday, September 27th, 2011

Twist And Pout
September 26 – September 30, 2011

As expected, the Federal Open Market Committee opted for Operation Twist, and will sell short-term Treasuries out of its portfolio and buy longer-term Treasuries. However, the size of the Fed’s operation was larger than anticipated and more out-the-curve, sending yields on long-term Treasuries tumbling sharply. In addition, to further aid the housing market, the FOMC voted to recycle is maturing mortgage-backed securities and agency debt back into mortgage-backed securities (instead of into Treasuries, as it has been doing currently). So what’s not to like? By themselves, the Fed’s latest moves aren’t going to lead to strong GDP growth anytime soon, but they should help. The banks, however, may not be all that enthused about it. Margins just got compressed. They could make up for that by making a lot more loans, which may have been the Fed’s intent.

In its policy statement, the FOMC said that, by the middle of next year, it would buy $400 billion in Treasuries with maturities of 6 to 30 years and sell an equal amount of Treasuries with maturities of 3 years or less out of its portfolio. That amounts to about $44.4 billion per month. In its operating directive, the New York Fed said its purchases would be distributed as follows:

*On-the-run 10-year notes will be in the 8- to 10-year sector.

In response to the FOMC announcement, the yield on the 30-year Treasury bond fell 20 basis points, then dropped another 20 basis points the next day. The decision to recycle MBS should help to keep home mortgage rates low.

We will get some insights into the Fed’s thinking behind Operation Twist this week. Fed Governor Sarah Raskin will speak on “monetary policy and jobs” (Bernanke will testify to the Joint Economic Committee of Congress on October 4, but Raskin should provide a partial preview of what the Fed Chairman will say). Lower long-term rates should encourage consumer and small business borrowing and increase home refinancing activity. All of this is helpful news to consumers and small businesses, but will the banks lend?

Lower long-term interest rates will reduce lending margins for the banks. A steeper yield curve helped banks improve their balance sheets. With banks in a much better position than they were three years ago, the Fed is betting that a flatter curve, and margin compression, will not cause undo strain, but instead lead them to make up the difference in loan volumes. We’ll see.

The Fed is also making a gutsy call on the inflation outlook. Consumer price inflation has risen this year – overall and core – but the Fed has to set policy with an eye to the future. Commodity prices have begun to unwind, similar to the pattern we saw in 2008. Subpar growth should put downward pressure on inflation. Moreover, with downside risks to the U.S. growth outlook and evidence of a broader slowing in the global economy, the Fed feels justified in taking the risk that inflation pressures won’t ebb as anticipated.

Prior to the Fed policy meeting, Republican leaders once again sent a letter to Fed Chairman Bernanke expressing reservations about additional monetary policy stimulus. This is bizarre. One of the most important aspects of the Fed – indeed, what many consider to be the most important aspect – is its independence. The Fed is under the purview of Congress. However, it should not be directed by Congress in its monetary policy decisions. Thankfully, Bernanke remains above the fray.

Fed Policy Outlook – Something, But What?
September 19 – September 23, 2011

Fed policymakers meet this week at a critical juncture. Growth has slowed in the last few months – no recession, but well below potential, leading to some softening in the labor market. Consumer price inflation has picked up in 2011 and August CPI figures were on the high side of expectations. In their public comments, Fed officials have been divided on the potential benefits and risks of additional policy accommodation. However, some action is expected on Wednesday. The only question is which tool the Fed will pull out of its kit.

Recall that the Fed has a dual mandate: price stability and maximum sustainable employment. “Price stability” does not mean an inflation rate of 0%. Rather, the Fed’s implicit target is 1.5% to 2.0%. The general belief is that the Fed’s two goals are really one. By keeping inflation low over the long term, economic growth, and in turn the labor market, will be stronger than it would be otherwise. In normal times, attempts to lower the unemployment rate would lead to inflation pressures, and higher inflation would lead to slower growth over the long term. However, these aren’t normal times.

The Fed’s aggressive monetary policy has contributed to higher commodity prices, as one might expect, but it hasn’t been the only cause (increased global demand has been a more important factor and the Arab Spring boosted global oil prices). Higher commodity prices, if sustained, may be partly passed through to the consumer and we’ve certainly seen some evidence of this. The apparel component of the CPI, for example, rose more in the last four months (5.0%) than it did over the previous 23 years. It remains to be seen whether these price increases will stick. Prices of finished imported goods have risen somewhat over the last year, but they’re not falling like they were over the previous decade.

The Fed sees inflation as driven largely by inflation expectations, which act as inertia, and the amount of slack in the economy. Inflation expectations are still low. The Cleveland Fed estimates the 10-year expectation of inflation at 1.63%. The amount of slack in the labor and product markets remains high. With unemployment elevated, wage pressures are muted. However, it’s not just labor costs that matter. It’s what you get for that labor expense. There are difficulties in estimating Unit Labor Costs, which is labor expense divided by productivity, but recent figures have suggested a possible increase. That doesn’t necessary imply inflation pressure from labor (as the measure is considered relatively unreliable), but it could mean more pressure on firms to trim their workforces.

For monetary policy, the inflation and unemployment outlooks generate considerable room for debate. Senior Fed officials have been vocal in their opinions about the appropriate stance of monetary policy and these officials are divided among the traditional camps, the hawks and the doves. The hawks, fearing inflation, are some of the district bank presidents, of which only five get to vote on monetary policy at any time. Some district bank presidents are doves, as are a few of the Fed governors. The moderates will then have the most sway.

The Fed has been open about the policy tools that were discussed in August and will be debated this week: a lengthening of the maturity of the Fed’s asset holdings, further asset purchases, and a reduction in the rate the Fed pays on excess bank reserves. Most likely, we’ll see a maturity lengthening announced on Wednesday. This is similar to the Operation Twist conducted in the early 1960s. That was considered a failure, but largely because it was offset by a lengthening of the maturities of securities issued by the Treasury. The Treasury won’t work against the Fed now.

Extraordinary Measures Needed
September 12 – September 16, 2011

Recessions that are caused by financial crisis are different than the usual downturn. Weakness is more severe and longer lasting. Monetary and fiscal policy stimulus can help limit the downside, but can’t create prosperity. Yet, policy efforts can buy some time for the private sector to recover. Long-term budget strains add to the difficulty of deciding how much to do and when to take support away. Nobody said it would be easy.

This was not your father’s recession. In a typical recession/recovery cycle, the Federal Reserve raises rates to cool inflation pressures. The economy slows, creating some pent-up demand in autos and housing. The Fed eventually lowers interest rates, the economy begins to improve, and the pent-up demand comes roaring back. This is a different animal. Auto sales have improved off the lows, but remain far below pre-recession levels. Housing is bouncing around the bottom. A strong V-shaped recovery was never in the works.

The labor market has been the main area of concern. Without job growth, the demand for housing is going to remain subdued and consumer spending growth is going to remain stunted. Job growth hasn’t been horrible this year. Strong job growth in the early spring may have borrowed from the late spring and early summer. Nonfarm payrolls were flat in August, but that included a 45,000 strike impact, which will reverse in September. One atypical element in this recovery has been the massive job losses in state and local government. We have lost 640,000 state and local government jobs since December 2008, and continue to lose about 40,000 per month. While many rejoice in the concept of smaller government, it’s worth pointing out that these people have families and mortgages, and they spend their income. So the economic impact is a lot more than it seems. Moreover, many of these jobs are in education, which should be a priority for the long-term prospects for growth.

The White House has a proposal to boost jobs. There are a number of elements in the plan. Some are a continuation of existing stimulus, which would prevent a large fiscal drag in 2012. Others include a variety of proposals that have received Republican support in the past. The key issues are how much of the president’s proposal can make it through Congress and how it will be paid for. There’s no disagreement that the long-term budget trajectory must be corrected. However, tightening policy too soon risks dampening and prolonging the recovery. Politically, the president’s proposal may put Republicans in a bind. Obama effectively laid support for the labor market in Congress’ lap (in his joint address to Congress, he used the phrase “pass this plan” 18 times). If Congress rejects the package outright, the job market will continue to languish and Obama could run in 2012 against a “do nothing” Congress. Remember that Bill Clinton was widely seen as “a one-term president” until a government shutdown gave him a foil.

While the job package would provide some support for the economy, it’s unlikely to lead to substantial improvement in the job market. The impact of pump-priming appears to be limited given the magnitude of the economy’s headwinds.

While Fed officials appear to be divided, the hawks are a minority. More monetary stimulus is coming, but it’s unclear whether this will include another round of asset purchases or a lengthening of maturities in the Fed’s asset holdings.

Looking at Europe, it’s difficult to quantify the probability of a banking crisis, the exit of one or more countries from the monetary union, or a complete breakup. The political environment is difficult in a different sort of way than in the U.S.

Fiscal and monetary policy efforts in the U.S. may not lead to a strong recovery anytime soon, but at least we try.

Tags: 30 Year Treasury, 30 Year Treasury Bond, Basis Points, Fed Chairman, Fed Governor, Federal Open Market Committee, Fomc, GDP Growth, Home Mortgage Rates, Joint Economic Committee, Joint Economic Committee Of Congress, Maturities, Mortgage Backed Securities, New York Fed, Open Market Committee, Outlook, Partial Preview, Pout, Raskin, Treasuries, Year Treasury Bond
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Twist and Shout: The Fed, as Expected, Announced “Operation Twist” (Sonders)

Thursday, September 22nd, 2011

Twist and Shout: The Fed, as Expected, Announced “Operation Twist”

Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.

September 21, 2011

Key points

• The Federal Reserve announced “Operation Twist,” which was largely expected.
• The goal is to further reduce borrowing costs and push money via lending out into the real economy.
• Whether it will work is the big question … because high interest rates are not the economy’s problem.

No doubt in reaction to the significant weakening of the economy over the past several months, the Federal Reserve acted as expected and announced what’s known as “Operation Twist” (OT). The goal of this program, first instituted in 1961 and indeed named after the dance popular at the time, is to lengthen the average maturity of the Fed’s balance sheet. The result, ostensibly, will be to lower longer-term borrowing rates, including mortgage rates.

The details
Specifically, the Fed will buy $400 billion of US Treasury bonds with maturities of six to 30 years through next June. Over the same span, the Fed will sell an equal amount of shorter-term Treasuries, with maturities of three years and less. The Fed also announced that it will reinvest maturing mortgage debt into mortgage-backed securities (MBS) instead of Treasuries. This is intended to help reduce mortgage borrowing costs and stimulate additional mortgage refinancings and demand for new mortgages.

Over the past three months, the value of government agency securities and mortgages on the Fed’s balance sheet has contracted by nearly $40 billion, and the move to reinvest into MBS is to prevent a shrinking of its balance sheet.

My office is adjacent to that of Kathy Jones, our fixed income strategist. We listened to the announcement together, and she had this to say: “The only surprise was that the Fed will shift nearly 30% of its $400 billion in bond holdings into 30-year Treasuries, which is more than most thought would occur at the very long end of the yield curve. This will flatten the yield curve even further. We’ve been using the mantra ‘lower for longer’ … now I guess we’ll have to say ‘lower and flatter for a lot longer’.”

Not everyone’s a fan
As has been the case recently, there were three dissenters on the Federal Open Market Committee (FOMC): Dallas Fed President Richard Fisher, Minneapolis Fed President Narayana Kocherlakota and Philadelphia Fed President Charles Plosser. They’ve been more “hawkish” on recent Fed decisions, concerned about the unintended consequences of extremely easy monetary policy, including inflation.

That said, the statement accompanying the FOMC’s decision did note that “inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks.” The statement did note additional downside economic risks though, specifically mentioning “strains in global financial markets.”

50 years later
Today’s OT has the same rationale as that of 1961—to stimulate a very weak economy while trying to keep inflation at bay. The decision to “sterilize” the purchases of longer-dated Treasuries with sales of shorter-dated Treasuries, thereby keeping the balance sheet at its current size, is an attempt to keep inflation at bay. Recall that both rounds of quantitative easing, QE1 and QE2, did expand the balance sheet and helped unleash a rapid acceleration of commodity inflation. The Fed had been very transparent about its desire to prevent the unintended consequences of more quantitative easing.

What differentiates QE from OT is that OT does not impact the amount of money supply in the markets and therefore the effect on the dollar, and in turn commodity prices/inflation, is more limited. By adding liquidity at the longer end of the Treasury curve and pumping up the supply of Treasuries at the shorter end of the curve, the Fed is hoping that cash will venture into the real economy.

Will it work?
There are risks that the money won’t find its way into the economy and create jobs, as intended by the Fed. Remember, full employment and stable prices are the Fed’s dual mandates. There’s legitimate fear that the Fed’s siphoning of liquidity at the short end of the curve won’t actually lead to increased lending in the real economy. Instead, the move could destroy yields on savings without the beneficial effect on growth, leading to a form of liquidity trap.

We’ve consistently expressed concern that the Fed is unable to cure what ails the economy. The problem is not that interest rates are too high, but that we’re in a debt-deleveraging cycle that started three years ago in the private sector and is only just beginning in the public sector. This will take time—a lot of it—and although the Fed is not impotent, it does not possess the Holy Grail for the economy.

As for housing and mortgage rates, we’re also still in a mortgage deleveraging and foreclosure cycle, and frankly, policy makers may be missing what ails the housing market. The focus has been on getting mortgage rates down further in order to stimulate refinancings and new borrowing. But as I’ve noted many times, it’s the “real” mortgage rate that matters to prospective borrowers, not the “nominal” mortgage rate. What do I mean by that?

The math of “real mortgage rates”
Back at the peak of the housing bubble in 2005, the 30-year fixed mortgage rate (the nominal rate) was about 6%. To get the “real” mortgage rate, you have to subtract the appreciation in home prices (the “deflator”). Home prices were appreciating at a 17% annual rate at the bubble’s peak. So, the real mortgage rate was actually -11%: 6% – 17% = (11%). No wonder we had a bubble … who wouldn’t want to borrow at negative rates? You could borrow at 6% to buy an asset appreciating at 17% per year.

Fast-forward to the trough in housing in 2009. The nominal 30-year fixed mortgage rate had dropped to 5%, but home price appreciation became depreciation at an ironic 17% rate. So, the real mortgage rate was actually +22%: 5% – (17%) = 22%. Who wants to borrow at any rate to buy a rapidly depreciating asset?

I think this is what many policy makers are missing. It’s the “rapidly depreciating” part of the equation that needs to heal. If home prices are still declining, even with rates low, there’s likely to be limited demand to borrow. I do think mortgage refinancings could get at least a marginal lift from OT if rates go lower, but we need to be realistic about the overall affect on housing.

Confidence is key
Ultimately, confidence has to improve before we’re likely to enjoy any reasonable pace of economic growth. Whether this move by the Fed starts the confidence-healing process remains to be seen. But we suggest you keep your expectations relatively low.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Tags: 30 Year Treasuries, Agency Securities, Balance Sheet, Bond Holdings, Bonds, Charles Schwab, Chief Investment Strategist, Commodities, Fixed Income, Government Agency, High Interest Rates, Kathy Jones, Liz Ann, Maturities, Mortgage Backed Securities, Mortgage Borrowing, Mortgage Debt, Mortgage Rates, Mortgage Refinancings, No Doubt, Senior Vice President, Us Treasury Bonds
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John Paulson’s Take on Markets

Thursday, May 12th, 2011

John Paulson, hedge fund billionaire of Paulson & Co that capitalized on the problems in mortgage backed securities, a few days ago addressed a Global Financial Services Conference hosted by UBS. The notes below are being circulated among traders. The original source is not known, but this version comes courtesy of Business Insider – Clusterstock.

In short, Paulson is bullish on financials and gold, confident about the recovery, and thinks housing will be stable by 2012.

The following are a few bullets on his talk:

• Believes financials are under-followed at present whilst earnings are recovering.

• Confident US recovery is going to continue. One weak segment impeding growth is housing. However transition rate of delinquencies has dropped, i.e pool of delinquent mortgages is declining.

• Expect normal housing market by 2013.

• Assuming 7% S&P earnings and a normalized market PE, there is 34% upside.

• Financials’ earnings expected to recover strongly as provision expenses decline.

• Sees 40–60% upside in bank stocks.

• Sees US banks as better capitalized an over-reserved vs European once, hence only European holding is Lloyds.

• Doesn’t see any good shorting opportunities in financials.

• Expect to see pick-up in M&A in financials, particularly cross-border.

• Doesn’t think gold is a crowded trade. Only a small portion of pension fund assets held in gold.

Source: Business Insider – Clusterstock, May 10, 2011.

[AA's Note:] Lyxor/Paulson Advantage Fund Limited and Lyxor/Paulson International Fund Limited can be accessed indirectly via PROPEL MULTI-STRATEGY FUND (PPF.UN-T), a closed-end trust, which trades on the Toronto Stock Exchange. The fund allocates roughly 80% of assets to the two Paulson partnerships, and the remaining 20% is allocated to the SPDR Gold Trust by way of forward agreement. [AA]

Disclosure: no position

Tags: Advantage Fund, Bank stocks, Business Insider, Cross Border, Delinquencies, Delinquent Mortgages, E Pool, Global Financial Services, Gold, Gold Source, Hedge Fund Billionaire, Housing Market, John Paulson, Lloyds, Mortgage Backed Securities, Original Source, Pension Fund Assets, Small Portion, Source Business, Strategy Fund, Toronto Stock Exchange
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