Wednesday, April 25, 2012 - Bernanke Approximately Right, UK Approximately Wrong, Students Approximately Taxed

DOW + 89 = 13,090

SPX + 18 = 1390
NAS + 68 = 3029
10 YR YLD +.02 = 1.98%
OIL -.11 = 104.01
GOLD + 2.80 = 1645.30
SILV - .12 = 30.81
PLAT + 8.00 = 1559.00

If you own shares in Apple, congratulations. It gained nearly $50 to finish at $610, up nearly 9%. If you don't own Apple, don't worry about it, don't chase it. Realize that a big chunk of the move today for the broader market, was really just Apple, but it was a good day, with gainers outpacing losers by 3 to 1.

The Federal Reserve wrapped up their FOMC meeting and announced no changes. Wow, what a surprise. The Fed didn't raise rates – they can't. They didn't lower rates – they can't. They didn't announce QE3, but they didn't take it off the table.

Bernanke told reporters at a press conference, “We see monetary policy as being approximately in the right place at this point.” He said, “Our intention is to maintain highly accommodative stance of policy for the foreseeable future.” Kind of like QE in Perpetuity.

Bernanke stressed that the Fed could purchase more assets if it looked like the economy needed help, but he said some ways to boost the economy, like tolerating higher inflation, would be “reckless.” At the same time, he said it was too early to raise rates, “I think it’s a little premature to declare victory. I think that keeping interest rates low is still appropriate for our economy.”

The Fed’s unemployment forecast was lowered and the inflation forecast hiked for 2012, 2013 and 2014, though by fairly minor amounts: for 2012, the jobless rate is seen between 7.8% and 8%, compared with January’s forecast of 8.2% to 8.5%, and the PCE inflation rate is seen between 1.9% and 2%, compared with January’s forecast of 1.4% to 1.8%.

Yea, they might not want too declare victory just yet; they might not want to have Bernanke in front of a banner saying “Mission Accomplished”. Presently, the Fed is missing its employment target, and it is also below its declared inflation target of 2 percent. As the statement says, "the Committee anticipates that subsequently inflation will run at or below the rate that it judges most consistent with its dual mandate." So there is no risk of overshooting the inflation target according to the Fed, only a risk of undershooting it.

If that's true, if the Fed is likely to undershoot both of its targets -- the committee believes that in the worst case it will only hit its inflation target, not exceed it -- then why not pursue more aggressive policy?

And the Fed is afraid of inflation, in large part because the derivatives market has cut off any possible remedies. Interest rate risk is now credit risk and credit risk is enormous. Also, if the Fed faces inflation, they really have a conundrum; do they use their tools to fight inflation or do they use their tools to fight unemployment? They can't fight both with the same tools.

The British economy shrank in the first three months of 2012, falling back into recession as construction activity and industrial output fell.

The U.K. Office for National Statistics said gross domestic product contracted by 0.2% in the first three months of the year, following a 0.3% fall in the final quarter of last year. A recession is widely defined as at least two consecutive quarters of shrinking GDP.

The economy contracted 0.8% on an annualized quarterly basis, the method used to express quarterly changes in U.S. GDP.

So, the Brits have been hoping that austerity would set the stage for growth but it hasn't happened. The results aren't drastic enough to reverse policy but these latest results do highlight that the economy will not withstand any further acceleration in cuts.

The British economy is more exposed to the euro-zone economy than the U.S., but the euro-zone debt crisis was well known when austerity was rolled out; in fact, it was an argument in the last general election, that Britain wanted to avoid becoming Greece. Mission Accomplished, maybe.

Spain is also in a recession. The Dutch opposition parties refused to back austerity cuts needed to meet EU budget targets. Greece's central bank governor warned politicians and voters that they must stick to austerity targets, even after the May 6 elections, or they will surely be kicked out of the Euro-Union. Italy has imposed a limit on cash transactions – no more than 1,000-euros in cash – trying to curb under-the-counter transactions.

And don't forget, it's a global economy; a recession in the world’s third-largest economy (UK), combined with the current slowdown in the world’s second-largest (China), spells trouble for the world’s largest (US). If there’s not enough demand for US goods and services coming from the second and third-largest economies in the world, then we got trouble right here in River City.

The US housing market is showing more signs of stabilization as price declines ease and home demand improves, spurring several economists to call a bottom to the worst real estate collapse since the 1930s. “The crash is over,” says Mark Zandi, chief economist for Moody’s Analytics . “Home sales — both new and existing — and housing starts are now off the bottom.” Economists including Bank of Tokyo-Mitsubishi UFJ’s Chris Rupkey, Bank of America’s Michelle Meyer and Mark Fleming of CoreLogic are also predicting prices have bottomed, even as the threat of more foreclosures loom to boost supply. Mission Accomplished.

Student loan debt has passed the $1 trillion dollar mark. The interest rate that students pay on the basic “subsidized” loan is slated to rise from 3.4% this year to 6.8% next year, unless the lower rate is extended by Congress.

How does the government profit from student loans? Yield spread. Treasury can borrow money at 0.5% or less, and lends it to students at 3.4%. Administrative costs are well below 1%. Prepayment risk is minimal; repayment stretches over many, many years, and the interest just keeps on growing. Interest rate risk is also minimal, given that Treasury can issue debt in a range of maturities.

Loans go into default at about 10% projected for 2013 loans, so credit losses are relatively modest. There is no statute of limitations on student loans, and even bankruptcy discharge is difficult. The $37 billion Treasury profit for FY2012 is after allowing for estimated credit losses in the $5 billion range. So what are the President and Congress arguing about? They are arguing about how much of the federal deficit to plug with student loan interest money. The current “baseline” budget assumes that the rate will jump up to 6.8% for 2013 loans, yielding another $30 to $40 billion return to Treasury. The debate is how much they can scalp off the students. Once upon a time college education was subsidized to a large extent. It was nearly free in California. The Arizona constitution requires that college education should be as nearly free as possible. Charging interest on student loans is just a way of moving the cost from one segment of the economy to another. It's a tax on young students. If the Federal Reserve can lend money to the banks at near zero, I don't know why they couldn't give a comparable deal to students. Just saying.

Of course, the default numbers could change. USA Today reports half of the new graduates are either jobless or underemployed in positions that don't fully use their skills or knowledge. Mission Accomplished.