Wednesday, July 31, 2013 - GDP, FOMC, Swipes

GDP, FOMC, Swipes

by Sinclair Noe

DOW – 21 = 15,499
SPX – 0.23 = 1685
NAS + 9 = 3626
10 YR YLD - .03 = 2.58%
OIL + 2.24 = 105.32
GOLD – 3.50 = 1324.20
SILV + .08 = 19.91

Here's the scorecard as we wrap up the month of July. The Dow Jones Industrial Average is up 19.9% year to date, with about a 550 point gain for July. The S&P 500 is up 19.6% YTD, with a 70 point gain for the month. The Nasdaq Composite has a 20.9% YTD gain, with a 190 point gain for July. Ten year Treasury Yield is up about 10 basis points for the month and since the start of the year, yields have climbed from the 1.75% range to today's close at 2.58%. Oil prices jumped from 97.88 at the start of the month to the current 105.32. And August gold futures bounced from the 1200 level to the current 1325.

The stock market started today's session with gains but could not hold on as the Federal Reserve FOMC wrapped up its two-day meeting by announcing they will stay the course, and will keep buying $85 billion a month in bonds to help lower long-term interest rates. And it says it plans to hold its key short-term rate at a record low near zero at least as long as the unemployment rate stays above 6.5 percent and the inflation outlook remains mild. They say the economy is growing only modestly, a downgrade from its June assessment. The Fed expects growth will pick up in the second half of the year, but today's statement reflected a more cautious message. Chairman Ben Bernanke said after the June meeting that the Fed could slow the bond purchases later this year if the economy and job market continued to strengthen. But after Wednesday's meeting, the Fed described the economy as expanding only at a "modest pace" and there was no talk of taper.

The FOMC had little time to digest the latest economic data. The government announced earlier this morning that the economy expanded at an annual rate of 1.7% in the second quarter, better than economists had expected but below the pace that Fed officials regard as necessary to create enough jobs to bring down the unemployment rate. The Fed has predicted faster growth in the second half of the year.

The economy grew a bit faster than analysts had predicted, topping expectations of 1% growth, but still, it was sluggish, hardly indicative of an economic boom, let alone enough to bring down elevated levels of unemployment soon. It is also the third quarter in a row in which growth failed to top 2 percent, the average since the recession ended in 2009. And the slightly better than expected number was tempered by a downward revision to first quarter GDP, revised from 1.8% down to 1.1%. Today's number is also subject to a couple of future revisions.

There were some positives in the GDP report,  residential fixed investment increased by 13.4 percent, a sign the housing sector continues to recover. Personal consumption rose 1.8 percent, as consumers showed some resiliency, especially given the increase in payroll taxes at the beginning of 2013. Higher inventories added 0.41 percentage point to overall growth, but inventories are volatile. Meanwhile, military spending flattened out after falling 21.6 percent in the final quarter of 2012, and another 11.2 percent in the first quarter of 2013, military spending last quarter barely budged, sinking just 0.5 percent, so it looks like most of the military wind-down has been completed – maybe.

Every five years the Commerce Department's Bureau of Economic Analysis revises the data used to calculate GDP, including changes to definitions and classifications of some measures that update the data to better reflect the evolving economy. The results of that revision were released today, and it covers 83 years of data. There were some interesting results.

Dating back to 1929, the U.S. economy grew at a 3.3% annual pace, which is one-tenth of a percentage point higher than previously published estimates. From 2002 to 2012, the growth rate was 1.8%, up from a previously reported 1.6% pace.

The great recession was less severe than previously thought, with the economy shrinking at an average annual pace of 2.9%, revised from a 3.2% contraction. In 2012, the economy expanded at a 2.8% pace versus a previous estimate of 2.2%. But that performance was wildly uneven over the course of the year, with a strong 3.7% annualized pace in the first quarter after a big upward revision, followed by two middling quarters and finally an abysmal 0.1% growth rate in the final quarter of the year. In current dollar figures the revisions added nearly $560 billion to the overall figure 2012 GDP figure of $16.2 trillion. The current recovery, while revised to show stronger growth, is still the weakest since World War II. The economy expanded at an average 2.3% annual pace between the second quarter of 2009 and the fourth quarter of 2012, compared with a previously published 2.1% pace.

One of the interesting revisions to GDP includes recognition of the contributions from entertainment. Film, long-running television shows and some aspects of the literary world, which previously had not been counted, now will be included. Entertainment will need to possess three qualities to be counted: Ownership rights, a long life, and repeated use. So, something like a motion picture will be included as investment even after the movie has its initial run in theaters. It will have streaming, DVD sales, online sales, TV movie of the week. That future stream of production makes it an investment.

The economic value of a Harry Potter movie under the old method only showed up in GDP through the personal consumption expenditures on movie tickets or DVD sales in a given period.  Under the new definition, the cost of producing the film would also be part of GDP as an investment that contributes to the production process over decades. The economic value of a large swath of TV shows will remain worthless.

In addition to entertainment, the new calculations include research and development, transactions involving defined benefit pension plans, and nonfinancial ownership transfer costs in real estate, or the costs involved in sales beyond agent commissions.  R&D is currently considered a cost of doing business but with the new classification it will be defined as an investment no different than spending for a building, equipment or software.

I'm not sure how swipe fees are counted in GDP, but there might be some changes. Retailers battling banks over debit-card transaction costs were handed a victory by a US judge, who said merchants were overcharged billions of dollars under an unlawful swipe fee set by the Federal Reserve.

The judge ruled  that the Fed considered data it wasn’t allowed to use under the Dodd-Frank law in setting the cap on debit-card transaction fees, known as swipe fees, at 21 cents, and neglected to bolster competition in card networks.

The decision, unless overturned on appeal, will force regulators to revisit rules that bankers said would cost them 45 percent of their swipe-fee revenue. Lenders collected about $16 billion annually from those fees before the Fed’s regulation and responded by cutting back on perks such as rewards programs and free checking to soften the blow to their profits.

The Fed’s rule, in effect since October 2011, will stay in place until the central bank drafts new regulations or interim standards. This is saying 21 cents may be too much. You’ll have to go back to the drawing board and figure out how much a debit-card transaction actually costs and is there going to be some kind of premium paid to that.

The Fed rule was called for by the 2010 financial overhaul law, which was enacted in response to the 2008 crisis. The ruling today finds that the Fed disregarded Congress's intent in passing the law by "inappropriately inflating all debit-card transaction fees by billions of dollars and failing to provide merchants with multiple unaffiliated networks for each debit-card transaction."

The retailers' lawsuit maintained that the cap is an "unreasonable interpretation" that exceeds the authority given to the Fed by the 2010 law. It also asserted that the Fed wrongly interpreted a provision of the law that requires that merchants have a choice of which bank network handles their transactions.

The retailers complained that the Fed had deviated from the law's intent by factoring expenses into the cap that the law didn't allow. They maintained that the Fed reversed its earlier view that the only costs that should be considered were those involved in the authorization, clearing and settlement of a transaction. Instead, the suit said, the Fed added costs such as losses from fraud that were outside the scope of the law.

The Fed in June 2011 formally set the cap for what banks can charge merchants at 21 cents for each debit-card transaction, plus an additional 0.05 percent of the purchase price to cover the cost of fraud protection.

Banks had lobbied hard against the cap, saying the lower fees wouldn't cover the cost of handling transactions, maintaining their networks and preventing fraud. Attempts by some big banks to compensate by charging consumers monthly fees for using debit cards sparked a nationwide furor in late 2011, leading the banks to drop their plans.