Monday, January 06, 2014 - A Cold Forecast

A Cold Forecast

by Sinclair Noe

DOW – 44 = 16,425
SPX – 4 = 1826
NAS – 18 = 4113
10 YR YLD - .03 = 2.96%
OIL - .31 = 93.65
GOLD - .20 = 1238.80
SILV + .02 = 20.27

A few big things this week. Friday we'll see the monthly jobs report. Today we had the confirmation of Janet Yellen, no surprise there; on Wednesday we'll see the minutes of the most recent FOMC meeting which will give us the justification for the taper. The minutes will likely include strong differentiation between taper and tightening, and the Fed is likely to stress the importance of accommodative monetary policy and ultra-low interest rates for the next 18 months or so.

Any bond gains have been curbed as we start the new year; a combination of the Fed slowing its bond purchases, plus corporate supply, plus there is still the safe haven aspect of bonds in the face of a few days of weakness in the equity markets. This Friday's jobs report will prove important as a barometer for yields. More than 2.2 million jobs were probably created in 2013, the most since about 2.5 million eight years earlier. The estimates call for 195,000 net new jobs in December and the unemployment rate to hold at 7.0%. If the economy added more than 200,000 jobs we might expect a more aggressive taper; fewer than 200,000 jobs and the taper might be more sanguine.

Healthcare spending in the US rose 3.7% in 2012 to $2.8 trillion, the fourth year in a row in this range as the slow economic recovery tempered private insurance use, drug prices fell and the government held back payment increases for doctors. For the first time in more than a decade, health care spending grew more slowly than the US economy from 2010 to 2012. It marks the slowest rate of increase in healthcare spending since 1960, even though that $2.8 trillion figure represents 17.2% of the national economy. Expenditures on health care, including everything from hospital procedures to prescription medicines, rose less than 4 percent a year from 2009 through 2012, after growing by an average of more than 7 percent from 2000 through 2008 and by double digits in the previous decade.

Today the Institute for Supply Management said its index on services fell in December, while the Commerce Department said new orders for factory goods rebounded in November following a drop in October. The pace of growth in the services sector slowed for a second straight month in December with business activity expanding at a lower rate and new orders contracting, according to the Institute for Supply Management. ISM’s index fell to 53 points last month from 53.9 in November, dropping to its lowest reading since June 2013 and under expectations for a read of 54.5. A separate report from the Commerce Department showed new orders for factory goods rebounded in November, rising 1.8%, as had been forecast. The department also said orders for durable goods, manufactured products expected to last three years or more, rose 3.4% instead of the 3.5% increase reported last month. Durable goods orders excluding transportation rose 1.2%.

And then, just to keep things interesting, Alcoa kicks off the earnings reporting season. And after the Fed minutes on Wednesday, the Bank of England and the European Central Bank will meet to determine monetary policy on Thursday. It should be a fun week.

Last Friday, Fed Chairman Ben Bernanke gave an upbeat outlook on the economy but he cautioned that the recovery "clearly remains incomplete." That was part of an economic conference in Philadelphia. Bernanke got most of the attention, but one of the more interesting comments came from New York Fed President William Dudley, who said  a lot is still unknown about how the bond buying works. His observation is important because he has long been a supporter of aggressive Fed actions to help the economy. The New York Fed leader has for some time expressed support for continuing the purchases, even as he also voted in favor of the Fed’s decision last month to cut back.

Referring to the Fed’s stimulus program, Mr. Dudley said, “we don’t understand fully how large-scale asset-purchase programs work to ease financial market conditions—is it the effect of the purchases on the portfolios of private investors, or alternatively is the major channel one of signaling?” Mr. Dudley also said that when it comes time to unwind the Fed’s easy-money stance, uncertainty is again a major issue facing central bankers. “There could be unintended consequences” about moving to a more normalized state of monetary policy, he said.

I tend to think that such uncertainty runs deeper than it appears at the Fed, which is why policymakers are eager to end asset purchases. The more they buy, the more they risk "unintended consequences" at exit time.

It's a cold week for most of the country. Spot wholesale electricity in Texas  topped $5,000 a megawatt-hour for the first time as cold weather boosted demand and prompted the grid operator to import generation from Mexico and ask users to conserve power until at least tomorrow. Power consumption on the Electric Reliability Council of Texas network, which covers most of the state, averaged 53,369 megawatts for the hour ended at noon, a 6.7 percent increase from the day-ahead forecast of 50,034 megawatts. One megawatt is enough to serve about 500 homes during mild weather and about 200 homes during periods of peak demand.

The forecast is extreme: 32 below zero in Fargo, N.D.; minus 21 in Madison, Wis.; and 15 below zero in Minneapolis, Indianapolis and Chicago. Wind chills, what it feels like outside when high winds are factored into the temperature, could drop into the minus 50s and 60s. That's dangerous cold weather. Frostbite and hypothermia can set in quickly at 15 to 30 below zero. A flu epidemic has now spread across half the country. It hasn't been this cold for almost two decades in many parts of the country.

There have been plenty of problems associated with the weather, not the least of which is air travel. Airlines canceled 4,400 flights on Monday, bringing the total to more than 17,000 over the last week. Today, there is a scheduled flight worth noting, Delta Flight # 2014 from Minneapolis to Atlanta; it marks the last commercial flight for the DC-9. For the past nearly 50 year, the Douglas DC-9 was an aviation workhorse, credited with bringing jet service to most small and medium sized US cities. Delta was the launch customer for the DC-9 back in 1965.

Business bankruptcy filings in the US dropped 24% last year to the lowest level since 2006. The American Bankruptcy Institute reports the total filings by businesses and individuals fell to 1.03 million, the report said, from 1.19 million in 2012.

A trial over how Detroit should end costly financial contracts with two big banks was suspended today after more than a foot of snow fell, paralyzing much of the city and closing the federal courthouse there. Creditors of the city had been scheduled to make their closing arguments against a plan for Detroit to pay $165 million to exit the contracts, known as interest-rate swaps. The creditors say that termination fee improperly favors the two swap counterparties, Bank of America and UBS.

The storm also stopped the trial just as a group of creditors accused the mediator who negotiated the swap-termination deal of misconduct. The creditors filed an objection last week, contending that the mediator had exceeded the limits of his authority when he publicly praised the $165 million deal and said he would recommend that the bankruptcy court approve it.

The creditors, including both financial institutions and labor groups, complain that the swaps were invalid from the time Detroit signed them, in 2005. They say that if Detroit took legal action against the two banks, instead of paying them to end the contracts, the city could obtain a much better deal. If Detroit cannot obtain the new loan, proposed by Barclays Capital, the city has warned that it soon will soon be out of cash and unable to pay its workers.

It was not clear when the trial might resume.

JPMorgan Chase is expected to announce this week that it has reached civil and criminal settlements to the tune of $2 billion for ignoring the signs of the Bernie Madoff Ponzi scheme. Madoff used JPMorgan as his bank, and this is basically a money laundering charge against JPMorgan. All told, after reaching the Madoff settlements with federal prosecutors in Manhattan and regulators in Washington, the bank will have paid some $20 billion to resolve government investigations over the last 12 months, and there might be more settlements in the months ahead. Authorities have opened a bribery investigation into JPMorgan’s hiring practices in China, prompting the bank to turn over internal emails and documents about its “Sons and Daughters” hiring program, which employed the children of the nation’s ruling elite.

The Madoff case, perhaps the largest threat to JPMorgan as it hung over the bank these last five years, produced its own damaging emails. The emails, some of which came to light in a private lawsuit against the bank, suggest that even as questions swirled about the legitimacy of Mr. Madoff’s operation, JPMorgan continued to do business with him. In one internal email sent before Mr. Madoff’s arrest in December 2008, a senior risk manager at JPMorgan reported that another bank executive “just told me that there is a well-known cloud over the head of Madoff and that his returns are speculated to be part of a Ponzi scheme.” No individual executives have been accused of wrongdoing.

JPMorgan’s Madoff settlements will also likely involve a so-called deferred prosecution agreement, a criminal action that would essentially suspend an indictment as long as JPMorgan acknowledged the facts of the government’s case and changed its behavior.  JPMorgan has publicly maintained that “all personnel acted in good faith” in the Madoff matter; they may have to modify that position in light of the deferred prosecution agreement.