Wednesday, July 09, 2014 - Waiting for Liftoff

Waiting for Liftoff
by Sinclair Noe

DOW + 78 = 16,985

SPX + 9 = 1972
NAS + 27 = 4419
10 YR YLD - .02 = 2.54%
OIL – 1.46 = 101.94
GOLD + 7.00 = 1327.60
SILV + .08 = 21.10

The Federal Reserve released the minutes of the most recent FOMC policy meeting from June 17-18.

The Fed is going to take away the punchbowl. As of October, no more punchbowl. That’s it, QE is drying up. I think we all knew that was coming. And then after the Fed stops buying Treasuries and mortgage backed securities, they will get around to probably raising their target on interest rates, but rates would remain near zero for a “considerable time” (probably the spring of 2015) after the Fed halts its program of bond purchases.

According to the minutes, there continues to be division over when the Fed should stop reinvesting proceeds of the $4.2 trillion in assets it purchased to support financial markets. Ending reinvestment will put the central bank's balance sheet on a declining path, and some members argue that should not take place until interest rates have been increased. Fed officials also agreed that the rate of interest on excess reserves would play a “central role” in moving rates higher when the time comes.

And this is a fluid timeline for all this; it is partly dependent on “liftoff”; that’s the new word from the Fed – liftoff. At some point, the economy will slip the surly bonds of earth and wheel, soar, and swing high in the sunlit silence, and do a hundred things we haven’t dreamed of for such a long, long time. Someday, we’ll have liftoff.

The market players looked at the minutes and pulling away the punchbowl, while painful, was an indication of economic strength. Fed officials expressed overall confidence that moderate economic growth will continue and unemployment and inflation will gradually move towards the central bank's targets. A couple of participants noted that consumer spending had been supported importantly by gains in household net worth while income gains had been held back by only modest increases in wages. So, an important element in the economic outlook was a pickup in income, from higher wages as well as ongoing employment gains that would be expected to support a sustained rise in consumer spending. Which is correct in theory; we just haven’t seen the pickup in income.

At the press conference after the June meeting, Fed Chairwoman Janet Yellen said that recent inflation readings were “noisy.” According to the minutes, the Fed staff was not concerned with inflation despite some recent higher readings. Although the Fed staff revised its inflation forecast up “a little” in the near term, the medium term projection was revised down slightly.

Yesterday I talked about an anomaly in the jobs number from Thursday. How could we have negative 2.9% GDP in the first quarter while we were adding all those jobs? I concluded that the problem was that productivity was declining.

New data was released this morning showing US productivity growth was the worst since the recession. The data from the Labor Department looks at multifactor productivity, and it includes the impact of capital, new machines, investment in technology, and such. The measure of capital services input grew 1.9%, which is the best showing since 2008, but that is more a reflection of the bounce from the 1st quarter, and still far from the pre-recession levels that were consistently above 3%. So, the data in this morning’s report is consistent with an economy coming out of a recession but nowhere near its pre-recession rate of growth. Bottom line is that productivity needs to increase if the economy is going to get better.

One of the concerns for Fed monetary policy is inflation, which isn’t a problem right now and when we have seen a problem in the past 20 years of so, the Fed has been able to tamp it down. The problems with inflation right now are tied to energy and food prices. Food prices are largely tied to weather, and we have seen some nasty weather, and the Fed can’t control the weather. Extreme weather will be an ongoing problem, and rising food prices will be an ongoing challenge, but for now, it’s a short term inflation problem.

Energy prices are largely tied to geopolitical problems in the Middle East. Iraq, Israel, Syria, and other problems could explode out of control at any given moment, but we’ve seen crude oil prices dropping for 9 sessions. The problem in Iraq may very well result in the country splitting apart, but the southern regions, which produce and export the most oil, will likely continue exporting oil. So, the oil traders don’t seem concerned about Iraq divided in 3 parts. Meanwhile, Ukraine hasn’t unfolded as Putin planned. Kiev did not roll over. Sanctions are painful. Putin doesn’t look like he wants to escalate the fight; at least not today.

Meanwhile, the US is more or less on track to pass Russia and Saudi Arabia as the world’s largest producer of crude oil within the next 5 years. Domestic crude output is increasing but the increase is coming from shale and shale is notoriously tricky and expensive to extract. The US will continue to extract more shale oil but certain projects, even mega-projects, have been abandoned because of the expense. We know that there are huge reserves in the US, but it doesn’t always pay to pump it; so the increase in output may not be as strong as hoped. For now, prices are high and oil extraction is soaring at shale formations from Texas to North Dakota as companies split apart rocks using high-pressure liquid, or fracking. The result is that now Oklahoma has more earthquakes than California, and we are less dependent on foreign oil.

The United States has just become the world’s biggest oil producer, at least when you consider crude oil plus natural gas together. The US has been the top global nat gas producer for the past 4 years, but a new report from Bank of America says that in the first six months of this year the US overtook Saudi Arabia and Russia to become the top producer of petroleum product, that is oil and natural gas and the liquids that are separated from nat gas.

Annual investment in oil and gas in the US is at a record $200 billion, reaching 20% of the country’s total private fixed-structure spending for the first time, but it will take some time for that investment to work its way through the rest of the economy. We now produce about 11 million barrels a day of crude oil and we consume about 18.5 million barrels a day. So despite the boom, we still import oil and we are still dependent on OPEC. If we converted from oil and gasoline to nat gas, starting running more cars on compressed natural gas, we could become energy independent in short order.

The other side of the equation remains conservation and not just a switch to nat gas but a switch to renewable energy. You think green energy is too expensive? Tosh; tosh and falderal. Global energy markets are reaching a tipping point. For the first time, a large fraction of the world's fossil fuels could be replaced at a lower cost by clean energy, with today's renewable technologies and prices. And virtually no further investments in fossil fuels make long-term economic sense because higher fossil fuel prices over their useful life will be exorbitant.

Barclay's Bank recently downgraded the entire US utility sector in fear that it would not respond to the disruptive challenge of distributed solar. The Barclays credit team believes that, over the next few years, the “confluence of declining cost trends in distributed solar photovoltaic (PV) power generation and residential-scale power storage is likely to disrupt the status quo.” The new government in India is cutting fossil fuel subsidies and promising to provide rooftop solar for 400 million homes. Conservation is another important element. Profitable building retrofits would cut fossil fuel used for heating and cooling by 20%, and displace another 15% of fossil fuel electricity demand.

International oil companies are hitting the wall on the price they will pay for big new oil projects. There is plenty of oil in Ohio but BP, in its last quarterly report, announced it would halt development of the Utica shale fields. Along with BP, Chevron, Shell, Total, Statoil, and Exxon have all cancelled or delayed mega projects or even sold off major investments in US oil projects

The latest Bloomberg New Energy Finance projection suggests that 2/3 of incremental global power generation over the next fifteen years will come from renewables. Declines in coal use in developed economies will be sharp enough to cut the global share of fossil fuels from 64% today to only 44% in 2030.

Electricity currently provides only 1% of global transportation energy; EV's and rail could today replace the first 15% of the oil used by cars and trucks at with an internal rate of return higher than 15%. Fossil fuels generate 63% of the world's power, renewables less than 5%, but 1/3 of fossil electricity now costs more than competing wind and solar. And that doesn’t even begin to factor in the externalities associated with fossil fuels.

A couple of quick notes as we wrap up. Citigroup is reportedly close to paying about $7 billion to resolve a probe into whether it defrauded investors on billions of dollars’ worth of mortgage securities in the run-up to the financial crisis. A majority of the settlement is expected to be in cash, but the figure also includes several billion dollars in help to struggling borrowers. An announcement of the settlement between the bank and the Department of Justice could come as early as next week.

This bit of economic data came in late this afternoon. The Arizona Regional Multiple Listing Service shows the Phoenix market saw overall sales in June drop 11% year over year; now back to the lowest sales since 2008. Non-cash sales were up 6% year over year, but cash sales were down 40%; so it looks like investors are moving on. Active inventory is up 43% year over year and at the highest level for June since 2011. So, sales are down, inventory is very high, and cash is scarce.

When do we start QE4?

Wednesday, January 08, 2014 - Tapering is Not Tightening

Tapering is Not Tightening

by Sinclair Noe

DOW – 68 = 16,462
SPX – 0.39 = 1837
NAS + 12 = 4165
10 YR YLD + .06 = 2.99%
OIL – 1.15 = 92.52
GOLD – 5.90 = 1226.90
SILV - .32 = 19.62

Repeat after me: “tapering is not tightening.” This is the new mantra of the Fed; tapering is not tightening.

Today we got the minutes of the Fed FOMC policy meeting of December 17-18, and one of the themes is that the policy setting members of the Fed want to proceed with caution in trimming asset purchases and tapering is not on a rigid preset course; it is subject to incoming economic data and tapering is not tightening.

You will recall that the Fed announced it would cut purchases by $10 billion per month, while still making $75 billion a month in purchases of mortgage-backed securities and Treasuries. The minutes reveal “concern about the potential for an unintended tightening of financial conditions if a reduction in the pace of asset purchases was misinterpreted as signaling that the committee was likely to withdraw policy accommodation more quickly than had been anticipated." So, it's just a little tapering, not tightening.

That said, even the more dovish policymakers had to concede that QE does not pack the punch it might have once packed. From the minutes:

Regarding the marginal efficacy of the purchase program, most participants viewed the program as continuing to support accommodative financial conditions, with a number of them pointing to the importance of purchases in serving to enhance the credibility of the Committee’s forward guidance about the target federal funds rate. A majority of participants judged that the marginal efficacy of purchases was likely declining as purchases continue, although some noted the difficulty inherent in making such an assessment. A couple of participants thought that the marginal efficacy of the program was not declining, as evidenced by the substantial effects in financial markets in recent months of news about the likely path of purchases.

This is not surprising, that the marginal efficacy has been declining; first, we would have to establish that there was efficacy in the scheme to begin with. OK, let's grant that QE had an effect; it certainly served as rocket fuel for the stock market and it was like bionic legs for the housing market, even if it didn't do much more. But there are limits.

The Fed has sopped up nearly a third of the Treasury market, and if they don't cut back significantly, they'll have half the market by the end off the year, and they would basically have everything on their balance sheet by 2018. This would create a liquidity problem for anybody seeking high quality collateral, and that might be problematic. Liquidity is not a problem right now, and even if the Fed continues with purchases, because they are not on a preset course with the taper, remember that there are still plenty of other central banks in the world and they have lots of liquidity to bring to the party.

But before the Fed could ever get that far, there was the concern about bubbles, or as the minutes tell us: Participants were most concerned about the marginal cost of additional asset purchases arising from risks to financial stability, pointing out that a highly accommodative stance of monetary policy could provide an incentive for excessive risk-taking in the financial sector. It was noted that the risks to financial stability could be somewhat larger in the case of asset purchases than in the case of interest rate policy...

You can see how the fear of bubbles, although the Fed would never call it a bubble, the fear of financial instability might be cause for the Fed to step back from its monetary experiment. The big banks have surely been feeling their oats, what with the Fed's Zero Interest Rate Policy, and the QE, and then the Department of Justice and SEC providing get out of jail free cards for everything from robo-signing to money laundering to well, everything.

And then back to the idea of marginal efficacy, maybe the Fed was feeling a little remorse that all the billions in asset purchasing did so very little for Main Street; maybe there was a hint of awareness of the dual mandate of price stability and maximum employment, which remains so far away. While the employment situation has been improving, it is still nowhere near maximum. We'll find out more about the direction of the the labor market on Friday with the monthly jobs report.

In a precursor to the Friday report, today ADP gave its private report showing private employers added 238,000 jobs in December, and the November figure was revised up to 229,000 from the initial estimate of 215,000; this marks the fastest pace of hiring in 13 months. The ADP report doesn't always match with the official government report, but we might guess that the Friday report will be a little stronger than the current estimates of 195,000 new jobs. Maybe.

In another positive read on the economy, the National Federation of Independent Business said small businesses hired the most workers in nearly eight years in December. In a separate report, retail industry tracker ShopperTrak reported sales rose 2.7 percent in the November-December holiday shopping season, but much of that was from promotions and discounts.

Also, the Mortgage Bankers Association reported today that applications for home mortgages rose 2.6% in the last week, rebounding from a 13 year low in the last week of December. And the Federal Reserve reports that consumer borrowing increased by $12.3 billion in November to just over $3 trillion, which pretty much matches the Fed's balance sheet after all the purchases from QE (just coincidentally). Almost all of the November increase came from an $11.9 billion rise in borrowing for auto loans and student loans. 

Fifty years ago today, then president Lyndon Johnson delivered a State of the Union address and he declared an “unconditional war on poverty”. At the time it was dismissed as so much rhetoric, but it was a significant shift in policy. Despite nostalgic reminiscence, poverty was a real problem. The idea of the massive middle class society enjoying postwar prosperity was less than a complete picture. About one-third of all Americans, 40-50 million people lived below those standards which we have been taught to regard as the decent minimums for food, housing, clothing and health.

The policies adopted as part of LBJ's War on Poverty included Medicaid, Medicare, subsidized housing, Head Start, legal services, nutrition assistance, raising the minimum wage, food stamps and Pell grants. And it worked, imperfectly, but it worked. The nation's poverty rate was cut in half, from 22.2 percent in 1960 to an all time low of 11.1 percent by 1973. Most dramatic was the decline of poverty among the elderly, from 35.2 percent in 1959 to 14.6 percent in 1974, thanks to enactment of Medicare in 1965 and cost-of-living increases for Social Security. The poverty rate among African Americans fell from 55.1 percent in 1959 (when most blacks still lived in the rural South) to 41.8 percent in 1966 (when blacks were an increasingly urban group) to 30.3 percent by 1974. But the victories in the war on poverty were short-lived.

Since 1964, the nation's population has roughly doubled while the actual number of people living in poverty is about 50 million, which works out to about 15% of the population, living below the poverty threshold. Almost as many poor people live in the suburbs as in cities -- a phenomenon that was unthinkable 50 years ago. About one-quarter (22 percent) of America's children now live in poverty. The poverty rate is much higher for Blacks (27 percent) and Latinos (26 percent) than for whites (10 percent). A significant proportion of America's poverty population are the working poor, who earn poverty-level wages.

Even more startling is the fact that 100 million people comprise what the US Census calls the poor and the "near poor," based on a new definition of poverty that measures living standards, not just income. Almost one-third of the nation, in other words, can barely make ends meet.

In the early 1960s, many Americans were ready to enlist in a war on poverty because the standard of living was improving for most families, inequality was shrinking, and people felt hopeful about the country and its future. A growing number of American families were able afford to move to the suburbs, buy homes, install air conditioners, purchase a TV, pay for a new car every few years, take a yearly vacation and even fly on an airplane. They could send their children to college and save money for a comfortable retirement. If rising affluence made a war on poverty possible, the civil rights movement and Cold War made it necessary.

During the past decade, ordinary Americans have experienced declining wages, rising joblessness, and an epidemic of foreclosures. Some pundits argue that it is difficult to elicit a generosity of spirit among economically-squeezed middle-class families. But as more and more middle class Americans face economic insecurity, they may identify their own fate with the plight of the poor. It's easier to slip into poverty than to climb out of it. Income inequality is greater in the United States than in other rich countries and Americans should be offended that a child born into poverty has such a hard time escaping it.

Within a decade after President Johnson declare a War on Poverty, we cut the nation's poverty rate in half. It is inaccurate to say that the War on Poverty failed. Without anti-poverty programs, the nation's poverty rate would likely be twice as large; and at the rate we're going, it might be.