Wednesday, April 09, 2014 - Feeding Time at the ZIRP Trough

Feeding Time at the ZIRP Trough
by Sinclair Noe

DOW + 181 = 16,437
SPX + 20 = 1872
NAS + 70 = 4183
10 YR YLD un = 2.68%
OIL + 1.04 = 103.60
GOLD + 4.30 = 1313.30
SILV  - .22 = 19.95

In an otherwise light week for economic news, the big report is today’s release of the FOMC minutes from last month’s meeting. No surprises. You may recall that after the last meeting, Chairwoman Janet Yellen talked about the possibility of raising the fed funds target rate after a “considerable time”; when pressed she indicated a “considerable time” was about six months after the Fed ends it asset purchases under Quantitative Easing. That would mean late spring or summer of 2015.

Fed policymakers were unanimous in wanting to ditch the thresholds they had been using to telegraph a policy tightening; no hard and fast target of 6.5% unemployment or 2% inflation. The minutes indicate the Fed would like to see more improvement in the economy; the emphasis on quality rather than quantity. In other words, the Fed remains dovish, and they will taper but they will also keep rates low for a long time. And also, those “dots” are over-rated.

The dots are actually charts suggesting the fed funds rate would top 2% by the end of 2016. In the minutes published today, several policy-makers claim the charts overstated the shift in projections, which would suggest the Fed is not ready to tighten policy. A couple of the voting members wanted to commit to keeping rates low if inflation remains persistently below the Fed's 2-percent goal.

Wall Street loves feeding at the Zero Interest Rate Policy trough. Stocks were up. Despite the three-day selloff, the S&P 500 index managed to hold above its 50-day moving average around 1,840, a key support level. The Nasdaq Composite is in positive territory year to date.

In other economic news, Commerce Department data showed that wholesale inventories rose at a slower pace of 0.5% in February, in line with expectations, after a revised gain of 0.8% in January, which could support views that restocking did not help the economy in the first quarter. You recall that companies were overstocked on inventory in the fourth quarter; we haven’t worked our way through those full shelves, and that likely means that the economy is slogging along in the first quarter.

The IMF, the International Monetary Fund says the global economy is strengthening but emerging markets still face challenges from outflows of capital and the big threat for the global economy is super-low inflation, or low-flation.

The IMF expects the global economy to grow 3.6% this year and 3.9% in 2015, up from 3% last year. Those figures are just one-tenth of a percentage point below the IMF's previous forecasts in January. And the forecasts will likely be revised lower as more months pass; that seems to be the tendency. The IMF made no changes to its forecasts for US growth, which it estimates at 2.8% this year and 3% in 2015. Overall, the recovery seems to be broad, fairly strong and more stable.

The IMF and the World Bank will hold their spring meetings in Washington this weekend. Finance ministers and central bankers from the Group of 20 leading economies will meet Thursday. The IMF is expected to reiterate the message that central banks should be more aggressive.

Inflation in the 18 countries that use the euro currency fell to an annual rate of 0.5% last month. Though consumers can enjoy flat prices, ultra-low inflation can stifle growth. People and companies postpone purchases knowing that prices will be little changed months later. Debts become harder to pay off. That's a particularly severe problem in Europe, where many governments remain squeezed by debts. Super-low inflation also raises the risk of deflation; a decline in wages and prices that slams the brakes on economic growth.

Another topic at the meetings is expected to be inequality. The IMF’s new interest in income distribution coincides with other, seemingly unorthodox positions coming from the fund and some of its experts since the financial crisis of 2008. It has come to support some controls on cross-border capital flows. Its research has argued in favor of fiscal stimulus, pointing out its positive impacts on economic growth.

In the latest edition of the World Economic Outlook, the fund makes the case that inflation in the United States and other developed nations should be higher to help pull the world economy out of its morass. IMF Director Christine Lagarde now argues economic policy cannot be only about promoting low inflation and robust growth. Healthy, stable economies also depend on a reasonably equitable distribution of the rewards. The study concludes a flatter distribution of income contributes more to sustainable economic growth than the quality of a country’s political institutions, its foreign debt and openness to trade, its foreign investment and whether its exchange rate is competitive.

Deep inequality breeds resentment and political instability, discouraging investment. It can lead to political polarization and gridlock, as it cleaves the political system between the interests of the haves and the have-nots. And it can make it more difficult for governments to deal with brewing crises and economic imbalances. An analysis published last year by economists in the IMF’s fiscal affairs department concluded that efforts to curb budget deficits increase inequality, especially if they take the form of spending cuts. It suggested that targeted government spending and progressive taxes could offset some of these effects.

Fears that High Frequency Traders have been rigging the stock market went mainstream last week when 60 minutes ran a story on Michael Lewis’s new book “Flash Boys”. Then the FBI announced it would investigate; my guess is that this will slowly fade away in the light of the Holder Doctrine, which basically says that the Department of Justice and other supposed law enforcement types only arrest petty criminals, and if you have enough money and provide jobs, you are entitled to a “get out of jail” card.

Anyway, the High Frequency Traders are nothing new, they've been around for a long time. The major exchanges lease high speed access. Perhaps less well known are the dark pools. So much trading is now happening away from exchanges that publicly quoted prices for stocks on exchanges may no longer properly reflect where the market is. And this problem could cost investors far more money than any shenanigans related to high frequency trading.

When the average investor, or even a big portfolio manager, tries to buy or sell shares now, the trade is often matched up with another order by a dealer in a so-called "dark pool," or another alternative to exchanges. Those whose trade never makes it to an exchange can benefit as the broker avoids paying an exchange trading fee, taking cost out of the process. Investors with large orders can also more easily disguise what they are doing, reducing the danger that others will hear what they are doing and take advantage of them. 

The rise of "off-exchange trading" is terrible for the broader market because it reduces price transparency. The problem is these venues price their transactions off of the published prices on the exchanges; and if those prices lack integrity then "dark pool" pricing will itself be skewed. Around 40% of all US stock trades, including almost all orders from "mom and pop" investors, now happen "off exchange," up from around 16% six years ago.

A brokerage has several ways to fill customers' orders. It can match buy and sell orders from its own customers, known as "internalizing," or sell its orders to another broker that can do the same. Brokers also send trades to "dark pools," which are similar to exchanges, except the fees are lower and they are anonymous, with orders going unreported until after they have been executed. And finally, they can send trades to exchanges, where they will have to pay higher fees. A major concern with off-exchange trading is that brokers who internalize trades and offer dark pools do not provide any data to the market before the trade is executed.

On a stock exchange, when an order is sent in, the price of the stock is adjusted and everyone with a data feed sees it. Dark pools only report data after a trade has occurred. At that stage, information about the trade has little influence on the price. In other words, dark pool trading is priceless, and you actually need prices to have a marketplace; price discovery is an essential element; cut that out of the equation, and you can see some serious manipulation and distortion.

And finally, in today’s edition of “Banks Behaving Badly”, Bank of America has agreed to pay nearly $800 million in fines and restitution to settle allegations of deceptive marketing and unfair billing involving credit card products. The Consumer Financial Protection Bureau and Office of the Comptroller of the Currency said the bank had misled roughly 1.4 million people about the cost of two credit card payment protection products, which allow consumers to suspend minimum card payments if they lose their job or suffer a severe illness, and the amount of time they would receive benefits from them.

The bank also billed customers for identity protection products before they received them and did not provide some fraud-monitoring services consumers thought they were buying. About 1.9 million people were unfairly billed. The fines work out to about $5 million the rest in restitution. The bank says it has already issued refund payments to most customers who were affected. Bank of America neither admitted nor denied wrongdoing.