Wednesday, July 16, 2014 - The Color of the Day is Beige

The Color of the Day is Beige

by Sinclair Noe

DOW + 77 = 17,138
SPX + 8 = 1981
NAS + 9 = 4425
10 YR YLD - .01 = 2.53%
OIL + 1.38 = 101.34
GOLD + 6.20 = 1300.80
SILV + .07 = 20.89

A record high close for the Dow; the 15^th record high close of the year for the Dow. The S&P 500 did not take out the old high from July 3^rd. We have a few economic reports to cover, plus Fed Chair Yellen continued testimony on Capitol Hill, and lots more.

Industrial production increased 0.2% in June to 103.9. This is 24.1% above the recession low, and 3.1% above the pre-recession peak. For the second quarter, industrial production advanced at an annual rate of 5.5%; so the quarter was good but the month of June was less than expected.

The Commerce Department reports producer prices increased by a seasonally adjusted 0.4% last month, above forecasts for a 0.2% gain, after falling 0.2% in May. Year-over-year, the producer price index rose at an annualized rate of 1.9% in June. The core rate, stripping out food and energy prices, was up 0.2%.

This afternoon, the Federal Reserve released its Beige Book, a collection of reports from the 12 Fed districts. The general consensus is that economic growth was moderate to modest. Most Districts were optimistic about the outlook for growth. Consumer spending increased in every district. Retail sales grew modestly in most districts. Auto sales, which have been on the upswing for more than a year, continued to stand out as particularly brisk support for the economy, but broader retail sales were more subdued. Labor market conditions continue to improve with all districts reporting slight to moderate employment growth. Several districts reported "some difficulty" finding staff for skilled positions, however there doesn’t seem to be any pressure on wages. Here’s a hint, if you can’t find skilled workers, try offering higher wages. The report gave a mixed appraisal of the US housing market. Conditions "varied" across the country, with some regions suffering from weak demand.

Fed Chair Janet Yellen returned to Capitol Hill to deliver her second day of Humphrey Hawkins testimony. The prepared remarks were the same as yesterday, then they open up for a Q&A. Some of the key points from today’s hearing:

Yellen said she is optimistic about the economy, “We had a very surprising negative growth in the first quarter, which is a number that in a way doesn't seem consistent with the underlining momentum in the economy and many indicators of spending and production. And I do think the economy is recovering and that growth is picking up and that we have sufficient growth to support continued improvement in the labor market."

Yellen said threats to financial stability are moderate “and not a very high level.” She again weighed in on valuations, saying: "Some things may be on the high side and there may be some pockets where we see valuations becoming very stretched but not generally. The use of leverage is not broad-based, it hasn't increased, and credit growth is not at alarming levels by any means."

Yellen did not single out specific sectors today. Yesterday she said biotech and social media looked a bit over-valued. That had some talking heads complaining; the funniest rant came from Jim Cramer, who said: “Next time, Fed Chief Yellen, it might pay to point out that there are plenty of cheap stocks out there, too. At least that way you can help us make money, not just lose it.” Maybe someone can tell Cramer the Fed is not in business to help him make stock picks, no matter how much help he needs. The Fed has been incredibly accommodative to Wall Street, and Cramer still complains. The Fed doesn’t issue a price target on Twitter. But if you read between the lines, Yellen was likely saying that there are no plans to raise the margin requirements on brokers.

There were some questions about a bill in the House that would require the Fed to follow a mathematical rule for when to raise or lower interest rates. Yellen didn’t like that idea; she said there is no magic formula for raising rates. Yellen again expressed confidence the Fed can exit when the time comes. The Fed has a variety of tools it can use to raise interest rates. In the distant future, the Fed’s balance sheet will shrink in size.

The best line from the Fed did not come from Yellen; Dallas Fed President Richard Fisher was speaking today at the University of Southern California. Fisher said ending asset purchases this fall isn’t enough; the Fed should start to taper the reinvestment of maturing securities in October. Fisher said: "Monetary policy is a bit like duck hunting. If you want to bag a mallard, you don't aim where the bird is at present, you aim ahead of its flight pattern. To me, the flight pattern of the economy is clearly toward increasing employment and inflation that will sooner than expected pierce through the tolerance level of 2%."

Meanwhile, it’s earnings reporting season. Bank of America said profit declined 43% as it spent $4 billion to cover litigation costs, including a mortgage settlement with AIG. There seems to be a trend developing in banks’ earnings reports; they are making money on investment banking and some other areas, but results are weak for mortgage originations, and they are setting aside big chunks of earnings to pay for legal settlements.

Bank of America and the Department of Justice are reportedly negotiating a mortgage securities settlement, which could cost the bank around $13 billion.

Intel was up more than 9% after a very strong earnings report after the close yesterday. Yahoo fell today following weaker than expected earnings. EBay posted lower than expected 2Q results and even though sales were up this month, EBay cut its outlook for the third quarter.

Merger and acquisition activity has been wild lately. Today’s M&A stories revolved around Rupert Murdoch’s plan to buy Time Warner for $85 a share, or about $75 billion. Time Warner says it isn’t interested in exploring a sale, but if they sell, there are other potential suitors. General Electric is in talks to sell its household appliances business; that’s a part of the company that’s been around since 1905, when they invented the electric toaster. Yesterday, the number 2 tobacco company, Reynolds American agreed to buy the number 3 tobacco company, Lorillard for $25 billion.

One of the motivating factors behind mergers lately has been something called inversion, basically merging with an overseas company to avoid corporate taxes in the US. Members of the House and Senate have made proposals to curb the inversion trend in recent months, and the president included a provision in the budget he presented to Congress this year that would have effectively banned the move. But none of these efforts have yet gained traction. Today, Treasury Secretary Jack Lew called on Congress to enact legislation to halt inversion, effective immediately and retroactive to May.  Making any new legislation retroactive through May could disrupt several megadeals that have already been struck, such as the Medtronics deal.

Global M&A volume in the first half was the highest since 2007. One of the side effects of the M&A frenzy back in 2007-2008 was the frenzy of pink slips that followed. Deals are sold to investors on the basis of “creating value” with terms like “efficiencies” and “synergies”; code words for cost cutting and mass-layoffs. Acquisitions, layoffs, and cost-cutting are the simplest things to do for a CEO, as opposed to inventing things and boosting sales organically, which is hard. Analysts love M&A, investors too, and of course the investment bankers promote it as the best thing since sliced bread, or maybe electric toasters.

Last year, Microsoft acquired Nokia’s mobile phone business and promised $600 million in cost saving and efficiencies and synergies. Now, Microsoft employees are bracing for up to 12,000 layoffs, the biggest ever for Microsoft. The layoff news will come before the company holds its post-earnings conference call after the market closes July 22.

Leaders of the five BRICS nations agreed on the structure of a $50 billion development bank by granting China its headquarters and India its first rotating presidency. The leaders also formalized the creation of a $100 billion currency exchange reserve, which member states can tap in case of balance of payment crises. Both initiatives, which require legislative approval, are designed to provide an alternative to financing from the International Monetary Fund and the World Bank, where BRICS countries have been seeking more say.

Wednesday, January 29, 2014 - Benny Jets

Benny Jets

by Sinclair Noe

DOW – 189 = 15,738
SPX – 18 = 1774
NAS – 46 = 4051
10 YR YLD - .07 = 2.67%
OIL – 01 = 97.40
GOLD + 12.00 = 1268.70
SILV + .15 = 19.81

You’ve heard the old post office creed; “neither snow nor rain nor heat nor gloom of night stays these couriers from the swift completion of their appointed rounds.”

Generally true, however I bet some letter carriers are having a tough time delivering mail in Atlanta today. The Federal Reserve apparently has a creed. Who knew? Neither a disappointing December jobs report nor turmoil in emerging markets nor gloom of the US economy shall stay these central bankers from the incremental completion of their taper.

Don’t worry; nothing to look at here; keep moving, keep moving. No sonny, that’s not a train wreck on Wall Street, that’s just the debris and detritus stirred up by the whirlybird which will now carry Helicopter Ben into the sunset, or more accurately to the boardroom of some investment bank. Yes, this is the last FOMC meeting for Ben Bernanke. He promised he would set a course for exiting QE, and he has; the problem is that the set course is fraught with perils.

The Federal Reserve’s policy making Federal Open Market Committee wrapped up a two day meeting today by announcing they would cut back their bond buying program by $10 billion, to a mere $65 billion per month.  The FOMC added that it was “likely” to continue the pullback, suggesting a similar cut is probable at its next meeting, in March. The stock market fell for the fifth session out of the past six, wiping out yesterday’s gains, but stocks were already moving lower before the Fed announcement.

While noting recent weakness in the housing sector recovery the FOMC statement says the overall economic picture continues to improve. And then the statement included a little slap on the wrist for Congress: “Taking into account the extent of federal fiscal retrenchment since the inception of its current asset purchase program, the Committee continues to see the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy.

The Fed reiterated their view that "risks to the outlook for the economy and the labor market as having become more balanced," language they added to the statement for the first time in December. They reconfirmed that they will likely keep interest rates in the near zero range even if the unemployment rate drops below the target of 6.5%. And just remember your mantra: tapering is not tightening, tapering is not tightening.

And if taper leads to a little turmoil in emerging markets, well what’s it to you? The Fed pullback is contributing to a global shift in investments. That is causing problems for countries like Turkey, which would the example du jour.  The central bank in Turkey tried to bolster that nation’s currency yesterday by sharply raising its benchmark interest rate. The Turkish central bank increased the rate for one-week loans to banks to 10% from the previous level of 4.5%. The idea was to lure investors with a better yield, instead it may be causing collateral damage to the rest of its economy.

And today, the Turks learned the meaning of the old axiom, “don’t fight the Fed”, as the Turkish lira slumped, along with other emerging market currencies. The Russian ruble took another hit, the Argentine peso continued to plunge, and the South African rand could not be shored up. The South Africans raised rates a more subtle half-percent from 5% to 5.5%.

We used to identify the fast growing emerging markets as BRICS – Brazil, Russia, India, China, and South Africa. Now the new catch phrase is the “fragile five” and it refers to the emerging economies of Turkey, Brazil, India, South Africa and Indonesia as economies that have become too dependent on skittish foreign investment to finance their growth ambitions. The term has caught on in large degree because it highlights the strains that occur when countries place too much emphasis on stoking fast rates of economic growth.

Actually, the emerging market turmoil may be working in the Fed’s favor. Investors concerned about emerging market risk are seeking out the safe haven of Treasury bonds, bidding up prices and pushing down yields even as the Fed pulls back from bond purchases. But there are limits to how low the Fed can push emerging market currencies. The declines could come back to bite the developed economies of the US, Europe and Japan. Developing countries have served as engines of global growth, but now they find their purchasing power diminished and that equates to buying fewer exports. The direct effects of the recent emerging market foreign exchange turbulence, if contained, are not likely to prove substantial, but that’s based on the idea that things don’t deteriorate from here.

It makes for challenging times for the central bankers of emerging economies. The flight of foreign capital, which is a primary reason for the currency declines, is a result of investors’ putting money back into developed countries as their economies improve. To counteract the outflow of capital, the policymakers lure investors with higher interest rates but higher rates put the brakes on economic growth. And currency investors know this and bet that the central banks won’t be able to keep rates high for long. Sure enough, in today’s case of the Turkish central bank, the currency sharks smelled blood and they killed off the policymakers last vestiges off credibility.

All the blame for the problems in Turkey can’t be laid at the feet of the Fed; the Turks had a big mess before the taper. There has been an extensive corruption probe against the government and Prime Minister Erdogan responded by purging the judiciary and the police force.

The world can be chaotic at times, but we usually muddle through, except when it gets too crazy. Whenever we talk about emerging market turmoil, we’re reminded of 1997, when the Fed raised rates just a little and a few months later, the hot money went flying out of the developing Asian markets, then Russia defaulted, Long Term Capital Management missed that bet, and wham, bam, it was a meltdown man.

Of course, back then we didn't have hundreds of trillions of dollars in derivatives to contain the risk. Nowadays we have more than a quadrillion in derivatives to protect us. What could go wrong?

And that brings us to our next question of the day: what the heck is a MyRA?

Did you catch that last night during the State of the Union speech? A quick and stumbling reference to My-aye-aye-aye-RA. Obama promised to use executive action to create a new middle class savings vehicle, although he didn’t explain what it was. So, the White House issued a briefing sheet to explain that the MyRA, or My Retirement Account, is a new simple, safe and affordable “starter” retirement savings account that will be available through employers and help millions of Americans save for retirement. This savings account would be offered through a familiar Roth IRA Account and, like savings bonds, would be backed by the US government.

The administration noted that many private-sector providers don’t allow “smaller balance savers” to open accounts; providers who do allow such accounts often charge fees that can eat up a proportionately high percentage of their balances. In his address, Obama described the myRA as “a new savings bond” that “guarantees a decent return with no risk of losing what you put in.”

Today, Mr. Obama signed a presidential memorandum to create the "myRA" program, which he told employees would go toward "making sure that after a lifetime of hard work you can retire with some dignity." The retirement accounts can be opened with as little as $25, and monthly contributions can be as little as $5, automatically deducted from paychecks. The program will operate like a Roth IRA, so contributions would be made with after-tax dollars. That means account-holders could withdraw the funds at any time without paying additional taxes.

The funds would be backed by US government debt, similar to a savings option available to federal employees, and earn the same variable interest rate return as the Thrift Savings Plan Government Securities Investment Fund accounts that federal employees enroll in. Investors could keep the accounts if they switch jobs or convert them into private accounts, and once the account reaches $15,000 funds must be withdrawn or it can be rolled over into a private sector Roth IRA. Treasury Secretary Jack Lew will be in charge of setting up the program and it should be available through some employers by the end of the year. Workers can invest if they make less than $191,000 a year. Businesses will not administer or run the accounts. They will simply offer them to their employees if they decide to participate.

There are still some details of the plan that are not quite clear. The Federal Thrift Savings Plan caps contributions to 10%, and there are rules on what investments are made. Already we are hearing the loons come out with conspiracy theories. This is not – repeat NOT – an effort to confiscate existing IRAs. It is a little like the old Savings bonds that you used to buy, which were actually a decent deal; not a big wealth builder but a decent savings vehicle.

There was plenty more to the State of the Union speech, but you probably slept through that part, so I’ll give you a quick recap: The state of the union is absolutely fantastic for the top 1%, and for about 25% it’s decent, and for the rest of the country things are pretty lousy. Fifty years after the declaration we can now announce that the War on Poverty has been won. The poor and the middle class have been defeated. 

Tuesday, December 17, 2013 - The Year in Financial Review

The Year in Financial Review

by Sinclair Noe

They say you can't know where you're going if you don't know where you're coming from, so today on the Review, we'll review some of the financial milestones of 2013.

You may recall that 12 months ago, we were headed over the fiscal cliff. The fiscal cliff really started in 2001 with the Economic Growth and Tax Relief Reconciliation Act, also known as the Bush tax cuts; after various extensions, they were set to expire at the end of 2012. And they did. In the end, Congress did not approve an extension of most of the tax cuts until late on New Year’s Day. Because all the Bush tax cuts had technically expired, Republicans could say they had not violated their No New Taxes pledge. The marginal rate on incomes over $400k increased, plus cap gains, and qualified dividends for high-income taxpayers, plus some estate tax changes, and the holiday on the payroll tax ended; just to be sure everybody felt some pain.

President Obama signed the American Taxpayer Relief Act of 2012 on January 2. The ATRA is usually described as a tax increase although technically it might be a tax cut. The confusion arises because there were so many expiring provisions at the end of 2012.  ATRA could be described as either a $618 billion tax increase, relative to maintenance of all of the provisions that had been in place – that is, relative to so-called “current policy”; or a $4 trillion tax cut, relative to the actual law.

It was an inauspicious start to the new year.

Wall Street found comfort in the resolution of the fiscal cliff, and of course the never-ending flow of free money from Quantitative Easing. Equity traders partied like it was 1999. Stock funds took in some $134 billion in the first ten months of this year. The Dow Industrial Average started the new year at 13,100, and never looked back. There were a few minor pullbacks but no significant corrections; just a string of record highs for the Dow, the S&P 500, and even the Nasdaq Comp hit the highest levels in 13 years. Milk and cookies indeed.

Turns out, the stock market wasn't dead,it just needed some juice from the Fed. The Federal Reserve had a major role in propping up Wall Street. The Fed's balance sheet grew by more than $1 trillion just since the start of the year, and not stands slightly north of 25% of GDP. Overlay a chart of the Fed's balance sheet with a chart of the S&P 500; carrots and peas; Fred and Ginger.

Bond markets had been absolutely giddy with QE. The yield on the 10-year note touched 1.39% back in the summer of 2012. Heading into the summer of 2013, Ben Bernanke sent up a trial balloon that the Fed had actually thought about how they might exit QE; not that they had any plans to exit; not that there was anything in reality; just a little contemplation. The bond market freaked, and threw a taper tantrum. In the process, conservative income investors were shocked to learn that bond funds can lose value. Who knew? And that is how the 30 year bond bull died.

Meanwhile, across the Pacific, Japan had been catatonic for 2 decades until Japan's new Prime Minister Shinzo Abe somehow got a hold of the Federal Reserve's playbook; but something was lost in translation. Instead of just applying enough stimulus to prop up the banks, Abe tripled the stimulus, and kicked in fiscal reform and structural reform. He tied a sack of bricks around the yen and tossed it in deep waters. The results were predictable; a smidge of inflation replaced deflation; the Japanese economy will expand about 2% for the year, and Japanese stocks are on pace for more than a 50% gain this year.

Who knew? Certainly not Ken Rogoff and Carmen Reinhart, who unfortunately became famous for their worst work – the sarcastically titled book: “This Time Is Different”. Not exactly. Turns out there was a miscalculation with the Excel spreadsheets and there isn't a real precise line where the ratio of debt to GDP becomes malignant. Simple error by a couple of academic wonks, except their theories had served as a template for economic reforms around the globe, with less than satisfactory results. If you followed the Rogoff-Reinhart Rule, you would have tightened the belt in the face of an economic slowdown; think Greece, Spain, Portugal, and to some extent, the US. The result in the Eurozone was narrowing credit spreads and scary spikes in unemployment; that eventually forced ECB chief Mario Draghi to announce “the ECB is ready to do whatever it takes.”

The Draghi Put sounded good, except to the Germans, and even after the Rogoff-Reinhart spreadsheet blunder became clear, Draghi still hasn't used the OMT, Outright Monetary Transactions, he promised back in 2012, and Euro-austerity has lead to even higher debt to GDP ratios in the most indebted Euro nations, and the ECB and IMF have denounced austerity, but they still haven't dared to experiment as boldly as the Japanese.

Meanwhile. the BRICS, Brazil, Russia, India, China, and South Africa were clobbered. In November, the Organization for Economic Cooperation and Development, the rich world's number-crunching club, lowered its global growth forecast for 2014 by nearly half a point, to 2.7%, because of the slowdown in emerging-market economies. The European Central Bank warned: "Any sharper or more disruptive adjustment in emerging market economies needs to be closely monitored, given the potential for stronger and more persistent euro area impacts." Their fast growth compensated for the developed world's stagnation and their currency reserves funded Western debt. The thirst of emerging market consumers for goods helped tide over Western companies, while their low production costs drove global trade.

Developing economies weren't prepared for a downturn in global trade. The prospect of costlier capital, courtesy of the Fed's taper talk, dried up the flow of hot money that never seemed to find its way to Main Street but did filter to emerging markets. A disinflationary environment also clobbered commodities, and many of the emerging markets rely on natural resources. Investors withdrew from emerging market equities, debt, currencies, and everything else. According to the Commodity Futures Trading Commission, the total value of commodity index-related instruments purchased by institutional investors rose from an estimated $15 billion in 2003 to at least $200 billion by mid-2008. And then the cycle turned; 2013 marks the third year of a downturn in commodity prices. At some point, the cycle will turn again.

And through it all, the United States has emerged as the cleanest shirt in the dirty clothes hamper. The Fed's QE might not have spread the wealth; actually it just concentrated the wealth, but that's not to say it didn't have some impact. The housing market bounced back; not all the way to the highs at the peak, but it helped. Global real estate deals are now back to late 2007 levels. The world population keeps growing, and the institutional buyers can't buy everything; even though they tried. That lead to an increase in rents. If, or when rates move even higher, it will likely dampen the enthusiasm for real estate. Look for a slightly calmer market in 2014.

The high price of oil pushed drivers to switch to more fuel efficient cars. The hybrid Prius is the top-seller in California and the Tesla outsold Audi and Jaguar. GM turned a profit, and completed the terms of its bailout. The US keeps coming up with new technologies, such as 3D printing and robotics. And we've become masters at spying on the rest of the world.

The US is now in its fifth year of economic expansion and economic growth is surpassing some of the emerging markets, which is back to that cleanest shirt theory. One of the big surprises for the US economy has been energy production. Domestic crude oil production is up 18% form one year ago; up 56% from 2007; nat gas production is up 28% from 2007. Oil imports have been dropping and exports of refined petroleum products has increased.

So everything was on track for economic recovery, until the politicians in Washington decided to shut down government. Remember the fiscal cliff deal that started the year? Turns out it was just a stopgap measure, and when it came time to work out a longer-term deal, well, what can I tell you; we've got the best politicians money can buy; which is to say that Congress is a train wreck waiting to happen, and it happened in October. The 16 day shutdown came with a price tag of $24 billion, with nothing to show for it but really bad political theater.

And then that was followed by the biggest municipal bankruptcy in US history. Detroit is on the skids. The BK process is still underway, and there are implications. We have seen an unelected emergency manager take over the governance of a major city. A coup. How will it turn out? I don't know but if this is going to be a template for other struggling cities, it could get ugly.

And finally, perhaps the most important financial development came from a source we didn't even know a year ago; a modest priest from the slums of Buenos Aires; Pope Francis, the new spiritual leader of more than 1.2 billion Catholics – it is a very large contingent. The new Pope published an apostolic exhortation in late November. Pope Francis called for renewal of the Roman Catholic Church and attacked unfettered capitalism as "a new tyranny", urging global leaders to fight poverty and growing inequality. Francis went further than previous comments criticizing the global economic system, attacking the "idolatry of money" and beseeching politicians to guarantee all citizens "dignified work, education and healthcare". He also called on rich people to share their wealth. "Just as the commandment 'Thou shalt not kill' sets a clear limit in order to safeguard the value of human life, today we also have to say 'thou shalt not' to an economy of exclusion and inequality. Such an economy kills," Francis wrote in the document issued on Tuesday. "How can it be that it is not a news item when an elderly homeless person dies of exposure, but it is news when the stock market loses 2 points?"

I think this, more than anything else, has changed the financial dialogue as we head into the new year. 

Thursday, September 19, 2013 - Shine On You Crazy Dimons

Shine On You Crazy Dimons

by Sinclair Noe

DOW – 40 = 15,636
SPX – 3 = 1722
NAS + 5 = 3789
10 YR YLD +.06 = 2.75%
OIL + .04 = 106.43
GOLD - .20 = 1366.10
SILV + .13 = 23.19

No taper, despite hints and great expectations. Having announced the intention to taper, ultimately, a few weeks later, the proposal was shelved. The reasons given were concerns about the strength of the economic recovery and the impact of high rates on the ability of an over-indebted world to continue to meet its obligations. All these factors were largely unchanged between the time of the original announcement and the repudiation.

What did change was the taper tantrum, the unpleasant market reaction to the hint of taper. Bond yields rose sharply; the Fed's tough talk has already led to a 140 basis point rise in 10-year Treasury yields, which would be roughly equivalent to six rate increases; that in turn resulted in pushing mortgage rates higher, putting a crimp in the housing recovery. Today we learned home sales were up. Sales of previously owned homes unexpectedly rose in August to the highest level in more than six years as buyers rushed to lock in interest rates before they jumped even higher.

The labor "participation rate" dropped to 63.2% in July, the lowest level since the late 1970s. The rate for men is at an all-time low. The unemployment rate has been falling, but chiefly because so many people are giving up hope and dropping off the rolls.

Fed governors tried to pass this off as a structural problem; due to evolving technology, or a "skills mismatch", or that catch-all concept "demographics". No doubt this is half true. But half truths also go by another name. Chronic lack of demand is the real villain is this jobs slump. The problem is not that the labor market is under performing; it is that the recovery has been very slow.

The economy has weathered the most draconian fiscal tightening (2.5% of GDP this year) since the end of the Korean War remarkably well, helped by shale gas, but it is not yet at "escape velocity". The fiscal squeeze goes on. The International Monetary Fund has advised Washington to go easy, citing an "output gap" of 4.6% of GDP. The Dallas Fed's measure of core inflation was 1.2% in July. Growth of the M1 money supply is the slowest in two years, while growth of broad M3 has slowed to the point where it could turn negative without QE. The inflation threat is a fiction; it could be a problem at some point, but not today.

The US dollar rose sharply and stocks sold off, and emerging markets sold off even harder. The BRICS have been hit hard already and given the dangers of another euro-zone debt hemorrhage, which happened after the end of QE1 and QE2, it would be a globally rude gesture to taper.

Ultimately, most market prices, except interest rates, headed back to where they roughly started before the taper talk. Billions of dollars were gained and lost in the zero sum marketplace casinos that constitute the modern economy. And really that seems to be the determinant factor for the Fed. The Bernanke Fed has twice misjudged the global effects of premature tightening already, each time precipitating a credit and stock market crash within weeks, and each time forcing the Fed to capitulate. The exit from QE3 will be ugly, when it eventually arrives.

A paper by former Fed governor Frederic Mishkin, "Crunch Time", warns that the Fed will struggle to extract itself from QE if it delays until 2014. It may drown from losses on its $3.6 trillion of bond holdings as yields rise. The Fed's own balance sheet is at risk, and the risks may indeed outweigh the rewards. Certainly some Fed policymakers would like to head for the exits, but they would like to exit without imploding the Wall Street debt machine; and that may not be realistic.

If QE as conducted is causing asset bubbles, then we should deploy central bank stimulus more creatively, should it prove necessary. We know how to do it. The methods were pioneered by Takahashi Korekiyo, who pulled Japan out of the Great Depression early in the 1930s. His feat is now the model for what Japan is doing again under Abenomics.

Takahashi turned the Bank of Japan into an arm of the treasury - "fiscal dominance" - and ordered it to finance the budget deficit. You can deploy QE in any way you want. It could be used to build houses, or to build infrastructure, or other ways of injecting the money directly into the veins of the economy, instead of the veins of hedge funds. There is no reason why it cannot be administered by an independent Fed, choosing the calibration level as they see fit.

Don't hold your breath. At this point, Bernanke seems content to leave the fuse burning on the financial weapons of mass destruction, as he rides off into the sunset.

Of course, the whole mess could implode, if the US decides it doesn't want to pay its bills. And that is looking more and more possible. The White House promised a veto of a Republican effort to gut President Barack Obama's health care law as part of a temporary funding bill in the House to prevent a partial government shutdown on Oct. 1.

The official policy statement said the GOP attempt to block Obamacare “advances a narrow ideological agenda that threatens our economy and the interests of the middle class" and would deny "millions of hard-working, middle-class families the security of affordable health coverage."

The veto threat was expected and wasn't going to stop House Republicans from pressing their effort to defund the health care law. Republicans in the House spent Wednesday talking about how hard they would fight to derail the health care law on the eve of its implementation and weren't conceding that their Senate rivals would undo their handiwork. A key force in the tea party drive against the law conceded the point even before the fight officially began, but urged the House to force a government shutdown rather than retreat.

The rhetoric will likely fade in the harsh light of an actual shutdown, but then again Congress is a hot mess. The Obama administration's budget director, Sylvia Burwell, issued a memo to department heads that said, "Prudent management requires that agencies be prepared for the possibility of a lapse" in funding.

In the years since the financial crisis, we may not have solved too big to fail, sent any bankers to jail, or done much to prevent another financial crisis, and we certainly haven't changed Wall Street's devotion to money-making at all costs.

But we at least have finally gotten a bank to admit it broke the law.

In what amounts to a relatively stirring triumph of justice on Wall Street, the SEC has convinced JPMorgan Chase to admit that it broke federal securities laws in its handling of the $6.2 billion "London Whale" trading debacle.

The SEC press release says: "JPMorgan failed to keep watch over its traders as they overvalued a very complex portfolio to hide massive losses..., While grappling with how to fix its internal control breakdowns, JPMorgan's senior management broke a cardinal rule of corporate governance and deprived its board of critical information it needed to fully assess the company's problems and determine whether accurate and reliable information was being disclosed to investors and regulators."

Jamie Dimon in a separate statement said: "We have accepted responsibility and acknowledged our mistakes from the start, and we have learned from them and worked to fix them." Which is true, depending on what Dimon means by "from the start." When the London Whale story first broke in the spring of 2012, Dimon infamously dismissed it as a "tempest in a teapot." He has since repeatedly admitted that the bank erred, although this is the first time it has admitted breaking laws.

JPMorgan also agreed to pay $920 million to the SEC and other agencies to settle various London Whale charges. That is quite a lot of money to you and me, more than twice the size of the current Powerball jackpot. And for JPMorgan it amounts to little more than 13 days' profits, and nothing more than the cost of doing business.

But it does mark a turning point, finally there has been an admission of wrongdoing. Finally.

But wait, there's more. Today, bank regulators also ordered JPMorgan to  correct its debt collection and other credit card procedures and to refund more than $300 million to customers harmed by the bank's practices. In separate orders, regulators faulted the bank for errors in how it pursued credit-card debts in court, and for charging customers for credit-monitoring services they never received.

The Consumer Financial Protection Bureau and the Office of the Comptroller of the Currency ordered the bank to refund $309 million to about 2 million customers charged for the credit-monitoring services. The orders also include $80 million in penalties. The OCC also ordered the bank to review past debt collections and compensate customers affected by errors. It did not provide details of how extensive the debt-collection problems were. That order did not include financial penalties, but left the door open to future fines.

At some point, you have to wonder how long a chronic offender can continue before we say, enough is enough.

Thursday, June 20, 2013 - Fed Fallout

Fed Fallout

by Sinclair Noe

DOW – 353 = 14,758
SPX – 40 = 1588.19
NAS – 78 = 3364
10 YR YLD + .11 = 2.42%
OIL – 3.61 = 94.70
GOLD – 73.50 = 1278.80
SILV – 1.75 = 19.70

Yesterday the Federal Reserve FOMC issued a formal statement that they were holding steady with their zero interest rate policy and their Quantitative Easing policy which involves buying up $85 billion a month in Treasuries and mortgage backed securities. Then, Chairman Bernanke held a press conference and said the Fed might scale back purchases if the economic data gets better. And while Bernanke was trying to make a very nuanced forecast with no specific call for action, what the market players heard was a threat the Fed would slash the flow of free money; the plug was being pulled on the money printing press.

Faced with the economic crisis of 2008, the Fed started creating money at a prodigious pace and giving it to the banks. Catastrophe was averted. The money flowed into the markets and financial asset prices jumped. The US equity markets have been on a 4 year bull run; housing prices have bounced back, at least a partial bounce. The money did not flow into the broader economy. Cheap money and credit, instead, lead to malinvestment. The result is that while some financial asset prices have jumped dramatically, the rest of the economy has stagnated or atrophied. The idea is that the economy did not go through its normal cycle of boom and bust; and by avoiding the catastrophe we also lost the opportunity to cleanse the malinvestment from the economy; we lost the opportunity to correct the structural deficiencies.

So, yesterday Bernanke hinted that QE might end later this year or maybe at some indefinite point in the future. The money power is so concentrated that the hint was interpreted as a threat and the threat was taken as an attack. Rarely do I say that the stock and bond markets go up or down on any given day because of some specific news story, but the past couple of days the markets dived because the Fed might take away the free money. The key question is how much malinvestment is still clogging up the economy.

The idea behind Quantitative Easing was that the free money would be spent; it would circulate through the economy; the economy would heal. There should be inflation by now; instead the free money either went down a dark hole or it has ended up in concentrated clusters. There should be a surge in employment and growing demand as workers spend their wages; instead the job growth has been anemic and the quality of jobs has been declining; the result is that demand has failed to gain traction.

Yesterday the New York Times had an article that said, “Even pessimists feel optimistic about the American economy.” And the Fed's monthly report concluded that the "downside risks" were reduced. Housing is coming back. The stock market is up. Profits are at record levels. The sequester cuts haven't sabotaged growth. Consumers feel more confidence.

Only one problem with all this. The economy can't recover if the people don't. Official unemployment has drifted down to an abysmal 7.6 percent but largely because people are dropping out of the workforce.

There are still over 20 million people in need of full time work. The employment rate -- the percentage of the population in the workforce -- hasn't budged from recession levels. At current rates, the US won't return to the pre-recession 5% unemployment rate until 2022, and even at that level, American families are losing ground.

Corporate profits are up, wages aren't. Wages are now at the lowest percent of the economy on record. The median wage hasn't budged this century. College and non-college grads are now losing ground. The good jobs that were lost are being replaced by low wage and part-time jobs. Young people are starting out behind, unemployed or underemployed at ruinous high rates. Our Gilded Age inequality is getting worse, with the top 1 percent pocketing all of the rewards of growth.

The Federal Reserve is turning out to be a one trick pony and that one trick is getting old. Maybe the Fed was fairly effective in avoiding a complete meltdown in 2008. Maybe the time has come to consider that the economic models need to be changed or at the very least adjusted. Maybe it is time for the Fed to move away from printing money and giving it to the banks. Of course, the fear is that every time the Fed pulls away the punch bowl, the financial markets shuffle to the edge of the dark hole and threaten to go over the cliff, like so many lemmings. The Fed has already "tightened" prematurely three times in the last five years, coming to regret its haste within three months on each occasion.

If the Fed is going to move forward with tapering or tightening or whatever you want to call it, it's not enough to exit QE and calm the froth in the financial markets. It may be a very good thing to flush out the excesses in the banking system; it would be great to see some reining in of the excessive risks in derivatives markets and some control over shadow banking and off-shoring of capital. But it would seem the only responsible way to flush out the malinvestment is to take some steps to provide stimulus to the broader economy. While lowering interest rates doesn't do much to stimulate demand in the real economy, raising rates will typically slow growth and might do more to choke off a recovery than the Fed has anticipated.

We need dramatic reforms to make this economy work for working people. That requires major long-term investments to rebuild the country and renovate education and training, from pre-K to affordable college, putting people to work. We need a sensible strategy for balancing our trade and reviving manufacturing, capturing the lead in the green industrial revolution that is already sweeping the world. It requires empowering workers to gain a fair share of the profits and productivity they are helping to generate, raising the minimum wage, and bringing millions of undocumented workers out of the shadows. And it requires curbing the executive compensation policies that give CEOs million dollar incentives to plunder their own companies. Tax reform that shuts down tax havens abroad and requires the wealthy to pay their fair share can cover the bill.

And we probably need some new thinking in economics. The alternative is that we stumbled along like this indefinitely. Not quite crashing, not quite recovering. Welcome to the new normal.

And what if the recovery stalls again? What if inflation fears never materialize? Can the Fed back away from QE now, only to flip the switch and turn it back on? Can they do that even if they have repeatedly shown they will cower in fear at the hint of inflation? Can they back away without having hit their targets? And if the recovery stalls, has the Fed done irreparable damage?

Meanwhile, amidst all the brouhaha over the Fed, you might not have noticed that China has taken a stand against expanding its money supply. It looks like the People's Bank of China will try to pop the credit bubble and do it fast, even if it results in short-term pain. The China strategy is to tighten before the Fed winds down QE in order to avoid two negative shocks occurring simultaneously.

The one-two punch has already hit the emerging markets, especially commodity exporters such as Brazil, South Africa and Russia that sell to China, but also tripping up Turkey, Ukraine, Hungary and others that rely on external funding. Everything is being hit indiscriminately.

Just take a look at the chart of the BRICS. The 10 year Treasury yield zipped up past 2.4%; gold has been tied to a whipping post. Asia had a nasty day of trading; the Nikkei dropped about 1.7%, although that's kind of a normal day lately; the Hang Seng dropped 2.9%. Major European markets were down hard. Copper hit a low for the year.

Protesters are expected to flood more than 100 Brazilian cities and surround two international soccer matches. After more than a week of the largest protests in over two decades, demonstrators show no signs of letting up. Though the transport fare hikes that sparked the unrest were rescinded in Brazil's two biggest cities yesterday, demonstrators by the hundreds of thousands promised to take to the streets in locales as diverse as the Amazon capital of Manaus to the prosperous southern city of Florianopolis.

The persistence of the protests reflects what has become a generalized host of complaints about high taxes, inflation, corruption and poor public services, from hospitals and schools to roads and police forces. The complaints about bus fares seems like such a mundane thing, but once you reach a certain point, whether it's bus fares in Sao Paulo or cutting down some trees in a park in Istanbul, it's a spark, and it just takes a little spark to light a fuse, and it can happen very, very fast.

Friday, April 20, 2012 - Burning Down Spanish Debt, AMR and Unions

DOW + 65 = 13,029
SPX + 1 = 1378
NAS – 7 = 3000
10 YR YLD +.02 = 1.97%
OIL + 1.05 = 103.32
GOLD - .20 = 1643.40
SILV - .10 = 31.80
PLAT unch = 1586.00

Italian and Spanish bond yields rose after a draft statement released by G-20 finance chiefs who are meeting in Washington said that Europe's debt crisis still poses a threat to global growth. Spanish bonds briefly pushed above 6%. That helped push the cost of credit-default swaps to insure Spanish government debt up to a record high 503 bp and increased the cost of insuring Italian debt up to 474 bp, a 3-month high. Credit default swaps pay the buyer face value if the borrower - in this instance Spain - fails to meet its obligations, less the value of the defaulted debt. They're priced in basis points. A basis point equals $1,000 on each $10 million in debt.

Credit default swaps, or CDS, are generally considered insurance against default, but it's not really insurance because anybody can write CDS against anybody else; there is no requirement for “insurable interest”. For example, if insurance worked like CDS, I could write a fire insurance policy on your house and if your house burned down, I would collect the payment. You might think that would give me an incentive to burn down your house. Yep, that might be what you would think.

Now the bankers in New York and London might also have a little incentive to burn down Spanish debt. They are taking out insurance on the bet that Spain will default on their debt, and to further the point, they are pushing yields higher and prices lower. The bankers are shorting Spanish debt knowing full well that there will be massive capital losses as Spanish bonds deteriorate. And they fully expect that the IMF and the ECB will eventually bailout Spain. And then they'll sell their CDS and go long Spanish bonds.

The European Central Bank created put $1.3 trillion into a special fund, the EFSF, or European Fubar Slush Fund, in order to build a firewall to prevent contagion. Now they say they're going to need a bigger fund. European banks reportedly will have more than $750 billion dollars in redemptions by the end of the year. They come at a time when the banks have sustained billions in capital losses they can't make up.

Holdings of Spanish government debt by lenders based in the country jumped 26 percent in two months, to 220 billion euros ($289 billion) at the end of January. Italian banks increased ownership of their nation’s sovereign bonds by 31 percent to 267 billion euros in the three months ended in February. Since 2010, banks in France and Germany have retreated, cutting lending to the governments of Spain, Portugal, Ireland and Greece 42 percent The more banks stop cross-border lending, the more the ECB steps in to do the financing, so the exposure of the core countries to the periphery is shifting from the private to the public sector.

Worse, they've borrowed a staggering 316.3 billion euros ($414.9 billion) from the ECB through March, which is 86% more than the 169.8 billion euros ($222.7 billion) they borrowed in February. This accounts for 28% of total EU-area borrowings from the EU

Spain (#12 Economy in the World) has gotten so bad, so fast that it has made us forget Italy (#8) and we're all ignoring France (#5). France holds their elections on the weekend; apparently they think this will make it easier for people to vote. The Socialist candidate, Francoise Hollande is likely to win the election; it won't be completely decided this weekend; this is just round one.

Also this weekend the G20 is meeting. This morning, the Group of 20 nations committed $430 billion to bulk up the International Monetary Fund's war chest to fight any widening of Europe's debt crisis. The money was available because of a pledge from the BRICS, who are now demanding more voting clout. The G20 issued the following statement: "The tail risks facing the global economy only months ago have started to recede, however, growth expectations for 2012 remain moderate, deleveraging is constraining consumption and investment growth, volatility remains high partly reflecting financial market pressures in Europe and downside risks still persist."

This one nearly slipped by without notice; about a week ago, Spain imposed a ban on cash transactions over 2,500-euro, or about $3275-dollars. Those who violate the rule will face fines amounting to 25 per cent of the value of the payment. About two weeks ago we told you the story of the elderly man who in Greece who publicly committed suicide, which rallied the masses in Athens. Meanwhile, it's really an epidemic in Europe, with suicide rates up 24% in Greece, 16% in Ireland and over 15% in the overall EU and climbing rapidly. Spanish unemployment is already at 23% and climbing while the official Spanish government projections call for an economic contraction of 1.7% this year. The analysts say Spain appears to be falling into its second recession in three years; which is absolute garbage; it's not a recession; it is a depression – full blown and nasty.

Against this backdrop, the International Monetary Fund today released their Financial Stability Report, which assesses how the world's financial system is holding up. Here are a few key points:

The IMF says under existing policies there will be a $2.6 trillion credit crunch in bank assets that will lead to a result in a 1.7% drop in euro-area credit. Under a best case scenario, there will be a $2.2 trillion dollar credit crunch and bank credit will contract by 0.6%. Worst case is $3.8 trillion dollars and bank credit shrivels by 4.4%.

In turn, this would force the Euro-banks to sells assets and freeze up interbank lending. Spain and Italy would be hit very hard, and the UK would take a bigger hit than France and Germany. Go figure.

Beyond Europe, it is essential to start addressing now the medium-term fiscal challenges in the United States and Japan. This should be accompanied by stronger efforts to address US household debt and accelerate housing market reforms.

Now, what does this mean for you? The quick answer: short the euro and go long the dollar, which might be a positive for US Treasuries, and the reason is simple: when you talk about going long the dollar, you really mean treasuries and I don't see treasuries moving much higher, conversely there just isn't much room for yields to drop significantly lower. It might also be a short-term negative for gold and silver, except gold and silver have been holding up quite nicely. We seem to be in a fairly tight range around 1640 to 1660. You might have expected a hit to the metals but it hasn't materialized. If gold drops under 1620, it might be nerve wracking but might offer a dip for buying. It would have to drop under 1500 to make me really nervous, but I don't think we'll get that low because what you're really looking for is a move to safety. In the long run, nothing is safer than the metals. All these moves to prop up the euro are just part of the process of debasing the currency. Right now the dollar looks safe to a whole bunch of investors. Right now, the US dollar is the cleanest shirt in a hamper full of dirty laundry, but that doesn't mean it will smell sweet.

For the week, the Dow gained 1.4 percent, the S&P 500 added 0.6 percent and the Nasdaq fell 0.4 percent, down for a third week running.

About 81 percent of S&P 500 companies that have reported so far have beat expectations, which means 19% of the companies are too stupid to manage analysts.

Apple shares posted back-to-back weekly declines of more than 4 percent for the first time since late December 2008.

Labor groups at bankrupt American Airlines say they support a potential merger with rival US Airways in a deal they say would save more jobs than a plan by parent AMR Corp to reorganize as a stand-alone carrier.

The unions representing American's pilots, flight attendants and ground workers said they struck a deal with US Airways that would preserve 6,200 of the 14,200 jobs American says it would cut if it pursues its current plan.

Their joint statement supporting a merger is an unusual twist that comes ahead of a showdown next week with AMR over the company's request in bankruptcy court for permission to void labor contracts and impose new terms. AMR filed for Chapter 11 last November, citing labor costs. I can't think of another occasion when airline unions actively supported a merger, because those deals usually mean job cuts. For the American unions, it's a real indictment to the company's plan. But it doesn't necessarily mean there will be a merger.

US Airways CEO Doug Parker cautioned his employees in a letter today that the union deal does not mean a merger is in the works. He noted that a deal would need support from the AMR creditors management team and its board of directors.

"But this is obviously an important first step along that path and we are hopeful we can all work together to make this happen," Parker said.

Although AMR has tried for months to blunt speculation, US Airways has hired advisers to explore merger options with AMR, but has not issued a proposal.

AMR spokesman Bruce Hicks dismissed union support for merger talks, noting the company's right in bankruptcy court to create its own reorganization plan without interference at least until September 28.

"These statements do not in any way alter the company's commitment to pursue our business," the airline said in a statement.

Parker has been a vocal proponent of airline consolidation as a means to cut excess capacity on unprofitable routes. He said a deal with AMR would create a "preeminent airline with the enhanced scale and breadth required to compete more effectively and profitably." You might also argue that consolidation means less competition and fewer traveling options, but you can't deny that it is the current trend. Another undeniable trend is that the airline workers have been getting the short stick in consolidation.

Delta is also studying a potential bid for AMR, but the carrier has not presented a merger plan to AMR's unions or creditors in a way that US Airways has made an outreach to the stakeholders of AMR

Earlier this week, Citigroup shareholders rejected a $15 million dollar pay package for CEO Vikram Pandit; the first time shareholders have rejected a compensation plan at a major US bank. Now Pandit and the board of directors are being sued for breaching their fiduciary duties by awarding more than $54 million of compensation in 2011 to the executives, including $15 million to Pandit, though the bank's performance did not necessarily justify it. The complaint says the pay increase proposal "has cast doubt on the board's decision-making process, as well as the accuracy and truthfulness of its public statements."