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HomeAmerica’s Hidden Inflation and How You’re Getting Screwed
Posted by Larry Doyle on March 23rd, 2010 1:47 PM |
Inflation is dead, right?
If we believe The Wall Street Journal, all we had to do was read yesterday’s edition to learn this fact. The WSJ wrote, Inflation is Dead? Long Live Long-Term Treasurys:
The Treasury Department is selling $118 billion in debt this week, just as Congress tackled a $940 billion health-care bill over the weekend, shining the spotlight on the U.S.’s hefty fiscal commitments.
Budget-deficit and debt levels are forecast to worsen: Total deficits including interest costs are set to remain above $1 trillion in the next decade, according to Barclays Capital. But longer-dated U.S. government debt is as popular as ever, even at the measly 3.689% and 4.580% yields that 10- and 30-year Treasurys are paying, respectively.
That popularity is supported by a single, compelling economic fact: Inflation is dead.
There you go. The WSJ said it, so it must be right. The policy wonks in Washington continually repeat it, so they must be right, too. Or are they? (more…)
Bill Gross Making Sense on Cents
Posted by Larry Doyle on October 14th, 2009 12:56 PM |
Looking beyond the liquidity provided by the Treasury and Federal Reserve to refloat our equity markets, what will be the drivers of our economy and markets going forward? While Uncle Sam may think he can leave rates at 0-.25% for an extended period, at some point even ‘extended’ runs out. Will the Uncle Sam economy have adapted and implemented the structural changes necessary to move on to a new phase of growth and prosperity?
I am very concerned and reiterate that our markets are masking significant embedded issues in our economy and overall fiscal health.
As much as I found Pimco to be challenging when trading with them, and question their integrity in handling their outstanding Auction-Rate Securities issuance, I respect their views on the markets and economy. In fact, I think Bill Gross and Mohamed El-Erian consistently provide a lot of “sense on cents.” What does Mr. Gross have to say about our economic landscape lately? He writes:
What is critical to recognize is that both California and the U.S., as well as numerous global lookalikes such as the U.K., Spain, and Eastern European invalids, are in a poor position to compete in a global economy where capitalism is morphing from its decades-long emphasis on finance and levered risk taking to a more conservative, regulated, production-oriented system advantaged by countries focusing on thrift and deferred gratification. The term “capitalism” itself speaks to “capital” – the accumulation of it and the eventual efficient employment of it – for growth in profits and real wages alike.
Regrettably, more and more capital here at home is being directed toward the servicing of our massive deficit. Additionally, taxes will surely increase to do the same. Over and above those two definites, I believe strongly that capital will increasingly look for opportunities outside our nation given the pressure on our greenback.
Gross touches upon an issue which I strongly believe is a MASSIVE drag on our current economy and our future well being, that is our secondary schools which rank 18th overall in the developed world. Gross writes:
What California once had and is losing rapidly is its “capital”: unquestionably in its ongoing double-digit billion dollar deficits, but also in its crown jewel educational system that led to Silicon Valley miracles such as Hewlett Packard, Apple, Google, and countless other new age innovators. In addition, its human capital is beginning to exit as more people move out of the state than in. While the United States as a whole has yet to suffer that emigration indignity, the same cannot be said for foreign-born and U.S.-educated scientists and engineers who now choose to return to their homelands to seek opportunity. Lady Liberty’s extended hand offering sanctuary to other nations’ “tired, poor and huddled masses” may be limited to just that. The invigorated wind up elsewhere.
Do the powers that be in Washington and in the state houses possess the necessary discipline to right our ship and set sail on smoother seas? If so, they will have to display a set of values and practices which are entirely inconsistent with how our government operates. While I remain bullish on those who want to educate themselves, practice discipline, and save for better days, I am bearish on people who think Washington or other entities can provide those necessary values. Gross is also cautious in concluding:
Now that our financial system has been stabilized, one wonders whether California’s “Governator” and indeed the Obama Administration has the capital, the vision, and indeed the discipline of its citizenry to turn things around. Our future doggie bags can hold steak bones or doo-doo of an increasingly familiar smell. For now investors should be holding their noses, their risk orientation, as well as their blue bags, until proven otherwise. Specifically that continues to dictate a focus on high quality bonds and steady dividend paying stocks that can survive, if not thrive, in our journey to a “new normal” economy of slower growth, muted profit gains, and potential capital destruction via default, abrogation of property rights, and dollar devaluation.
If we think a return to business as usual is the proper path, we will merely go in circles and end up right back in this same spot….if not worse.
I welcome comments from those who share or differ with these assessments.
LD
Is the Federal Reserve Readying a Stealth Tightening of Monetary Policy?
Posted by Larry Doyle on September 22nd, 2009 4:11 PM |
The Federal Reserve impacts the economy by raising and lowering the Federal Funds Rate. With the Fed Funds rate currently at a range of 0-.25%, the Federal Reserve has no more ammo to positively impact the economy, right? No! Readers of Sense on Cents are fully aware of the other measures the Fed, in conjunction with the Treasury, has utilized to inject money into the economy, including:
1. quantitative easing in which the Fed has purchased U.S. Treasury and mortgage-backed bonds
2. backstopped money market funds (FYI . . this program ended last Friday)
3. providing federal guarantees for banks to issue debt
4. facilities to assist in the issuance of securitized assets (TALF)
Collectively, these programs have achieved an effective negative Fed Funds Rate. This development is not only historic but very daunting for the economy and market. When and how will the Federal Reserve and Treasury begin to exit some of these programs, and take some liquidity out of the system without spooking the markets? In the process, the Federal Reserve will begin a de facto tightening of the monetary policy even if it does not immediately begin to raise the Fed Funds Rate.
This tightening process may be in its formative stages. How do we know? Bloomberg reports, Fed Said to Start Talks With Dealers on Using Reverse Repos:
The Federal Reserve has started talks with bond dealers about withdrawing the unprecedented amount of cash injected into the financial system the last two years, according to people with knowledge of the discussions.
Central bank officials are discussing plans to use so- called reverse repurchase agreements to drain some of the $1 trillion they pumped into the economy, said the people, who declined to be identified because the talks are private. That’s where the Fed sells securities to its 18 primary dealers for a specific period, temporarily decreasing the amount of money available in the banking system.
Given the amount of liquidity the Fed has pumped into the economy over the last year, these reverse repurchase agreements would have to be of huge size and for a longer tenor in order to truly make an impact.
What would be the impact of sizable reverse repurchase agreements? I would make the following assessments based upon my feeling that the market would perceive these agreements as a tightening of Fed policy:
1. the yield curve would flatten, meaning short term rates would raise relative to long term rates (revisit your Algebra II chapter on slope)
2. the U.S. dollar would strengthen as the market perceives this move an indication that the Fed is closer to raising the actual Fed Funds Rate than it was previously.
3. the markets, both equities and bonds, would very likely sell off in a reversal of the price action of the last six months. Both our equity and bond markets have been supported by the cheap funding provided by the Fed. This phenomena led to the dollar carry trade which I highlighted a week ago in writing, “Dollar Carry Trade Drives Global Equity Markets.”
The dollar is getting hammered again today and that fact is supporting our markets, both equity and bonds. Watch the US Dollar Index as it is clearly the best indicator as to the Fed’s intentions and market direction. If and when you see the dollar start to improve (currently quoted at 76.13), then look for stocks and bonds to weaken.
LD
Bernanke Conundrum
Posted by Larry Doyle on June 8th, 2009 7:27 AM |
Overnight markets indicate that Treasury prices are lower and interest rates subsequently higher (remember the inverse relationship between bond prices and interest rates). 2yr Treasury notes are trading at 1.33% and 10yr Treasury notes are trading at 3.85% (both are .03% higher from Friday’s close).
If interest rates are higher, clearly that move must be an indication that economic activity is improving and equity markets should be higher overnight, correct? In “normal” economic times, perhaps that line of reasoning would hold water, but in the Uncle Sam economy, we need to go deeper.
Equity futures indicate our stock markets will open lower by approximately 1%. What’s going on? Welcome to the Bernanke conundrum! What is the riddle wrapped inside our economic enigma? How can Fed chair Ben Bernanke nurse our economy back to health while at the same time maintaining the necessary fiscal independence, integrity, and discipline of robust Fed policy?
Big Ben has used aggressive measures to backstop a wide swath of our markets. In the process, he has created a fair amount of stability but with an effective government guarantee “insurance” policy as the cost of stability. Some of these policies have lessened in size as certain sectors have normalized. However, the major Fed programs remain in place. What are these?
1. quantitative easing: commitment to buy $1.3 trillion in total of Treasury and mortgage-backed securities in an attempt to keep these rates down. Then why are rates rising? More on this in a second.
2. commitment to provide necessary liquidity as needed to support the “wards of the state” including Freddie Mac, Fannie Mae, GM, AIG, Citigroup.
These programs in conjunction with the massive deficit spending programs undertaken by the Obama administration have ballooned our expected funding needs in calendar 2009 to upwards of $3 trillion, a fourfold increase over prior years.
In my opinion, interest rates are moving up much less on any real signs of economic improvement than on these funding needs and very real signs of a monetary printing press malfunction. What’s that? With the Fed Funds rate at 0-.25%, the Fed is literally flooding the economy with cash. Where is that cash going? Is it flowing through to the economy? Not really.
The cash is pouring into the banking system to cushion and support financial institutions from the ongoing losses connected to rising defaults on credit cards, residential mortgages, commercial real estate, and corporate loans.
The market is now very clearly sending a signal to Bernanke, Geithner, Obama and team that if they want to continue their programs as designed (and they do and will), the price, that is the rate of interest, is going up. Why?
The market is very concerned that the flood of liquidity will lead to inflation if not rampant inflation and potentially hyperinflation. How does Bernanke head that off?
Withdraw the very liquidity that he has found so necessary to pour into the financial system. How does he do that?Two ways.
1. increase the Fed Funds rate: that is, make borrowing more expensive.
2. reverse the quantitative easing program so that the Fed actually sells Treasury and mortgage-backed securities into the market and takes liquidity out in the process. What are the impacts of both those maneuvers? Higher interest rates.
In fact, interest rates are moving higher already in anticipation of Bernanke being forced to make these moves. Can Bernanke “thread this needle?” What will happen if interest rates move higher?
Slow the economy, especially housing given higher mortgage rates, and lower earnings especially for financial institutions. To wit, our equity markets are lower overnight.
Nobody said this was going to be easy.
LD
Review of Economy, Fed Reserve Statement, and Market
Posted by Larry Doyle on April 29th, 2009 2:57 PM |
The Federal Reserve released its regular statement on the economy at 2:15pm. The statement includes:
1. no change in the Fed’s interest rate policy with the Fed Funds rate remaining between 0-.25%.
2. no change in the Fed’s asset purchase program of government and mortgage-backed securities.
3. overall economic activity remains weak but the pace of decline is slowing.
4. inflation remains below the Fed’s long term target.
5. the Fed will employ all available tools at its disposal to help the economy recover.
The equity markets are having a strong upward move today based not on the Fed’s statement but reaction to the DRAMATIC decline in inventories reflected in this morning’s VERY weak GDP report. If an equity market rallying after a VERY weak GDP report seems counterintuitive it is due to the fact that if and when consumer demand picks up it will drive production.
In my opinion, banking on a pickup in consumer demand is a big if. With credit tight and likely to remain tight, I believe our economy needs to and will adjust to lessened demand.
The WSJ comments on this economic activity, U.S. Economy Shrank At 6.1% In First Quarter:
Weaker investment in housing combined with the enormous inventory adjustment to pull the economy downward. But the aggressive drawdown of stockpiles of goods, while hurting the economy in the short run, is beneficial because it is an important step toward bringing inventories under control and ending a production freefall. U.S. industrial production retreated a fifth straight month in March, recent data show. Over the past 12 months, output was down nearly 13%. Capacity use by industries receded to 69.3%, a historical low since records began in 1967.
One area of concern for me is the uptick in prices. Although economists and analysts are panning the near term inflation risks, in my opinion, this risk should not be underestimated. The increase in prices in today’s GDP report has received little coverage, but
Price indicators within Wednesday’s report suggested inflationary pressures rose in first-quarter 2009, easing fears of deflation. For instance, the price index for personal consumption expenditures fell by 1.0%, a decline much smaller than the fall of 4.9% in the fourth-quarter 2008. The PCE price gauge excluding food and energy rose 1.5%, after increasing 0.9% in the fourth quarter.
Free money in the form of a 0-.25% Fed Funds rate will continue to help banks recover but government deficits as far as the eye can see must be addressed. If the economy stabilizes, look for interest rates to ratchet higher.
In fact, in today’s trading government bonds are down and rates are back to the highs seen last November.
LD
Quantitative Easing? Welcome to Vegas!!
Posted by Larry Doyle on March 19th, 2009 9:07 AM |
The Federal Reserve has ZERO room to maneuver on its interest rate policy given the fact that its interest rate tool, the Fed Funds Rate, is currently set at 0-.25%. Could that rate be set at a negative level? Well, let’s just say that it has never happened with any central bank in the world. With no more arrows left in its interest rate quiver, what is a Federal Reserve to do to manage an economy? Let’s enter the world of “quantitative easing.”
Quantitative easing by any central bank is a policy in which that bank grows its balance sheet to purchase assets (government bonds, mortgage securities, government agency debentures, etc). The purpose of purchasing these assets is to drive the prices for these assets higher which in turn brings the interest rates on these assets lower (bond prices and interest rates on those bonds have an inverse relationship). The hope the Federal Reserve holds is that in bringing rates down (government rates and mortgage rates dropped by .3% to .5% yesterday) consumer and institutional demand for money will go higher and spur the economy in the process. (more…)
Libor Creeping Higher
Posted by Larry Doyle on March 11th, 2009 5:45 AM |
For those involved in the markets, very often the first rate one checks in the morning is Libor (London Interbank Offered Rate). For those not directly involved in the markets, perhaps tomorrow morning or Thursday you may start your day by asking your partner, “where’s Libor?” In all seriousness, the 1 month and 3 month Libor rates may very well be the most closely watched indicators of market health in the world.
As Libor is the rate at which banks can borrow from each other in the London market, the rate is an indication as to the availability of dollars and the confidence banks have in each other’s credit. Traditionally, Libor tracked the Federal Funds rate (the rate at which banks borrow from the Federal Reserve) very closely. However, on the heels of the failure of Lehman Bros. last September, the confidence banks and investors had in each other plummeted. The relationship between the Fed Funds rate and 3 month Libor blew out. The 3 month Libor rate went as high as 4.7% from just outside 1%. Recall that at that period there was concern about money market funds “breaking the buck” amongst a whole set of other issues. (more…)
