Friday, June 5, 2009

Interest Rates: What Will the Fed Do Next?

from the Calculated Risk Blog:

First from Reuters: Fed's Lockhart: Can't wait too long to tighten (ht Alan)

The Federal Reserve needs to be "anticipatory" and not wait too long to tighten monetary policy, Atlanta Fed President Dennis Lockhart said in an interview published on Friday. ... Lockhart is a voter on the Fed's policy-setting Federal Open Market Committee, which meets June 23-24.
This is similar to the comments of Kansas Fed President Thomas Hoenig on Wednesday.

Yields are rising across the board, with the Ten Year yield at 3.84%.

This will push mortgage rates higher ... here is a scatter graph I posted last month showing the relationship between the Ten Year yield and 30 year mortgage rates.

30 Year Mortgage Rates vs. Ten Year Treasury Yield Click on graph for larger image in new window.

This graph shows the relationship between the Ten Year yield (x-axis) and the 30 year mortgage rate (y-axis, monthly from Freddie Mac) since 1971. The relationship isn't perfect, but the correlation is very high.

Based on this historical data, a Ten Year yield at 3.84% suggests a 30 year mortgage rate of around 5.75%.

Freddie Mac reported that 30 year mortgage rates were at 5.29% for the week ending June 4th, and the MBA reported rates at 5.25% for the week ending May 29th. These rates should jump again next week putting pressure on the Fed.

Payroll Data In Perspective

from David Rosenberg at Merrill Lynch:

We have to put the data into perspective. Before the Lehman collapse, when equities were in a moderate bear market and bonds in a moderate bull market, the worst nonfarm payroll result we saw was -175,000. We don’t seem to recall too many pundits rejoicing over employment declines at that time, which were basically half of what was just posted in May. Moreover, the worst nonfarm payroll number in the 2001 recession — right after 9-11 — was -325,000; and before that, at the depths of the 1990-91 recession, the worst report showed a -306,000 print. So basically, what we saw today was a number consistent with a deep recession — just not quite as deep as the near-6% at an annual rate contraction we saw in the first quarter. It is difficult to rejoice over an employment data that is consistent with real GDP still declining anywhere from a 2% to 4% at an annual rate. Now here we are, close to nine months after the Lehman collapse, and we are still printing employment numbers that are double what they were before pre-Lehman. That is the bigger picture.

Moreover, the internals of today’s report, in a word, were awful. Not only are businesses still cutting jobs but they are also reducing the hours that their employees are working; the private workweek hit a new record low of 33.1 hours (from 33.2 hours in April). So, total labour input was much weaker than the headline payroll suggests and this is vividly illustrated in the aggregate-hours worked index, which fell 0.7% MoM and something ‘green shoot’ advocates will not like discuss since this was actually worse than the 0.3% MoM drop in April; this takes the three-month trend to a -8.6% annual rate. Think about that for a moment because what goes into GDP is total hours worked and productivity — so the latter better continue to hang in there or else we are going to be seeing some nasty output data going forward that may well take Mr. Market by surprise. Put another way, if companies had held hours worked constant in May instead of cutting them, to achieve the total labour input they achieved last month would have required — get this — a 927,000 payroll cut. ‘Green shoot’ indeed.

Temp Workers Hide Magnitude of Joblessness

from APNews:

But consider these numbers:

_The 8.9 percent April unemployment rate was based on 13.7 million Americans out of work. But that number doesn't include discouraged workers or people who gave up looking for work after four weeks. Add those 700,000 people, and the unemployment rate would be 9.3 percent.

_The official rate also doesn't include "marginally attached workers," or people who have looked for work in the past year but stopped searching in the past month because of barriers to employment such as child care, poor health or lack of transportation. Add those 1.4 million people, and the unemployment rate would be 10.1 percent.

_The official rate also doesn't include "involuntary part-time workers," or the 2 million people like Noel who took a part-time job because that's all they could get, plus those whose work hours dropped below the full-time level. Once those 9 million workers are added to the unemployment mix, the rate would be 15.8 percent.

All told, nearly 25 million Americans were either unemployed, underemployed or had given up looking for a job in April.

The ranks of involuntary part-timers has increased by 4.9 million in the past year, according to a May study by the Federal Reserve Bank of Cleveland. Many economists now predict unemployment won't peak until 2010. And since employers generally increase the hours of existing workers before hiring new ones, workers could be looking for full-time jobs for some time.

Even so, one economist said the increase in involuntary part-timers might have a silver lining. Gary Burtless, a senior fellow in economic studies at the Brookings Institute, said employers are likely cutting back everyone's hours instead of laying off people.

Unemployment Jumps to 9.5%, But Rate Slows

from WSJ:
U.S. job losses softened markedly last month, sending one of the strongest signals yet that the severe recession may be winding down.

Still, another jump in the unemployment rate to a fresh 25-year high served as a sober reminder that even if the economy does stabilize in coming weeks, a rapid return to growth is unlikely given the pressures households face from a sluggish labor market.

Nonfarm payrolls slid 345,000 in May, the U.S. Labor Department said Friday, well below the 525,000 decline economists in a Dow Jones Newswires survey had expected. Last month's drop was the smallest since September 2008, when the recession intensified in the wake of the collapse of Lehman Brothers.

More Czars Than Historical Russia

The Obama Administration has appointed 18 czars to date, including yesterday's "Great Lakes Czar". Give me a break! A czar for the Great Lakes? Now, they are poised to appoint a 19th one next week to regulate compensation. Unbelievable!

Cabinet officers require approval by the United States Senate and Congressional oversight. However, the Obama Administration is claiming the privilege of appointing so many czars through the TARP authorization bill. It really is an end run around the Constitution, since none of these czars are known to the American people or accountable to its elected representatives in Congress.

State Tax Revenue Shortfalls Rising

from New York Times:
DENVER — The carnage in state budgets is getting worse, a report said Thursday, with places like Arizona being hurt by falling revenue on multiple fronts, like personal income and sales taxes. Other states are having mixed experiences, with some tax categories stable, or even rising, even as others fall off the map.

The report, by the National Conference of State Legislatures, also provided a scorecard for how well drafters of state budgets read the recession’s economic tea-leaves — and the short answer is, not very well.

Thirty-one states said estimates about personal income taxes had been overly optimistic, and 25 said that all three major tax categories — sales taxes, personal income taxes and corporate taxes — were not keeping up with projections.

Even gloomy-Gus states that saw the recession coming and low-balled their tax estimates had little room for celebration, the report said. “The handful of states that have weathered the economic decline reasonably well are starting to report adverse revenue developments,” it said. “The news is alarming.”

Welfare Society

from USA Today:

The recession is driving the safety net of government benefits to a historic high, as one of every six dollars of Americans' income is now coming in the form of a federal or state check or voucher.

Benefits, such as Social Security, food stamps, unemployment insurance and health care, accounted for 16.2% of personal income in the first quarter of 2009, the Bureau of Economic Analysis reports. That's the highest percentage since the government began compiling records in 1929.

In all, government spending on benefits will top $2 trillion in 2009 — an average of $17,000 provided to each U.S. household, federal data show. Benefits rose at a 19% annual rate in the first quarter compared to the last three months of 2008.

The recession caused about half of the increase, according to the report. Unemployment insurance nearly tripled in the past year. The other half is the result of policies enacted during President George W. Bush's first term.

Following the 2001 recession — when costs normally decline — social spending soared to pay for the Medicare drug benefit, expanded health care for children and greater use of food stamps.

Thursday, June 4, 2009

Being Right Is Over-Rated

from Abnormal Return blog (one of my favorites):

Joe Weisenthal at Clusterstock points out today an interesting (long) piece by Holman Jenkins at on the financial crisis. The gist of the article is that the financial crisis was by and large a massive financial accident that was unforeseeable.

Jenkins notes that even investors like John Paulson, who many claim to have foreseen the meltdown of the global financial system, did not in fact foresee the crisis. If they had they would have invested quite differently:

But those who bet successfully against subprime did so through elaborate, expensive, negotiated deals to purchase credit default swaps or buy “put contracts” on subprime indexes. Had they really seen what was coming, they would saved themselves a great deal of expense and bother by simply shorting Citigroup, Bank of America, Lehman, Bear Stearns, etc. Their profits would have been huger, their workload and hassle factor much less.

The point of the above quote is not whether the crisis was foreseeable, nor is it a criticism of Paulson. In today’s financial markets traders can express their viewpoints about the future through derivatives and structured products in a very precise manner. If Paulson had foreseen the collapse of the global financial system there were much easier ways to profit from (and express) that viewpoint. (Not that he is complaining.)

Much too much is made in the media about who is right, and who is wrong. (Not that these thing are well tracked.) On television, in print and on the Internet we are inundated with pundits who crow about their prescience, while omitting their missed forecasts. The funny thing is that for investors, being right is greatly overrated.

Investors and traders need only worry about one thing: profitability. Are you generating requisite profits from your portfolio for the risks assumed? Everything else is just noise.

The need to be right is a common error for beginning investors. Any one who has ridden a stock down for a large loss can attest to this. Behavioral finance experts have a term for this: the disposition effect. Investors tend to sell winners too soon, and losers too late. You could even think of this as ‘get-even-it is.’ Investors do not want to admit that they made a mistake.

The fact of the matter is that all investors make mistakes. It is simply a part of doing business. One way traders look at their profitability is expectancy. In a vintage post, Trader Mike does a nice job describing the components of expectancy. The take away is that the percentage of times you are right is only one component in your profitability. In theory, a trader could be wrong much more that 50% of the time and still be profitable, if the profits from their winning trades far exceed the losses on their losing trades. As he writes:

Expectancy, position-sizing and other aspects of money management are far more important than discovering the holy grail entry system or indicator(s).

Stated another way: For traders, being right is overrated. It is far more important knowing when you are right, and when you are wrong, and acting accordingly.

In summary, being right may be a necessary component of trader profitability, but it is not sufficient. Proper money management techniques are required to turn trading decisions into trading profits. While it is difficult some times to take, being wrong is a part of being a trader. Don’t let the need to be right prevent you from becoming a beter trader.

Cotton Is Worst Hit Commodity During Recessions

from Agweb:
Linda Smith, Top Producer Executive Editor

The recession is a mixed bag for consumer demand for ag commodities, according to economists at Rabobank. In general, food demand is quite inelastic – people have to eat. Interestingly, consumers are least likely to give up coffee, meat, fish, and bottled water. At the grocery store, they are more likely to give up or switch away from things like sauces, dry soups and canned vegetables. (See table; the larger the negative number, the more sensitive to price changes or income losses.)

click to enlarge
There is some swapping from “luxury” products and “lifestyle” foods—a switch from steak to sausage, and slowing in organic purchases, for example, they say. As you would expect, eat-out meals are being hurt more than grocery-based at-home meals, they add. A 2008 survey found 21% of consumers cutting back on entertainment/going out; 14%, dining in restaurants; 5%, fast food/takeaway; 4% “luxury foods”; and 3% groceries.
However, cotton demand is languishing as housing sales have plummeted. New homes require draperies, rugs, furniture and the like. In addition, new clothing can be delayed until better times, whereas food cannot. Meanwhile, a major factor in cotton demand is its rapidly shrinking share of the textile market in developing countries. In the 1980s, cotton represented more than 60% of all textiles used in developing countries; today that has fallen by more than half. (See graph.)

Watch unemployment numbers for a signal the U.S. economy is ready to turn back to the positive side, the Rabobank economists say, based on eight completed recessions in the post WWII period.

Wednesday, June 3, 2009

Grains Overbought?

I have been feeling for several days that grains might be overbought despite supportive fundamentals. Apparently, I'm not the only one. From grain analyst Vic Lespinasse yesterday:

Many traders, myself included, think we overdid it to the upside yesterday and we are due for a correction to the downside today. Frequently, when the market makes a big move on Monday, it gives back part of the move on Tuesday, the "turn-a-round Tuesday" syndrome.
And today:
Crude oil and the equity markets are lower while the $ index is higher, a bearish combination for the grains. It is looking increasingly like the market is undergoing a technical correction after making eight month highs in several pits recently. The increasingly widespread thinking that prices are overbought and overdue for a correction, or at least a period of consolidation, is likely to make sellers out of many specs, either to liquidate longs or initiate new short positions, which could put a lot of pressure on the market today.
from Arlan Suderman:
A couple of bearish manufacturing reports and a warning from Federal Reserve Chairman Ben Bernanke that U.S. deficit spending is contributing to higher long-term interest rates cast a bearish cloud over the equity markets this morning. Mortgage rates are going higher, which has equity traders concerned that rising interest rates may slow the recovery. Investors rushed to unwind positions while the dollar surged higher. The shifting winds provided incentive for traders to take profits on recent gains in the grain and oilseed markets.

Grain and oilseed prices tumbled this morning, although corn tried to hold on for a while. Little had changed fundamentally, but rather the difference between Tuesday and today had much to do with the flow of money. A sinking dollar and confidence in the equity markets led investors to pump massive quantities of cash into the grain and oilseed markets in recent days. A surging dollar and renewed concerns in the equity markets caused some of the money to pull back. Now we'll have to monitor end users to see how anxious they are to take advantage of the price break.

Libor Drop Paints Incomplete Picture

excerpt from

However, analysts and bankers warn that Libor rates may not be telling the full story.

That is because there are wide differences between the rates at which individual banks can borrow. The biggest institutions are able to fund themselves at around Libor levels while smaller institutions have to pay, in some cases, more than 100 basis points above Libor. This is explained by continuing counterparty risk in what remains an uncertain economic environment.

That contrasts with the situation before the credit crisis when institutions paid similar rates to borrow.

Meyrick Chapman, fixed income strategist at UBS, says: “We should not build up our hopes that the fall in Libor is such a positive sign for the markets. We have a very tiered market, where many smaller banks are still having to pay relatively high rates to borrow.”

Lena Komileva, head of market economics at Tullett Prebon, adds: “What we are seeing is a huge difference in the price of borrowing for individual banks. There is a higher proportion of banks paying above Libor.”

The British Bankers’ Association, which sets Libor by compiling an average cost of lending from the 16 banks, defends the rate, stressing that the market understands it is a reference point for the strongest banks.

John Ewan, director at the BBA, says: “We use 16 banks to set the Libor rate. They are among the biggest banks in Europe. The market knows this and understands that other smaller banks may have to pay more. This is not a false signal to the markets.”

Some analysts also point out that a rate of 100bp above Libor is still very low on an historical basis. Libor rates are at record lows as they track central bank rates, which are close to zero in the US, 0.5 per cent in the UK and 1 per cent in the eurozone.

Central banks have helped the market, too, by providing vast amounts of liquidity in secured lending, where banks and institutions can raise money at low rates in exchange for collateral.

However, the higher rates the smaller institutions have to pay in the unsecured lending markets, which were the most flexible and easiest to access before the credit crisis, will slow recovery as the higher costs will act as a drag on their earnings and mean institutions will take longer to recapitalise. Institutions also face difficulties funding much further out than three months as banks are reluctant to lend beyond this period due to counterparty risks. And when they do so, it is at punitive rates.

At the same time, funding in the longer-term corporate bond markets is very expensive.

The bond markets, where bond funds and asset managers are the main lenders rather than the banks, may be open with issuance at record levels, but the costs for an investment grade company is nearly 200 basis points more than it was at the start of 2008.

The average rate for a triple-B rated company to issue bonds in dollars is 7.75 per cent compared with 5.92 per cent in January 2008, according to Merrill Lynch.

That forces many institutions to roll over their debt in the short-term markets, where maturities are typically no more than a month.

Significantly, this type of funding is likely to become more expensive as most analysts expect Libor rates to rise with official central bank rates unlikely to fall much lower.

Steven Major, head of global fixed income at HSBC, says: “Libor is very misleading. The published levels may be very low compared with recent history, but in reality I am not convinced much volume is going through beyond the one-month maturity. Furthermore, if institutions want to fix their debt over a longer term they have to pay enormous rates to do so.”

Gary Jenkins, head of fixed income research at Evolution, agrees: “The fall in Libor rates is not a great guide to what is happening in the overall economy. We are definitely in for a long haul. We won’t get back to a situation where banks are lending in the way they were before the credit crisis for a long, long time.”

Dollar Regains Some Footing!

Broad Commodity Sell-Off On Economic Weakness

Crude Oil
Nat Gas

Grains Plunge On Economic Weakness

IntradayDailyLook at wheat today -- down 50 cents! Nearly limit down! Corn is down 15 cents, and soybeans about 30 cents! Soybeans is holding up, in percentage terms, better than any other grain. We could see a new bull market if there is significant follow-through in other sectors.

Stocks Hit By Service Sector Contractions, Higher Interest Rates

NEW YORK (Reuters) - The United States may have hit a bump on the road to economic recovery, according to data released on Wednesday, with half a million private sector jobs lost in May and mortgage applications falling last week in the face of rising interest rates.

The reports illustrate the policy dilemma of the Federal Reserve, which has committed trillions of dollars to keep market interest rates low, only to watch them shoot higher in recent weeks.

One ray of hope, though, came from a report showing planned layoffs at U.S. firms fell for a fourth consecutive month in May, reaching the lowest level in eight months, suggesting the pace of future job cuts could slow.

But other data showed the service sector, which accounts for about 80 percent of economic activity, contracted for the eighth straight month in May, even though the rate of deterioration slowed.

"It kind of fits with all the other news we're getting: things are less bad but they're not yet growing," said Jonathan Basile, economist at Credit Suisse in New York.

"It's encouraging to see this stabilization process start to take hold, but at the same time the weakness does persist. These are still indications that we're not totally out of the woods yet."

The Mortgage Bankers Association said its seasonally adjusted index of mortgage applications, which includes both purchase and refinance loans, for the week ended May 29 decreased 16.2 percent to 658.7.

In the labor market, U.S. companies axed 532,000 jobs last month, more than economists had expected, according to ADP Employer Services.

Huge job losses are unlikely to lend support to the housing market or to an economy that has been overwhelmingly driven by consumer spending in recent years.

Worse yet, April's ADP figures were revised to show more job cuts than previously estimated, meaning May's job losses were smaller, but highlighting the ongoing deterioration in an economy that may have difficulty living up to expectations that it will resume economic growth in the second half of the year.

The bolded sections are those that were largely ignored by other media outlets. They preferred to report them as "better than expected". Hmm!

Chavez Says He And Castro Are More Conservative Than "Comrade" Obama

from Reuters:

Venezuela's President Hugo Chavez said on Tuesday that he and Cuban ally Fidel Castro risk being more conservative than U.S. President Barack Obama as Washington prepares to take control of General Motors Corp.

During one of Chavez's customary lectures on the "curse" of capitalism and the bonanzas of socialism, the Venezuelan leader made reference to GM's bankruptcy filing, which is expected to give the U.S. government a 60 percent stake in the 100-year-old former symbol of American might.

"Hey, Obama has just nationalized nothing more and nothing less than General Motors. Comrade Obama! Fidel, careful or we are going to end up to his right," Chavez joked on a live television broadcast.

During a decade in government, Chavez has nationalized most of Venezuela's key economic sectors, including multibillion dollar oil projects, often via joint ventures with the private sector that give the state a 60 percent controlling stake.

ADP: 532,000 Jobs Lost

from Reuters:

U.S. private employers chopped more than half a million jobs in May, signaling job conditions remain tough and dashing some hopes the economy was not deteriorating as rapidly as thought, a report on Wednesday showed.

U.S. companies axed 532,000 jobs last month, though this was fewer than the revised 545,000 jobs lost in April, according to the ADP National Employment Report.

The April figure was originally a decline of 491,000.

State Budget Dilemmas

from WSJ:

State budgets look bad now, but they are set to get worse.

The bulk of funds from the federal government's stimulus package will be allocated by 2011, but tax collections aren't likely to be enough to take their place -- even if the economy is recovering.

The drop in tax revenue is set to be deeper and last longer as collections have become more sensitive to business cycles in recent years. At the same time, states face growing health-care costs and the need to replenish pension programs funded by decimated investments. And some of the stimulus funds expand programs that will require state money to sustain them after the federal largesse runs out.

"There are so many issues that go way beyond the current downturn," said Scott Pattison, executive director of the National Association of State Budget Officers. "This is an awful time for states fiscally, but they're even more worried about 2011, 2012, 2013, 2014."

Already, acrimony is building as states grapple with budget problems. In Illinois, lawmakers failed to pass a budget Sunday after rejecting the tax increases that Gov. Pat Quinn, a Democrat, said were needed to close an $11.6 billion spending gap. The Texas Legislature adjourned Monday in disarray, without approving funding needed to keep the state's transportation and insurance agencies running.

In Arizona, Gov. Jan Brewer, a Republican, on Monday released a controversial budget proposal that would temporarily raise the sales tax and partly revive a state property tax.

And in California, Republican Gov. Arnold Schwarzenegger warned Tuesday that lawmakers have until June 15 to close the state's budget deficit, or California will be unable to borrow the cash it needs to pay its bills after July.

With most governors busy stanching the current budget bleeding, only a few have taken steps to head off future problems.

Tennessee Gov. Phil Bredesen, a Democrat, in March laid out a four-year plan to balance the budget without using rainy-day funds. In Oregon, Democratic Gov. Ted Kulongoski has called for a "reset" of state government, arguing that voters must reconsider 1990s ballot measures that shifted school funding from property taxes to income taxes and that imposed mandatory minimum prison sentences. Gov. Schwarzenegger is proposing lasting cuts to health care and prisons.

Altogether, states face aggregate budget shortfalls of at least $230 billion from fiscal 2009 through fiscal 2011, said Mr. Pattison. For most states, that covers the period from July 1, 2008, to June 30, 2011.

That aggregate figure is nearly double the roughly $130 billion in federal stimulus funds that states can use flexibly over three years. (About $120 billion in further stimulus funding comes with stricter requirements, and sometimes new, costly mandates.)

When today's federal assistance peters out, a number of state budget officers don't expect new tax revenue to replace it. As the recession grinds on, states are posting significant declines in revenue from their three major sources: sales, personal-income and corporate taxes.

About a quarter of states saw their economies contract last year, the Commerce Department said Tuesday. Alaska's gross domestic product -- the total value of all the goods and services it produced -- slipped the most in 2008, falling an inflation-adjusted 2% from the previous year largely because of declining oil output.

The Great Lakes states of Michigan, Ohio and Indiana posted some of the steepest GDP drops, as the woes of Detroit's auto makers hurt manufacturers throughout the region.

North Dakota's GDP gain of 7.3% topped the nation. Its largely agricultural economy has been well shielded from the housing bust, financial crisis and manufacturing decline that have weighed on the overall U.S. economy.

Still, in general most forecasters see a very slow recovery, which suggests a commensurately slow upturn in state revenues. Federal Reserve officials, for instance, see unemployment, at 8.9% at last report, averaging between 9% and 9.5% next year and remaining elevated through 2011; some private forecasters are more pessimistic.

State tax collections could take five years or more from when the recession began in December 2007 to recover to prerecession levels, says Donald J. Boyd, senior fellow at the Nelson A. Rockefeller Institute of Government at the State University of New York.

In addition, revenues appear to have grown more sensitive to the business cycle in the past decade, in part because capital-gains taxes have become a bigger component of tax bases, according to new research by Federal Reserve Bank of Chicago economists Leslie McGranahan and Richard Mattoon. That could prolong the effect of the downturn and, by increasing volatility, make it harder for states to plan budgets.

The best outcome they can imagine, some state officials say, is that the stimulus funding allows them to make spending cuts gradually: for example, by relying more on attrition and less on layoffs to cut payrolls. (Unlike the federal government, states generally are required to balance their budgets.)

That's sparking tough choices. In April, Tennessee's sales tax revenue was 9.9% below the previous year, and total tax revenue for the month was nearly $200 million less than the state's forecast.

The state expects general-fund tax revenue to rise about 4.4% in the fiscal year beginning July 1, 2010, from a year earlier. But that entire increase is expected to be eaten up by inflation in education costs, increased Medicaid enrollment, and funding a pension plan whose nominal value has dropped from $32 billion to $25 billion.

So the state is looking to make long-lasting spending cuts. It plans to eliminate 1,373 jobs. Some economic-development projects are potentially on the chopping block.

"This is not simply trimming around the edges," said the state's top budget officer, Dave Goetz. "This is entire programs."

States also can raise taxes and fees, of course, but if residents continue to hold down their spending, that thriftiness will limit additional sales-tax revenue. Massachusetts state Treasurer Timothy P. Cahill, a Democrat who is considering a run for governor next year, has been critical of discussions in the Legislature to raise the sales-tax rate.

"This is such a consumer-based recession that I think you'd be compounding the problem by increasing a tax on consumer spending," he said.

Bernanke Says Interest Rates Rising Due to Growing Federal Debt

This is significant because just week, he attributed the higher rates to improvement in the economy.

from Bloomberg:

Federal Reserve Chairman Ben S. Bernanke said large U.S. budget deficits threaten financial stability and the government can’t continue indefinitely to borrow at the current rate to finance the shortfall.

“Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth,” Bernanke said in testimony to lawmakers today. “Maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance.”

Bernanke’s comments signal that the central bank sees risks of a relapse into financial turmoil even as credit markets show signs of stability. He warned the financial industry remains under stress and the credit crunch continues to limit spending.

The Fed chief said in his prepared remarks to the House Budget Committee that deficit concerns are already influencing the prices of long-term Treasuries.

Yields on 10-year notes have climbed about 1 percentage point since the Fed announced plans in March to buy $300 billion of long-term government bonds. The notes yielded 3.57 percent at 10:34 a.m. in New York, down from 3.61 percent late yesterday.

Rise in Yields

“In recent weeks, yields on longer-term Treasury securities and fixed-rate mortgages have risen,” Bernanke said. “These increases appear to reflect concerns about large federal deficits but also other causes, including greater optimism about the economic outlook, a reversal of flight-to-quality flows and technical factors related to the hedging of mortgage holdings.”

Chrysler Bankruptcy Stayed By Appellate Court

from WSJ:

A federal court late Tuesday agreed to hear an appeal related to the bankruptcy of Chrysler LLC, potentially extending the auto maker's stay in Chapter 11 reorganization by at least several days.

The Second U.S. Circuit Court of Appeals in New York said it would hear an appeal by a group of Indiana pension funds challenging the sale of most of Chrysler's assets to the company's proposed partner, Fiat SpA of Italy. Oral arguments in the appeal will begin Friday, according to the court's order.

Tuesday, June 2, 2009

More Dollar Dumping

from Bloomberg:
The dollar dropped to its lowest level against the euro this year on speculation record U.S. borrowing will undermine the greenback, prompting nations to consider alternatives to the world’s main reserve currency.

The 16-nation euro gained for a fourth day versus the dollar as the Russian government said emerging-market leaders may discuss the idea of a supranational currency. The pound strengthened to $1.65 for the first time since October.

“There’s been a lot of talk out of Russia about a new global currency, and that’s contributing toward this latest bout of dollar weakness,” said Henrik Gullberg, a currency strategist at Deutsche Bank AG in London. “These latest comments are just adding to the general dollar weakness we’ve seen recently.”

The Dollar Index, which ICE uses to track the currency’s performance against the euro, yen, pound, Canadian dollar, Swedish krona and Swiss franc, fell 0.5 percent to 78.77.

Russian Proposal

Russian President Dmitry Medvedev may discuss his proposal to create a new world currency when he meets counterparts from Brazil, India and China this month, Natalya Timakova, a spokeswoman for the president, told reporters by phone today. Medvedev first proposed seeking alternatives to the U.S. dollar as a reserve currency in March.

The dollar also declined on speculation “smaller” central banks started today’s selling of the greenback, said Sebastien Galy, a currency strategist at BNP Paribas SA in New York.

Monday, June 1, 2009

World Bank Says Stimulus is Just "Sugar High"

from Bloomberg:
World Bank President Robert Zoellick warned policy makers that fiscal-stimulus plans are insufficient to turn around the “real economy” and rising joblessness threatens to set off political unrest across the globe.

“While the stimulus has given an impulse, it’s like a sugar high unless you eventually get the credit system working,” Zoellick said in an interview yesterday with Bloomberg Television’s “Political Capital with Al Hunt.” “When unemployment increases, that’s probably the most political combustible issue.”

Zoellick’s caution is a contrast with private economists, who are raising their outlooks for growth from India to China as stimulus measures take effect. The biggest developed and emerging nations have committed spending increases and tax cuts totaling 2 percent of their combined economies, a level the International Monetary Fund recommended to end the recession.

Treasury Worries Cause Interest Rates to Rebound

Sunday, May 31, 2009

Morgan Stanley Say Dollar to Depreciate

from Arlan Suderman tweet:

Morgan Stanley models put probability of a large US$ depreciation over next year the highest in decades. No full-scale crisis tho.

Beans One Tick from $12

Dollar Down, Commodities Up

Oil = $67

The Next Bubble = Government

from Finem Respice blog:

It has been the habit of the United States, in its capacity as a nation of investors and consumers with a highly developed sense of entitlement when it comes to returns and little or no tolerance for corrections of any kind, to sate the appetite of the cult of buoyancy by inflating various bubbles. This is particularly so when it appears the national vessel is beginning to sit low in the water. Loyal readers will know that finem respice does not go so far as to call for the abolition of the Federal Reserve, or make bleating noises about fiat currencies, but, without a doubt, it is worth looking at the role of various institutions as we confront the next gas-filled, surface-tension-bound, expanding topography. That sort of reflection, culminating in exactly nothing, is about all we can expect. The tools of the Federal Reserve and the Treasury are a grant of immense power to the executive, and he or she is unlikely to relinquish it without the sort of battle that resembles a protracted land war in Asia. So serial-bubbology will prevail. Junk Bonds to Dot-Com to Real Estate, for instance. Of course, this means we don't exactly have a large sample size with which to draw conclusions (n=3 perhaps) but it stands to reason that the longer we delay correction and manipulate markets with bloody sacrifice to the minions of buoyancy, the worse the wrath of the deleveraging.

Having taken great pains to ignore this lesson, and to obfuscate it completely no matter form with which it attempts to make its presence felt, it is pretty obvious that the present administration intends to bubble its way out of the latest opportunity to reset prices and moderate debt. Moreover, our leaders intend to do so via massive borrowing to pay for about every government program of any size ever conceived going all the way back to that one that crossed the kickback-addled mind of some flaccid congressman while waiting in line at Disney World back in 1972.

Small sample size or not, it is so clear that the next bubble is on the horizon, or, perhaps, already upon us, that a great deal of time and effort is spent speculating as to which asset class will be next. Oil or energy in general is a popular theory. Gold has its advocates. James Simons likely points to high beta stocks when asked. A few clever commentators have suggested Treasuries. This last is closest to the mark.

Of course, the next bubble (and perhaps the last for a while) is government. The state government bubble is beginning to burst even as you read this. The federal government bubble is next. You might want to open your mouth and plug your ears.

The US Dollar Vs. The Chinese Yuan

from Blog for Trading Success:

Whenever I have suggested that China may stop supporting the US$, skeptics have effectively said:

Yeah! And pigs can fly!”

It would be instructive to review their thinking:

  1. China has reserves of US$2 trillion
  2. Its reserves are so massive that the only country that can accept buying of that size is the US.
  3. Thus, China must continue to buy US securities and continue to support the US$ even if it believes the US is embarking upon a path of devaluation through inflation.

The apologists have a point but need to start looking over their shoulders. The Chinese are not one to sit idly by while the US debases its currency.

What can it do?

Reading the news, it’s clear that there is a minor and major strategy at play:

  1. Minor: diversify into gold and perhaps oil. Chinese gold reserves since 2004 have increased by over 70% at a reported expenditure of over US$30 billion.
  2. Major: raise the credibility of its own currency. It is doing this in two stages. The first stage is to undermine world confidence in the US$ by proposing an alternative to reserve currency. The second stage would be to substitute the Yuan for the US$.

Substituting the Yuan for the US$ will take time; but the Chinese are nothing if not patient. China has been laying the foundation. Witness:

  1. Since January 2009, China has signed currency swap agreements worth US$95 million with Argentina, Brazil, South Korea, Indonesia, Malaysia, Belarus and Hong Kong.
  2. The cross-straits agreement between China and Taiwan
  3. The yuan carry trade

These are all steps in China’s efforts to dethrone the US$. Sure it won’t happen tomorrow. But if Obama continues on his merry way, expect it to happen.

Credit Crisis Watch from John Mauldin -- Signs of Improvement

from John Mauldin's Outside the Box, written by Dr. Prieur du Plessis:

Credit Crisis Watch: Thawing – noteworthy progress

Are the various central bank liquidity facilities and capital injections having the desired effect of unclogging credit markets and restoring confidence in the world's financial system? This is precisely what the "Credit Crisis Watch" is all about – a review of a number of measures in order to ascertain to what extent the thawing of credit markets is taking place.

First up is the LIBOR rate. This is the interest rate banks charge each other for one-month, three-month, six-month and one-year loans. LIBOR is an acronym for "London InterBank Offered Rate" and is the rate charged by London banks. This rate is then published and used as the benchmark for bank rates around the world. The higher the LIBOR rate, the greater the stress on credit markets.

Interbank lending rates – the three-month dollar, euro and sterling LIBOR rates – declined to record lows last week, indicating the easing of strain in the financial system. After having peaked at 4.82% on October 10, the three-month dollar LIBOR rate declined to 0.66% on Friday. LIBOR is therefore trading at 41 basis points above the upper band of the Fed's target range – a substantial improvement, but still high compared to an average of 12 basis points in the year before the start of the credit crisis in August 2007.


Importantly, US three-month Treasury Bills have edged up after momentarily trading in negative territory in December as nervous investors "warehoused" their money while receiving no return. The fact that some safe-haven money has started coming out of the Treasury market is a good sign.


The TED spread (i.e. three-month dollar LIBOR less three-month Treasury Bills) is a measure of perceived credit risk in the economy. This is because T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. An increase in the TED spread is a sign that lenders believe the risk of default on interbank loans (also known as counterparty risk) is increasing. On the other hand, when the risk of bank defaults is considered to be decreasing, the TED spread narrows.

Since the peak of the TED spread at 4.65% on October 10, the measure has eased to an 11-month low of 0.48%. This is a vast improvement, although still somewhat above the 38-point spread it averaged in the 12 months prior to the start of the crisis.


The difference between the LIBOR rate and the overnight index swap (OIS) rate is another measure of credit market stress.

When the LIBOR-OIS spread increases, it indicates that banks believe the other banks they are lending to have a higher risk of defaulting on the loans, so they charge a higher interest rate to offset that risk. The opposite applies to a narrowing LIBOR-OIS spread.

Similar to the TED spread, the narrowing in the LIBOR-OIS spread since October is also a move in the right direction.


Further evidence that the convalescence process is on track comes in the form of data showing a sharp decline in borrowing by primary institutions at the discount window – down by almost 65% since the "panic peak" recorded during the week of October 29, 2008.


The Fed's Senior Loan Officer Opinion Survey of early May serves as an important barometer of confidence levels in credit markets. Asha Bangalore (Northern Trust) said: "The number of loan officers reporting a tightening of underwriting standards for commercial and industrial loans in the April survey was significantly smaller for large firms (39.6% versus peak of 83.6% in the fourth quarter) and small firms (42.3% versus peak of 74.5% in the fourth quarter) compared with the February survey and the peak readings of the fourth quarter of 2008."


"In the household sector, the demand for prime mortgage loans posted a jump, while that of non-traditional mortgages was less weak in the latest survey compared with the February survey. At the same time, mortgage underwriting standards were tighter for both prime and non-traditional mortgages in the April survey compared with the February survey," said Bangalore. In other words, more needs to be done by the lending institutions to revive mortgage lending.


The spreads between 10-year Fannie Mae and other Government-sponsored Enterprise (GSE) bonds and 10-year US Treasury Notes have compressed significantly since the highs in November. In the case of Fannie Mae, the spread plunged from 175 to 26 basis points at the beginning of May, but have since kicked up to 37 basis points on the back of the rise in Treasury yields.


After hitting a peak of 6.51% in July last year, there was a marked decline in the average rate for a US 30-year mortgage. However, the rise in the yields of longer-dated government bonds over the past nine weeks – 92 basis points in the case of US 10-year Treasury Notes – resulted in mortgage rates creeping higher since the April lows. Also, the lower interest rates are not being passed on to consumers, as seen from the 434 basis-point spread of the 30-year mortgage rate compared with the three-month dollar LIBOR rate. According to Bloomberg, this spread averaged 97 basis points during the 12 months preceding the crisis.

Fed Chairman Ben Bernanke said earlier in May that "mortgage credit is still relatively tight", as reported by Bloomberg. This raises the possibility that the Fed will boost its purchases of Treasuries to keep the cost of consumer borrowing from rising further. [The Fed has so far bought $95.7 billion of Treasury securities from $300 billion earmarked for this purpose. Similarly, purchases of agency debt of $71.5 (out of $200 billion) and mortgage-backed securities of $365.8 billion (out of $1.25 trillion) have taken place.]


As far as commercial paper is concerned, the A2/P2 spread measures the difference between A2/P2 (low-quality) and AA (high-quality) 30-day non-financial commercial paper. The spread has plunged to 48 basis points from almost 5% at the end of December.


Similarly, junk bond yields have also declined, as shown by the Merrill Lynch US High Yield Index. The Index dropped by 44.4% to 1,213 from its record high of 2,182 on December 15. This means the spread between high-yield debt and comparable US Treasuries was 1,213 basis points by the close of business on Friday. With the US 10-year Treasury Note yield at 3.45%, high-yield borrowers have to pay 15.58% per year to borrow money for a 10-year period. At these rates it remains practically impossible for companies with a less-than-perfect credit status to conduct business profitably.


Another indicator worth monitoring is the Barron's Confidence Index. This Index is calculated by dividing the average yield on high-grade bonds by the average yield on intermediate-grade bonds. The discrepancy between the yields is indicative of investor confidence. There has been a solid improvement in the ratio since its all-time low in December, showing that bond investors are growing more confident and have started opting for more speculative bonds over high-grade bonds.


According to Markit, the cost of buying credit insurance for American, European, Japanese and other Asian companies has improved strongly since the peaks in November. This is illustrated by a significant narrowing of the spreads for the five-year credit derivative indices. By way of example, the graphs of the North American investment-grade and high-yield CDX Indices are shown below (the red line indicates the spread).



In summary, the past few months have seen impressive progress on the credit front, with a number of spreads having declined substantially since their "panic peaks". The TED spread (down to 0.48% from 4.65% on October 10), LIBOR-OIS spread (down to 0.45%% from 3.64% on October 10) and GSE mortgage spreads have all narrowed considerably since the record highs.

In addition, corporate bonds have seen a strong improvement, although high-yield spreads remain at elevated levels. Credit derivative indices for companies in all the major geographical regions have also shown a marked tightening since the November highs.

Most indications are that the credit market tide has turned on the back of the massive reflation efforts orchestrated by central banks worldwide and that the credit system has started thawing. However, although the convalescence process seems to be well on track, it still has a way to go before confidence in the world's financial system returns to more "normal" levels, liquidity starts to flow freely again, and the economic recovery can commence.

Exploding Debt Threatens America

from John Taylor on

Standard and Poor’s decision to downgrade its outlook for British sovereign debt from “stable” to “negative” should be a wake-up call for the US Congress and administration. Let us hope they wake up.

Under President Barack Obama’s budget plan, the federal debt is exploding. To be precise, it is rising – and will continue to rise – much faster than gross domestic product, a measure of America’s ability to service it. The federal debt was equivalent to 41 per cent of GDP at the end of 2008; the Congressional Budget Office projects it will increase to 82 per cent of GDP in 10 years. With no change in policy, it could hit 100 per cent of GDP in just another five years.

“A government debt burden of that [100 per cent] level, if sustained, would in Standard & Poor’s view be incompatible with a triple A rating,” as the risk rating agency stated last week.

I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis. To understand the size of the risk, take a look at the numbers that Standard and Poor’s considers. The deficit in 2019 is expected by the CBO to be $1,200bn (€859bn, £754bn). Income tax revenues are expected to be about $2,000bn that year, so a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?

Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. But it would not be that smooth – probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession.

The fact that the Federal Reserve is now buying longer-term Treasuries in an effort to keep Treasury yields low adds credibility to this scary story, because it suggests that the debt will be monetised. That the Fed may have a difficult task reducing its own ballooning balance sheet to prevent inflation increases the risks considerably. And 100 per cent inflation would, of course, mean a 100 per cent depreciation of the dollar. Americans would have to pay $2.80 for a euro; the Japanese could buy a dollar for Y50; and gold would be $2,000 per ounce. This is not a forecast, because policy can change; rather it is an indication of how much systemic risk the government is now creating.

Why might Washington sleep through this wake-up call? You can already hear the excuses.

“We have an unprecedented financial crisis and we must run unprecedented deficits. While there is debate about whether a large deficit today provides economic stimulus, there is no economic theory or evidence that shows that deficits in five or 10 years will help to get us out of this recession. Such thinking is irresponsible. If you believe deficits are good in bad times, then the responsible policy is to try to balance the budget in good times. The CBO projects that the economy will be back to delivering on its potential growth by 2014. A responsible budget would lay out proposals for balancing the budget by then rather than aim for trillion-dollar deficits.

“But we will cut the deficit in half.” CBO analysts project that the deficit will be the same in 2019 as the administration estimates for 2010, a zero per cent cut.

“We inherited this mess.” The debt was 41 per cent of GDP at the end of 1988, President Ronald Reagan’s last year in office, the same as at the end of 2008, President George W. Bush’s last year in office. If one thinks policies from Reagan to Bush were mistakes does it make any sense to double down on those mistakes, as with the 80 per cent debt-to-GDP level projected when Mr Obama leaves office?

The time for such excuses is over. They paint a picture of a government that is not working, one that creates risks rather than reduces them. Good government should be a nonpartisan issue. I have written that government actions and interventions in the past several years caused, prolonged and worsened the financial crisis. The problem is that policy is getting worse not better. Top government officials, including the heads of the US Treasury, the Fed, the Federal Deposit Insurance Corporation and the Securities and Exchange Commission are calling for the creation of a powerful systemic risk regulator to reign in systemic risk in the private sector. But their government is now the most serious source of systemic risk.

The good news is that it is not too late. There is time to wake up, to make a mid-course correction, to get back on track. Many blame the rating agencies for not telling us about systemic risks in the private sector that lead to this crisis. Let us not ignore them when they try to tell us about the risks in the government sector that will lead to the next one.

The writer, a professor of economics at Stanford and a senior fellow at the Hoover Institution, is the author of ‘Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis’