Friday, January 15, 2010
from Yahoo finance:
California's main debt rating was cut on Wednesday by Standard & Poor's, which said the government of the most populous U.S. state could nearly run out of cash in March -- and another rating cut might follow.
"The big question is, is there any fear they will get downgraded out of investment grade (so) you may have to sell ... that's where I think it would get interesting or hairy," said Eaton Vance portfolio manager Evan Rourke.
S&P's downgrade was overdue because the state's revenues have been so weak, said Dick Larkin, director of credit analysis at Herbert J. Sims Co Inc in Iselin, New Jersey. "Frankly I can't understand why it took S&P so long," he said. "They could have made that decision back in September."
Larkin said the three major rating agencies will hold off on more downgrades to California's credit rating to avoid roiling the municipal debt market, even in the event budget talks between Schwarzenegger and lawmakers drag on.
"They'll give the state an awful lot of rope," Larkin said. "For a state to go below investment grade would cast a pall on every state and local issuer out there."
Thursday, January 14, 2010
U.S. retail sales fell in December unexpectedly, signaling restraint by consumers during the holidays as the economy wrestles with high unemployment.
Meanwhile, the number of U.S. workers filing new claims for jobless benefits unexpectedly increased last week, but a drop in the four-week moving average to its lowest level since August 2008 showed claims are still trending downward. Total claims lasting more than one week, meanwhile, decreased.
Will the stock market shrug it off? Consider it shrugged!
Wednesday, January 13, 2010
Perhaps we should have called it stimu-LESS!
Tuesday, January 12, 2010
WASHINGTON — A new report that reviewed 200 years of economic data from 44 nations has reached an ominous conclusion for the world’s largest economy: Almost without exception, countries that are as highly indebted as the United States is today grow at sub-par rates.
The report was written by two respected academic researchers who recently published a thick book on eight centuries of economic crises.
The study by Carmen Reinhart and Kenneth Rogoff — well-regarded economists from the University of Maryland and Harvard University, respectively — found statistical breaks at different points in the relationship between a country’s national debt and its gross domestic product. GDP is the broadest measure of a country’s trade in goods and services.
When a nation’s debt exceeds 60 percent of its GDP, its growth rate slows precipitously, the study found. When that ratio exceeds 90 percent, nations’ economies barely grow, and can even contract.
The implication is stark: The authors don’t say that the U.S. economy can’t grow briskly despite even higher debt, but if it does, it would be an outlier in roughly 200 years of economic statistics.
“We’re racing toward this (90 percent) limit, and maybe it will prove a soft limit for the United States. But not forever,” Rogoff said. “I think it is certainly a cautionary tale.”
Reinhart and Rogoff last year published the book titled “This Time Is Different,” which examined how countries have repeated mistakes from earlier crises over the past 800 years.
The economists’ new paper, presented this month at a conference to review important economic studies, wasn’t meant to be a diagnosis of the current U.S. debt picture. Rather it seeks answers about the consequences of mounting debt.
“Outsized deficits and epic bank bailouts may be useful in fighting a downturn, but what is the long-run macroeconomic impact of higher levels of government debt, especially against the backdrop of graying populations and rising social insurance costs?” the pair ask in the report.
Most mainstream economists think that what has been dubbed the Great Recession is ending and that the U.S. economy will post strong growth in the first half of this year. Much of that growth is coming from government stimulus spending designed to compensate for the drop in private-sector activity.
By midyear, however, much of the spark from that spending is expected to wear off, and Congress already is debating whether to provide additional stimulus money to sustain the recovery.
Fiscal conservatives say the nation’s deep debt argues against further stimulus spending.
Reinhart doesn’t share that view, saying that the Great Depression taught economists that reducing government spending too soon can plunge the economy back into the doldrums.
“My own view has been that until we are out of this recession and are in recovery, don’t jump the gun in removing stimulus too soon,” she said.
“As soon as we get grounded in our recovery, something really has to give in the fiscal adjustment or you are in a lost decade. High levels of debt and growth don’t go hand in hand.”
She gave the examples of Japan in the 1990s and Latin America in the 1980s, when mounting debt led to roughly a decade of stagnant and sub-par growth.
Could that happen to the United States?
One reason the authors’ data are so troubling is that today’s crisis comes against the backdrop of the pending retirement of 75 million baby boomers, born from 1946 to 1964, the first of whom reach official retirement age at the end of this year.
“Surely when we compare to other episodes in history,” Rogoff said, “this is an unusual period for high debt because we’re adjusting to this aging population.”
Facing higher government burdens for health and retirement spending, the United States may be forced to choose among cutting Medicare and Social Security benefits — which is politically unpalatable, if not impossible — slashing other spending while raising taxes or some combination of both in order to reduce the public debt, which stood at $12.3 trillion last week.
Another option is to continue borrowing. But statistics from the Reinhart and Rogoff study show that higher debt levels historically have equated to slower growth.
It’s also unlikely that China and other nations would continue lending to a sluggishly growing, heavily indebted United States without demanding a premium that would be an additional drag on the U.S. economy.
“If the Chinese would lend us money forever in increasing quantities ... that’s very wishful thinking,” Rogoff said. “The United States is not immune to (debt-rating) downgrades, to having its risk premium go up ... if investors don’t see us as willing to tighten our belt.”
Among the findings by Reinhart and Rogoff:
- When external debt reaches 60 percent of GDP, it results in a 2 percentage point decline in the annual growth rate. At higher levels than that, growth rates are cut roughly in half.
- At debt-to-GDP ratios above 90 percent, the result is a 1 percentage point drop in the median (midpoint) growth rate, and average growth falls considerably more.
- The 90 percent threshold applies similarly to developed and developing nations.
- To their surprise, the two economists found little evidence of a link between inflation and public debt levels for developed nations, although the United States has experienced higher inflation during periods of high debt-to-GDP ratios.
excerpt from Mish Shedlock:
Here is the full text.
I don't know about you, but I am outraged.
I am outraged and not just about Goldman Sachs, but about a process that allows, even encourages political pandering, by time and time again rewarding leveraged riverboat gamblers and failed institutions and at taxpayer expense.
I am outraged that real people are suffering massively while the influence peddlers have stolen the country for their own personal benefit.
I am outraged at a political system that is totally unresponsive to the American people.
I am outraged by campaign contribution and lobbying processes that allows corporations to buy votes with donations.
I am outraged how legislators ignored the wishes of the people who clearly did not want these bailouts in the first place.
I am outraged that very little of this is in mainstream media. Why is this stuff not on the frontpage of every newspaper in the country or at least in the editorial pages?
I am outraged that the average US citizen is not aware of any of this, instead depending on CNBC, or "The View" for their interpretation of the world.
I am outraged how special interest groups have exercised their power to monopolize the economy for the benefit of themselves, US citizens be damned.
I am outraged that all these bailout programs are doing nothing to alleviate the massive consumer debt problems. Every program, virtually every program was designed to bailout lending institutions, not consumers.
I am outraged at fees charged by banks receiving bailouts.
I am outraged over government pension plans and government pay scales massively out of line with the private sector.
I am outraged that Congress and this administration thinks the solution to massive budget deficits are still higher budget deficits in excess of a trillion dollars.
I am outraged about indictments. Paulson Admitted Coercion to force a shotgun wedding between Bank of America and Merrill Lynch yet no indictments were handed out. Let the Criminal Indictments Begin: Paulson, Bernanke, Lewis.
I am outraged that US citizens are not concerned enough and not educated enough to demand change.
I am outraged that the two party system has failed. Neither party has delivered meaningful change on budgets, on taxes, on social security, on deficit spending, on the size of government, on military spending, or fighting needless wars.
I am outraged at a Fed that purports to be "inflation fighters" when the only source of inflation in the word are central bankers, and their fractional reserve lending policies.
I am outraged that Greenspan and Bernanke could not see a housing bubble that 1000 bloggers could see.
I am outraged at the selective memory of Bernanke when speaking to Congress about these problems.
I am outraged that Bernanke's one sided response to asset bubbles, letting them grow without end, then bailing out the financial institutions that cause them.
I am outraged the Fed exists at all. It is a useless organization that cannot see bubbles, that panders to banks, that supports inflationary policies that are tantamount to theft by fraud.
I am outraged that the Obama Administration promised changed and did not deliver. "Yes We Can" was a lie. The reality is "It's Business As Usual, Only Worse, With Higher Deficits".
I am outraged there is not enough outrage over this.
Where the hell is the outrage?
Today, the yield curve hit a record. At 380 basis points, which incidentally was the widest spread between the 2 Year and the 30 Year ever, it has never been easier for banks to make money on the short-long interest spread.
Indeed, there are some wacky things happening in bond land. Recently, just like in the days after Lehman imploded, short-maturity bills traded at negative yields. While that particular rush for short maturities was at the time explained by a desire for year end window dressing and cash parking, the continued exuberance in bills (see chart below) can no longer be explained that simply.
There are a variety of explanations as to this surge in steepness, as well as for a continued preference of the short end of the curve. Some of these include the desire of foreign buyers to minimize duration, and as we have been pointing out over the past several months by deconstructing TIC data, the bulk of foreign purchasing has been in the Bill sector. And while there is no shortage of Bill interest, the traditional 30-Year buyers have shunned the long-end, and instead are opting for corporates for a better duration-risk profile. This is further coupled with the global doctrine of moral hazard which has made corporate failure essentially a thing of the past. With Bernanke onboarding private risk to the public balance sheet, the next big blow up will undoubtedly be sovereigns themselves. This is, in fact, confirmed by a glance at the spread between the SovX and the ITRAXX MAIN ex-FINS: for the first time in history, it is riskier to be a sovereign that it is to be an IG credit (green line on chart below).
So with the sweet spot in governments being exclusively Bills, it is natural to see further steepening, as more and more investors avoid the long end due to increasing sovereign and perceived inflation risk.
Yet there is nothing inherently wrong with steep curves. The bogeyman in credit land has always been the flat (or, heaven forbid inverted) curve. As CreditSights characterizies the flat curve situation:
A flat yield curve usually occurs when the market is making a transition that emits different but simultaneous indications of what interest rates will do. In other words, there may be some signals that short-term interest rates will rise and other signals that long-term interest rates will fall. Investors are uncertain and the margin for error is high. Tails get fat. Black Swans fly. X-Factors propagate.What are the benefits of steep curve? They are numerous for all investor classes: i) a steep curve allows a wide margin for error, which incentivizes yield seeking lower in the capital structure, primarily equities; ii) banks can borrow cheap and lend expensive, which is a green light to "print money", and iii) a knee-jerk trading response to a steep curve is to buy equities, which creates a self-referential feedback loop, whereby steepness leads S&P higher, which increases asset prices, and hikes inflation expectations, which leads to an even steeper curve. The relationship is mapped on the chart below:
Lastly, by pushing yields down, the Fed is naturally trying to encourage the "virtuous cycle" of encouraging consumption and corporate investment. When inflation expectations are high and rates are low, companies and individuals are encourage to borrow as they should anticipate this debtload will be inflated in the future. However, judging by the latest consumer credit report and exorbitant excess reserve levels, Bernanke's plan has failed, as only Goldman et al can borrow at the short end.
In the current environment, in which economic reality is disjointed with the market, the steep curve is a source of concern. As CreditSight notes:
A steep yield curve can be a good thing. It should help the economic recovery and debt and equity markets. One could even argue that the Fed has done its job. ZIRP-American-style has both helped repair banks balance sheets and forced investors to take on riskier assets. Steep yield curves are generally seen at the end of a recession, when the economy is about to kick into full-gear.One certain outcome of a steep curve is dollar debasement: one of the goal of the Fed all along. And as Zero Hedge has been noting for almost half a year, the current FX dynamics are such that the dollar has supplanted the Yen to become the funding currency of choice (much to the chagrin of the BOJ). Logically, the question arises: how big is the carry trade?
So why all the worry? Well here is the rub: the evidence for economic expansion or the elements that make up an upward sloping yield curve are just not there yet. While it is a lagging indicator, credit creation has been scant. A recent survey from the Federal Reserve showed that since peaking in July 2008, consumer credit is down more than 4.8 percent. Bank lending is also down more than 8 percent over the past 12 months. Without a recovery in credit, there can be no self-sustaining economic recovery.
Also, it is interesting that we are seeing inflationary expectations when there is a complete lack of wage or producer price pressure. Employment (also a lagging indicator) has been weak and consumption continues to decline (though given its historic rise over the past decade, this could be a good thing). None of this seems consistent with a steep yield curve.
The carry trade notably reared its wild and wooly head during the late 90s, when Japan announced a Zero Interest Rate Policy (sound familiar). Traders sold short the yen and bought just about anything else they could find, because everything was higher yielding. Indeed, if you were a mortgage trader, chances are you funded trades in yen. If you traded emerging markets, you crossed in yen. Baseball cards? Sell yen. Before the last time the world blew up, way back in 2007, the yen carry trade was estimated to be about $1 trillion (but who knows for sure). When the credit crisis hit, this trade was unwound, quickly. The dollar was (is) still the world’s reserve and money flocked to safety. Dollars were needed. The carry trade was killed and people lost big.Zero Hedge has previously discussed why due to a funding mismatch, the globalized economy was on the dollar shortfall hook for a number as large as $6.5 trillion, which in turn explained why the Fed has to rush to save all Central Banks by pumping hundreds of billions of FX liquidity lines.
How do we tell there is a dollar carry trade? First off, Chairman Bernanke seemed to give the carry trade his blessing during his recent speech at the NY Economic Club, firmly saying that interest rates will not be raised in the short term. This gives traders license to sell dollars, not fearing that the Fed will raise rates and they will be caught out short.
Second, correlation. Everything seems to be correlated to everything (and we know how well that ended in 2007).
As the dollar weakens, investors look to harder or higher-yielding assets to contain some of the depreciation effects, causing asset classes to rise in tandem. In a recent piece, we pointed out that the correlation between equities and debt had an R-squared of greater than 90 percent. Dollar-equities, same thing, but inverse. Indeed, this is the first time since 1938 that we have had zero interest rates, dollar depreciation and equity markets rising. High yield continues to receive record inflows, despite coupons and current yield falling far short of extraordinary. Gold is also at record highs.
And here comes the first estimate ever attempted at quantifying the Fed sponsored "Dollar Destructive" moral hazard: the upper bound of the total loss in the case of a major liquidity event occurring with the Fed's complicit bailout on the table would amount to a staggering $6.5 trillion from a dollar duration funding mismatch alone! This is an astounding, unfathomable and untenable number. Yet it is likely the same now as it was at the onset of the Lehman crisis...As the H.4.1 discloses weekly, the Fed's liquidity swaps are now back to almost zero. This means that foreign Central Banks believe they have the FX swap and dollar maturity situation under control. They thought the same before Lehman blew up. And they were wrong. As the DXY continues tumbling ever lower to fresh 2009 lows, the trade de jour is once again the dollar funding one, although unlike before when the Yen was the carry currency of choice, this time it is the dollar itself, positioning banks for the double whammy of not just a dollar funding shock, but one coupled with a potential massive and historic short squeeze. If and when an exogenous event occurs, not even $6.5 trillion in Fed swap lines will be sufficient to bail out the world economy.We wrote this in October 2009, before Roubini et al became dollar carry trade experts. We would like to highlight that the last time around, the dollar funding risk did not include the incremental need to cover hundreds of billions if not trillions in dollar shorts. The next time there is a risk flaring scenario, the cost to fund the dollar mismatch will be even greater due to additional rush to cover shorts.
The Minsky Moment
Today we pointed out that the VIX is at multi-year lows: complacency once again reigns supreme. So if indeed the market is correct, and growth is back, the Fed presumably has the tools required to facilitate and unwind, whether it is rising rates or using reverse repos. A return to Fed normalcy, however is not in the cards, as Bullard's presentation earlier highlighted. In fact, look for more Q.E., and more ZIRP.
So what happens if the optimists are wrong. A CreditSights readers makes the following observations:
I think what you are suggesting is a reversal of the high beta compression trade; we haven’t really seen economic recovery, just return from the precipice, so the markets have probably gone too far too fast.To which CreditSights responds:
Of course the brutality of the unwind in the carry trade depends on what moves the Fed off its mark. If it is inflation concerns, fixed income asset prices are dead and probably equities too, just on the discount factor. If it is due to real signs of economic recovery, then the carry trade unwind is mitigated by dollars chasing the economic recovery story in credit and equities. Third possibility is that the Fed intervenes on concerns about dollar weakness, but I really don’t see that happening.
To have a dampening effect on dollar depreciation, the Fed would have to raise interest rates early and dramatically. Drawing from Chairman Bernanke’s recent statements, high unemployment and worries about choking off the recovery too soon are of greater concern. Also, a weak dollar solves a lot of problems for the US—of course, it creates problems for the rest of the world. But, as long as the US’s creditors are willing to accept dollar denominated debt, currency devaluation has to dual effect of monetizing the US’s debt and helping rebalance the trade deficit. But what happens if the world is no longer willing to accept Uncle Sam’s IOU? Last I checked, the US had some pretty big deficits it needs to finance.The last is precisely what keeps PIMCO's Bill Gross at night, and is one of the main reasons why we believe the Fed has no option but to continue with Quantitative Easing...No option but to perpetuate the status quo which will merely make the ultimate unwind truly unprecedented.
The confluence of all these risk factors implies that there are simply too many variables for the Fed to be able to sustain control over what is an inherenetly chaotic situation:
An overly steep yield curve, combined with run away dollar depreciation generally indicates that authorities have lost control. There is a legitimate and real risk that the long-end could become “unstable,” as supply/inflation fears kick in. While consumer leverage is declining, leverage in the financial world is on the rise. And, it does feel like we have been here before: 2002, 2007—the so-called Minsky Moment years.We have come full circle, only this time it took a mere two years. As Justin Lahart so effectively summarized some years ago:
At its core, the Minsky view was straightforward: When times are good, investors take on risk; the longer times stay good, the more risk they take on, until they've taken on too much. Eventually, they reach a point where the cash generated by their assets no longer is sufficient to pay off the mountains of debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. "This is likely to lead to a collapse of asset values," Mr. Minsky wrote.The Minsky moment is, once again, knocking on the door.
When investors are forced to sell even their less-speculative positions to make good on their loans, markets spiral lower and create a severe demand for cash. At that point, the Minsky moment has arrived.
In the current hodge podge of abstract finance, it is easy to get lost in the numbers and lose sight of the forest for the trees. Which is why we provide the ultimate simplification: In calendar (not fiscal) 2009, the US grew its budget deficit by $1.47 trillion. In the same time, the Federal Reserve grew its securities holdings from $500 billion to $1.85 trillion, a $1.34 trillion increase. Keeping it simple: 91% of the budget deficit increase in 2009, under the authority of President Obama, was funded by the... United States.
from Ambrose Evans-Pritchard:
The labour force contracted by 661,000. This did not show up in the headline jobless rate because so many Americans dropped out of the system. The broad U6 category of unemployment rose to 17.3pc. That is the one that matters.
Wall Street rallied. Bulls hope that weak jobs data will postpone monetary tightening: a silver lining in every catastrophe, or perhaps a further exhibit of market infantilism.
The home foreclosure guillotine usually drops a year or so after people lose their job, and exhaust their savings. The local sheriff will escort them out of the door, often with some sympathy –– just like the police in 1932, mostly Irish Catholics who tithed 1pc of their pay for soup kitchens.
Realtytrac says defaults and repossessions have been running at over 300,000 a month since February. One million American families lost their homes in the fourth quarter. Moody's Economy.com expects another 2.4m homes to go this year. Taken together, this looks awfully like Steinbeck's Grapes of Wrath.
Judges are finding ways to block evictions. One magistrate in Minnesota halted a case calling the creditor "harsh, repugnant, shocking and repulsive". We are not far from a de facto moratorium in some areas.
This is how it ended between 1932 and 1934, when half the US states declared moratoria or "Farm Holidays". Such flexibility innoculated America's democracy against the appeal of Red Unions and Coughlin Fascists. The home siezures are occurring despite frantic efforts by the Obama administration to delay the process.
This policy is entirely justified given the scale of the social crisis. But it also masks the continued rot in the housing market, allows lenders to hide losses, and stores up an ever larger overhang of unsold properties. It takes heroic naivety to think the US housing market has turned the corner (apologies to Goldman Sachs, as always). The fuse has yet to detonate on the next mortgage bomb, $134bn (£83bn) of "option ARM" contracts due to reset violently upwards this year and next.
US house prices have eked out five months of gains on the Case-Shiller index, but momentum stalled in October in half the cities even before the latest surge of 40 basis points in mortgage rates. Karl Case (of the index) says prices may sink another 15pc. "If the 2008 and 2009 loans go bad, then we're back where we were before – in a nightmare."
David Rosenberg from Gluskin Sheff said it is remarkable how little traction has been achieved by zero rates and the greatest fiscal blitz of all time. The US economy grew at a 2.2pc rate in the third quarter (entirely due to Obama stimulus). This compares to an average of 7.3pc in the first quarter of every recovery since the Second World War.
Fed hawks are playing with fire by talking up about exit strategies, not for the first time. This is what they did in June 2008. We know what happened three months later. For the record, manufacturing capacity use at 67.2pc, and "auto-buying intentions" are the lowest ever.
The Fed's own Monetary Multiplier crashed to an all-time low of 0.809 in mid-December. Commercial paper has shrunk by $280bn ($175bn) in since October. Bank credit has been racing down a hair-raising black run since June. It has dropped from $10.844 trillion to $9.013 trillion since November 25. The MZM money supply is contracting at a 3pc annual rate. Broad M3 money is contracting at over 5pc.
Professor Tim Congdon from International Monetary Research said the Fed is baking deflation into the pie later this year, and perhaps a double-dip recession. Europe is even worse.
This has not stopped an army of commentators is trying to bounce the Fed into early rate rises. They accuse Ben Bernanke of repeating the error of 2004 when the Fed waited too long. Sometimes you just want to scream. In 2004 there was no housing collapse, unemployment was 5.5pc, banks were in rude good health, and the Fed Multiplier was 1.73.
How anybody can see imminent inflation in the dying embers of core PCE, just 0.1pc in November, is beyond me.
Mr Rosenberg is asked by clients why Wall Street does not seem to agree with his grim analysis.
His answer is that this is the same Mr Market that bought stocks in October 1987 when they were 25pc overvalued on Shiller "10-year normalized earnings basis" – exactly as they are today – and bought them at even more overvalued prices in 2007, long after the property crash had begun, Bear Stearns funds had imploded, and credit had its August heart attack. The stock market has become a lagging indicator. Tear up the textbooks.
Tweets in the past few minutes from Arlan:
Winter wheat seedings 37.1 mln acres vs 43.3 last year and expectations of 40.9 mln
Total corn prod 13.151 bln bu vs 12.921 bln in Nov and expectations of 12.819 bln
Soybean production 3.361 bln bu vs. 3.319 bln in Nov and expectations of 3.337 bln
Dec 1 corn stocks 10.934 bln bu vs expectations of 10.663 bln; soybeans 2.337 bln bu vs expectations of 2.411
Ending stocks vs prev. mo; corn - 1.764 vs 1.675, beans - 0.245 vs 0.255, wheat - 0.976 vs 0.900 bln bu
Early call from CBOT corn, beans dn 10-15; wheat steady to up 5; However, bearish outside mkts won't help; Brace for a ride today.
USDA to resurvey producers in key states and update production estimates on March 10. "Expected production" included from these states
Perspective: USDA's Jan. soybean ending stocks estimate was too high in 13 of past 14 yrs by avg of 54 mln bu.
Monday, January 11, 2010
The financial and commodity markets will be influenced by a number of major events in 2010. Central banks are ripe to exit a period of unprecedented monetary ease, governments in Japan, Europe, and the U.S. will issue historically high levels of debt, parts of the emerging world face real estate and equity market bubbles, and the U.S. will hold important midterm elections, which could impact consumer and business confidence. Furthermore, the euro will face a test of its reserve currency status with numerous countries failing to meet the Maastricht Treaty. These dynamics are occurring during a historically slow economic rebound. Below are ten themes which should influence market pricing throughout 2010.
1. Trend toward normalized monetary policy
As the international macro landscape continues to show signs of improvement, the unwinding of the ultra-stimulative policies that fueled the global recovery will be a major theme of 2010. Monetary tightening will remain very uneven as the continued variation in the pace of regional recoveries dictates a divergent exit. The draining of excess liquidity will expose vulnerabilities in the financial system.
2. Excessive appreciation in emerging market real estate and equity markets
Policy stimulus in the emerging world was excessive and likely exceeded the amount necessary. The policy backdrop remains supportive for EM equities. The cocktail of globally loose policy, the search for yield, and fundamentally appealing EM picture may prove to be a mixture quite alluring to capital, thus encouraging speculative flows.
3. Growing uncertainty over the ability of governments to fund large decifits
The IMF predicts that in 2010, the average government gross debt as a percentage of GDP for the seven major advanced economies will be 109 percent, and 113 percent in 2011. It was only 84 percent in 2007 and 77 percent in 2000. History suggests that post-recession, the reduction in government spending is rarely equivalent to the increase catalyzed by the retrenchment in the private sector. Diluted interest in government debt and an increased budget deficit-to-GDP ratio will put upward pressure on yields, and perpetuate steepness in the yield curve.
4. Jobless Recovery
A jobless recovery will characterize 2010. MFGR sees the unemployment rate peaking in 2010 at 10.5 percent and closing the year between 9.5 percent and 10 percent. The unemployment rates in EM and ASEAN countries should fall more steadily, while it will likely increase in Europe. On the U.S. front, the outlook for taxes is murky, and the healthcare initiative, which will likely force all employers to provide care or pay a penalty, will discourage the expansion of the labor force.
5. The composition of global growth in 2010 is not significantly different than 2009.
MFGR believes that the recovery pattern witnessed in 2009 will continue into 2010. Asia will see steady expansion. The U.S.’s economic outlook will pick up gradually and Europe will face a stagnant and anemic recovery. The U.S. will lead the recovery out of the Eurozone and Japan. Global imbalances will continue to unwind. Countries such as China will ultimately move toward tighter monetary polic and looser fiscal policy in terms of tax regimes in order to control inflation and perpetuate growth.
6. Passage of the Democratic healthcare plan will mark an apex in U.S. liberlism. Government policy will shift toward the center into mid-term elections.
The public is angry over the impact of a stimulus plan which may have saved the financial system from meltdown, but did little to improve the standards of living. Politicians, at the core, are survivalists, and thus, policy is likely to move toward the center to attract discontented voters.
7. The tax burden in the U.S. and Europe is likely to increase.
The ongoing deterioration in public finances, at both the state and government levels, will put upward pressure on taxes in the U.S. In Europe, taxes are increasing for higher-income workers in the U.K., and the Greek budget will work to cut down on tax evasion, while raising tax on property transactions.
8. The VIX is likely to remain capped.
Historically, the VIX moves inversely to the path of profit growth and positively correlates with the trend in the Fed funds rate, with a two-year lag. The trend in profit growth and the level of the Fed funds rate argue for low volatility through 2010. A major or lasting rally in capital market volatility looks more likely in 2011.
9. Investor appetite for commodity investment is uncertain, but most likely to ease.
Investment flows into commodities had been strong in recent years. The low interest rate environment and distrust of equity markets have supported commodity buying. Going into 2010, some of the headwinds supporting commodities as an asset class will diminish. It is hard to believe investors will year after year raise their allocations to commodities.
10. Intermarket correlations will erode as individual market fundamentals become the predominate driver of capital and commodity market price direction.
The heavy liquidation of all asset classes in late 2008 and early 2009 has ended, and money has moved back into the financial and commodity markets. The normalization of investment flow should allow markets to focus more on individual fundamental factors. Hot money is not likely to just flow in and out of the market based on risk-taking, as most books should be near desired weighting.