Across the Curve

Bullish on Gold and Bearish on PHD Economists

July 30th, 2016 1:44 pm

I always enjoyed reading the well written and erudite Interest Rate Observer by Jim Grant. It certainly had its share of miscues but it was always quite logical and it stimulated one’s thinking in an unconventional way. Barron’s interviewed Grant this weekend.

Via Barron’s:

For the past 33 years, Grant’s Interest Rate Observer has chronicled the ups and downs of financial markets, its elegant prose and opportunistic investment ideas rendering it a must-read for countless investment professionals. Its founder and proprietor, James “Jim” Grant, 70, is a Navy veteran and an amiable bear who has prospered during the lengthy bull markets in equities and bonds, despite his avowed skepticism.

Grant inaugurated Barron’s Current Yield column in the 1970s—an era of inflation, monetary disorder, and upheaval in interest-rate markets, as he has observed. He founded Grant’s in 1983, and is viewed by many on Wall Street and elsewhere as one of the most astute market analysts around. Indeed, a presidential hopeful once called Grant his likely candidate for chief of the Federal Reserve.

Disorder and upheaval could also become the legacy of today’s disquieting trends, from explosive money growth in Japan to potential bank bailouts in Europe to populist politics that hint at greater government spending. The very thought put us in a mind to check with Grant about what might lie ahead.

Barron’s: Until recently, sub-zero was a brand of refrigerator. Now it is an interest-rate regime. Will it succeed in reviving national and regional economies?

Grant: No. It’s an experiment, isn’t it? I called up Dick Sylla, co-author of that page-turner titled A History of Interest Rates, which chronicles 5,000 years of interest-rate history. I said, “Dick, did you come across any examples of negative yields?” He said no. We are living in a unique time. Negative rates aren’t a naturally occurring phenomenon in finance but a creation of our ingenious central bankers. Furthermore, they seem to defy common sense. Interest rates exist because we want things now rather than later. That’s the nature of human desire. Negative interest rates turn that on its head. So they are a sign not of constructive policy making, but of trouble.

On the subject of policy making, you invented the term Ph.D. standard—not to be confused with the gold standard. What does it mean?

The Ph.D. standard is the regime of discretionary monetary management by former tenured economics faculty. Not much is new under the sun in finance, except for this regime of improvisation by college professors trying stuff because it looks good on a blackboard. What it means for investors is thrills and chills. Richard Feynman, the wonderful physicist who was such a wit and so wise about much in life besides physics, talked about cargo cult science, in which things have the appearance of scientific rigor but not the substance. That’s what characterizes the body of knowledge we know as macroeconomics. The people who deploy it are very well intended but very dangerous.

Where will it lead?

We’ve seen low rates beget lower interest rates, and radical policy making beget more radical policy making, because it doesn’t work. So we need something else, which seemingly invariably is a more intense form of price administration. You know interest rates are critical prices. They help us understand and measure in price risk, set investment hurdles, and discount future cash flows. These prices are increasingly under the thumb of government functionaries—the ones we call central bankers—and because that’s the case, asset prices have become distorted and the standard signposts of valuation have been twisted and turned.

We’re on the long, winding road to confetti—to the discrediting of fiat currencies. That is the end game. Adam Smith cautioned against being excessively bearish. One shouldn’t be dogmatic about when things will happen. But we’re on the road to an important perception that central bankers don’t have the answers and are in fact in the process of discrediting the very money they are meant to protect. I would be short the Ph.D. standard, long the periodic table.

In our previous conversation, in 2011, you were bullish on gold at $1,800 an ounce, near the top. You are still bullish today, with gold at $1,321. Do you have a forecast?

From the guy who loved it at $1,900, I’ll shut up. It’s a provocation to the market gods to stick a number up there. I’m very bullish on the metal, bullish on miners. Bears on credit finally get paid in gold. At the end of the road to confetti, gold will reclaim some position as an active monetary asset, not a crank’s asset. It is now a relatively high-yielding asset, yielding, as it does, nothing.

The gold stocks have come a long way [from a recent bottom]. But many were priced for bankruptcy, notably Barrick Gold [ticker: ABX], an encumbered mining company priced at $6 at the bottom, as if its debt would not be paid. Now the stock is $20. I personally own Newmont Mining [NEM], Goldcorp [GG], and New Gold [NGD], which is more speculative, but that I like in part because [Canadian businessman] Pierre Lassonde is involved. We are also bullish on silver. It is the crazy uncle in the attic of monetary assets. It is as volatile as Donald Trump. It has industrial uses as well as monetary ones, which will come to the fore as the gold bull market progresses. In June, we recommended Pan American Silver [PAAS] and long-dated, out-of-the-money call options on the silver exchange-traded fund iShares Silver Trust [SLV].

In 2011, when the euro was at $1.40, you called it confederate money and said it should fetch around $1.10 instead. Good call. Do you have a new forecast for the euro?

I don’t. I wasn’t born yesterday. However, we all know about the centrifugal political forces that are coursing through the world, not least in Europe. There is always risk of one kind or another. The question is whether you’re being paid to bear it. Europe offers no such compensation. Big-cap stocks on the Continent change hands at more than 22 times earnings. Ten-year Italian sovereign debt yields 1.2%. German government bonds yield—after a nasty selloff—exactly nothing. Italian banks interest me a little because they are among the most despised assets on Earth. The euro doesn’t interest me in the least.

The Spanish bank Banco Bilbao Vizcaya Argentaria [BBVA] did well for itself during the terrifically deep and troubling Spanish recession. It has a $1 billion euro, 8.875% junior subordinated perpetual bond. The yield was recently quoted just below 9%. We think that’s a pretty good value. It’s much safer than Deutsche Bank [DB], for example, and is yielding much more than the comparative Deutsche issue.

Will low yields prevail for the rest of your career?

You are talking to a guy who lived through all but three months of the bond bear market of 1946 to 1981. In the spring of 1946, a long bond yielded about 2.25%, and it ended in 1981 at 15%. Everyone was looking backward to the credit experience of the 1930s and the early ’40s, not anticipating they were about to be treated to a generation-length bear market in interest rates. That was 35 years in the making. And almost 35 years ago, the great bond bull market began that may, or may not, be ending right now. Since the 19th century, the cycles in interest rates are very long-lived. They have ranged from 20-odd years in this country to 85 years in 19th century Britain. So you can’t dogmatize on the timing. At Grant’s, we are very bearish on bonds.

Where are the opportunities for people seeking yield?

I am stumped. One can shop for manufactured yields, and there are plenty available in the shape of real estate investment trusts and mortgage REITs, and they’re all levered and attempt to make something of nothing.

Speaking of real estate, you have been negative on luxury residential real estate in Manhattan. Separately, you were early to buy a town house in Brooklyn Heights, back in 1994. So, is Brooklyn over, too?

Not long ago, [BlackRock CEO] Larry Fink was talking to investors in Singapore and said the two things you had to own were super-high-end real estate in the world’s destination cities and contemporary art. With respect to super-high-end real estate in Manhattan, the top was actually 2014. There aren’t enough billionaires to go around, and maybe fewer still if the bond market does what we think it ought to do.

As for Brooklyn, in May friends of mine bought a condo in the neighborhood called Boerum Hill. They bought a parking spot at the same address, for which they paid $60,000. Today, it’s worth $90,000. House prices peaked around Brooklyn Heights probably as early as 2014. But there is still an arbitrageable difference with Manhattan. You could sell your $10 million brownstone in Manhattan and buy a $6.5 million brownstone in Brooklyn. Or maybe just sell your place in Manhattan. Brooklyn may be soft, but it isn’t cheap.

You are less well known for the excellent work you do on individual stocks. Let’s have some names.

All kudos go to Evan Lorenz, who has been with the firm more than five years and is one of the best security analysts I’ve ever worked with or heard about. One idea that hasn’t worked yet is being bearish Big Food, like Campbell Soup [CPB] and Kraft Heinz [KHC]. Both are indicative of one form of excess, reaching for yield in equities. Campbell is trading for 23 times trailing net income, and Kraft is 46 times. Both are battling new trends in eating.

Then there is the question about the consumer environment generally: Campbell admits that shoppers are making more frequent trips [to the grocery store] than a year ago but purchasing less per trip. These stocks aren’t safe. They are standing on tiptoes, figuratively speaking, with regard to their valuation. Target recently redesigned its center-display offerings. They are getting rid of dry grocery items and displaying items like organic, gluten-free, and other such things, which isn’t good news for ketchup or canned soups. The stocks are priced as if for growth, but we don’t see organic revenue growth or margin growth.

I’m also bearish on United Rentals [URI], which rents construction and industrial equipment: forklifts, aerial work platforms, excavators—you name it. It leads the American equipment-rental industry with an 11% market share. The stock looks cheap—just 12 times trailing net—and earnings are strong. What could go wrong? Well, in early 2008, the ratio of debt to assets was 46%. Today, it’s 65%. Ex-goodwill, liabilities exceed assets by almost $1.8 billion. If you liquidated all the equipment on the balance sheet, United Rentals couldn’t pay off the debt. Insiders are net sellers. Shrewd investors, I’d say.

What do you like aside from gold stocks?

When I look back to 2007, I really wish we hadn’t reached for long ideas simply because we felt we had to have them. I’m not going to try to find what can’t be found.

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More GDP

July 29th, 2016 9:37 am

Via Chris Low at FTN Financial:

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Weak GDP

July 29th, 2016 9:34 am

Via Millan Mulraine at TDSecurities:

US: Economic Recovery Stuck in First Gear 

·         GDP advanced at a very paltry 1.2% q/q in Q2, disappointing the market consensus for a more robust 2.5% q/q advance.

·         Consumer spending, however, was one of the bright spot of this report, though the buoyant spending performance was partially offset by weaker investment and trade activity.

·         The overall tone of this report was quite weak, and when combined with the downward revisions to the prior estimates it points to a US economic recovery that is stuck in low gear. 

·         The ECI ticked modestly higher, up 0.56% q/q, though the annual pace of employment cost inflation accelerated to 2.3% y/y from 1.9% y/y on favorable base effects.

 

The US economy eked out a very meager 1.2% q/q advance in Q2. This was a far weaker performance than the above-trend 2.5% q/q advance expected by the markets. This disappointing performance follows and equally subpar 0.8% q/q gain in Q1, which was downwardly revised from +1.1% q/q. Despite the sticker shock on the headline number, the sharp acceleration in personal consumption activity, which rose at a robust 4.2% pace from 1.6%, points to strong underlying fundamentals underpinning the economic recovery. Final private domestic sales, a more objective measure of domestic economic strength, was quite constructive, rising at a very brisk 2.7% pace.

Outside of the sharp rise in PCE, which contributed a robust 2.8ppts to topline growth, the sharp decline in the other segments of the economy points to a very narrow platform for growth. In particular, investment activity was quite weak, as both fixed investment (subtracting 0.5ppt) and inventory investment (subtracting 1.2ppt) subtracted from growth, underscoring the continued sluggish performance in this segment of the US economy. Government spending was also a source of drag on economic activity, subtracting a further 0.16ppt from growth. Surprisingly, net trade added modestly to growth, bolstering the headline number by 0.23ppt, though this is likely to reverse in the coming months on account of the strong dollar and weaker global demand.

The historical benchmark revisions also added to the narrative of subdued growth, as sharp downward revisions to prior estimates point to an economic recovery that has been in far weaker shape than previously thought. For example, the Q2-2015 estimate was revised down from 3.9% q/q to 2.6% q/q, effectively signaling that the economy never really fully recovered from the Q1 weather hit. Since then, the economy is reported to have grown at a paltry 1.2% q/q average pace, essentially reflecting a stalled recovery. Note, however, the savings rate was revised sharply higher.

On the inflation front, the core PCE inflation rate decelerated to 1.7% y/y from 2.1 y/y. The ECI, however, rose at a respectable 0.56% q/q pace, with the annual pace of growth accelerating from 1.9% y/y to 2.3% y/y. Wage growth was a tad stronger, up 0.64% q/q and with the annual pace of wage growth accelerating to 2.5% y/y from 2.1% y/y.

The overall tone of this report was quite weak, and the hugely disappointing GDP performance in Q2 along with the big downward revisions to the prior quarters points to an economic recovery that is stuck in low gear.  In particular, the below-trend pace of growth over the past year suggests that the level of economic slack is beginning to grow in the economy, which is likely to temper inflationary pressures further. To be sure, the sharp acceleration in personal consumption activity is a net positive for the economic recovery. However, this buoyant pace is unsustainable and the sharp rise in precautionary savings suggests that US consumers continue to be cautious in the face of continued global uncertainties. Furthermore, even though growth momentum is likely to rebound in the coming quarters, the potential for further headwinds to investment activity and the fallout from the strong dollar tempering growth suggests that any H2 bounce in activity will be very modest at best. For the Fed, this is hardly the environment in which they will want to consider raising rates. As such, we continue to feel comfortable about our expectation for the Fed to remain on the sideline until June next year as they continue to nurse the US economy back to full health.

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FX

July 29th, 2016 6:30 am

Via Marc Chandler at Brown Brothers Harriman:

Kuroda Hesitates, Yen Advances, Focus Turns to Europe and North America

• The BOJ increased its ETF purchases from JPY3.3 trillion a year to JPY6 trillion
• There was a last minute private sector attempt to buy Monte dei Paschi, Italy’s troubled bank
• The European bank stress test results will be reported at the close of the North American session today
• US reports Q2 GDP and Canada reports May GDP
• Central bank of Russia meets and the market is split; Colombia’s central bank is expected to hike rates 25 bp to 7.75%

The dollar is mostly softer against the majors in the wake of the BOJ decision.  The yen and the Swiss franc are outperforming while the Norwegian krone and the Loonie are underperforming.  EM currencies are mixed.  KRW and SGD are outperforming while RUB and MYR are underperforming.  MSCI Asia Pacific was up 0.5%, with the Nikkei rising 0.6%.  MSCI EM is down 0.6%, with Chinese markets down 0.5%.  Euro Stoxx 600 is up 0.4% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is up 2 bp at 1.52%.  Commodity prices are lower, with oil down 1%, copper down 0.4%, and gold down 0.2%.  

Bank of Japan Governor Kuroda appears to be the central banker that the markets have the most difficulty reading.  The activist Governor provided the barest of tweaks to what is by nearly any reckoning among the most aggressive monetary policies by a high income economy.  Moreover, much of the important data reported during the BOJ’s meeting, including inflation and consumption, were weaker than expected.  

The BOJ increased its ETF purchases from JPY3.3 trillion a year to JPY6 trillion.  This was the lowest hanging fruit for the central bank, and there was broad agreement that this step would be taken.  The BOJ also doubled its dollar-lending facility.  And that was it.  No cut in the negative deposit rate.  No additional JGB purchases.  No pushing out the inflation target or increasing the JPY80 trillion monetary base growth.    

The market’s response was clear and not surprising.  The yen strengthened.  The dollar plunged to JPY102.70 after having been squeezed to JPY105.50 in the NY afternoon yesterday.  The JPY102.25 area corresponds to a (61.8%) retracement of the greenback’s rally from the Brexit low of JPY99 to last week’s high near JPY107.50.  Moving beyond that retracement objective may embolden participants to look for another test on JPY100.  On the topside, the dollar has been unable to retake the JPY104 handle since the BOJ announcement.

Kuroda’s pledge of a comprehensive review of the monetary policy framework at the September 20-21 meeting is not the main focus now.  However, it promises to inject fresh volatility in the market after the summer.  Draghi also flagged the September ECB meeting as important.  

Japanese government bonds sold off hard, with the benchmark 10-year JGB yield rising eight bp, which leaves it at minus 20 bp.  Japanese stocks overcame initial weakness to close higher, with the Topix up 1.2% and the Nikkei gaining almost 0.6%.  On the week, both indices lost about a third of a percent.  Nearly all of the other markets in the region fell, but Tokyo was sufficient to lift the MSCI Asia Pacific Index 0.5%, the fifth consecutive advance and 13 of the past 15 sessions.

In Europe, there are two main developments.  First, the economic data.  The preliminary July CPI estimate came in at 0.2% after 0.1% pace in June.  The market had expected a 0.2% increase, but after the firmer than expected German data yesterday, the risk was on the upside.  The core rate was steady at 0.9%.  The median guesstimate was for slippage to 0.8%.   June unemployment was steady at 10.1%.  

The initial estimate of GDP showed a 0.3% expansion, which was in line with forecasts, and it follows a 0.6% expansion in Q1.  The year-over-year pace held in at 1.6% after 1.7% in Q1, which is seen as a bit better than a trend.  Details will be available in a couple of weeks.  

We do know that the French growth disappointed by there not being any.  A 0.2% expansion was expected.  However Q1 GDP was revised up to 0.7% from 0.6%.  Spain’s 0.7% expansion may be the envy of most in Europe, but it matches the country’s slowest pace since Q3 14.    Separately, Spain reported an easing of deflationary forces.  CPI fell 0.6% from a year ago after a 0.8% fall in June.  Lastly, German retail sales disappointed by falling 0.1% (median forecast was for a 0.1% gain) and the May gain was shaved to 0.7% from 0.9%.  

The second development in Europe today is the last minute private sector attempt to buy Monte dei Paschi, Italy’s troubled bank.  Reports indicate that a local businessman has proposed to team up with a Swiss bank, which is rivaling another offer from a US bank and an Italian bank combine.  The market’s initial response is favorable.  The Milan bank index is up nearly 4.5% near midday in Italy.  The gain is enough to turn the week positive, and it is the fourth consecutive week Italian banks have recouped some of the year’s steep decline.  

The development in Italy is helping lift European banks.  While the Dow Jones Stoxx 600 is up 0.25%, the financials are the strongest sector, up 1.8% at pixel time.  Overall, the index is up about 3.25% this month, which is its biggest advance since last October.  

The European bank stress test results will be reported at the close of the North American session today.  The potential deal for Monte Paschi may reduce the anxiety over the results.  Moreover, it is not as simple as a pass/fail grade, or specifying precisely how much capital particular institutions must raise.  However, many investors are not convinced European banking challenges have been addressed.  As such, the test’s credibility will require some actionable results.  

Attention now turns to North America.  US reports Q2 GDP and Canada reports May GDP.  The wider trade deficit and weaker inventories that were reported yesterday prompted economists to slash their forecast for today’s US report.  Many economists more or less matched the Atlanta Fed’s GDPNow tracker, which cut its estimate to 1.8% from 2.3%.  One thing to watch out for today is whether the more severe inventory correction in Q2 will increase the prospect for Q3 GDP and this may be seen in the NY Fed’s GDP tracker that is published on Friday’s.  

Separately the US reports the Chicago PMI, which is notoriously volatile, and the University of Michigan’s consumer sentiment report.  In addition to the headline, where consumer confidence remains elevated even if not accelerating higher, the inflation expectations will be watched, as the FOMC statement referred to survey-based measures as stable.  The 2.6% pace expected for July matches the 6- and 12-month averages.

Canada’s May GDP is expected to have contracted by 0.5%.  While Alberta’s fires and the related disruption did not help matters, the Canadian economy has faltered this year after a reasonably good Q4 15, which was the first quarter since Q2 14 that the economy expanded in each month.  Canada began the year with good momentum.  In January, the economy grew 0.5%.  And that’s been it.  Small contractions were reported in February and March before the 0.1% growth in April.  The Bank of Canada seems willing to write off the first half and anticipating (hoping?) for better traction in H2.

Oil prices are closing the week on a soft note and this is not particularly helpful for Canada.  Oil prices are off 7.8% this week.  It is the largest weekly fall since January.  It brings the loss on the month to an eye-catching 15.7% on the continuation futures contract, the largest monthly drop since the end of 2014.  

Central bank of Russia meets and the market is split.  Of the 39 analysts polled by Bloomberg, 29 see no change and 10 see a 50 bp cut to 10%.  We lean towards a rate cut but it’s a close call, especially with the ruble weakening.  USD/RUB traded at multi-month lows near 62.60 as recently as July 15, but has since reversed higher.  Note that RUB one of the worst EM performers over the past five days at -3.2%.  This is second only to COP at -4.6%.  Lower oil and copper prices are a major culprit, as MXN (-2.1%), CLP (-2.0%), and PEN (-1.3%) round out the other top EM losers over the past five days.  

Colombia’s central bank is expected to hike rates 25 bp to 7.75%.  Higher than expected inflation in June may force the bank’s hand, as officials seemed to signal an end to the tightening cycle after its June hike.  Yet as stated above, lower oil prices are the main driver for COP right now.  

Brazil reports June consolidated budget data.  The central government primary deficit was lower than expected, and so there is risk of a better consolidated primary deficit too.  Consensus is at –BRL16.3 bln.  June manufacturing PPI will also be reported today.

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Surfeit of Oil

July 29th, 2016 6:21 am

Via WSJ:
By Sarah McFarlane and
Jenny W. Hsu
July 29, 2016 5:31 a.m. ET
0 COMMENTS

Oil prices extended their recent slide on Friday, as a deluge of oil and refined products in the market weighed heavily, keeping prices near three-month lows.

Brent crude, the global oil benchmark, fell 1.2% to $42.71 a barrel on London’s ICE Futures exchange. On the New York Mercantile Exchange, West Texas Intermediate futures were trading down 1% at $40.74 a barrel.

A combination of an expanding global gasoline glut, early signs of increasing production in the U.S., and rising output from the Organization of the Petroleum Exporting Countries have dragged down oil prices by around 20% since they broke above $50 in June.

“The unexpectedly weak performance raises the important question of whether this is a short-lived blip or has the fragile recovery in oil prices been derailed,” said brokerage PVM in a note.

The market was caught off-guard by an unexpected rise in weekly U.S. gasoline stocks which showed inventories rose 452,000 barrels to hit 241.5 million barrels in the week ended July 22. The increase comes at a time when stocks are usually being drawn.

“Global (gasoline) stocks should usually peak just before the start of the driving season,” said Patrick Kulsen, analyst at Dutch consultancy PJK International. “The expectation was that there would be more consumption in the U.S. and apparently those expectations were exaggerated.”

Support from temporary factors including Canadian wildfires, oil workers on strike in Kuwait and militant attacks in Nigeria that helped oil prices recover since February have now dissipated and the focus has reverted to the overhang of supply.

Investors will also be watching the weekly U.S. drilling report released later today for cues. Data from industry group Baker Hughes Inc. have shown an increase in oil drilling activities in the U.S. for four consecutive weeks to 371 as of July 22.
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“In addition to having more rigs drilling, the average productivity of rigs continues to increase,” said the U.S. Energy Information Administration. In the three major oil producing regions of Bakken, Eagle Ford, and Permian, daily productivity picked up by 155 barrels, 226 barrels and 111 barrels, respectively, per well, over the 2015 average.

In June, OPEC crude production increased by 264,000 barrels a day to average 32.86 million barrels, according to the cartel’s monthly report.

The increased barrels come at a time when the refined market is becoming bloated as output outstrips demand. The fear is that the glut of fuels will erode appetite for crude in the coming months and suppress prices to below the $40 mark.

Nymex reformulated gasoline blendstock—the benchmark gasoline contract—fell 1.5% to $1.28 a gallon. ICE gas oil changed hands at $367.00 a metric ton, down $6.75 from the previous settlement.

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Stiglitz Calls Apple Tax Accounting a Fraud

July 29th, 2016 6:04 am

Via Bloomberg:

“Here we have the largest corporation in capitalization not only in America, but in the world, bigger than GM was at its peak, and claiming that most of its profits originate from about a few hundred people working in Ireland — that’s a fraud,” Stiglitz said. “A tax law that encourages American firms to keep jobs abroad is wrong, and I think we can get a consensus in America to get that changed.”

Apple has a corporate structure that allows it to transfer money to low-tax jurisdictions, and one of those is Ireland, where the corporate tax rate is 12.5 percent — far below the U.S. top statutory rate of 35 percent. The European Commission, the European Union’s executive arm, is probing whether Ireland violated the bloc’s state-aid rules by helping Apple lower its Irish tax liability.

For more on Apple’s tax structure from Bloomberg Intelligence’s Matt Larson, click here.

Apple, which declined to comment on Stiglitz’s remarks, has firmly denied using any tax gimmicks, telling an EU tax panel in March that it had paid all of its taxes due in Ireland. Apple employs 5,500 people in Ireland, according to its website.

In Senate testimony in 2013, Apple Chief Executive Officer Tim Cook advocated a change to the corporate tax code which would “eliminate all corporate tax expenditures, lower corporate income-tax rates and implement a reasonable tax on foreign earnings that allows the free flow of capital back to the U.S.,” adding that such legislation would increase Apple’s U.S. taxes.

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Q2 GDP Guesses

July 29th, 2016 5:59 am

Via Bloomberg:
July 28, 2016 — 11:52 AM EDT

Previously unavailble figures on June inventories lead to cuts
Wider trade gap also contributing to lowered expectations

 

Some forecasts for second-quarter U.S. gross domestic product tumbled after a new report showed weaker inventories and a wider trade deficit in June.

Economists at JPMorgan Chase & Co. lowered their growth estimate to 1.7 percent from 2.2 percent, while the Federal Reserve Bank of Atlanta’s GDPNow projection declined to 1.8 percent from 2.3 percent. Others issued smaller reductions.

The catalyst was a Census Bureau report Thursday that, for the first time, provided data on wholesale and retail inventories for the last month of a quarter prior to the release of GDP, figures that were previously available only with a one-month lag. The advance numbers will be reflected in the government’s GDP report Friday, rather than forcing the agency to make educated guesses for the missing data.

The preliminary data from Census showed wholesale stockpiles were little changed in June after rising 0.1 percent the prior month. Retailers had 0.5 percent more goods on hand for a second month. Meanwhile, the trade gap for goods widened 3.6 percent to a four-month high of $63.3 billion, from $61.1 billion in May.

The reading on stockpiles at wholesalers was weaker than the 0.2 percent gain preliminary median forecast of economists surveyed by Bloomberg ahead of the final figures to be issued on Aug. 9. The merchandise trade gap exceeded the projected $61 billion deficit in a survey of 36 economists.
‘Severe’ Correction

“The inventory correction looks severe in 2Q,” and probably subtracted more than a percentage point from GDP last quarter, JPMorgan economist Daniel Silver wrote in a research note. Still, the rundown in stockpiles “should be a positive for growth going forward” as companies look to restock shelves and warehouses, he said.

Others lowering GDP estimates included analysts at Macroeconomic Advisers in St. Louis, who reduced it to 2 percent from 2.3 percent, and their counterparts at TD Securities in New York, where the forecast declined to 2.2 percent from 2.5 percent.

The combined advance estimates for trade and inventories issued Thursday provide a more timely update on inputs to GDP and may improve the accuracy of the growth numbers and limit the magnitude of next month’s GDP revisions.

The world’s largest economy grew at a 2.5 percent annualized rate from April through June, according to the median estimate of 76 economists surveyed ahead of Friday’s release. The updated projections cut it from 2.6 percent

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Stiglitz on the Euro: “A Tragic Mistake”

July 28th, 2016 6:59 am

Via the NYTimes:

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Yield Curve Signals

July 28th, 2016 6:52 am

Via WSJ:

Record-low yields on U.S. Treasurys have for decades signaled weakness in the U.S. economy and foreshadowed recession. Not this time.

Some economists are pointing to the so-called yield curve—the difference between long-term and short-term rates—as a harbinger of a new slowdown. Yields on 30-year and 10-year Treasurys plumbed record depths earlier this month, setting fresh milestones in three-decade downward trends.

Yields have since retreated a bit from their lows. But combined with weak business investment, falling corporate profits and slipping auto sales, the slump in bond yields has led some investment banks to put the risk of recession as high as 60%, accounting for past yield-curve compressions that were followed by recessions.

But unlike in the past, the pressures likeliest to trigger an economic contraction this time lie outside the U.S. Turmoil and weakness overseas have drawn investors to the security of U.S. government bonds, driving their prices up and their yields down.

“The low level of U.S. rates is not a reflection of the health of the U.S. economy,” said Torsten Sløk, chief international economist for Deutsche Bank Securities. “It is much more a reflection of how the rest of the world is chasing yields and the result of the Brexit vote.”

Past falls in the Treasury yield curve roughly coincided with other signs of a deteriorating U.S. economy. The recessions in 1990, 2001 and the Great Recession of 2007-09 were all preceded by steep declines in hiring levels. Similarly, manufacturing activity fell precipitously in advance of those contractions, according to a historical index managed by the Institute for Supply Management.

The last time the yield curve was this flat was in December 2007, when financial turmoil was about to wreak havoc on the global economy, the U.S. economy was averaging around 55,000 new jobs a month and the manufacturing index showed a contraction in activity.

Now, the U.S. economy is in one of its longest expansions in modern history and showing signs of gathering steam. Sentiment in the manufacturing and services sectors is rising, according to ISM’s index. Wage inflation appears to be ready to take off. And employment numbers in June showed a strong rebound, averaging 218,000 new jobs on the nonfarm payroll over the last six months.

“It represented the difference between sustained recovery and potential recession in the U.S.,” said Megan Greene, chief economist for the financial services firm Manulife.

Yields on bonds are composed of three dynamics: How much future price rises could erode their value, the expected path of interest rates, and the “term premium” lenders charge to hold longer-dated debt instead of short-term securities.

Much of the movement in the yield curve in recent days has come from changes in the term premium, said Olivier Blanchard, the International Monetary Fund’s former chief economist. That means the old interpretation of the correlation between the yield curve and recession “has no reason to hold,” he said.

In 2008, the probability of a recession was higher because of the housing-market imbalance. “Now, we have no such obvious imbalance. There are no bubbles of any macroeconomic magnitude that I can see,” said Mr. Blanchard, a senior fellow at the Peterson Institute for International Economics.

That’s not to say there isn’t trouble brewing in the world.

Michael Lebowitz, co-founder of investment consultancy 720 Global, said the “bond market is screaming that something is really wrong. Hope you are paying attention.”

As global investors grow worried, they pull their cash out of riskier investments and pour it into U.S. government bonds. That’s one reason why plummeting yields are often used as an indicator of recession.

Meanwhile, a multitude of factors—Brexit, weakness in Brazil and Russia, slowing growth in China—are fueling a hunt for yield at a time when there’s a scarcity of safe assets around the world, many economists argue.

Long-running economic weakness in Europe and Japan, along with limited space in government coffers, has forced their central banks to push interest rates into negative territory. Fitch Ratings estimates the total amount of sovereign debt with negative yields is now close to $12 trillion.

Besides lowering rates for safe assets, that dearth of secure assets around the globe could strain the financial system and undercut the effectiveness of central banks’ monetary policy, some economists argue.

But “we don’t think it’s an indicator of a U.S. recession,” said Nigel Chalk, the IMF’s U.S. mission chief.

He pointed instead to global factors.

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More FX

July 28th, 2016 6:34 am

Via Marc Chandler at Brown Brothers Harriman:

Dollar Pulls Back Further Post-FOMC

• After reversing lower yesterday after the FOMC statement, the US dollar has continued to move lower against the major currencies, save sterling
• German and Spanish labor market reports showed improvement
• As more details of Japan’s fiscal plans are known, the less impressive they seem
• The US reports the advanced look at merchandise trade (June) and weekly jobless claims
• South Africa reports Q2 unemployment; Brazil reports central government budget data

The dollar is mostly softer against the majors in the wake of the FOMC decision.  The yen and Aussie are outperforming while sterling is underperforming.  EM currencies are broadly firmer.  KRW and MYR are outperforming while RUB and TRY are underperforming.  MSCI Asia Pacific was up 0.1%, even with the Nikkei falling 1.1%.  MSCI EM is up 0.2%, with Chinese markets up 0.1%.  Euro Stoxx 600 is down 0.4% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is flat at 1.50%.  Commodity prices are mixed, with Brent oil down 1.1%, copper up 0.7%, and gold flat.

After reversing lower yesterday after the FOMC statement, the US dollar has continued to move lower against the major currencies, save sterling.  While the market is not fully confident of a rate cut by the Reserve Bank of Australia, indicative pricing in the derivative markets suggest a UK rate cut has been fully discounted (and a new asset purchase plan may also be announced).  

Sterling is off by about 0.3% near midday in London, unable to get above the mid-point of its recent range (~$1.3000-$1.3500).  The Australian dollar is the strongest of the majors, rising about 0.7%.  The Aussie’s gains put it at the upper end of yesterday’s wide range and come despite a smaller increase in Q2 export prices and weaker than expected import prices.  Export prices rose half as much as the Bloomberg median guesstimate (1.4% vs. 3.0%) after a 4.7% plunge in Q1.  Import prices fell 1.0%.  The median forecast was for a 1.5% gain after a 3.0% drop in Q1.  If anything, today’s data providing more evidence of a disinflationary thrust would increase the risk of a rate cut next week.  

The US dollar’s slide since the FOMC statement also cannot be easily attributed to a shift in interest rate expectations.  Not only was the statement largely as expected, but the September and October Fed funds futures were unchanged on the day, implying 41 bp and 44.5 bp respectively.  The implied yield on the December contract increased by half a basis point to 48 bp.  

Our work suggests these yields imply a greater risk of a rate cut than the popular and often cited estimates.  Given the lateness of the September meeting (September 21), the October contract may be a cleaner read.  Consider that if the Fed were to hike at the Sept meeting, the fair value of the October meeting would likely be around the mid-point of the new target range (50-75 bp) or 63 bp.  As we have seen, the Oct contract implies 44.5 bp.  That translates into about a 30% chance being discounted (1- (44.5/63)).  

Here is another way to think about what is discounted.  Look at the December contract. The meeting is on December 14.  If we assume that in the cash market, the Fed funds will average what they currently are, which is 40 bp for the first 14 days of the month, and then average the new mid-point of the target range, assuming a 25 bp hike for the remainder of the month ((40 bp * 14 days) + (63 bp * 17 days) ) = 1631.  Divide by 31 days in the month to get the average Fed funds assuming a 25 bp hike, or 52.6.   So, if the Fed does nothing, the implied yield should be 40 bp and if they hike fair value is 52.6 bp.  The contract is currently implying a yield of 48 bp, which is the equivalent of about 63% of the move having been priced-in.    

Equity markets are mixed today.  The MSCI Asia-Pacific Index managed to extend its advancing streak to a fourth consecutive session.  Although the gains have been modest this week, they were sufficient to lift the index to its highest closing level today since last November.  European equities are themselves mixed, with small gains in Germany and France blunting losses elsewhere.  Financials are the largest drop, while many sectors are firmer, led by industrials, materials, and health care.  

Tomorrow the European stress test results will be announced.  Ahead of it, there has been a push to address the problems of Italy’s weakest bank, Monte Paschi.  Reports indicate a proposal has been sent to the ECB that calls the bank to shift EUR10 bln of its NPLs to a combination of the recently established Atlante (Atlas) Fund and private funds (with a government guarantee), and it would raise EUR5 bln in new capital.  The markets do not seem impressed, and the FTSE Milan Index of Italian banks is off nearly 2% today.  

The skepticism stems from several considerations.  One issue is the price at which the NPLs will be sold.  Will they be sold to the Atlas Fund at higher than market prices?  A problem has been that there has not been much interest among the private sector to purchase the NPLs.  So, another issue whether the government guarantees, especially if they are only for the safest tranches and cost the investors extra, make a significant difference.  Another source of doubt is the bank’s ability to raise another five bln euros, which are five times its current market cap when the previous two bailouts have failed.  

Even if the plan works, the bank will still have 40 bln euros in NPLs and Italy’s banking system will have roughly 340 bln euro of NPLS and provisions for a little less than half.  And this does not address the larger issue of profitability amid low interest rates and slow growth.  

German and Spanish labor market reports showed improvement.  Germany’s states have reported July inflation figures, and they are consistent with the national rate ticking up to 0.3% from 0.2%.  It is not particularly striking and will not change minds about the prospects for another extension of the ECB’s asset purchase program.  Nor does it explain the euro’s strength.  It exploded out of narrow lackluster ranges around $1.10 to reach $1.1120 in early European turnover.  A move above there could spur a further advance toward $1.1170.   We are more inclined to see a test of support in the $1.1060 area.  

As more details of Japan’s fiscal plans are known, the less impressive they seem.  Of the JPY28 trillion (5% of GDP), only about a quarter has been identified as direct fiscal support.  And even this seems to combine a traditional supplemental budget as well.  The immediate focus is now on the BOJ.  Even if investors knew precisely what the central bank would do, it still might not be confident of the response.  Judging from the newswires, it appears a consensus has emerged for ETF and long-dated JGB purchases to be announced.  Many also suspect that either a greater share of reserves will be covered by the minus 10 bp rate or that the rate itself may be shaved.  

The US dollar found support a little below yesterday’s low near JPY104.50.  Look for narrow ranges to prevail in the North American session.  The initial cap may be near JPY105.00.  On the other hand, a break of JPY104.50 may see JPY104.25.  

The US reports the advanced look at merchandise trade (June) and weekly jobless claims.  The former is the last piece of data that economists will have for fine-tuning their Q2 GDP forecasts ahead of tomorrow’s report.  Canada reports May GDP tomorrow.  The median expectation from the Bloomberg survey is for a 0.5% contraction.  

South Africa reports Q2 unemployment, which stood at 26.7% in Q1.  Last week, the SARB signaled that the tightening cycle is on pause and cut its growth forecast for this year.  June money and credit growth will be reported Friday, along with June fiscal and trade data.  This week’s data is expected to reflect the ongoing weakness in the economy.  If the rand remains fairly firm, then no action is likely to be seen at the next SARB meeting September 22.

Brazil reports central government budget data, ahead of consolidated data tomorrow.  Market is looking for a central primary deficit of –BRL14.5 bln, which would boost the 12-month total to a new high of –BRL151.4 bln.  Yesterday, Brazil reported formal job creation (destruction?) of -91k.  This was worse than the expected -58.7k.  We think that the poor state of the economy will prevent much of the fiscal adjustment from taking place, as desired.

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