Tuesday, June 30, 2009

More interest in European economics

Consumer confidence is down in the US and the Case Shiller index is slightly better than expected. Chicago PMI was above expectations and Milwaukee NAPM is at 50, but the real news is that the rest of the world is doing slightly better.

Industrial production in South Korea is positive MOM and the leading index is up. Japan sees slightly better small business confidence. UK housing prices are not as bad as expected and Thai trade balance is better from rising exports. Swedish retail sales are up as well as retail volume MOM in Norway. However, UK GDP is down and Eastern Europe does not look good. Mexico's budget balance has turned negative fast.

The key is that some devastated economies are showing signs of life in Asia and Europe is showing some positive signs. There is also greater differentiation across countries. More is going on than what is being reported in US.

Jump risk and commodity markets

One of the difficulties with trading commodities is the low mix between public and private information. Public information will usually be the announcements from the government in the form of some macro data. This could also be firm specific information. but is disseminated to the entire market at one time. Private information is data that which is gathered by an individual and is not obtained simultaneously with other investors. This information is not revealed through an announcements but through the activities of the holder of the private information through its impact on price. A large grain company will have private information on their activity which may be displayed through their actions in the market.

If there is little public information in the market, that is, infrequent announcements, there is a greater chance for a large surprise for those who do not gather private information and depend on this information. So now we come to the acreage report that was announced today. The government reported that acreage was much greater than expected. This was especially surprising given all of the poor weather in the Midwest. The result is that a number of the grain markets were limit down. The reaction was swift and severe because there was little other prior public information to suggest what would be the direction of this report.

Usually in financial markets you have a number of announcements through the month that provide an indication of the direction of the macro environment. There will be surprises but there also may be a better idea of where an economy may be headed. This does not mean that there will not be surprises but there will less concentration of risk like what we may see in commodity announcements.

The lack of public information is also the reason why there is a greater concentration in technical analysis over fundamental analysis. There will be fewer fundamentalist if there is less data to work with. If all you have is price information, then that is what you will use.

Sunday, June 28, 2009

The scary debt projections from CBO

If you want to have a hard time going to sleep, read about the latest long-term projections for the Federal budget by the CBO. The CBO study, The Long-Term Budget Outlook, shows a deficit that is out of control and that cannot be sustained. We will be above 100% debt to GDP in approximately 10 years by following an extended-baseline scenario. If the Federal deficit does not change, interest payments will surge to 2.5% of GDP by 2020. Many are expecting that the economy will grow under 3%, so all of the growth will go to paying interest.

Breaking the budget will be three programs. Medicare, Medicaid, and Social Security. Sure we can change these programs but there is a terrible headwind that cannot be controlled, demographics. The baby boom generation will be retiring so there will be increased demand for services so the only way that this can change is if the services are curtailed or there are significant efficiencies and cost-savings. While everyone is talking about health care insurance, the real issue is still the retirement programs. The Federal government has not been able to control these costs.

Yes, we can insure more with health care but that does not change the problems with Medicare and Medicaid. These two programs represent about 5 percent of GDP but will increase to 10% in 2035 and more than 17% by 2080. These two programs will have the same share as the total current Federal budget. This is where we will have real problems and this is one reason for high long-term rates.  

Friday, June 26, 2009

History repeating the Jazz Age of credit

Good opinion piece in the FT, "Lessons in the Jazz Age for Creditors" by James McDonald. It tells an interesting story associated with the debt imbalances in the 1920's leading to inflation and default in Germany. In the 1920's, it was Germany the debtor borrowing from the large exporter and creditor America. Every time is different but there is always something to learn from history. It does repeat itself.

Confidence up

We are still a long way from being optimistic but the University of Michigan confidence survey has us at the highest level since February 2008. Certainly below the 200o recession but we are higher than the lows of the 1990 recession which was associated with a supply shock and the saving and loan debacle. Recoveries are gradual bu this is good news.

Income is up and spending is positive. This is good. there is some gain in spending and with income up there is some fixing of the balance sheet through savings.

Monetary policy uncertainty resolved

The statements and activities of the Fed and ECB resolve some of the monetary policy uncertainty that was overhanging the market. It will be the macro data or green shoots story that will again be the focus of the market as we move through the summer. This story becomes all the more important as the consensus suggests that we may be moving to an improving global economy as evidenced by the better growth report from the OECD.

From the Fed, we learned that monetary policy will continue to stay in easing mode but there will be no new buying of Treasuries. This was the major fear in the market, the monetizing of debt. Clearly, that was not the intent of the Treasury purchases but the perception was present given the size of the Treasury debt auctions. This fear is real but overblown given the size of the current output gap. The steady Fed policy is good for the market.

The ECB ran their 1-year fund auction which some have called stealth or endogenous QE. At a fixed rate, they are willing to lend an almost unlimited amount. This provides funds at a limited cost to the market and serves as a good way to get cash into the banking system. We now know the size and timing of this injection. Again uncertainty is resolved.

Now let's get set for unemployment before the 4th of July week-end.

Tuesday, June 16, 2009

BRIC meeting and dollar premium

Over the week-end we got positive dollar comments from Russian finance Minister Kudrin at the G8 finance minister meetings. Now we have the BRIC meeting in Russia to discuss global finance. One day dollar positive and the next day we may get dollar negative news about the reserve status of the dollar.

This back and forth does not help the world financial system when there is mixed statements on the role of the dollar. While there is unlikely to be a significant change in reserve status in the near-term, the continued discussion of this issue creates noise and uncertainty. This has created a risk overhang in the dollar which I call the dollar reserve risk premium.

Monday, June 15, 2009

Commodities and sunspots

Plantings are off in both the Northern and Southern hemispheres. Could this be the result of global warming? Empirically this effect is very hard to measure; however, we do know the world becomes cooler if there are fewer sunspots. More sunspots mean there is more energy disturbances on the surface of the sun which leads to more radiance sent out into space which eventually warms the atmosphere. When the earth is cooler, there is a decline in crop yields which leads to higher prices. This relationship between sunspots and grain prices was first found by William Hershel in the 1800's.

Agricultural crops are a weather play. Corn and wheat are still down for the year -2.7% and -9.46% but soybean meal is up 44% YTD and soybeans up 27% YTD. This may not be enough to say that we should become astronomers, but we still have to realize that the driving factors in grains may not have as much to do with global recession as we may imagine.

Sunday, June 14, 2009

V-shaped recovery unlikely

Citibank analysts have come up with an interesting stat on recoveries. They looked at post-WWII recessions and compared the drop in GDP against the size of the recovery through measuring their correlation. They concluded that there is an 80% correlation between the size of the drop and the size of the recovery. The faster you go in, the faster you come out.

Numbers never lie, but do they do not tell the truth. The analysis would be correct if we were in a normal recession. A normal recession, if there is such a thing, would be one that has a negative supply shock which leads to higher inventory levels which require a slowdown in order to work out the excess.

Is this the problem with the current recession? The answer is very much no. This is a banking crisis liquidity event which generally does not fit the normal behavior of recessions. We actually have a fair amount of information on the behavior of banking crisis and this data suggests that the recession is much more long-lived. There is usually much more government deficit financing and there is a longer time for banks to work off their bad loans and actually lend at previous levels. Now we may have a recovery which is stronger than some other bank crises given the size of the stimulus but this has nothing to do with the fast in fast out theory.

We would argue that it is good to be more defensive because the data suggests that the crisis will take some time to work out, green shoots or not.

The WTO stimulus and bail-out problem

The US has aggressively employed bail-outs and stimulus programs to help banks, auto companies and the overall economy. Now Argentina and 15 other countries are bringing a grievance to the WTO that these programs are industrial subsidies. They provide an unfair advantage in international trade and should allow retaliation by other member countries.

The longer the recession as lasted the more likely there will be a trade war. This is especially the case given this global recession is driven by such a large decrease in trade. Countries have seen 20+ percent declines in exports and similar declines in industrial production. This countries to have the same access to capital markets, so the US and Europe can deficit finance bail-outs to their home country industries. GM is a case in point. The "Buy American "language in the stimulus package is another example.

This could start a wave of tit-for-tat actions which will further retard global growth.

Stats of the week

The KBW bank stock index is up 100% from the lows. What a change in bank expectations.

The mortgage application index has fallen from 1200 in March to just over 600 in the last three months. 30-year mortgages have moved up from 4.75% to over 5.5% during the same period. Refi's has been a great way of restoring broken balance sheets. The higher mortgages rates cannot be good for the housing market as we enter the key summer season.

$199 billion of TARP funds have been given to banks. $2 billion has been paid back. Another $68 billion is expected from banks which means 35% has been given back in less than nine months.

Is this good or bad? When you look ta write-downs and potential losses, it is hard to imagine that we are out of trouble. The IMF believes there will be %1.o64 trillion in losses. Banks have written-down $564 billion so far, so there still has to be another $500 billion to go. Banks have raised about $75 billion, so where will the rest of the money come from?

Obscurity, Stupidity, and GM - quotes for the week

The obscure takes time to see, but the obvious takes longer. -Edward R Murrow

Interesting quote from a reporter. How much is obvious but not reported or misreported in the news?

"Think of how stupid the average person is, and realize half of them are stupider than that" -George Carlin

"What's good for GM is good for America" - GM President Charlie Wilson

At the time the quote was made in 1953, 1 out of every 200 workers was employed by GM and 3% of GDP. We may still be living in the past on the importance of GM. Motor vehicles only represents 1.5% of GDP from 4% as late as 1988. Japanese and European automakers sell more cars in the US than US big three. The value of GM market cap before bankruptcy was less than the Turkey's and Egypt's auto makers.

Endogenous versus exogenous QE monetary policy

There is growing discussion on differences in quantitative easing monetary policy. On the one hand, there is the activist exogenous monetary policy followed by the Bank of England and Fed through explicit purchase of financial assets in order to control rates. The purchase of mortgages or Treasury debt increases the central bank balance sheet. The purchase of specific securities is expected to lower rates directly. The central bank decides on the when and how much not the market.

On the other hand, endogenous quantitative easing has been followed by the ECB. In this case, the central bank sets a rate of interest but makes funds available to all that want them. The ECB balances has also exploded but it is based on the demand for funds by banks. The endogenous approach is solely based on market driven demand. Perhaps this is easier for a country that has more developed bank system but there has been less aggressive reaction to the endogenous approach than the activist approach.

Which is better? My guess is that the endogenous approach will be easier to reverse and control. The exogenous approach will require an active transaction of selling bonds by the central bank. The impact from their purchases could be offset by the future sale. The endogenous approach is a matter of banks making the decision of what they need from the central bank at its stated price. The bank doe snot have to do anything but change the price of money to change the balance sheet and demand.

Friday, June 12, 2009

As we consider tax policy....

A government that robs Peter to pay Paul can always depend on the support of Paul.

- George Bernard Shaw
How will deficits be paid? There are only three ways, increasing tax rates, growing to increase revenues, or inflating to reduce the nominal value of debt. The big fear is that alternatives are limited. There are limits to the increase in tax rates. Many households do not pay taxes now, so there are constraints to the "soak the rich" strategy. The growth alternative is limited if we do not have a V-shaped recovery. An inflation story is limited at this time given the large output gap, but the fear is that the inflation alternative becomes more likely if the first two policy choices are clearly closed. This explains why the back-end expected inflationary expectations are at 2% given the deep recession.