Today: Did you miss JACKSON WHOLE? Global manufacturing getting reshuffled. Earnings Watch.
Jackson Hole Theme: Labor Markets Can’t Take Higher Rates Global central bankers led by Federal Reserve Chair Janet Yellen said labor markets still have further to heal before their economies can weather higher interest rates.
The focus on jobs suggests the Fed and Bank of England will tighten policy within a year as their economies show signs of strengthening. By contrast, European Central Bank President Mario Draghi and Bank of Japan Governor Haruhiko Kuroda acknowledged they may be forced to deploy fresh stimulus. (…)
Yellen’s message was “there is room for debate over how much slack, as we say, is in the U.S. labor market,” said former Fed Vice ChairmanAlan Blinder, who now teaches at Princeton University in New Jersey. “But in her view, as she looks at all the evidence, the case is close to overwhelming that there is a significant amount left.”
Blinder said there’s a “vigorous debate” among economists and investors about how sluggish the labor market still is. Its surprising strength suggests “we are closer to Fed liftoff than we were a year ago” and rates probably will be increased early next year, he said. (…)
More Economists See Fed Policy As Too Loose Economists overwhelmingly expect the Federal Reserve to hold off raising short-term interest rates until at least 2015. But nearly a third say doing so would mean the central bank waited too long, a new survey found.
The share of economists saying the Fed should raise rates in 2014 has grown from 25% in the organization’s February policy survey.
In a separate Wall Street Journal survey released earlier this month, 91% of economists said the Fed waiting too long to raise rates was a greater risk than lifting rates too soon.
Euro Down on Draghi Comments The euro sank to its lowest level in nearly a year and European stocks climbed, after ECB President Mario Draghi signaled a shift in emphasis.
“The main thing people should understand is that our policy is quite capable of being fully independent, as it has been these past few years,” Mr. Poloz said in an interview at the annual gathering of central bankers and economists at Jackson Hole, Wyo., over the weekend. (…)
While Mr. Poloz insisted he wasn’t making predictions, he offered several reasons to explain why he would feel no pressure to reflexively follow the Fed. For one, the Bank of Canada has a head start. “It’s worth reminding people that we are at 1 per cent,” Mr. Poloz said. “In this world, that’s a high number when everything is starting at zero.”
The Bank of Canada is seeking to return its benchmark interest rate to a setting that neither stokes inflation nor hurts the economy. Before the crisis, the “equilibrium rate” was understood to be about 4 per cent. The central bank now thinks scars from the crisis have lowered that rate. “When you think the equilibrium number is at some lower rate than in the past, which I do, but I don’t know yet what it might be, then at least we know that we are part way there already,” Mr. Poloz said.
The other factor is the relative strength of the two economies. The U.S. has considerable forward momentum, while Canada still is waiting on a revival in exports and business investment. Stronger demand in the U.S. should benefit Canada’s economy. Monetary policy in the two countries is so similar because of their close trade links: When the U.S. economy grows, Canada sells more exports, which boosts economic growth and puts upward pressure on inflation.
Canada’s loss of market share raises questions about whether stronger U.S. growth will boost Canada’s economy to the extent it has in the past. Mr. Poloz says he is counting on new exporters to replace those wiped out by the recession, creating an incentive to leave borrowing costs low to help those entrepreneurs get started. Canada’s job growth this year is almost entirely driven by part-time positions, while U.S. employers are adding jobs at one of the most impressive rates on record.
“The linkage between their recovery and ours is not mechanical … We still have question marks around ours,” Mr. Poloz said. “We ought to be able to strike a fully independent course determined by these other things quite independently of what theirs are.”
Like Draghi, Poloz wants (needs) a weaker currency. This is not unrelated:
(…) According to a new report from the Boston Consulting Group—which for several years has tracked the competitiveness of global producers—the old assumptions of low cost versus high-cost regions is outdated. (…)
Mexico is now cheaper than China and the U.K. has emerged as a low-cost manufacturer relative to most of its European neighbors, according to the BCG calculations. Brazil, meanwhile, has become one of the world’s priciest places to make things; its cost structure is tied with those of Italy and Belgium in the BCG rankings.
The study used the U.S. as a baseline and found Brazil’s average costs went from 3% lower than in the U.S. in 2004 to 23% higher today. BCG notes Brazilian factory wages more than doubled over the decade, while productivity growth faltered. The cost of buying electricity for factories in that South American country have doubled, while natural gas prices have leapt nearly 60%.
The clear winners in this global scramble, according to BCG, are Mexico and the U.S. The two neighbors saw their competitiveness improve more than in any other country studied. “Because of low wage growth, sustained productivity gains, stable exchange rates, and a big energy-cost advantage, these two nations are the current rising stars of global manufacturing,” the report said.
THE U.S. KEEPS ON TRUCKING
American Trucking Associations’ advanced seasonally adjusted For-Hire Truck Tonnage Index rose 1.3% in July, following a decrease of 0.8% the previous month. In July, the index equaled 130.2 (2000=100) versus 128.6 in June. The index is off just 0.6% from the all-time high in November 2013 (131.0).
Compared with July 2013, the SA index increased 3.6%, up from June’s 2.3% year-over-year gain. The latest year-over-year increase was the largest in three months. Year-to-date, compared with the same period last year, tonnage is up 2.9%.
“After a surprising decrease in June, tonnage really snapped back in July,” said ATA Chief Economist Bob Costello. “This gain fits more with the anecdotal reports we are hearing from motor carriers that freight volumes are good.”
Costello added that tonnage is up 4.9% since hitting a recent low in January.
Trucking serves as a barometer of the U.S. economy, representing 69.1% of tonnage carried by all modes of domestic freight transportation, including manufactured and retail goods.
MORE ON THE U.K. EMPLOYMENT SURGE
WEAK COMMODITIES TO KEEP INFLATION IN CHECK
Hedge Fund Crude Bets Tumble Amid Surging Global Supply Speculators are the least bullish on U.S. crude oil prices in 16 months as refinery maintenance weakens demand at a time when Libya and Iraq are swelling global supplies.
Futures dropped a fifth consecutive week after money managers reduced net-long positions in West Texas Intermediate, the U.S. benchmark grade, by 14 percent in the seven days ended Aug. 19, the Commodity Futures Trading Commission said.
Hedge funds and other speculators cut bullish bets on Brent to the lowest level in two years, data released today by the ICE exchange show. Money managers’ wagers that prices will rise, in futures and options combined, outnumbered wagers that prices will fall by 63,079 contracts in the week ended Aug. 19, the least since July 10, 2012.
Net-longs for WTI slipped by 30,225 to 188,589 futures and options, the lowest level since the seven days ended April 23, 2013. Long positions fell 4.2 percent to 258,246, the least since June 2013. Shorts climbed 37 percent to 69,657, the highest level since December 2012.
Prices sank below $95 on Aug. 19 for the first time in seven months as U.S. air strikes in Iraq helped reverse the advance of Islamic State fighters and the country’s Kurds work to increase oil shipments. Libyan output climbed last week and exports resumed from the port of Es Sider. Refineries in the U.S. typically schedule work for September and October, when demand for gasoline declines after the summer peak, and before consumption of heating fuel picks up during winter. (…)
Iraq’s Kurds are working to quadruple the capacity of their oil-export pipeline within months, an official with knowledge of the situation said, asking not to be named because of policy. The Kurdistan Regional Government, or KRG, more than doubled daily capacity to 300,000 barrels on its link toTurkey as of Aug. 21, and is considering another increase that would allow the line to move 500,000 barrels a day to the Mediterranean port of Ceyhan within as little as three months, he said.
In Libya, production increased to 612,000 barrels a day on Aug. 21, according to Mohamed Elharari, a spokesman for National Oil Corp. Two cargoes have loaded at the reopened port of Es Sider, according to the NOC. The North African country pumped 400,000 barrels a day in July, according to a Bloomberg survey of oil companies, producers and analysts.
Earnings season effectively over. Factset:
Of the 490 companies that have reported earnings to date for Q2 2014, 74% have reported earnings above the mean estimate and 66% have reported sales above the mean estimate. The blended earnings growth rate for Q2 2014 is 7.7%. On June 30, the estimated earnings growth rate for Q2 2014 was 4.9%. Eight of the ten sectors have higher growth rates today (compared to June 30) due to positive earnings surprises, led by the Health Care sector.
Earnings Guidance: For Q3 2014, 74 companies have issued negative EPS guidance and 27 companies have issued positive EPS guidance.
This 73% negative guidance is below that of May 22 (75%) and March 21 (84%). It is also substantially lower than that of August 22, 2013 (83%).
S&P’s tally puts Q2 EPS at $29.45 (+11.7% Y/Y), rising to $30.11 (+11.8%) in Q3 and $32.39 (+14.7%) in Q4, all only pennies lower than in previous weeks. Trailing 12-m EPS are now $111.94 (+12.8% Y/Y). They are seen rising to $115.13 after Q3 and to $119.27 after Q4, up 2.8% and 6.5% from Q2’s number respectively.
Inflation having stabilized at 2.0%, the fair Rule of 20 P/E is 18 which gives a target of 2015 for the S&P 500 Index, potentially rising to 2072 and 2150 after Q3 and Q4 respectively.
The earnings tailwind is pretty good while inflation seems to have stabilized at 2%. The market keeps bumping against the “20” valuation level without enough impetus or confidence to traverse it like it normally does (see THREE-STARRED EQUITIES). There has been no “sell in May” and no “summer swoon”. There has also been no “mid-term bust”, so far, which would break a pattern perfect since 1962. These may be comforting as we enter the more volatile months of the year…If you missed it Sunday, maybe you should read JACKSON WHOLE.
Companies with lower credit ratings have raised $186 billion in junk loans so far this year, according to Dealogic. The riskiest tranche of that debt—so-called second-lien, or junior, loans—amounts to $3.3 billion, almost double the amount raised at the same stage last year and the most over the same period since 2007. (…)
If a borrower goes bust, junior lenders are only repaid if some other, higher-ranking lenders, get all their money back. Only unsecured creditors and shareholders are further down the queue. Companies also get better terms—junior loans are less restrictive when it comes to taking on additional leverage than senior debt, while borrowers get more flexible repayment options than bonds.
In exchange for the additional risk, investors get a better return. Interest rates on junior loans are typically 3.5 percentage points higher than senior loans, bankers say. (…)
Dealogic data show that more than half the loans that include junior debt have been used for acquisition financing, with a smaller proportion financing dividend payments. (…)
Losses on junior loans can be steep if a company fails. The average recovery rate on defaulted junior loans in Europe between 2003 and 2013 was 36%, according to Standard & Poor’s. That compares with 76% on senior loans, S&P data show.
Ordinarily, monetary tightening is an attempt to contain the inflationary risks arising from above-trend business activity. Because of the latter, high-yield bond spreads tend to narrow at the start of a series of Fed rate hikes. However, spreads often widen considerably once activity has slowed by enough to shrink profits, threaten liquidity, and materially lift recession risk.
Regarding the four episodes of Fed rate hikes since 1993, the high-yield bond spread narrowed by -26 bp, on average, six-months after the start of monetary tightening, but would then widen by 26 bp and 118 bp, on average, 12- and 18-months after the first rate hike. (…)
Beware of averages, even more so if over only 4 cycles which include two huge bubbles. Looking carefully at Moody’s charts, I would take little solace from the “average” narrowing in spreads early on.
S&P 500 companies reduce buybacks Corporate treasurers are wary of high stock prices
Companies in the S&P 500 bought back $120bn of shares in the quarter to June 30, down from $159bn in the first quarter, which was the second-largest amount ever, according to preliminary data from S&P Dow Jones Indices.
Market watchdog issues cyber attack warning Iosco chief says hackers have potential to trigger ‘black swan’ event
Greg Medcraft, chairman of the board of the International Organisation of Securities Commissions (Iosco), predicted that the next major financial shock – or “black swan event” – will come from cyber space, following a succession of attacks on financial players.
He warned that there needed to be a more concerted effort to tackle cyber threats around the world as current approaches varied widely. “The feedback we have had from industry in discussions is that there is not a consistency in approach,” he said.