Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Edge and Odds

Invest with smart knowledge and objective odds

Month: June 2014

NEW$ & VIEW$ (19 JUNE 2014)

LOWER FOR LONGER
Fed Keeps Rates Low, Sees Rise in ’15, ’16 With its bond-buying program winding down, officials are turning their attention to the question of when to start raising the federal funds rate from near zero—where it is likely to remain through the year.

(…) With the job market gradually improving, the Fed is taking away that support and slowly turning its attention to the timing and pace of short-term interest rate increases. It has kept short-term rates near zero since December 2008 and isn’t planning to start raising them until next year.

Investors appeared cheered by that timing. The Dow Jones Industrial Average rose 98.13 points, or 0.58%, to 16906.62 after earlier being down 26 points, while the 10-year U.S. Treasury note rose 12/32 in price to push the yield down to 2.611%.

On average, Fed officials projected the benchmark federal funds rate would hit 1.2% by the end of 2015 and 2.5% by the end of 2016, up slightly from averages of 1.125% in 2015 and 2.4% in 2016 when the Fed last projected rates in March. Over the longer run, officials on average said the target interest rate could settle in at a lower-than-normal 3.75%, down from earlier forecasts of 4%.

Officials also projected the jobless rate falling more than previously thought. They see it receding to 6% or 6.1% by year-end and then to the mid-5% range in 2015 and low-5% range in 2016.

The revisions from March suggest the Fed sees less slack in the economy than previously thought, which could lead to higher inflation and helps explain the slightly higher near-run interest rate projections. Ms. Yellen dismissed as “noisy” recent increases in inflation, though some market analysts said the Fed risks allowing inflation pressures to build as unemployment falls. (…)

“There is uncertainty about what the path of interest rates, short-term rates, will be, and that’s necessary because there’s uncertainty about what the path of the economy will be,” she said.

Underscoring that point, she noted there is a wide range of views even among Fed officials about where rates will be by 2016. Fed forecasts range between 0.5% and 4.25%.

Mohamed A. El-Erian: Fed Dishes Out Continuity

(…) For 2014, the Fed no longer believes that the U.S. economy will recover fully from its first-quarter, weather-induced disappointments. Beyond that, it has joined those worried about the growth potential of the economy. As such, Fed officials have started to concede that the long-term Fed funds rate is likely to settle below its historical level, though they don’t think by much (at least so far). Finally, to the extent that Fed officials worry about inflation, it is limited primarily to movements in prices of goods and services, and the concerns have more to do with “persistently low” rates rather than excessively high ones.

For those of us following closely the evolution of Fed policy, this seemingly steady Fed is one that also has to deal with some pretty large unanswered questions. Consider the following four as an illustration of a broader phenomenon:

  • The balance between cyclical considerations, which validate a “highly accommodative stance of monetary policy,” and secular and structural ones that would limit the beneficial impact of such an approach while increasing the costs and risks;
  • The extent to which asset-price inflation will serve as a conduit for higher growth and employment, rather than financial instability down the road;
  • The ability of macro-prudential measures to counter the risks of bubble-ish markets, overexuberant investors and deteriorating technical market conditions; and
  • How U.S. policies will impact the rest of the world in the context of “multi-speed central banking.”

Each of these issues is complex and consequential as a standalone. The whole is materially more so. And all will require a tremendous amount of intellectual and operational agility on the part of the Fed. Fortunately, this was also the first Fed meeting at which the number of governors participating in the policy deliberations is almost complete.

Ms. Yellen says that “the decline in headline unemployment to 6.3% overstates the improvement in the labor market” explaining why the Fed plans on holding rates low even after the rate falls to 5.5%.

The U-rate is now a moving target, no longer THE benchmark as Yellen said that the Fed will now be preoccupied by a large number of indicators. Recall that the U-rate goal post was 6.5% in Dec. 2012 and 7% in June 2013.

Let’s hope that the recent rise in inflation is just noise, as she says, even though the increase was fairly broad based.

As to the overstatement by the lower U-rate, let’s remember two facts:

  • The recent drop in the U-rate was not because of a decline in the participation rate.
  • The JOLT report indicates that for each job offering, and job openings have spike up in recent months, there are currently 2.2 job seekers, down from 6.8 in 2009 and close to the 2000-2007 range. Workers on the sideline should eventually take notice of the renewed balance in the job market and re-enter. Otherwise, wages could well keep rising, especially given the inflation “noise”.

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image(http://stateofworkingamerica.org/)

Weak GDP numbers apparently did not dampen labor demand a whole lot, with net gains in jobs posting an 8 month run. Job openings (not able to fill currently)
remained at the highest level in the expansion and plans to create new jobs gained more strength. Although the percent of owners reporting job openings is ten points below the record high, it is holding at the highest level seen since mid- 2007, suggesting that labor markets might be tighter than the unemployment rate
suggests. (NFIB)image

Talks that the Fed is behind the curve will reappear in a media near you…

China Housing Slump Hits More Than Homes

China’s housing slump is affecting other parts of the world’s No. 2 economy, hitting everything from construction-worker wages to furniture demand to sales at Yang Limin’s steelyard in this dusty northern Chinese town.

This is typically the time of year when construction companies are at their busiest, said Mr. Yang, manager at Ningxia Yanbao Steel Market Co. But the firm sold only 100,000 tons of steel this year, he said, down 30% from the same period a year ago. In several steel trading offices down the street, several employees appeared to be dozing at their desks.

“It’s already June, and things haven’t improved,” Mr. Yang said. “And next year doesn’t look so good either.” (…)

The latest negative news came Wednesday, when government data showed average new home prices in 70 cities fell 0.15% month-on-month in May, according to Wall Street Journal calculations. That marked the first monthly drop in the measure since May 2012. Housing prices also declined slightly in Shanghai and Shenzhen, suggesting the slump is spreading to China’s most-developed cities, although they rose slightly in Beijing. (…)

PBOC Keeps Pumping Cash

China’s central bank will pump cash into the country’s financial system for a sixth straight week, as Beijing grapples with a still-nascent economic recovery, a sharp slowdown in capital inflows and a decline in foreign investment.

The move to ease funding conditions for banks, the longest of its kind since an 11-week streak last summer, is part of a broader effort by policy makers to lower borrowing costs for businesses and debt-laden local governments.

The People’s Bank of China will inject a net 15 billion yuan ($2.4 billion) into the money market this week via short-term loans to commercial lenders, said traders participating in the bank’s open-market operations that fall on each Tuesday and Thursday. It follows a net injection of 104 billion yuan last week and 73 billion yuan in the previous week. (…)

Vietnam Devalues Dong First Time in a Year to Spur Exports
Brent Rises to Nine-Month High on Iraq Conflict Brent crude traded at a nine-month high as Iraqi forces battled insurgents north of Baghdad. West Texas Intermediate rose for the first time in four days after a government report showed U.S. crude supplies shrank.
Punch WHY IRAK MATTERS

Via ValueWalk:

On Tuesday, IEA’s report forecast that 60 percent of expected growth in OPEC’s crude production capacity in 2019 would come from Iraq.incremental opec crude production capacityWatch the south:iraqi oil production by region

SENTIMENT WATCH

(Bespoke Investment)

Buyback Binge Surges to New High

(…) Stock buybacks and cash dividends reached $241.2 billion during the first three months of the year, exceeding the previous record of $233.2 billion set in the fourth quarter of 2007, according to S&P Dow Jones Indices. The new high is more than three times the $71.8 billion total in the second quarter of 2009, when the economy was in the early stages of recovering from the financial crisis. (…)

Companies particularly splurged on buybacks during the first quarter. They bought back $159.3 billion worth of stock during the first three months of 2014, up 59% from a year ago and a 23% increase from the fourth quarter. (…)

FedEx Sets Ambitious Targets

FedEx Corp. FDX +6.16% posted impressive fourth-quarter earnings gains and set ambitious targets for the new year despite the challenges at its express business caused by lackluster global trade.

Chief Financial Officer Alan B. Graf Jr. called fiscal 2014 “a good year” despite a third quarter plagued by rough weather. He said FedEx expects 2015 “to be even better.”

He and other executives said FedEx’s restructuring plan is still on track but told analysts on an earnings call that the company had to take different steps than initially planned to achieve the goal of $1.6 billion in profit improvements by the end of 2016. Global trade isn’t improving as quickly as expected, he said.

“It used to be that international trade was a multiple of GDP, and those days have passed,” Mr. Graf said. “We do expect global trade will pick up, but I don’t think it’ll be a multiple of GDP.” (…)

Overall, FedEx posted a profit for the fourth quarter ended May 31 of $730 million, or $2.46 a share, more than doubling from $303 million, or 95 cents a share, in the year-earlier period, which included $1.18 a share in charges tied to a business realignment program and an aircraft write-down. The company had projected per-share earnings of $2.25 to $2.50.

Revenue rose 3.5% to $11.8 billion, above the $11.66 billion projected by analysts polled by Thomson Reuters.

For the new fiscal year, the company said it expects earnings of $8.50 to $9 a share, with the outlook reflecting no expected year-over-year fuel impact along with moderate growth in the economy. Analysts polled by Thomson Reuters projected $8.76 a share. (…)

NEW$ & VIEW$ (18 JUNE 2014)

INFLATION WATCH
U.S. Consumer Prices Jump 0.4% Consumer prices rose at the fastest pace in more than a year in May, extending a period of higher inflation that could weigh on Federal Reserve officials as they debate when to raise short-term interest rates.

The consumer-price indexclimbed a seasonally adjusted 0.4% in May from a month earlier, the most since February 2013, the Labor Department said Tuesday.

Excluding food and energy, so-called core prices climbed 0.3%, the sharpest increase since August 2011.

The overall CPI was up 2.1% in May from a year earlier, the most since October 2012, with core prices up 2%, the most since February 2013.

However, the central bank’s preferred inflation gauge, the Commerce Department’s price index for personal consumption expenditures, has run below target for two years, though it picked up recently. In April, that index was up 1.6% from a year earlier, with core prices up 1.4%.

The CPI and PCE price index typically run in tandem over time but often diverge month to month because they are calculated differently. Over the past 25 years, PCE inflation has been about 0.5 percentage point lower per year than the CPI.

The acceleration in core prices has been rapid as the table below shows. Over the last 3 months, core CPI is up at a 2.8% annualized rate while the median CPI is up at a 3.2% annualized rate.

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State Street PriceStats inflation series, a daily measure of inflation derived from prices posted to public websites by hundreds of online retailers, is up 2.05% Y/Y as of June 14. It was up 2.1% at the end of May, 2.0% at the end of April and 1.9% at the end of March.

In all, U.S. inflation is back to 2% and is threatening to move higher. This will add to markets nervousness.

The two previous episodes of accelerating inflation (2010 and 2011) were dismissed by the Federal Reserve as transitory due to relative price changes. Dismissal will not be easy this time around. That’s because all of the main components of the CPI are growing at a much faster pace. As today’s Hot Charts show, owners’ equivalent rent, medical care, and food prices all show price increases in excess of two percent from year-ago levels. This is occurring at the same time that hourly wage inflation for non-supervisory workers is accelerating. This is the first time since the recovery began that we see inflation exceeding 2% for all of these main components. This suggests that the current buildup in inflation is much more than just a relative price change. (NBF)

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Cass Truckload Linehaul and Intermodal Price Index

Truckload linehaul price indexCompared to the same time last year, truckload linehaul costs in May averaged 5.8% higher – an increase that is consistent with those of the previous two months (5.7% in April and 6.0% in March). With demand improving and capacity exiting the marketplace at a faster pace, the 2014 bid season (~70% of all contracts are negotiated in the first 4 months) has resulted in higher truckload costs for the shipper. Industry analyst firm Avondale Partners expects truckload pricing to increase 4-6% in 2014.

From April to May, pricing fell 2.2% (slightly less than the historical average), after displaying above-normal sequential increases in five of the last six months.

Total intermodal costs rose 2.6% year over year in May, after seeing increases of 1.4% in April and 1.8% in March. Sequentially, intermodal costs fell 2.7%, in line with seasonal trends.

UPS to Factor Box Size Into Pricing

The move follows rival FedEx Corp.’s decision in May to start pricing packages according to size instead of by weight alone.

UPS on Tuesday said it thinks the new pricing—which will use so-called dimensional weight—will encourage shippers to pack lighter items in smaller boxes. Packages have become less dense in recent years, with the ratio of weight to external packaging declining, the company said.

$120 Seen Danger Point for Oil Return as Economic Threat

The rule of thumb favored by many economists is that every $10 increase in the price of a barrel of oil ends up cutting global growth by about 0.2 percentage point.

Upshot of Domestic Oil Boom: Fewer Shocks The latest spasm of Mideast violence has sent crude-oil prices climbing in recent weeks, a familiar action-reaction that frequently has proved to be a drag on economic growth. Yet that dynamic figures to ease as U.S. dependence on Mideast oil is at a generational nadir.

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So, this is Fed week:

The Fed, which concludes a two-day policy meeting Wednesday, is expected to reduce its monthly bond purchases by another $10 billion to $35 billion a month, staying on track to wind down that program later this year. Fed officials have been looking for higher inflation for reassurance the economy is stable as their bond-buying program ends. But if inflation continues to accelerate faster than the steady pace they have projected, officials could give stronger consideration to raising short-term interest rates sooner. Fed officials are also set Wednesday to release updated forecasts for economic growth and inflation, which they use to steer their decision making (WSJ)

The Federal Reserve will probably raise its benchmark interest rate faster than money-market investors expect, according to most economists surveyed by Bloomberg News.

But Tim Duy thinks the Fed will be patient:

(…) Increasingly the Fed will be concerned that the balance of risks is shifting from prematurely reducing financial accommodation to concern about falling behind the curve.  And that transition may be abrupt – not unlike what we witnessed recently on the other side of the pond. 

All that said, if such a change were to occur, it will not be in this week’s statement.  My expectation is that Yellen sticks to the fairly dovish tune she has been singing. If there are clues that the tenor of the tune is changing I think they would be subtle.  Watch for any language from Yellen regarding proximity to goals, optimism on the JOLTS numbers, or references to inflation bottoming out and turning higher.  These would be hints that the Fed is increasingly concerned of the possibility of falling behind the curve.  Such talk would also hint at the possibility that the new Board members seek to edge policy in a different direction.

On the other side of the coin, look for policymakers to make note of geopolitical risk.  The mess in Iraq is already pushing oil prices higher, which the Fed should read as more likely to soften the recovery rather than fuel inflation

Bottom Line:  My baseline expectation is minimal policy changes this week.  Moreover, my baseline remains a still long period of low rates.  I think the Federal Reserve would like to hold onto the “low wage growth means plenty of slack and no inflation story” as long as possible.  Watch also the geopolitical risk, as that will tend to reinforce the Fed’s existing path. Overall, the situation altogether still argues for the first rate hike in the second half of next year. The Fed’s low rate story, however, will come under increasing pressure as the Fed gets closer to reaching its policy goals. And that pressure will only intensify if growth does in fact accelerate. That leaves me feeling that the risk to my baseline assumption is that the first rate hike comes sooner than currently anticipated.

U.S. Housing Starts Fall 6.5% A gauge of new home construction fell in May after several months of gains, another sign of the housing sector’s uneven recovery.

Single-family housing starts fell 5.9%, while multifamily fell 7.6%. April’s surge in home building was revised down slightly to 12.7% growth from 13.2%.

Newly approved applications for building permits, an indicator of future construction, fell 6.4% in May to 991,000 on a sharp decline the volatile multi-family segment.

But in one bright spot, single-family permits jumped 3.7% to 619,000, their fastest rate of increase since September 2012. Single-family construction represents the bulk of the housing market and is considered a better gauge of demand.

But in reality, the single-family permits pace is now trending in line with the full-year 2013 average of 620,000. There is really no upward momentum building in housing as these Haver Analytics charts demonstrate:

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Summer Job Outlook Sunnier for Teens as U.S. Market Mends

(…) Teen hiring posted the biggest gain in eight years this May, not counting for seasonal adjustments. If the nascent job recovery retains steam through the summer, it could bolster wallets and resumes for U.S. youth.

Sixteen-to 19-year-olds last month gained the most jobs for May since 2006, based on Bureau of Labor Statistics data not adjusted for seasonal fluctuations. The group added 217,000 jobs, compared with 215,000 the prior year.

BOE Edges Toward Rate Increase

Bank of England officials Wednesday signaled that interest rates in the U.K. could rise before the end of the year—but only if they are satisfied the economy can cope with higher borrowing costs. (…)

“The relatively low probability attached to a Bank Rate increase this year implied by some financial market prices was somewhat surprising,” the minutes record, referring to the BOE’s benchmark rate. (…)

Li Says China Will Avoid Hard Landing While Limiting Stimulus

“The Chinese government is adjusting its economic operations to ensure the minimum growth rate is 7.5 percent, the level to ensure job creation,” Li said in a speech at Mansion House in London today. Inflation won’t exceed 3.5 percent, he added, without specifying a time period for the prediction.

China will have “medium to high-level” growth in the long run and will rely on “smart and targeted regulation” rather than strong stimulus measures, Li said.

“I can promise everyone honestly and solemnly, there won’t be a hard landing,” the premier said.

Nerd smile Is that a stronger promise than “read my lips”?

CEBM Research’s surveys reveal no change in momentum just yet:

Up to now, high-frequency real estate sales Y/Y are still close to -20%. Sales Y/Y in Tier 2 and Tier 3 cities were higher than -10% in previous weeks and then deteriorated again. Meanwhile, inventory levels remained high.

In addition, other hard indices, such as electric power output, crude steel, and cement output remain sluggish Y/Y. Loosening monetary policy began at the end of May, so it will take time for those hard indices to recover. The Politburo meeting in July will be critical to gauge the policy outlook going forward.

Bond star Hasenstab warns on US debt Fall in US yields has ‘stretched envelope’ says fund manager

Like many investors, Mr Hasenstab was wrongfooted by this year’s unexpected fall in US Treasury yields; also like many others, he has yet to find a single convincing explanation. But, he maintains: “We have really stretched the envelope in terms of how much lower US yields can go.” He wants to be “negative correlated” with US yields.

(Bespoke Investment)

EARNINGS WATCH

First Call’s earnings revisions index surged to 57.5 this week, suggesting 2Q earnings are likely to surprise. Fingers crossed

Devil WTO warns of creeping protectionism

G20 economies have introduced more measures to restrict trade than encourage it over the past six months even as the global economy has seen a faltering recovery in both growth and trade.

(…) a report released on Wednesday by the World Trade Organisation as part of its remit to monitor any post-crisis trade restrictions by G20 members offers a picture of creeping protectionism even as the global economy continues its struggle to recover from the crisis.