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

THE DAILY EDGE (14 December 2017):

Fed Raises Interest Rates as U.S. Economy Picks Up

(…) “The growth that we’re seeing, it’s not based on, for example, an unsustainable buildup of debt,” she added. “The global economy is doing well. We’re in a synchronized expansion. This is the first time in many years we’ve seen this.”

The Fed said it would increase its benchmark federal-funds rate Thursday by a quarter percentage point to a range between 1.25% and 1.5%, the fifth such increase in the past two years. Officials penciled in three quarter-point rate increases for next year, as they had in September, and two such increases each in 2019 and 2020. (…)

Fed officials projected the economy would grow 2.5% next year, up from the 2.1% they predicted in September. They also expect the unemployment rate will fall to 3.9% by the end of next year, down from their earlier forecast of 4.1%.

Officials didn’t project more interest-rate increases or higher inflation because price pressures have been surprisingly muted this year. They still project inflation to rise to their 2% target by 2019, the same as they expected in September. (…)

Fed officials’ projections show they don’t see the tax cut raising the economy’s long-run growth rate, which they left unchanged at 1.8%. (…)

“Taking what is already a significant [debt] problem and making it worse, it is a concern to me,” she said. (…)

Source: Natixis (via The Daily Shot)

China Raises Market Rates Hours After Fed Move

The Chinese central bank raised the rates it charges commercial banks on seven-day and 28-day loans by 0.05 percentage point each. It also raised rates for a medium-term liquidity instrument. The increases were smaller than 0.10 percentage-point moves in the first quarter, and the bank left the benchmark policy rates unchanged. (…)

World Oil Supply Hits Year High, Boosted by U.S. Shale Surge Shale producers are roaring back to life, pushing the global oil supply to its highest level in a year and undermining OPEC’s efforts to rebalance the market, the International Energy Agency said.

In its closely watched monthly oil market report, the IEA said the amount of crude oil on the global market rose by 170,000 barrels a day in November to 97.8 million barrels a day. The agency cited a surge in U.S. shale production and increased drilling and completion activity. (…)

OPEC crude oil supply fell in November for the fourth straight month, to 32.36 million barrels a day on the back of lower output from Saudi Arabia, Angola and Venezuela and overall higher compliance with the accord, the IEA said.

However, the agency said next year “might not be quite so happy for OPEC producers,” forecasting total supply growth could exceed demand growth in the first half of 2018 by 200,000 barrels a day.

The IEA raised its forecast for U.S. crude production growth to 390,000 barrels a day in 2017 and 870,000 barrels next year.

However, the agency said commercial petroleum stocks in the Organization for Economic Cooperation and Development—a group of industrialized, oil-consuming nations that includes the U.S.—fell to the lowest level since 2015 in October, at 111 million barrels above OPEC’s target of the average of the last five years.

The IEA left its forecasts for global demand growth in 2017 and 2018 unchanged, at 1.5 million barrels a day and 1.3 million barrels a day, respectively.

Nearly 5 Million Americans in Default on Student Loans The number of Americans severely behind on payments on federal student loans reached 4.6 million in the third quarter, a doubling from four years ago, despite a historically long stretch of U.S. job creation and steady economic growth.

In the third quarter alone, the count of such defaulted borrowers—defined by the government as those who haven’t made a payment in at least a year—grew by nearly 274,000, according to Education Department data released Tuesday.

The total number of defaulted borrowers represents about 22% of the Americans who were required to be paying down their federal student loans as of Sept. 30. That figure has increased from 17% four years earlier. (…)

Defaulted student loans totaled $84 billion at the end of the quarter, or 13% of the roughly $631 billion that borrowers were required to be paying down.

The government’s student-loan portfolio now totals $1.37 trillion. (…)

FYI:

Source: RealClear Politics (via The Daily Shot)

  • The betting markets’ probability of the GOP retaining control of the House of Representatives after next year. (The Daily Shot)
Initial Coin Offerings Surge Past $4 Billion—and Regulators Are Worried Money raised from initial coin offerings has surged past $4 billion for the first time, even as regulators world-wide have escalated warnings about the new form of corporate funding.
From German Faucets to Italian Chocolate, Trade Barriers Are Rising Again in Europe The rise of economic nationalism is clashing with the open-market ideals of the EU’s original founders. Member states, including France and some in the east, are introducing new rules to favor domestic production and labor.

THE DAILY EDGE (13 December 2017): Inflation?

U.S. Business Prices Rose Broadly in November A gauge of U.S. business prices rose across a broad range of goods and services in November, a signal of building price pressures at a time when inflation has remained puzzlingly low.

The producer-price index for final demand, which measures changes in the prices that U.S. companies receive, advanced 3.1% in November from a year earlier, the biggest jump in nearly six years, the Labor Department said Tuesday.

Producer prices rose 0.4% in November for the third consecutive month. Energy prices, which grew 4.6% last month, boosted the overall month-over-month rise in producer prices. Even when excluding food and energy and a volatile category known as trade services, prices businesses charged were up 0.4% in November from a month earlier. (…)

Haver Analytics’ Robert Brusca refuses to see an inflation threat in this PPI report:

Core and headline PPI ‘Final Demand’ inflation are now moving up together. Both series are more or less sequentially. Headline inflation rises from 3% over 12 months to 3.2% over six months to 5.4% over three months. Core inflation logs 2.4% over 12 months, then is more or less steady at 2.3% over six months and then rises to a pace of 4% over three months. The main question of interest is this: “will the Fed find this vexing?” The correlation between the PPI and the CPI yields an R-Square fit of 0.88 which means that PPI can explain 88% of the variance is the CPI headline- impressive. But there the magic ends. When we compare the core PPI to the core CPI, the R-Square falls to essentially zero- no explanatory power of the PPI core for the CPI core.

Still, I doubt that the FOMC will write off the PPI completely. And remember that the Fed actually targets the PCE where inflation is even lower than in the CPI framework. However, in the U of M consumer confidence report this month, there was a slight uptick detected in inflation expectations (which are nonetheless at extremely low historical levels). And in the last employment report, we saw that even with continued and unexpectedly strong job gains average hourly earnings trends remain remarkable docile. On balance, the PPI simply does not fit into the main inflation picture painted by other variables. It is a square peg in a round-hole world. It simply does not fit anywhere.

One additional reason to ‘write off’, the PPI is the transitional behavior of oil prices which are on the rise again with energy costs busting higher by 4.6% in November and gaining at a 36% annual rate over three months. When there is such clear distortion to the trend, it is good to step back and gain some perspective. Final demand goods core inflation is actually showing less acceleration than final demand core overall with services and construction factored in. For the core goods measure, inflation transits from 2.4% over 12 months dropping to a 2% pace over six months then gaining to an elevated but more modest 3.2% pace over three months compared to the 4% pace of the overall core. Still, services, trade, and transportation & warehousing are sectors showing inflation building momentum at the PPI level. Construction is an exception.

Intermediate goods trends do not demonstrate sequential gains generally but do show that three-month inflation rates are higher than 12-month gains, except for construction. (…)

  • “When we compare the core PPI to the core CPI, the R-Square falls to essentially zero- no explanatory power of the PPI core for the CPI core.”

This chart seems to suggest that, other than between 1990 and 2002, core CPI has been pretty much in sync with core PPI

Here’s the YoY chart, also disproving Brusca’s point:

Let’s break the recent PPI into total and core:

  • Total PPI-Final Demand has been up 0.4% MoM in each of the last 3 months; 3-m SAAR: +5.4%. A lot of it is Energy.
  • Core PPI-Final Demand is up at a nearly same monthly pace; 3-m SAAR: +4.0%.
  • PPI-Core Goods has accelerated sharply in the last 3 months: +3.2% SAAR. Same with Services: +4.3% SAAR.
  • The pipeline of intermediate goods and services is also showing sharply accelerating inflation.

From Markit’s latest PMI surveys:

  • Average prices charged by [U.S.] manufacturers rose further in November, with the pace of inflation accelerating to the fastest in almost four years. Anecdotal evidence suggested the increase was due to greater cost burdens which were largely passed on to clients. Input price inflation also quickened since October and was steep overall.
  • Average prices charged for services increased further in November, with the rate of inflation accelerating. Panellists stated the rise was due to higher input costs which were passed on to clients.
  • [Composite PMI]: In terms of prices, the upturn continues to show signs of gradually feeding through to higher inflationary pressure. Average selling prices for goods and services showed one of the largest increases recorded over the past four years, linked to rising cost pressures.

Markit analysed price pressures throughout its global PMI reports:

Average factory selling prices showed the largest monthly rise since May 2011, often as a result of firms needing to pass higher costs on to customers. Average input prices also showed the largest increase since May 2011.

However, many price hikes were again associated with suppliers being busier, and therefore enjoying a sellers’ market as demand often outstripped supply. Average suppliers’ delivery times have been lengthening to the greatest extent since 2011 in recent months, albeit with some reduction in the number of delays in November.

While longer delivery times have in part been the result of hurricane disruption in the US in recent months meaning delivery times are in effect lengthening more than current output growth would normally suggest would be expected, November brought signs that global input cost inflation may be increasingly driven by demand outpacing supply.

Time will tell if the hurricanes explain most of the recent hikes but corporations throughout the world are now saying that they are able to pass their cost increases, including energy, on to their customers. So even the so-called “transitory” costs increases, including energy (are recent increases really transitory?), are being passed on to the corporate end users because “global demand is now outstripping supply”.

Yesterday’s NFIB report showed that small businesses are also increasing prices more liberally:

image

We shall see if these higher corporate costs get passed on to the true end users, the consumers. If so, we will need to worry a lot more about inflation and its impact on real income, interest rates and equity valuations. If not, we will need to worry about profit margins. Sad smile

Here’s a chart that shows both inflation and margin pressures:

Crude oil prices are up 31% since June and 110% since January 2016. Yet core CPI is up only 0.8% and 3.5% in each respective periods. Somebody has been absorbing higher transportation and heating bills.

This morning, the November CPI was reported up 0.4% MoM (+2.2% YoY) but core CPI was up only 0.1% (+1.7%). Last 3 months, core CPI is up 1.6% a.r., the same pace as the previous 3 months. Core Goods prices declined 0.1% in November (-0.9% YoY). They have declined in 6 of the past 7 months  at a –1.4% annual rate. It would appear that manufacturers and service providers are able to pass their costs increases on to their corporate clients but wholesalers and retailers are not due to heavy competition at the consumer level.

This next chart (which includes November data) plots Core CPI inflation minus Core PPI. Obviously not a perfect measure for margins but the trend is interesting and increasingly worrisome, especially if we presume that opportunities to trim operating costs (labor, SG&A, interest)are much less now than during the last 7 years.

Meanwhile, the GOP is deflating:

Moore over: Democrats win in Alabama

Republicans must come to terms this morning with Doug Jones’s victory, by 49.9% of the vote to 48.4%, for the Senate seat. Mr Moore, the Republican incumbent, was once popular there, and had received the backing of President Donald Trump. But accusations of sexual impropriety against nine, then mostly teenage women, took their toll (Mr Moore denies the allegations). Mr Jones threaded a difficult needle. Black voters turned out in droves and Mr Jones won 96% of their votes. He also appears to have flipped some white suburbanites. White evangelicals—Mr Moore’s core supporters—comprised a smaller share of the turnout than usual. Some of them stayed home, or even voted for Mr Jones, despite vehemently disagreeing with his pro-choice position on abortion. The result leaves Mr Trump’s party with a single-seat majority in the Senate. If the president found it difficult to pass legislation this year, it is about to get tougher. (The Economist)

It should also be noted that per the exit polls, 51% of Independent voters went Democrat compared with 23% in the presidential election.