WTI – and Gold – Drops on Date – as Global Manufacturing Misses Estimates

West Texas Intermediate crude fell amid speculation that weakening manufacturing from Germany to China will cap global oil demand. Brent declined in London.

Futures dropped as much as 1.2 percent from the Aug. 29 close. Floor trading in New York was shut for the Labor Day holiday, and transactions will be booked for settlement purposes today. Purchasing manufacturing indexes for Germany, Italy, the U.K. and China all came in below estimates for August, while OPEC’s output increased to the highest level in a year.

“All eyes are on the demand side, and weaker statistics for example in China are bearish,” Bjarne Schieldrop, chief commodity analyst in Oslo at SEB AB, said by telephone. “The increase in tension between Russia and Ukraine is bearish for oil” because economic sanctions on Russia may eventually result in a slowdown in Europe, he said.

WTI for October delivery declined as much as $1.19 to $94.77 a barrel in electronic trading on the New York Mercantile Exchange and was at $94.88 at 1:46 p.m. London time. The volume of all futures traded was more than double the 100-day average for the time of day. Prices decreased 2.3 percent last month and are down 3.6 percent this year.

Brent for October settlement was $1.11 lower at $101.68 a barrel on the London-based ICE Futures Europe exchange. The European benchmark crude traded at a premium of $6.83 to WTI, compared with a close of $7.23 on Aug. 29.

Factory Output

China’s manufacturing slowed more than projected last month, joining weaker-than-anticipated credit, production and investment data in indicating that the economy is losing momentum. The nation is the world’s second-largest oil consumer.

Markit Economics’ euro-area gauge slid more than initially predicted, with the index for Italy unexpectedly falling below 50, signaling the first contraction in 14 months. In the U.K., manufacturing expanded by the least in more than a year.

A final reading of Markit’s U.S. manufacturing PMI is due today, along with the Institute for Supply Management’s factory index for August, which economists forecast will drop to 57, from 57.1 in July.

“There are slowdowns occurring,” Jonathan Barratt, the chief investment officer at Ayers Alliance Securities in Sydney, said by phone. “OPEC is producing enough oil to placate any issues.”

Production from the 12-member Organization of Petroleum Exporting Countries rose by 891,000 barrels a day to 31 million in August, according to a Bloomberg survey of oil companies, producers and analysts. Nigeria, Saudi Arabia and Angola led supply gains as new deposits came online, security improved and field-maintenance programs ended. Iran and Venezuela were the only members to reduce output.

Ukraine warned of an escalating conflict in its easternmost regions as U.S. President Barack Obama headed to eastern Europe to reassure NATO members. Ukraine’s army will take on Russia’s “full-scale invasion,” Defense Minister Valeriy Geletey said on Facebook, a shift away from the government’s earlier communication that focused on battling insurgents.

Dollar Strengthens Before Data as Bonds Decline With Gold

The dollar strengthened to a seven-month high against the yen, government bonds tumbled and gold fell before data that analysts forecast will show expansion in U.S. manufacturing.

The dollar climbed 0.6 percent to 104.93 yen at 8:42 a.m. in New York and gained 0.4 percent to $1.6535 per British pound. Yields on 10-year Treasury notes increased four basis points to 2.38 percent. Futures (SPX) on the Standard & Poor’s 500 Index added 0.1 percent after the index rallied the most since February last month. Gold dropped 1.5 percent.

U.S. investors return after the Labor Day break with manufacturing and construction spending reports. Gauges of factory output in Europe and China signal slower growth, boosting speculation that policy makers will need to boost stimulus measures. European money markets are pricing in about a 50 percent probability that the European Central Bank will cut interest rates by 10 basis points this week, according to BNP Paribas SA.

“In the U.S. across the board we have had strong data,”said Niels Christensen, chief currency strategist at Nordea Bank AB in Copenhagen. “That will keep growth momentum going. We have had a positive dollar trend for the past two months. I find it difficult to see this trend is going to disappear in the short term.”

U.S. Reports

The Institute for Supply Management’s August factory gauge probably held last month near the highest since April 2011, according to the median of 70 estimates in a Bloomberg survey. Another report probably will show U.S. construction rebounded in July, a Bloomberg survey showed. Reports yesterday signaled manufacturing slowed in China, the U.K. and the euro area.

The yen fell to its lowest level against the dollar since Jan. 16 amid speculation Japan’s Prime Minister Shinzo Abe will appoint an ally to head the ministry in charge of reforming the Government Pension Investment Fund, potentially boosting investment overseas. The currency weakened to 105.44 on Jan. 2, a level not seen since October 2008.

The Bloomberg Dollar Spot Index, which tracks the U.S. currency against 10 major peers, climbed 0.3 percent to 1,033.71 and touched 1,034.16, the strongest since January.

The pound weakened after a YouGov Plc poll showed growing support for Scottish independence before this month’s referendum. One-month implied volatility on sterling versus the dollar jumped by the most in almost six years.

Government Bonds

European government bonds fell as Germany’s 10-year yield increased four basis points to 0.91 percent and the U.K.’s rose five basis points to 2.43 percent.

The euro overnight index average, or Eonia, which measures the cost of lending between euro-area banks, fell to a record minus 0.013 percent yesterday.

Corporate borrowing costs fell to a record in Europe, with the average yield demanded to hold investment-grade bonds in euros dropping to 1.28 percent, according to Bank of America Merrill Lynch index data. The gauge declined 19 basis points in the past month on stimulus speculation.

The Stoxx 600 of European shares fell 0.1 percent after increasing 0.5 percent in the past two days.

Vallourec SA climbed 4 percent after UBS AG advised investors to buy shares of the French producer of steel pipes for the oil and gas industry. Weir Group Plc gained 2.9 percent after Credit Suisse Group AG raised its recommendation on the British supplier of pressure pumps to outperform from neutral.

S&P 500 Tops Record Level

U.S. stocks climbed, sending the Standard & Poor’s 500 Index above a closing record, as investors speculated the Federal Reserve will continue to support the economy as central bankers meet in Jackson Hole.

The S&P 500 added 0.1 percent to 1,988.94 at 9:34 a.m. in New York, above a closing high of 1,987.98 reached July 24.

“Markets are looking for some indication from Yellen as to what happens once quantitative easing stops,” Peter Dixon, a global equities economist at Commerzbank AG in London, said by phone. “I suspect she’ll say that it depends on the data. The U.S. economy is in reasonable shape. The task for central banks, and Yellen is at the forefront, is how to wean markets away from almost unlimited liquidity provisions when the economy is recovering but remains fragile.”

The S&P 500 rose 0.3 percent yesterday, closing within two points of a record. The benchmark index has rebounded 4 percent from a three-month low on Aug. 7 as investors speculated central banks will keep interest rates low even as the economy shows signs of recovery.

Fed Minutes

Minutes to the central banks’ July meeting released yesterday showed that officials raised the possibility that aggressive stimulus will end sooner than anticipated, even as they acknowledged persistent slack in the labor market. The central bank will probably wind up its asset-purchase program at its October meeting, according to a Bloomberg survey of economists.

Data today showed fewer Americans than forecast applied for unemployment benefits last week. Yellen has highlighted uneven progress in the labor market in making the case for further accommodation.

The Fed minutes showed “many participants” still see “a larger gap between current labor market conditions and those consistent with their assessments of normal levels of labor utilization.” At the same time, “many members” noted that the “characterization of labor market underutilization might have to change before long,” particularly if the job market makes faster-than-anticipated progress, the minutes also said.

Jackson Hole

Fed Chair Janet Yellen will speak tomorrow at the Fed Bank of Kansas City’s economic symposium that starts today in Jackson Hole, Wyoming. European Central Bank President Mario Draghi will also speak.

The S&P 500 has almost tripled since its March 2009 low, helped by three rounds of Fed stimulus, coupled with better-than-projected corporate earnings. The gauge has not had a decline of 10 percent in almost three years. It trades at 17.8 times the reported earnings of its companies, near the highest level since 2010.

Soft Touch

Investors are betting that a soft touch on monetary policy will continue to suppress stock volatility, pouring a record stretch of cash into an exchange-traded note that rallies as calm returns to equities. The Chicago Board Options Exchange Volatility Index, the gauge known as the VIX (VIX), has lost 31 percent this month, closing at its lowest level since July 23.

Among other economic reports today, data at 9:45 a.m. may show a preliminary gauge of manufacturing slipped to 55.7 this month from 55.8 in July. Another report may indicate existing-home sales expanded at a slower pace in July while the Conference Board’s index of leading indicators, a measure of the outlook for the next three to six months, rose 0.6 percent in July, economists forecast.

Gap Inc. and Salesforce.com Inc. are among eight S&P 500 companies reporting earnings today.

One of the worst trading days this year has even market bulls warning investors to brace for sharper pullbacks and volatility in days to come.</p>
<p>” />   Fears over Argentina’s default sent equity markets tumbling Thursday, as analysts say that investors are becoming less forgiving of worrisome economic and geopolitical news, warning that a stock correction could be looming. The S&P 500 fell 39.4 points or 2%, or to close at 1,930.67, while the Dow Jones Industrial Average saw its gains for the year erased after falling 317.06 points or 1.9% to 16,563.30. The S&P/TSX Composite slid 194.08 points or 1.3% to 15,330.74. “We are witnessing … classic signs of an impending correction,” said Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch who was once seen as the biggest cheerleader of the current rally. “We expect volatility will rise in coming months. TORONTO — North American stock markets had their biggest one-day tumble since early February on Thursday but analysts were hard-pressed to identify a single reason for the drop. The S&P/TSX composite index in Toronto fell 194.08 points to 15,330.74, as a number of big Canadian corporations missed earnings forecasts, but the index remained up about 1,736 points since the beginning of the year. New York’s Dow Jones industrials plunged 317.06 points to 16,563.3, leaving the index below where it started the year by about a dozen points. The Nasdaq lost 93.13 points to 4,369.77 and the S&P 500 index declined 39.4 points to 1,930.67.   The loonie closed down 0.02 of a cent to And volume is less than usual with many market participants on holidays. But the stock market declines also come at a time when many investors have registered substantial gains. “You get thinner markets and it doesn‘t take much to move things around,” said Wes Mills, chief investment officer Scotia Private Client Group. “Clearly everyone has made good money and there is no evidence that people are taking money off the table yet. It‘s probably just an overdue correction in a thin summer market with a combination of factors.” Valeant Pharmaceuticals International Inc., which is making a hostile takeover bid for Botox maker Allergan, posted a quarterly net profit of $126 million or 37 cents a share. Adjusted income was $651 million, or $1.91 per share, missing estimates of $1.98 a share, and its shares fell $9.59 or 7% to $127.83. Barrick Gold Corp. delivered a US$269-million quarterly net loss and $159-million of adjusted earnings in the second quarter, missing analyst estimates on both counts. The adjusted profit amounted to 14 cents US per share, two cents below estimates. Barrick shares dipped 44 cents to $19.70. 91.71 cents US. The U.S. Federal Reserve indicated Wednesday that it will keep short-term interest rates low “for a considerable time” after it ends its bond purchases, likely in October. The Fed is expected to start hiking rates mid-2015, but stronger than expected economic growth in the second quarter has investors concerned that the Fed could raise rates sooner. Argentina moved into a debt default for the second time in 13 years after a deadline of midnight Wednesday night came and went without a deal with bondholders.</p>
		</div>
		<div class=

Permalink

Stocks Slide With Portugal Bonds as Treasuries, Gold Gain

European stocks fell and Portuguese bonds dropped as concern deepened over missed debt payments by a company linked to the nation’s second-largest bank. Standard & Poor’s 500 Index futures signaled a selloff earlier this week will resume, while the yen, Treasuries and gold gained.

The Stoxx Europe 600 Index lost 1.3 percent at 8:35 a.m. in New York, led by a gauge of banks dropping to this year’s low. Financial bond risk increased in Europe for a fifth day. Standard & Poor’s 500 Index futures fell 0.9 percent. Portugal’s 10-year bond yield rose 11 basis points to 3.88 percent while Treasuries gained and the yen advanced against all but one of its 16 major peers. Indonesian stocks climbed to a one-year high as polls showed Jakarta’s Governor Joko Widodo won the presidency. West Texas Intermediate oil slid 0.3 percent to $101.62 a barrel while gold climbed 1.1 percent.

Bonds of Europe’s most-indebted nations declined as speculation resurfaced that the euro region remains vulnerable to shocks as it emerges from the sovereign debt crisis. The sell-off comes after minutes of the Federal Reserve latest meeting showed yesterday some policy makers were concerned investors may be growing too complacent. The value of global equities climbed to a record $66 trillion last week, data compiled by Bloomberg show.

Photographer: Dimas Ardian/Bloomberg
One-month rupiah forwards added 0.2 percent as unofficial counts showed Jakarta… Read More
“The concern of an event like this is always determining whether it’s occurring in isolation or whether it’s the first domino,” said Lawrence Creatura, a fund manager at Federated investors Inc. in Rochester, New York. His firm manages about $363.8 billion. “People will shoot first and ask questions later when news like this hits. It’s a classic flight to safety across the equity, commodities and bond markets. Portugal has been perceived as a weaker link so it’s not a particular surprise they’re encountering this kind of trouble now.”

Fewer Americans than forecast filed applications for unemployment benefits last week, a sign the labor market is strengthening, a government report showed today.

Peripheral Bonds

Portuguese bonds fell for a fourth day. The yield on 10-year Italian notes rose six basis points to 2.94 percent and Spain’s rate jumped six basis points to 2.82 percent. The Markit iTraxx Europe Senior Financial Index of credit-default swaps on 25 European banks and insurers rose two basis points to 71 basis points, the highest since June 4.

While Portugal’s central bank said Banco Espirito Santo SA, the nation’s second-largest lender, is protected after its parent missed debt payments, Moody’s Investors Service downgraded a company in the group citing a lack of transparency and links to other companies.

Banco Espirito Santo tumbled 17 percent before the Portuguese securities regulator said it stopped trading in the shares pending an announcement. Espirito Santo Financial Group SA, which owns 25 percent of the lender, fell 8.9 percent before the company suspended trading earlier in stocks and bonds, saying it’s “currently assessing the financial impact of its exposure” to Espirito Santo International, which has missed payments on short-term paper.

Fugro Tumbles

More than nine shares declined for every one that advanced in the Stoxx 600, with trading volumes 72 percent higher than the 30-day average, according to data compiled by Bloomberg. The gauge of banks tumbled 2.7 percent to the lowest since Dec. 18.

Banco Popular Espanol SA (POP) dropped 4.8 percent. The Spanish lender said it postponed a planned issue of the riskiest bank debt because of “heightened volatility” in credit markets.

Fugro NV (FUR) sank 20 percent, the most since November 2012, after the Dutch deepwater-oilfield surveyor forecast a drop in profit margin and writing off of as much as 350 million euros ($477 million). Skanska AB lost 2.5 percent after the Nordic region’s biggest construction company by global revenue said it will scale down operations in Latin America after booking 500 million kronor ($73.7 million) in project writedowns and restructuring costs.

Jobless Claims

The S&P 500 index (SPX) rebounded 0.5 percent yesterday following two days of losses.

Jobless claims declined by 11,000 to 304,000 in the week ended July 5, the fewest in more than a month, a Labor Department report showed today in Washington. The median forecast of 45 economists surveyed by Bloomberg called for 315,000.

Federal Reserve Bank of St. Louis President James Bullard said yesterday that a surprisingly fast decline in unemployment will fuel inflation and back the case for higher interest rates.

The Jakarta Composite Index added 1.4 percent to 5,095.20, heading for its highest close since May 2013. The rupiah gained 0.7 percent to 11,555 per dollar, according to prices from local banks, after touching the strongest level since May 22.

Both Widodo, known as Jokowi, and his opponent Prabowo Subianto claimed victory in yesterday’s presidential vote. Jokowi had about a five percentage point lead in the poll, according to unofficial counts from two survey companies that declared him the winner. Official results aren’t due for about two weeks. Bank Indonesia will probably hold its reference rate at 7.5 percent today, according to the median of 21 estimates from economists surveyed by Bloomberg.

The Hang Seng China Enterprises Index of mainland companies listed in Hong Kong advanced 0.3 percent, after losing 1.6 percent yesterday, its biggest decline in two weeks. The Shanghai Composite Index slipped less than 0.1 percent, extending yesterday’s 1.2 percent retreat.

China Exports

China’s overseas shipments fell short of the 10.4 percent expansion that was the median of 47 economists’ estimates compiled by Bloomberg. Imports grew by 5.5 percent in June, less than the 6 percent increase projected. The trade surplus fell to $31.6 billion for June, from $35.92 in May. Data yesterday showed producer prices fell last month at the slowest pace in more than two years.

“Extreme cautiousness towards China’s economy has receded overall, with the government showing signs it will step in to support growth when needed,” said Mari Oshidari, a Hong Kong-based strategist at Okasan Securities Group Inc.

West Texas Intermediate oil dropped to $102.01 a barrel. Gasoline inventories increased by 579,000 barrels last week as a measure of consumption slid, the Energy Information Administration said yesterday. Brent declined 0.2 percent to $108.10 a barrel, the ninth consecutive decline in the longest streak since May 2010. The crude closed at a two-month low yesterday amid signs that Libya, the holder of Africa’s largest crude reserves, will boost exports, while Iraqi production remains unaffected by an insurgency.

Treasury Sale

Gold for immediate delivery jumped to $1,342.23 an ounce, the highest since March 19. Palladium rose 0.3 percent to $876.25 an ounce, the 14th consecutive advance and the longest streak since June 2000. Cotton fell 0.4 percent to the lowest price since July 2012 on ample supplies.

The yield on 10-year Treasuries dropped five basis points to 2.50 percent. The rate on 30-year notes declined five basis points to 3.33 percent as the U.S. prepares to sell $13 billion of the debt.

Greece’s five-year note yield increased 11 basis points 4.33 percent. The government sold 1.5 billion euros of three-year notes via banks, priced to yield 3.5 percent. That’s higher than forecasts earlier this week for a rate of about 3 percent from HSBC Holdings Plc and Royal Bank of Scotland Group Plc.

The yen strengthened 0.3 percent to 101.36 per dollar and gained 0.3 percent to 138.31 per euro.

Australia’s dollar retreated from the highest in a week, falling against all of its 16 major counterparts after the nation’s jobless rate climbed. The Aussie weakened 0.4 percent at 93.74 U.S. cents.

Bill Gross : U.S. Still Faces Permanent Slump

When the Federal Reserve meets this week, the Wall Street Journal reports the most challenging question won’t be where to push interest rates in the near term, but where they belong years into the future. The WSJ indicates policy makers have believed the benchmark interest rate — known as the federal-funds rate — should be about 4% in a balanced economy, but officials are now debating whether interest rates need to remain below that threshold long after the economy returns to normal (i.e. once inflation is stable at 2% and unemployment around 5.5%).

Pimco, the world’s largest bond manager with close to $2 trillion in assets under management, believes the federal funds rate will remain well below the “neutral” policy rate of 4% once the economy returns to full health. The firm is predicting a “new neutral” rate of 2% (nominal), given the highly leveraged economy. In the video above, Pimco founder and CIO Bill Gross says the difference is “critical” as the neutral policy rate “basically determines the prices of all assets.”

He tells us the biggest investment theme for the next five years will be, “how far does the Fed go in terms of their tightening and their journey back up, as opposed to down,” as the central bank moves to get out of the business of buying treasury bonds and mortgage-backed securities, and begins to raise rates from near zero.

The head of the International Monetary Fund on Monday said the Fed should move rates up only gradually when it finally begins to lift borrowing costs, Reuters reports.

While tightening may be the next phase of the monetary policy story, what does Gross think about the impact of the Fed’s easy money policies and how successful they have been over the last five years — with rates held near zero and the balance sheet expanded by trillions of dollars?

 

He says, “so far, so good.” Gross credits the Fed for over five years of “beautiful deleveraging,” as hedge fund titan Ray Dalio calls it. Gross also sees success in other factors, including real economic growth of 2%, institutions being shored up, the stock market being close to record highs and employment growing at 200,000 a month. He says it remains a legitimate question what the central bank can do when it stops buying bonds and starts raising rates, though, conceding that things could get ugly.

And while 2% growth is less than stellar considering a historical norm of 3.5% to 4%, the lower growth is inline with what Pimco dubbed the “new normal” for the economy back in 2009. More recently, economists such as Larry Summers have advanced the idea that the U.S. may be facing secular stagnation — a permanent slump, with the economy hindered by structural issues such as demographics and the automation of jobs.

Related:  Has the U.S. Economy Entered a ‘Permanent Slump’?

In the video below, Gross says he agrees we are in a secular stagnation period and says it is difficult to get out of. He jokes that Summers “took our [new normal] idea and called it secular stagnation,” adding, “come on, Larry … give Pimco some credit!” Check out the bonus video for more.

 

 

 

Nobel Prize Economist Warns of U.S. Stock Market Bubble

An American who won this year’s Nobel Prize for economics believes sharp rises in equity and property prices could lead to a dangerous financial bubble and may end badly, he told a German magazine.

Robert Shiller, who won the esteemed award with two other Americans for research into market prices and asset bubbles, pinpointed the U.S. stock market and Brazilian property market as areas of concern.

“I am not yet sounding the alarm. But in many countries stock exchanges are at a high level and prices have risen sharply in some property markets,” Shiller told Sunday’s Der Spiegel magazine. “That could end badly,” he said.

“I am most worried about the boom in the U.S. stock market. Also because our economy is still weak and vulnerable,” he said, describing the financial and technology sectors as overvalued.

He had also looked at “drastically” higher house prices in Rio de Janeiro and Sao Paulo in Brazil in the last five years.

“There, I felt a bit like in the United States of 2004,” he said, adding he was hearing arguments about investment opportunities and a growing middle class that he had heard in the United States around the year 2000.

The collapse of the U.S. housing market helped trigger the 2008-2009 global financial crisis.

“Bubbles look like this. And the world is still very vulnerable to a bubble,” he said.

Bubbles are created when investors do not recognize when rising asset prices get detached from underlying fundamentals.

Related Stories

Is The Fed Running A Ponzi Scheme

Madoff’s Ponzi Scheme Looks Like a Joke Compared to This

By Michael Lombardi, MBA for Profit Confidential

 

The “Bernie” Madoff name became famous while the stock market was falling during the credit and financial crisis. He was responsible for running one of the biggest Ponzi schemes in U.S. history—if I recall correctly, it was a $65.0-billion scheme. But as the scam got bigger, Madoff couldn’t go on. He was caught, prosecuted, and sentenced to more than 100 years in jail.

What did we learn from the Madoff ordeal? At the very least, we learned Ponzi schemes eventually become impossible to hide, no matter how smart and cunning the perpetrator.

Wednesday of this week, we learned that the Federal Reserve’s Ponzi scheme of printing paper money and giving it to the government via the purchase of U.S. Treasuries will go on.

While the Fed says it wants to keep the “stimulus” going until the economy gets better, as I have written in these pages many times, the Fed cannot stop printing because if it did stop, three things would happen: 1) the stock market would collapse; 2) housing prices would fall; and 3) the government would have no real buyer for its debt (especially in light of China and Japan pulling back on buying U.S. Treasuries).

Madoff’s $65.0-billion Ponzi scheme is nothing when I look at the U.S. national debt figures. While it looks like we are beyond the point of no return, our national debt level would have to double from $17.0 trillion to $34.0 trillion before our debt-to-gross domestic product (GDP) ratio matches that of Japan. (And don’t for a moment think that’s not going to happen!)

In 2011, only two years ago, we heard Congress debate whether they should increase our national debt limit or not. The theater of a government shutdown was on for a while; it drove key stock indices lower and bond yields higher. Now we’re at square one again. Secretary of the Treasury Jack Lew sent a letter requesting an increase in our national debt limit by October, or the U.S. economy would face a risk of default.

The bottom line, dear reader, is that the U.S. government is broke. To keep the government afloat from now until Congress passes a new national debt limit, the government has stopped investing into the pensions of federal government workers.

I don’t for a second doubt that Congress won’t raise the national debt limit—it will; it has done just that 78 times since 1960. Why would this time be any different?

What has happened so far—the massive printing of paper money—is just one part of the puzzle. The Ponzi scheme is complex and has many moving parts. The government’s failure to clamp down on spending is the main problem.

In the 11 months of the fiscal 2013 year, the U.S. government has incurred a budget deficit of $755 billon, according to the Bureau of Fiscal Services. (So much for those estimates that said the U.S. government budget deficit would be below $700 billion this year!)

The Congressional Budget Office (CBO) expects the U.S. government to continue posting budget deficits until 2015, when it says the annual budget deficit will equal two percent of the gross domestic product of the U.S. economy. (Source: Congressional Budget Office, September 17, 2013.) I don’t buy that prediction for a moment. Interest costs on the national debt alone could be a huge problem going forward.

For the government’s fiscal year ending this September 30, the U.S. government expects to have incurred $414 billion in interest payments alone. Assuming a national debt of $16.7 trillion, this equates to an interest rate of about 2.5%. But interest rates are rising!

And the more the national debt increases, the higher the interest payment. Think what will happen once interest rates in the U.S. economy start to climb higher, and when creditors start asking for higher returns due to our massive amount of national debt. Even if our national debt doesn’t change and interest rates go back to normal (it’s going to happen), the interest payments on the national debt would rise to over $900 billion a year!

Bring Social Security liabilities into the picture, and the future looks even more gruesome. According to the Pew Research Center, every day 10,000 Americans reach retirement age. (Source: Pew Research Center, December 29, 2010.) With the financial crisis having placed pressure on retirement savings, retirees are now relying on Social Security more than ever.

Right now we are seeing the government hoping investors will keep re-investing in U.S. bonds while the Fed picks up the slack. But what happens when they say, “We want our money back?” It will make Madoff’s Ponzi scheme look like a joke.

 

Who Will Replace Bernanke At The Fed ?

  • Larry Summers, the man suspected to become the next Federal Reserve chairman, withdrew his name from the running last night. “I have reluctantly concluded that any possible confirmation process for me would be acrimonious and would not serve the interest of the Federal Reserve, the Administration or, ultimately, the interests of the nation’s ongoing economic recovery,” Summers wrote to the president.
  • The dollar immediately weakened on the news that Summers was out. Emerging markets, on the other hand, rallied. Market-watchers are pointing to the fact that Summers was perceived as more hawkish — meaning less likely to use monetary policy to juice the economy —than his main rival and current frontrunner Janet Yellen.
  • Many are now predicting (and for some, hoping) that Fed Vice Chair Janet Yellen will win the nomination. Writes our Josh Barro: “She’s a key architect and proponent of the Fed’s appropriately accommodative monetary policies. Her selection would reassure financial markets that easing would continue as appropriate. And she doesn’t have Summers’ track record of undermining his initiatives by unnecessarily alienating people.” Other names being floated are Jack A. Bass, former Fed Vice Chairmans Don Kohn and Roger Ferguson. Former Treasury Secretary Tim Geithner has held steady that he does not want the job.

Today In the Market

    • This morning at 9:15 A.M. we’ll get U.S. industrial production figures. Economists are expecting a 0.5% increase in August after July’s 0% print.
    • Later this week, the Federal Reserve will hold its two-day FOMC meeting. Economists are expecting the Fed to “taper” its $85 billion a month purchasing plan of Treasury notes and mortgage-backed bonds. On weaker economic news, many on Wall Street are predicting a “taper lite” – a reduction in bond purchases of $10 billion per month, bringing the total monthly purchase down to $75 billion (as opposed to the previous market consensus of $70 billion).
  • UPDATE
  • Stocks & bonds rally, dollar dips as Summers quits Fed race
    1 hour ago – Reuters
    Stocks & bonds rally, dollar dips as Summers quits Fed raceBy Ryan Vlastelica

    NEW YORK (Reuters) – U.S. stocks and Treasuries rallied on Monday as investors saw the withdrawal of Lawrence Summers from the running to head the Federal Reserve as making a more gradual approach to monetary tightening more likely.

    Further boosting risk assets around the world, and weighing on the U.S. dollar, were signs of progress in Syria following a Russian-brokered deal aimed at averting U.S. military action, all of which helped propel world shares <.MIWD00000PUS> to a five-year high.

    Summers’ surprise decision came just before the U.S. Federal Reserve meets on Tuesday and Wednesday to decide when, and by how much, to scale back its asset purchases from the current pace of $85 billion a month.

    Investors wagered that U.S. monetary policy would stay easier for longer should the other leading candidate for Fed chair, Janet Yellen, get the job.

    The Dow Jones industrial average <.DJI> was up 142.01 points, or 0.92 percent, at 15,518.07. The Standard & Poor’s 500 Index <.SPX> was up 13.20 points, or 0.78 percent, at 1,701.19. The Nasdaq Composite Index <.IXIC> was up 16.20 points, or 0.44 percent, at 3,738.39. Gains in the Nasdaq were limited by a 1.7 percent decline in Apple Inc <AAPL.O> shares.

    European shares <.FTEU3> rose 0.5 percent while the MSCI all-country world equity index rose 1 percent. Markets had perceived Summers as less wedded to aggressive policies such as quantitative easing and more likely to scale stimulus back quickly than Yellen, who is second in command at the Fed.

    “His passing as a contender for the top role has left in its wake a significant risk-on rally,” said Andrew Wilkinson, chief economic strategist at Miller Tabak & Co in New York.

    It was even possible a first Fed interest rate rise could be pushed out to 2016, rather than 2015 as currently expected, added Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ. Going by Yellen’s past speeches, he said she would most

    probably prioritize reducing unemployment.

    “Yellen looks like the clear front-runner and seems to be the public’s popular choice,” he said. “The Fed will shoot to lower the unemployment rate to the full employment level, and this means the new target could be more 5.5 percent, not 6.5 percent.”

    DOLLAR DIVE

    The dollar <.DXY> slipped to a near four-week low against a basket of currencies, with the euro up more than half a U.S. cent at $1.3370 after hitting its highest in almost three weeks and sterling at an eight-month high. <GBP/>

    The greenback proved more resilient against the yen, which was hampered by its status as a safe haven and pared early losses to stand at 98.76. Liquidity was lacking, with Japanese markets closed for a holiday on Monday.

    In the latest U.S. data, industrial output rose 0.4 percent in August, as expected, while manufacturing output rose 0.7 percent, a slightly faster rate than had been forecast.

    MSCI’s broadest index of Asia-Pacific shares outside Japan <.MIAPJ0000PUS> had gained 1.8 percent overnight as South Korean shares <.KS11> added 1 percent, Australia’s <.AXJO> rose 0.5 percent and Indonesian stocks climbed 3.4 percent <.JKSE>.

    PUSHING OUT THE HIKE

    Sentiment was underpinned by Saturday’s deal between Russia and the United States to demand that Syrian President Bashar al-Assad account for his chemical arsenal within a week and let international inspectors eliminate all the weapons by the middle of next year.

The Debt Ceiling End Game

Citi FX guru Steven Englander has a new note out this evening titled: No coin + temporary debt ceiling extension + sequester = USD negative.

 

In it he notes that the rejection of the trillion dollar coin idea to avert the debt ceiling is not alone a market moving event, but that the hard language taken by the White House that the choices boil down to clean lift or default raises the odds of a debt ceiling breach.

His take:

So it is possible that we will get a technical default for a few days, but more likely that Congress will give in, vote the debt ceiling up temporarily, and let the automatic sequesters kick in. Mounting risk of a technical default was USD positive in 2011 because it led to cutting of long-risk positions and the USD/Treasury market remained safe havens.  However, it also occurred in an environment of slowing EM growth and intensifying euro zone sovereign risk pressure, so the USD support came from external forces as well. Given that investors are now somewhat long risk again, the position cutting is again likely to be USD positive, however, unattractive US assets were. As was the case in 2011, it is very unlikely that the Treasury will not pay its bills, although even a technical default could have very unforeseen consequences, given the multiple functions that Treasuries play in global financial markets. The more likely scenario of sequester plus grudging debt ceiling rise is USD negative.

It will put more pressure on the Fed to keep pumping liquidity into the US economy without giving any reassurance to investors that long-term fiscal issues are close to resolution.

That seems reasonable. A debt ceiling hike + a full sequester, which would equal a weaker economy and more pumping.

With Europe healing and China rebounding, USD would be the big loser.

QE 4 Update/ Review

English: President Barack Obama confers with F...

English: President Barack Obama confers with Federal Reserve Chairman Ben Bernanke following their meeting at the White House. (Photo credit: Wikipedia)

The Big Picture

Link to The Big Picture

  • Our market letter will return in the New Year
What Is The Purpose of QE?

Posted: 25 Dec 2012 02:00 PM PST

As detailed earlier in the month, the Federal Reserve announced more stimulus, otherwise known as QE4, at its recent meeting.

Lots of the discussion thus far has focused on whether or not QE will happen and not on the purpose of QE.

What we discuss below is a good example of economists discussing the probability of QE rather than why QE is necessary or what it will accomplish.

So, what is QE supposed to do?  Bernanke told us in his speech over the summer in Jackson Hole:

“After nearly four years of experience with large-scale asset purchases, a substantial body of empirical work on their effects has emerged. Generally, this research finds that the Federal Reserve’s large-scale purchases have significantly lowered long-term Treasury yields. For example, studies have found that the $1.7 trillion in purchases of Treasury and agency securities under the first LSAP program reduced the yield on 10-year Treasury securities by between 40 and 110 basis points. The $600 billion in Treasury purchases under the second LSAP program has been credited with lowering 10-year yields by an additional 15 to 45 basis points.12 Three studies considering the cumulative influence of all the Federal Reserve’s asset purchases, including those made under the MEP, found total effects between 80 and 120 basis points on the 10-year Treasury yield.13 These effects are economically meaningful.

LSAPs also appear to have boosted stock prices, presumably both by lowering discount rates and by improving the economic outlook; it is probably not a coincidence that the sustained recovery in U.S. equity prices began in March 2009, shortly after the FOMC’s decision to greatly expand securities purchases. This effect is potentially important because stock values affect both consumption and investment decisions.

While there is substantial evidence that the Federal Reserve’s asset purchases have lowered longer-term yields and eased broader financial conditions, obtaining precise estimates of the effects of these operations on the broader economy is inherently difficult, as the counterfactual–how the economy would have performed in the absence of the Federal Reserve’s actions–cannot be directly observed. If we are willing to take as a working assumption that the effects of easier financial conditions on the economy are similar to those observed historically, then econometric models can be used to estimate the effects of LSAPs on the economyModel simulations conducted at the Federal Reserve generally find that the securities purchase programs have provided significant help for the economy. For example, a study using the Board’s FRB/US model of the economy found that, as of 2012, the first two rounds of LSAPs may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred.15

This is not the first time the Federal Reserve has laid out this argument.  In a November 4, 2010 Washington Post op-ed, the day after QE2 was approved, Ben Bernanke defended their actions with the following passage:

Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

Federal Reserve Board Chairman Ben Bernanke said Thursday that a controversial $600 billion bond buying plan has contributed to a stronger stock market. “Our policies have contributed to a stronger stock market just as they did in March 2009 when we did the first iteration of this program,” Bernanke said at a Federal Deposit Insurance Corp. forum on small businesses. “A stronger economy helps small businesses more than larger businesses. Interest rates are higher but that’s mostly because the news is better. It has responded to a stronger economy and better expectations.”

To sum it all up:

• The Federal Reserve buys Treasury bonds in order to push down interest rates, making them an unattractive investment (last shown here, page 6) .

• Investors respond by moving out the risk curve and buying assets like corporate bonds and stocks, pushing them higher.  The Federal Reserve believes this happens via the portfolio balance theory.

• But according to the Federal Reserve, moving out the risk curve does not include buying agricultural or crude oil futures, so do not blame them for higher food or gasoline prices.

• Higher asset prices create a wealth effect, which increases spending and confidence and improves the economy. The Federal Reserve believes this has helped create 2 million jobs.

We agree with half of what is written above.

• QE does produce lower interest rates, or at least the belief that rates are too low.  This then pushes investors out the risk curve which is why stocks have such an immediate and positive reaction whenever QE is speculated.

• The Federal Reserve is playing politics in regards to the effect of QE on commodity prices.  There is no reason to believe the risk curve ends at low-rated stocks.  How much QE affects food and gasoline prices can be debated, but to argue there is no effect at all, and will never be an effect under any scenario, merely because the Federal Reserve does not want to answer for these higher prices, is just wrong.

• The argument that higher asset prices produce a wealth effect is only partially correct.  Two conditions must be met for a wealth effect to ensue.  Net worth must reach a new high and it must be perceived to be permanent.  This is why housing produced such a powerful wealth effect before 2006.  Home prices always went up and their gains were perceived to be permanent.  Currently we have a retracement of losses and a widespread distrust of financial markets.  These conditions will not produce any wealth effect and we believe they have not.

QE is great for Wall Street as it produces more volatility (brokers like this), higher stocks prices (fund managers like this) and draws lots of attention (analysts like this).  It is not good for Main Street because it does not create wealth.  QE’s effects are not perceived to be permanent, so it does not lead to higher GDP or job growth.

What Will The Federal Reserve Do?

In Septmber we noted that the median expectation in a survey of primary dealers calls for $500 billion of additional purchases heavily tilted toward mortgage-backed securities.   If the purpose of QE is to push stock prices higher, then the Federal Reserve has to deliver at least $500 billion in purchases.  Otherwise it will disappoint risk markets.

Right now, if we have to guess, we believe the Federal Reserve will announce purchases of less than $500 billion. In January the Federal Reserve adopted an inflation target of 2.0%.  As we detailed in a conference call last month (transcripthandoutaudio), inflation expectations are running well above this target.  One measure of inflation expectations, the 10-year TIPS inflation breakeven rate, is shown below.  Further, in April, when Bernanke was asked if he would adopt a suggestion from Paul Krugman to expand the target to 3%, he flatly rejected the idea (explained here).

The hawks will argue expected inflation is too high to add more stimulus, an argument which will carry some weight.  The compromise will be a program of less than $500 billion in purchases which will disappoint the markets.

Click to enlarge:

Source: Arbor Research

 

 

 

 

 

 

Follow

Get every new post delivered to your Inbox.

Join 2,154 other followers