Archive for October, 2014

How They Carry On!

Friday, October 31st, 2014

When you listen to financial guru’s discuss the imminent demise of quantitative easing, you might conclude that higher interest rates are lurking just around the corner.  Headlines argue about “lift off,”  the date when our Federal Reserve begins raising interest rates.  One thing all seem to agree on is that it is not a matter of if, just when.  Atlas won’t argue about the ultimate inevitability that rates must go up at some time; after all, right now they are sitting close to zero.  Unlike most pundits however, we don’t see it happening in a meaningful way anytime soon.

High finance, meaning the guys who push big bucks around the world orchestrating foreign exchange and global trade (including the biggest banks with an international reach), manage risk via a process called the carry trade.  Not insignificantly, they also use this process to speculate with their own investment accounts in arenas they tend to dominate, if not control outright.  Here’s how it works: borrow money from a country that charges low interest rates and buy bonds from a country that pays higher rates.  For instance, you could borrow money from German banks at very low rates and invest in U.S. bonds with a ten-year maturity.  Currently such a strategy has the potential to yield a decent return with seemingly little risk if you have a couple billion dollars laying around.

This carry trade has consequences.  Most obvious, the demand for the currency needed to buy those higher-yielding bonds tends to force the price of that currency higher.  This demand for the higher-paying bonds tends to raise their price, thus lowering the yield for the next buyer.  Such mechanisms generally tend to be short-lived, arbitraged away in normal daily trading.  There are times, however, when the effects can be longer lasting and pernicious.

Many nations, especially the developed ones, have huge economies.  As ours here in America continues to show encouraging signs that we are returning to a more robust level of growth, funds from around the world seek to take advantage of our (relatively) higher rates.  They buy  dollars which drives the price of our currency up.  This allows American’s to buy foreign goods more cheaply at the expense of those produced domestically.  Producers here begin to complain about unfair trade practices.  Congress begins debating how to punish our partners of dumping.  Trade sanctions often follow. Additionally, nations that borrowed money in dollars find they can’t service the debt as it becomes ever more costly to convert their depreciating currency into U.S. funds.  Talk surfaces about sovereign default in countries that suddenly seem candidates for bankruptcy

This isn’t news to our own Federal Reserve.  We believe they will do their best to avoid seeing most of these issues manifest in the near term.  The quickest way to ensure this would be to lower rates here.  That might not happen, but it sure seems unlikely that they will raise them anytime soon.  Rather, they may decide to wait until our other major trading partners like Japan and the Eurozone show signs of sustainable recovery.  And that, in our opinion, still lies a long way off.     (by J R)

September New Home Sales

Thursday, October 30th, 2014

Sales of new homes hit a recovery high in September according to the Census Bureau.  Transactions totaled 467,000 on an annualized seasonally adjusted basis to end the third quarter.   This beats the prior period by 1,000 units after August’s tally was revised significantly lower to 466,000 from 504,000 in the initial estimate.  Transaction levels have not been this high since July 2008 when the nation was still in recession.

Prices may have helped boost the number of sales in September.  Both price measures (average and median) fell substantially during the month.  On average, a new home cost $313,200 in the period, a drop of $36,100 or 10.3 percent.  The median home price fell $27,800 or 9.7 percent to $259,000.  In just one month, the average and median price measures gave back all of their post August 2013 gains.

New home inventory is reasonably ample.  On a seasonally adjusted basis, there are currently 207,000 units for sale in various stages of completion.  At the currents pace of sales, this stock of homes will last 5.3 months.

As a gauge of economic health, the new housing market is inconclusive lately.  New housing sales reached a recovery high but needed some hefty price concessions to achieve the mark.  Housing starts, something Atlas does not write about on a regular basis, have been noticeably choppy lately, gaining 6.3 percent in September after falling 12.8 percent in August, which followed July’s 21 percent surge after two consecutive months of declines in May and June.  The steady climb of permits from earlier in the recovery has been replaced by a period of home builder uncertainty.  This is not necessarily a silent canary, but Atlas is hearing fewer chirps from the new housing songbird recently.                (by C. Cox)

September Leading Economic Index

Wednesday, October 29th, 2014

The Conference Board’s Leading Economic Index (LEI) advanced in September after falling flat in August.  Up 0.8 percent, this forward looking indicator is pointing to continued economic growth in the U.S.  It may even be pointing to faster growth.  In the last six months, the LEI has improved by just over 3.5 percent (about 7.1 percent annualized), faster than the 2.7 percent change in the previous 6 months (about 5.6 percent annualized).

Interest rates and credit made the largest impact on the index, but the increase was also pushed higher by seven out of the eight remaining components.  Central bank influence continues to keep the interest rate yield curve positive, and it became steeper in September as the difference between the virtually zero percent overnight interest rate and the 10-year Treasury bond widened to 2.44 percent from 2.33 percent a month earlier.  The Conference Board’s proprietary Leading Credit Index was the second largest contributor to the headline figure.  Four components (weekly unemployment claims, manufacturer’s new orders, building permits, and stock prices) moved from negative to become positive contributors in the period.  Only consumer expectations for business conditions subtracted from the total.

For now, our economy’s path of least resistance appears to be forward.  This foretelling  indicator pairs well with the recently released Chicago Fed’s National Activity Index we discussed yesterday, adding to evidence the economy is currently moving  forward just like the LEI suggested it would three to six months ago.  From the looks of things, America’s economic expansion is not over.   (by C. Cox)

September Chicago Fed National Activity Index

Tuesday, October 28th, 2014

Economic activity accelerated in September according to the Chicago Branch of the Federal Reserve System’s National Activity Index (CFNAI).  After posting a downwardly revised tally of -0.25 (originally -0.21) in August, this index of 85 components move back above zero to +0.47, suggesting output accelerated in the period.  This monthly uptick helped increase the three-month moving average to +0.25 from +0.17 in August; readings above zero for the three-month average indicate growth is increasing faster than its recent trend.

Internally, the negative bias of August’s reading disappeared and was replaced with a more encouraging tally in September.  Of the 85 elements in the indicator, 58 made positive contributions to the headline total and 56 of them improved over the prior period.  In August, a slight majority of the components deteriorated.

The Chicago Fed puts the 85 components into one of four broad categories, and three of these categories were positive.  Production contributed the most to the CFNAI.  Adding 0.3 to the headline total, it was boosted in part by the 1.0 percent rise from industrial production.  Also adding to production’s total was an increase in capacity utilization by the manufacturers.  The employment category added to the indicator too, as did the sales, orders, and inventory group.  Personal consumption and housing was the only fly in the ointment as this lot deteriorated in the period, primarily because of weakness in various consumption indicators since housing starts were actually higher in the period.

Once again, the CFNAI demonstrates that our economy, while growing, is not accelerating at a pace that would likely stoke price pressures.  Within the September release, the Chicago Fed acknowledges there is limited inflationary stress on the economy because this indicator is not nearing the +0.7 level.  For now, the report continues to support Atlas’ view that the central bank will be very slow to raise interest rates materially next year, if at all.         (by C. Cox)

September Consumer Price Index

Monday, October 27th, 2014

Prices paid by Americans were 0.1 percent higher in September according to the Bureau of Labor Statistics’ Consumer Price Index (CPI).  This only partially offsets the 0.2 percent decline in August.  Over the last 12 months, prices have grown by 1.7 percent.  September’s year-over-year price increase matches August’s uptick.  In all there is little in the CPI releases suggesting prices are moving substantially higher.

In the headline number, increases in shelter and food prices outweighed energy’s decline.  Food costs rose 0.3 percent as five of the six grocery food indices increased during the month.  Shelter was also 0.3 percent higher; this index has been gaining momentum recently and hit 3.0 percent on a year-over-year basis for the first time since 2008 in September.  All three components of the energy index (gasoline, electricity, and fuel oil) dropped in the period which caused this sub-index to fall 0.7 percent.

Stripping out the most volatile components (food and energy) leaves the “core” CPI. This measure of inflation was also tame in September, moving up 0.1 percent.  Along with the previously mentioned shelter category, most of the uptick in core CPI can be attributed to higher costs for medical care, alcoholic beverages, and personal care.  Several components were unchanged in the period while airline fares and the index for used cars and trucks fell.  On a year-over-year basis, core CPI is also just 1.7 percent higher.

September’s CPI report continues to tell the same narrative about inflation: it is mild relative to previous recoveries and below the levels America’s central bank is targeting.  It is as if there are flaws in the Federal Reserve’s models and theory; these central planners have been trying to induce inflation rates to rise above 2.0 percent for years now with all of their experimental monetary policies, yet price acceleration has not been able to sustain their desired pace on a consistent basis during the current expansion.  Despite what seem to be apparent imperfections in the Federal Reserve’s presumptions, they continue with what they feel is the perfect antidote, more experimenting.  Zero interest rate policies are expected to continue well into 2015, and if the economy experiences a large enough hiccup before then, Atlas fully expects the zero interest rate to remain intact and thinks Quantitative Easing could be started again as well, but we are not convinced it will be any more effective at stimulating the economy.  (by C. Cox)

September Existing Homes Sales

Friday, October 24th, 2014

Existing homes sales rebounded in September after falling in August according the National Association of Realtors.  There were 5.17 million units sold on a seasonally adjusted annualized basis versus 5.05 million in August.  This 2.4 percent increase was enough to make up the entire 1.8 percent drop in the prior period and even moved the figure about 0.5 percent higher than July’s total.  Also, while still negative, the year-over-year tally improved to minus 1.7 percent from minus 5.3 percent in August.

Existing home inventories were tighter in September than in August.  There are currently 2.3 million homes for sales in the U.S., down 10,000 from the prior month’s total. Despite the lower inventory level from a month earlier, there were still 6.0 percent more existing homes on the market than in the same period last year.  Since the monthly sales pace improved and fewer homes were on the market in September, supply relative to sales dropped to 5.3 months versus 5.5 months in August.

Prices fell for the third consecutive month but remain higher than a year earlier.  The average price for a home in the U.S. was $255,500 in the period, a drop of 3.1 percent.  The median price fell 4.0 percent to $209,700 in September.  Both price measures were lower in all four regions of the country; however, average and median prices are up 3.7 percent and 5.6 percent respectively on a year-over-year basis.

Interest rates moved higher for the first time since April, but the uptick was marginal.  According to Freddie Mac, the average commitment rate for a 30-year, conventional, fixed-rate mortgage rose to 4.16 percent from 4.12 percent in August.  Even with the monthly increase, rates were lower than a year earlier when borrowers paid an average of 4.49 percent for the same loan.

Greater transaction levels are good for the economy.  For one thing, it keeps folks employed in the real estate related fields.   Also, as folks move into their latest dwelling, they will likely make improvements and decorate which helps employ Americans in other areas of the economy.  To help confirm the knock-on effects of the used housing market, which does not directly impact GDP, Atlas will be looking for furniture orders and sales within the durable goods orders report during the months ahead.  In all, September’s existing home sales release is constructive for the economy.          (by C. Cox)

Asymmetry

Thursday, October 23rd, 2014

Typically, risks and rewards move in tandem.  In other words, those seeking substantial outcomes are required to accept large levels of risk.  Put one more way, the relationship between risk and reward is symmetrical. Of course, this only applies if you are not a bank.  These institutions, led by some of their employees who have fewer scruples than average, tend to find ways to decouple this relationship.

A shot may have been fired across the bow on October 20, 2014 by a Governor of the Federal Reserve during a conference centered on reforming culture and behavior in the financial services industry.  Governor Daniel K. Tarullo noted that the financial system is more resilient than before the 2008-09 crisis but also pointed out that headlines describing misconduct within financial firms continue to appear regularly.  He went on to suggest that this was more pervasive that just “a few bad apples” within a couple of institutions.  As a reminder, a few of the more egregious post financial-crisis  infractions include interest rate and foreign exchange price fixing, tax evasion facilitation, inadequate controls against money laundering, and front running their clients via esoteric and opaque trading platforms.  It starts to sound like the system is rigged when you put it that way!

Tarullo is concerned that “corporate culture” allows for such malfeasance. He is concerned about compliance department being nothing more than window dressing; departments willing to follow the letter of the laws but not the spirit of the rules.  Some companies do not seem willing to punish those folks who choose to operate outside of internally set guidelines.  Lack of action by superiors has created environments where workers are not concerned about the risks they are taking because their personal downside has been minimized by the firm’s culture.  Instead, they are able to focus more on the potential upside of their questionable behavior.

As greater rewards are sought, their corresponding risks must exist somewhere.  Atlas contends that it is being placed on the shoulders of Americans via a less stable financial system.  From this perspective, it appears that the individual actors who are marginally destabilizing the financial structure are sharing the risk with the nation while hoarding the bounty, when outcomes go their way, among a few.  Perhaps folks like Daniel K. Tarullo will begin to speak up more frequently, and more Americans will begin to take notice.    (by C. Cox)