Saturday, August 24, 2013

Weekly indicators: Steel production debuts, plus, Gallup gets a bad panel edition

 - by New Deal democrat

In July monthly data reported this past week, existing home sales rose, while new home sales fell sharply, confirming that higher interest rates are having an impact on that important, leading market. Meanwhile the Index of Leading Indicators rose sharply. A year ago this index was stalled, but it has been more consistently positive in the last 9 months, suggesting that the remainder of this year will continue to show economic expansion.

One blind spot in the high frequency weekly indicators I've been trying to fill in is manufacturing, since it would be helpful to compare it with transport. There are several weekly indexes, but these appear to mainly work backward from rail transport. I finally found one direct measure of at least one sector, so let me spotlight that this week:

Steel production from the American Iron and Steel Institute

+0.9% w/w

-1% YoY

Steel production over the last several years has been, and appears to still be, in a decelerating uptrend. Obviously there is some noise in the weekly numbers. Last week it was off -1.7% YoY, so we can start by watching to see if the uptrend re-asserts itself in the next several weeks.

Employment metrics

Initial jobless claims
  • 333,000 up +13,000

  • 4 week average 330,500 down -1500

The American Staffing Association Index was unchanged at 96. It is up +3.9% YoY

Tax Withholding
  • $119.2 B for the first 16 days of August vs. $111.0 B last year, up +8.2 B or +7.4%

  • $147.1 B for the last 20 reporting days vs. $132.4 B last year, up +14.7 B or +11.1%

This week the four week average of initial claims made a new nearly 6 year low, placing it firmly in a normal expansionary mode. Interestingly, it has been at this point in the year for each of the last three years that this same, good, downside breakout has occurred.

Temporary staffing had been flat to negative YoY for a few months, but has now also broken out positively. Tax withholding, which had one of its worst readings in the last 7 months last week, is back within its normal range for most of this year.

Consumer spending Gallup's 14 day average of consumer spending absolutely plummetted this week. Last week it was over $100 for the second week in a row, its best showing in nearly 5 years, and has been strong since late last November. Now suddenly it is back at readings of one and two years ago. Contrarily, the ICSC varied between +1.5% and +4.5% YoY in 2012, while Johnson Redbook was generally below +3%. The ICSC had a decent week, and Johnson Redbook remains close to the high end of its range. I'll have more to say about the Gallup anomaly at the conclusion of this piece.

Oil prices and usage
  • Oil down -1.04 to $106.42 w/w

  • Gas $3.55 down -0.01 w/w

  • Usage 4 week average YoY up +2.2%
The price of Oil retreated but remained near its 52 week high. The 4 week average for gas usage was, for the seventh week in a row after a long streak to the contrary, up YoY.

Interest rates and credit spreads
  • 5.44% BAA corporate bonds up +0.10%

  • 2.73% 10 year treasury bonds up +0.11%

  • 2.71% credit spread between corporates and treasuries down -0.01%
Interest rates for corporate bonds had been falling since being just above 6% in January 2011, hitting a low of 4.46% in November 2012. Treasuries previously were at a 2.4% high in late 2011, falling to a low of 1.47% in July 2012, and have decisively risen more than 1% above that mark. Spreads remain slightly above their recent new 52 week low this week. Their recent high was over 3.4% in June 2011.

Housing metrics

Mortgage applications from the Mortgage Bankers Association:
  • +1% w/w purchase applications

  • +5% YoY purchase applications

  • -8% w/w refinance applications
Refinancing applications have decreased sharply in the last 13 weeks due to higher interest rates, declining by more than 50% in total, and are now just about as bad as they have been at any point in the last 7 years. Purchase applications have also declined from their multiyear highs in April, but are still slightly up YoY.

Housing prices
  • YoY this week +10.3%
Housing prices bottomed at the end of November 2011 on Housing Tracker, and averaged an increase of +2.0% to +2.5% YoY during 2012. This weeks's YoY increase is yet another 7 year record.

Real estate loans, from the FRB H8 report:
  • down -20 or -0.6% w/w

  • up +0.1% YoY

  • +1.1% from its bottom
Loans turned up at the end of 2011 and averaged about 1% gains YoY through most of 2012.  Over the last few months, the comparisons have completely stalled.

Money supply

  • -1.4% w/w

  • +1.4% m/m

  • +7.9% YoY Real M1

  • -0.2% w/w

  • +0.9% m/m

  • +5.1% YoY Real M2
Real M1 made a YoY high of about 20% in January 2012 and eased off thereafter. Earlier this year it increased again but has backed off its highs significantly.  Real M2 also made a YoY high of about 10.5% in January 2012.  Its subsequent low was 4.5% in August 2012. It increased slightly in the first few months of this year and has generally stabilized since, although it has declined slightly in the past several months.


Railroad transport from the AAR
  • +1500 carloads up +0.5% YoY

  • +800 carloads or +0.5% ex-coal

  • +9700 or +3.7% intermodal units

  • +10,800 or +2.0% YoY total loads
Shipping transport Rail transport has been both positive and negative YoY in the last several months. This week was the second solid positive week in a row since then. The Harpex index had been improving slowly from its January 1 low of 352, but then flattened out for 9 weeks before making a new 52 week high again this week. The Baltic Dry Index has rebounded to close to its recent 52 week high. In the larger picture, both the Baltic Dry Index and the Harpex declined sharply since the onset of the recession, and have been in a range near their bottom for about 2 years, but stopped falling earlier this year, and now seem to be in a slight uptrend.

Bank lending rates The TED spread is still near the low end of its 3 year range, although it has risen slightly in the last couple of months.  LIBOR established yet another new 3 year low this past Tuesday.

JoC ECRI Commodity prices
  • down -0.46 to 124.53 w/w

  • +3.34 YoY

Before we get to the other issues, let's deal with the collapse in Gallup consumer spending. This isn't the only Gallup indicator which has collapsed over the last week or so. Gallup's unemployment rate survey increased a full percent over the last two weeks. Gallup consumer confidence also fell sharply. But the other measures of both consumer spending and employment reported above have held up nicely, or even improved. So we are left with explalining why there has been a sudden sharp downturn in all of Gallup's consumer metrics, but only in Gallup's consumer metrics. Either (1) there has been a sudden but hidden crash in the economy over the last several weeks, or (2) Gallup got an unrepresentative survey panel, as is going to happen from time to time in such surveys. Until I see evidence backing up the cliff-diving of Gallup's consumer metrics, I'm going with (2).

Otherwise, there were only 3 negatives this week: interest rates, housing loans, and the still elevated price of Oil. Steel production was positive week over week, while negative (but less so, and the overall trend is still up) YoY.

Everything else was either weakly or strongly positive. Tax withholding and commodities were weakly positive. House prices, the ICSC and JR measures of consumer spending, temporary staffing, jobless claims, gas prices and usage, money supply and bank rates, interest rate spreads, and both rail and shipping transportation, were all solidly positive.

Although several of the long leading indicators - interest rates and housing - are problematic, the shorter leading indicators in both the ECRI WLI and the Conference Board's LEI point to nearer term imporovement. Have a nice weekend.

Friday, August 23, 2013

Weekend Weimar, Beagle and Pit Bull

NDD will be here over the weekend; I'll be back on Monday.

Food CPI Contained

Riffing off the grain post from earlier today, here's a chart of the year over year percentage change in food CPI.  Notice that prices are very much contained at this point, coming at under 2%:

More Downward Pressure On Grain Proces Likely

From the Financial Times:

The US drought of 2012, the worst since the Dust Bowl years of the 1930s, is finally releasing its grip on world agricultural markets. 

Propitious growing conditions from Brazil to Ukraine and the US have raised hopes of a sharp rebound in world cereals stocks, easing inflation pressures and pushing food security down the policy agenda. 

World corn, rice, soyabean and wheat production will break records this year, the US Department of Agriculture estimated this week. The International Grains Council in London expects grain inventories in critical exporters such as Argentina, Australia, Europe, Russia and the US to rise 40 per cent. 

Let's take a look at some of the agricultural ETFs:

The weekly chart of the gains ETF shows that prices spiked in the late spring, rising to 64.92 as a high.  But since then, they have been trending downward in a slow, consistent selling channel.  Prices have lost about 32% so far.  We see weak momentum and volume flow along with a very bearish shorter EMA picture (all are moving lower with the shorter below the longer).  Finally, prices are now below the 200 day EMA, indicating a bull market.

While we're here, let's take a look at softs:

The softs market has been in a decline for over two years, falling over 50% during the period.

Thursday, August 22, 2013

Dear Kevin Drum, CNN Money, CNBC, ABC News, Huffington Post, and AP: No, household income does not equal "compensation" or "earnings"

- by New Deal democrat

If you were wondering why I spent so much time and effort researching the the "median wage " and "median income" question, Kevin Drum becomes the latest economic observer to conflate the two, reprinting Sentier Research's latest graph of household income with the observation that
median household income today isn't just below the level of 2007, it's below the level of 2000. If you add in health benefits, the picture is brighter, but only modestly: Total household compensationtoday is still below its level in 2000 even when you count healthcare premiums. We are now well into our second decade of flat incomes for the non-rich.
[my emphasis]

As I showed last week, household income includes things like interest, and it's decline from both 2007 and indeed 2000 is almost completely accounted for by Baby Boomer retirements and the decline in the labor force itself. Wages are higher than they were in 2000, equal to what they were in 2007, and about 2% to 3% below their level of 2009 due to the effects of $3+ gasoline feeding through into the general economy.

The conflation of these two metrics is obviously endemic. Drum's error was repeated as fact in the blog Prairie Weather. But I intend to continue to point it out.

Update:Doug Short does his usual terrific work on this issue. If you haven't already, you should add him to your reading list. Here's a chart from his latest:

Take a look at what the Boomer cohort is doing to the age 55 through 74 cohorts, and take a look at the median income for those cohorts compared with younger working age cohorts.

UPDATE 2: And the Huffington Post and ABC News also repeated the error. It looks like all of these erroneous comflations began with an AP report that started: "The average American household is earning less than when the Great Recession ended four years ago, according to a report released Wednesday."

Kudos to the New York Times, which avoided the error.

UPDATE 3: This is from the Sentier report itself (pdf):
The decline in real median annual household income for households with an unemployed householder far exceeded that of any other subgroup. Median income for households with an unemployed householder declined by 21.0 percent, from $41,806 to $33,036, during the post-recessionary period. This decline reflects, in part, the continued high number of long-term unemployed. In contrast, the median income for households with a working householder declined by only 4.1 percent, from $71,191 to $68,275.
In other words, once you strip out "an unemployed householder" (they don't define how that applies in dual-income households), the decline is very close to that of wages alone. The report does not directly address the issue about Boomer retirements.

UPDATE 4: Add CNN Money to the list of media that completely got the facts wrong. Their story reads:
The nation may be in better economic shape, but that doesn't mean Americans' paychecks are. Median annual household income has fallen
EVERY SINGLE COMMENTER at these outlets, from what I have read of them, thinks that that the Sentier report is about wages.

UPDATE 5: CNBC copies and pastes the AP misreporting as well. Shouldn't a network that devotes itself to business know better?

Interest rates in disinflationary vs deflationary environments

- by New Deal democrat

I wanted to follow up on a point I made the other day in my post about "Three ways to look at interest rates." Namely (quoting myself here), I think it is important to keep in mind the difference between inflationary recessions and deflationary recessions. All of the post-WW2 recession through 2000 were inflationary recessions. Inflation increased, the Fed raised short rates to counter it, long rates began to decline as bond investors anticipated weakness, and a recession began. In deflationary recessions, an asset bubble bursts, and/or a debt overhang reaches critical mass, and the inflation rate declines, possibly turning into deflation. Interest rates follow, subject ot the zero lower bound.

The difference in the two types of scenarios is manifest in the different way that interest rates have behaved vis-a-vis stock prices during the disinflationary period of 1982-97 vs. 1998 to the present.

First, let me show you simple graphs comparing the performance of the S&P 500 vs. the 10 year treasury bond. Here's 1982-90:

Here's 1991-98:

And here is 1998 to the present:

It's easy to see in the depictions above that from 1982 through 1997 at least, rising stock prices were paired with declines in bond yields. What is harder to see is that the mirror image of declining yields ands rising stock prices also applies to shorter periods. Conversely, and again it is somewhat harder to see in the depiction above, the period from 1998 on features bond prices declining in much more subdued fashion, and no longer as a mirror image of stock prices, even over most shorter terms.

But fear not, I wanted to show you the above just to give you the raw comparison. The difference in the relationship between stock prices and bond yields becomes much clearer when I measure each by their YoY percentage change. Here's 1982-97:

And here is 1998 to the present:

Now it is much more obvious. During the disinflationary period of 1982-97, the YoY percentage change in stock prices was the mirror image of the YoY percentage change in bond yields. Stocks rose when bond yields fell, and stocks fell when bond prices rose. From 1998 on, however, almost always stock prices and bond yields have moved in the same direction (with the exception of late 2003 through mid-2006).

During the disinflationary period of 1982-97, as interest rates fell, there was continual room for consumers to refinance debt at lower rates. Further, consumers took on more and more debt. When inflation briefly broke back over 6% at the end of the 1980's, the Fed raised rates and inverted the yield curve, and the subsequent recession brought even lower interest rates, and an even lower general rate of inflation in the 1990's. During that period, bond yields fell even with a strong economy.

But that changed beginning in 1998. From that point until the present, bond yields have generally risen with a strengthening economy, and fallen with a weaker economy. As first the tech stock bubble burst, and then the housing bubble burst, there were deflationary moves in asset prices and declining bond yields simultaneously. Several times since then, there have been brief periods of outright deflation. Perhaps a more finely grained assessment is that, since 1998, during periods of a strong economy, bond yields and stock prices behaved as mirror images. But during periods of a weak economy (which has been the vast majority of the time since the turn of the Millenium), the two asset classes have moved in tandem. Since I think it is fair to say that the economy is quite weak, I expect that any decoupling in bond yields and stock prices now to be brief.

Consumers Are Spending More on Durable Goods This Recovery

The chart above from the St. Louis Federal Reserve shows non-durable (in blue) and durable goods (in red) purchases, with 2007 being base 100.  While durable goods dropped more sharply during the recession (as would be expected), their purchases have clearly increased at a sharper rate during the recover.  Non-durable purchase, in contrast, are rising at a far slower rate.

Let's take the consumer purchasing numbers and compare them to overall consumer industrial production.  We see a sharp drop in consumer goods IP during the recession followed by a moderate increase. 

The above spending pattern leads to a large increase in the production of durable goods (blue line) than non-durable goods (red line).

Wednesday, August 21, 2013

Indian Situation Continues To Deteriorate

The situation in India continues to deteriorate.

First, yields are spiking:

A surge in Indian sovereign debt costs to a 12-year high this week is threatening Prime Minister Manmohan Singh’s plan to cut the budget deficit and fueling the fastest surge in credit risk since 2008. 

Ten-year (GIND10YR) yields rose 72 basis points this month through yesterday to 8.92 percent, the most among 14 regional markets tracked by Bloomberg, touched the highest level since 2001 of 9.48 percent. They plunged 57 basis points today after the Reserve Bank of India said late yesterday it will buy long-dated notes via open-market auctions. Government debt in Indonesia added 68 basis points to 8.39 percent.

In response, the Reserve Bank of India has gone into the market to buy bonds with the intended effect of lowering yields:

Late on Tuesday night the RBI announced that it would purchase Rs80bn ($1.2bn) of long-dated government bonds, along with other measures to ease pressures on banks, whose valuations have been badly hit by a series of measures introduced to protect the rupee over the past month.

The moves partially reversed previous tightening measures and led to accusations from analysts of policy “flip-flops”.

These moves have led to questions about the overall veracity of the RBIs policies:

However, the latest move followed a series of other minor interventions, including steps to tighten controls on domestic capital controls last week and further open market interventions to support the rupee on Tuesday, leading to doubts about the RBI’s overall approach.

“Over in India, flip-flops by policy makers continue,” Rajeev Malik, senior Asia-Pacific economist at brokerage CLSA, wrote in a note. “The latest moves by the RBI are aimed at cleaning up the unintended mess in the bond market from their convoluted and ineffective currency defence. But they still appear unsure of what [growth, rupee, bonds] they want to eventually save.”

Nancy Folbre pre-buts Paul Krugman on math and trade

- by New Deal democrat

Prof. Noah Smith writes a searing indictment of most macro economic theory, saying:
But macro was a different story [from physics].

In macro, most of the equations that went into the model seemed to just be assumed. In physics, each equation could be - and presumably had been - tested and verified as holding more-or-less true in the real world. In macro, no one knew if real-world budget constraints really were the things we wrote down. Or the production function. No one knew if this "utility" we assumed people maximized corresponded to what people really maximize in real life. We just assumed a bunch of equations and wrote them down....

In other words, the math was no longer real. It was all made up....

We were told not to worry about this. We were told that although macro needed microfoundations - absolutely required them - it was not necessary for the reality of any of these microfoundations to be independently confirmed by evidence. All that was necessary is that the model "worked" after all the microfoundations were thrown together. We were told this not because of any individual failing on the part of any of our teachers, but because this belief is part of the dominant scientific culture of the macro field. It's the paradigm.
To which Prof. krugman replies:
the main way (in my experience) that mathematical models are useful in economics: used properly, they help you think clearly, in a way that unaided words can’t.

Take the centerpiece of my early career, the work on increasing returns and trade. The models I and others used were, in a way, typical of economics: clearly untrue assumptions (symmetric constant elasticity of substitution preferences; symmetric costs across products!), and involved a fair bit of work to arrive at what sounds in retrospect like a fairly obvious point: even similar countries will end up specializing in different products, and because there are increasing returns in many sectors, this will produce gains from specialization and trade. But this point was only obvious in retrospect. People in trade were not saying anything like this until the New Trade Theory models came along and clarified our thinking and language.
Via Mark Thoma, Nancy Folbre of U Mass Amherst has in essence a perfect pre-buttal:
... Trade theory emphasizes that those who benefit from free trade should be able to compensate those who suffer, making everyone better off. What trade theory doesn’t explain is why the beneficiaries would offer such compensation unless they are forced to do so. ...
And there goes all of Prof. Krugman's eloquent math (which, to his credit, he has realized at least in substance in subsequent writings.). In the meantime, because Krugman and his cohorts' math was persuasive, hundreds of millions of workers around the world have suffered.

When Bonddad wrote last week that neither of us were "trained" economists, that wasn't entirely true. I took a year of graduate level macro at a School the name of which you would instantly recognize before leaving in disgust, for the exact criticisms made by Noah Smith. Nothing that has happened in the last 10 years has caused me to re-evaluate that opinion (although I greatly credit Thoma and DeLong, among others, for recognizing and trying to address the issue).

p.s. U Mass Amherst has really been kicking economist butt recently!

The oil choke collar and wages

. - by New Deal democrat

I remain mystified why virtually the entire Econo-commentariat fails to notice the importance of the Oil choke collar operating in the background of almost all economic events. It is clear to me that the constraint imposed by the vanishing supply of cheap petroleum is an important determinant of how weak the economy has been since even before the great recession.

To refresh your memory, here is a graph of the price of Oil (blue) for the last 50 years, and the price of gasoline (red) since the EIA started keeping statistics in the early 1990's, adjusted by average wages. I use wages as the deflator since the price of Oil itself is a component of the CPI. Both are normed to 1 at the peak in July 2008:

It is fair to categorize what happened between 1999 and 2008 as the second Oil shock, the first being the 1970's. And both had similar economic outcomes. In fact, at one point Prof. James Hamilton estimated that the Oil shock of 2008 was responsible for about half of the GDP loss during the great recession.

Further, note that in a "real" sense, the prices of Oil and gas remain very elevated, far higher than at any time except for the end of the 1970's and in early 2008. If Oil were not such a constrained resource, and gas was priced at $1.60 or even $2.60 a gallon vs. around $3.60 a gallon, as it has been for the last 2 years, there is little doubt that we would be seeing a much stronger recovery.

To make the point, well, more pointedly, the below graph shows the CPI (green) , CPI ex-energy (blue), and median wages from the Employment Cost Index (red):

Normally it takes about 12 months or so for energy prices to feed through into the broader array of prices. Notice that the "ex-energy" measure of CPI makes more subdued peaks and troughs, and does so about 12 months after the measure that includes energy. It's bad enough that the Employment Cost Index decreased from growing at over 3% YoY before the recession to only 1.5%-2% per year since, but notice that when the YoY increase in the price of gas has exceeded the increase in median wages, it has correlated with a virtual stall (or worse) in GDP. Conversely GDP has recovered when the YoY increase in the price of gas has been below the increase in median wages.

In short, the paltry increase in nominal median wages is only half of the story of working class wage stagnation. The other part is the surge in the real price of Oil, its continued highly elevated price, and its effect of being a choke collar constraining the economy.

Developing Market Currencies Dropping Sharply

India is in a very difficult position, as it seems that several major macro-level economic problems are coming to a boil.

First, they have a large current account deficit, which is having an overall negative impact on the rupees value.

Secondly, inflationary pressures -- while lower -- are still cropping up underneath the surface.  To stem both of these problems, the central bank would normally raise interest rates.  However, overall economic growth has been dropping as well, hemming in the Central Bank.

Brazil is another developing country that has a very difficult economic environment.  Growth is slowing

while the inflation rate remains elevated:

All of these problems are starting to come to a head in the respective ETF charts of these currencies:

Both are weekly charts.

The rupee ETF (top chart) has fallen through support at the 19.5 level and is currently trading near three year lows.  Momentum is negative, as is the volume flow.  Prices are pulling the shorter EMAs lower.

The real ETF has the same technical profile, except with different support levels, with its occurring right about 18 and 17.


Tuesday, August 20, 2013

Oil Is Consolidating Recent Gains

Oil is consolidating in a symmetrical triangle pattern between 104 and 108.  If I was to place any bets, I'd wager a move higher.  All the short-term trending indicators (shorter EMAs) are moving higher, there's still a positive volume inflow and the MACD is positioned to give a buy signal on a price upswing.

Also note the bullish tenor of the weekly chart: rising EMAs, capital inflow and rising MACD. 

Three ways to look at interest rates

- by New Deal democrat

The impact of the Fed's "taper" on longer term bonds has been one of the big events of the last three months. It is well known that bonds tend to serve as a long leading indicator for the economy (think of it as the "price of money"), but there are several different ways to look at bond yields: (1) whether they are rising or falling; (2) their "real" rates, i.e., their relationship to inflation; and (3) the yield curve, which is the relationship between shorter term and longer term bonds. Depending on how you look at bonds, the story is quite different.

First, let's look at what the back-up in long term rates is showing us. The following is the YoY graph of long term rates, showing that they have increased by over 1%:

As I have previously pointed out, since WW2, an increase of 1% in long rates has been necessary, but not sufficient to indicate that a recession is coming within the next 12 months.

A second way to look at interest rates is to gauge then vs. inflation, i.e., what is the "real" price of money? The theory is that the economy slows down when "the price of money" gets more expensive. Let's take a look, using long rates:

It is readily apparent that the actual "price of money" does not predict strength vs. recession. But it is also apparent that prior to recessions, the "price of money" declines. So let's look at the same data, but the YoY change vs. the absolute rate:

"Real' long interest rates have almost always turned negative before a recession, at least in the post-WW2 period. But there are far too many false recessionary signals to make this measure worthwhile, except perhaps as a negative for recession if the measure has been positve for the last 2 years up until the present.

Since short and lomg rates may give different results, the following variation averages short rates, represented by 3 month treasuries, and long rates, represented by 10 year treasuries, comparing that average to inflation:

Once again, the actual "price of money" is less predictive than the directional move. Here's the same information, but plotted as the YoY change:

This is more interesting. Almost always, within 12 months before a recession, the average of long and short "real" rates is negative by at least 1%, although there are a few false positives. Note that by this measure, as opposed to just long term rates, the recession signal is on - but it has also been on twice before since the 2008-09 recession without any new downturn.

Finally, let's look at the yield curve. It has a nearly impeccable recond of corresponding to recessions approximately 12 months later since WW2, having only one false positive in 1966:

I used to swear by the yield curve as a long leading indicator. I approach it with more caution now. In particiluar, while an inverted yield curve is always a bad thing, and an inverted curve in the presence of deflation is what I dubbed the Death Star, since it has occurred twice in the last 90 years (in 1928 and 2006); the yield curve remained positively sloped from the end of 1929 throughout the entire Great Depression, and was normally sloped from early 2007 on, giving no warning at all of the late 2008 calamity.

In any event, if you are following the yield curve, then its steepening is regarded as a good sign of a strengthening economy. If the economy is going to remain in inflation, I agree with you. If it is verging on deflation, in my opinion all bets based on the yield curve are off.

More deeply, I think it is important to keep in mind the difference between inflationary recessions and deflationary recessions. All of the post-WW2 recession through 2000 were inflationary recessions. Inflation increased, the Fed raised short rates to counter it, long rates began to decline as bond investors anticipated weakness, and a recession began. In deflationary recessions, an asset bubble bursts, and/or a debt overhang reaches critical mass, and the inflation rate declines, possibly turning into deflation. Interest rates follow, subject ot the zero lower bound. In inflationary recessions, the decline of inflation to less than the rate of wage increases signals the bottom. In deflationary recessions, it is the decline in the rate of deflation which signals the bottom.

So I do not think the inflationary regime applies. Hence my focus on whether the middle and working class can continue to refinance debt at lower rates, and how wages are behaving relative to prices. In short, I am paying more attention to the first measure than to the yield curve.

The Case Against Larry Summers As Fed Chair

I will admit upfront that I do not get into the personalities of the various Fed presidents; I couldn't tell you who's a dove or hawk, or who has strong verses weak growth projections for the economy.  But I can tell you the qualities that I'd like the next Fed chief to have.  First, a track record of being right about the economy and business cycle in general is a foregone conclusion -- especially when considering the current recession and slow recovery.  Secondly, the last thing that needed is a divisive character; what we do need is someone who has the ability to listen to all sides, develop a consensus and nurture that conclusion.  For that reason, Larry Summers is clearly not the right person for the job, while Janet Yellen is.

Let's start with who's been right and who's been wrong about the economy.  Larry Summers has a spectacular track record of being on the wrong side of many policy issues.  I'll let Barry over at the Big Picture provide the rundown:
•  He has consistently argued for privatization and deregulation of the financial sector;
• He oversaw the repeal of Glass-Steagall via the passage of the Gramm-Leach-Bliley Act;
• He approved the (previously illegal) merger between Citibank and Travelers;
• He oversaw (and indeed encouraged) concentration in the financial sector, thinking bulked up banks are a virtue. This led to the rise of the TBTF institutions (formerly known as mega-banks).
• He successfully fought Brooksley Born, then chair of the Commodity Futures Trading Commission, to rein in financial derivatives;
• He oversaw passage of the Commodity Futures Modernization Act of 2000, preventing ALL Federal regulation of derivatives; The CFMA also exempted derivatives from state insurance oversight and antigambling laws.
• Thanks to Summers, derivatives still have no minimum reserve requirements, no disclosure obligations, no transparency and no exchange listing / reporting requirements.
To put it more generally, Summers has argued for all the ingredients that led to the financial collapse of 2007.  That's just not someone who should be in a position of authority.

Let's compare that to Janet Yellen:

In interviews with more than a dozen people who have worked closely with Yellen, the portrait that emerges is of a careful and deliberate thinker who has been mostly right in her assessments over the tumultuous past six years of crisis, recession and grinding recovery.  She has been a strong intellectual force within the Fed, a tough taskmaster for staff and  single-minded in her desire to push down joblessness. She has been less inclined to wring her hands over the risks that the Fed’s easy money policies could create new bubbles or stoke inflation.  

The fact that she's been right about the current economic situation speaks volumes about skills.  Also consider this:

At the University of California-Berkeley, Yellen studied the crucial question of why labor markets don’t work like other types of markets. In particular, she looked at why, in a recession, people go without work rather than take a lower wage — of particular interest in the past few years of high unemployment.

At a time when unemployment is clearly the main problem facing the country and the economy, we have someone who is an expert in that very problem.

And consider her warnings about the housing bubble in 2007:

So when the leaders of the Fed gathered around their big mahogany table overlooking the National Mall on Dec. 11, 2007, Yellen was perhaps the most gloomy.

“The possibilities of a credit crunch developing and of the economy slipping into recession seem all too real,” she said, reading carefully measured words from a sheet of paper. The “shadow banking system,” the complex financial markets that funnels credit to Americans, was freezing up, she said, and the economy was likely to slow significantly.

The above statements show a high level of prescience about the US economy which few economists had.

Let's turn to the issue of "likeability."  The floating of the Larry Summers trial balloon was greeted with remarkably stiff Congressional opposition:

The Wall Street Journal reports this morning that roughly a third of Senate Democrats have signed on to a letter urging Barack Obama to appoint Janet Yellen as the next chairman of the Federal Reserve. It’s being widely assumed that Obama’s first choice is Larry Summers, who is opposed by a number of progressive economists for various reasons, among them his previous support for banking deregulation. The letter is not available — nor is a list of signatories, but you can assume it’s compromised of the liberal flank of the Dem caucus — and is being closely guarded by the office of its lead author, populist Senator Sherrod Brown.

The push from Senate Democrats on behalf of Yellen — who is currently the Fed’s board of governors vice chairperson and would be the first female Fed chair — is significant, because the next chair will obviously need a lot of support among Dems. The letter doesn’t actively oppose Summers, but the groundswell of support for Yellen to replace Ben Bernanke is an implicit demand that the White House pass over him and pick her instead.

Before getting out of the gate, Summers is drawing fire.  That's just not the way we should be doing business.

And then there is Summer's personality, which is described as combative and undiplomatic -- not exactly the leadership qualities we should be looking for in a Fed Chair.

Compare that with Yellen:

“Janet was very much a person who asks very probing questions, wants to understand kind of what’s below the conclusions,” said John Williams, who was head of research under Yellen and followed her as president of the San Francisco Fed. 

I think Yellen's primary drawback is she has less personal experience with the financial sector than is ideal for a Fed President.  But this time around, that might actually be a good thing as she doesn't have the super-close relationship with banks.

And finally, consider this point about Summers:

This post is the product of numerous conversations with Summers’s supporters who, to my continuing frustration, typically refuse to be quoted even when they’re just saying nice things about their former colleague. Given the centrality of their testimony to this process, however, it’s important to know what they’re arguing. So here are the key points they make — points I’m passing along, to be clear, without endorsement:

Think about the emboldened statement.  His friends are basically saying this: "he's a really good guy.  Brilliant economist.  Wonderful mind.  Just don't quote me on that."  There's something fundamentally wrong with that development. 

I used to work with a guy who people would universally describe in the following way: he's a genius and he's an asshole.  And this guy was both.  Financially, he had one of the sharpest minds anyone had ever met.  But he was without a doubt, the biggest asshole anyone had met.  Larry Summers strikes me the exact same way.  Yes, he's brilliant.  But he appears to be distinctly lacking in people skills, which is something a manager cannot have.

So we have the following choice:

Janet Yellen was right about the recession and recovery, is a well-respected economist, has the ability to develop consensus and has extensive experience in the Federal Reserve System.

Larry Summers endorsed policies that created this mess, is well-respected but also feared and has all the people skills of Attilla the Hun.

Why is there even a debate? 

Monday, August 19, 2013

SPYs Beating BRICs in Return

From Bloomberg:

Investors are favoring U.S. stocks over emerging markets by the most ever as fund flows and volatility measures show institutions are increasingly seeking the relative safety of American equities. 

Almost $95 billion was poured into exchange-traded funds of American shares this year, while developing-nation ETFs saw withdrawals of $8.4 billion, according to data compiled by Bloomberg. The Standard & Poor’s 500 Index (SPX) trades at 16 times profit, 70 percent more than the MSCI Emerging Markets Index. A measure of historical price swings indicates the U.S. market is the calmest in more than six years compared with shares from China, Brazil, India and Russia. 


“The weakness in emerging markets and the associated economic troubles have encouraged some investors to reallocate from the emerging world to the U.S.,” James Gaul, a fund manager at Boston Advisors LLC, which oversees about $2.3 billion from Boston, said by phone on Aug. 15. “The U.S. is seen as the most stable economy at the moment, and the equity market is viewed as having better prospects than the rest of the world.”  


Capital is fleeing developing nations as China’s economy grows at the slowest pace in 13 years, India’s current-account deficit widens to a record, and persistent inflation in Brazil erodes purchasing power. The share losses are a reversal from the past decade, when the countries led gains during a commodity boom and rising consumption from the middle class. 

Here is a chart comparing the SPYs with the BRICs over the last three years:

Should Industrial Production and Capacity Utilization Be Concerning Us?

Consider the following charts:

Industrial production has increased the last four months.  However, the last 9 readings of this metric have been closely bunched.  As opposed to seeing a strong, continued uptrend, there is far more static in the data series.  Compare the recent slope with that which occurred in late 2012.

Also consider that you can bunch the readings into two levels.  The overall level remained fairly static in 2012, jumped up to a slightly higher level in 2013 but then again printed readings around a certain level.

This metric does not seem to be making a lot of forward progress.

Capacity utilization has been printing around the 77.5 level for nearly two years.  At this point, we can say with a high degree of certainty that this measurement has stalled at this level.

And just to make matters a bit more dire, consider this chart:

US capacity utilization has been peaking at lower and lower levels for the last twenty+ years.

Market/Economic Analysis: US

As always, let's start with last week's economic releases:

The Good

Prices are under control.  CPI increased .2% (2% Y/Y)PPI was 0% (2.1% Y/Y) and import prices were up .2% (-3.3% Y/Y).   All of these numbers indicate that inflation is very much under control.  It also means the Fed is still a long way from increasing short-term rates.

Retail sales increased .2%, .5% ex-autos.  Here's a chart of the overall retail sales data that shows we are still in an upswing and are also at higher levels than the previous expansion:

Housing starts increased 5.9%  M/M.  The real reason for the increase was the jump in multi-unit housing. 

Homebuilder confidence increased to its highest level in eight years:

Builder confidence in the market for newly built, single-family homes rose three points to 59 on the National Association of Home Builders/Wells Fargo Housing Market Index (HMI) for August, released today. This fourth consecutive monthly gain brings the index to its highest level in nearly eight years.

“Builders are seeing more motivated buyers walk through their doors than they have in quite some time,” said NAHB Chairman Rick Judson, a home builder from Charlotte, N.C. “What’s more, firming home prices and thinning inventories of homes for sale are contributing to an increased sense of urgency among those who are in the market.”

“Builder confidence continues to strengthen along with rising demand for a limited supply of new and existing homes in most local markets,” noted NAHB Chief Economist David Crowe. “However, this positive momentum is being slowed by the ongoing headwinds of tight credit and low supplies of finished lots and labor.”

The above two data points indicate the housing recovery is still on track and doing well.

The Neutral

The August 2013 Empire State Manufacturing Survey indicates that conditions for New York manufacturers improved modestly for a third consecutive month. The general business conditions index, at 8.2, was little changed from last month. The new orders index slipped four points to 0.3 and the shipments index fell seven points to 1.5, suggesting that both orders and shipments were flat.

I'm placing this in the neutral category because of the new orders and shipments drop.  Both are right above a "0" reading, indicating a contraction.  Also, this data series, while positive, has been a very "weak" strong for the last few months.

The Philly Fed's index, while positive, is also showing some problems:  

The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, decreased from 19.8 (its highest reading since March 2011) to 9.3 this month (see Chart). The index has now been positive for three consecutive months. The percentage of firms reporting increased activity this month (28 percent) was greater than the percentage reporting decreased activity (19 percent).

Other current indicators suggest growth moderated this month. The demand for manufactured goods as measured by the current new orders index remained positive for the third consecutive month but fell 5 points to 5.3. The shipments index fell 15 points to just below zero, its first negative reading in three months. Both unfilled orders and delivery times indexes were negative this month, suggesting continued slack conditions. 

Like the Empire state number, the internals of this report are a bit concerning.  

Industrial production was unchanged from the preceding month, while capacity utilization dropped. 

Consumer confidence dropped five points.  The concern here is this number is already at low levels and the drop was caused by higher interest rates.  This may indicate that consumers will start to pull back from the housing market.

The Bad

Conclusion on the economic numbers: we had some concerning developments this week.  First, the industrial production numbers along with the related regional indexes were weak.  Both the Empire State and Philly Fed indexes have had a difficult time printing continued strong numbers this year, and the capacity utilization numbers numbers have been dropping since February.  Consumer confidence - which was also at weak levels -- dropped as well.  While retail sales were positive, they also printed just barely so. 

Let's turn too the markets:

The longer-term chart (top chart) shows that prices dropped below the 168 level, which was established as a technical point in late May.  The MACD -- which printed a selling cross-over a few weeks ago, continues to weaken, along with the CMF.  Also note the uptick in the Bollinger Band width, indicating an increase in volatility.

The lower chart simply shows the important technical levels for a short-term market sell-off.  Prices are currently at the 50 day EMA and are just above the 61.8% Fib level. 

The long-end of the yield curve broke technical support.  The TLHs moved through the 128 level while the TLTs' dropped below 105.  The MACD's of both are in negative have also given a sell-signal, indicating a higher probability of moving lower.  The treasury market is preparing for the eventual withdrawal of Fed stimulus, which many are saying will occur in September.

The dollar made a round-trip trade this week, starting and ending around the 21.9 level.   The overall trend since the beginning of July is lower, but there is still plenty of support at the 21.5 level to contain prices.