Charting the Course
Friday July 24th, 2015 1:22 pm CDT
A week before the next Fed meeting and the Treasury market is beginning to call the Fed's bluff. Yes, short-term rates, most noticeably the 3mo T-Bill and the 2yr Note have reacted in kind by increasing to higher in recent days. And yes, some of the economic data surrounding the housing and labor markets have 'tightened' lately - which would but them in the rate hiking camp. However, the truth behind the economic music is that fact that both of these are not enough acceleration to escape the black hole-like pull a widening output gap. The ratio of unemployment to long-term interest rates says as much.
Initial jobless claims came in at decades low, yet that isn't nearly enough. Over the last few years, we have argued that based on the accumulating nature of surplus productivity the natural level of unemployment in the U.S. is very low. How low? We are on record of saying at least down to 2.0 percent unemployment but we've also thought out-loud that it might be lower than that and even negative. That would mean people working multiple jobs at once.
Today's market is reflective of the fact the Fed appears to be getting in the way of that dynamic once again. Due to the regulatory increases that the Fed has imposed since March of 2013, financial conditions have tightened significantly and the ratio shows that. Now, with the Fed acting as though it will raise rates, the output gap has fuel to widen further which would require another 180 degree turn around in Fed policy. We say this twice before (2002 and 2007) in the ratio. It looks like it is going to happen again.
This time though, the unemployment rate may not rise. In fact, it may not do anything at all. In fact, all the action on the ratio will most likely come from long-rates moving much, much lower. After all, even if the unemployment rate stays around 5.0 percent, if the 10yr falls to 1.0 percent that ratio would increase to 5.0. Looking at the chart, that would put it right back on trend. If the 10yr goes to 0.5 percent the unemployment rate could fall to 2.5 percent and the ratio would still make economic sense.
Charting the Course
Tuesday, July 14th 2015 1:46pm CDT
Excuses to the contrary, the fact of the matter is consumers are still suffering from too much inelasticity from higher prices. The ratio of gas station sales (inelastic demand) to general merchandise (elastic demand) is climbing higher after bouncing off of January's level. Gas prices would need to go much lower (easily under $1 a gallon) before any impact would be felt. More importantly, this chart doesn't bode well for (upward) pricing power. In fact, retailers should concentrate of improving their discounting prowess. Those who bleed first but slower will live longer than those who bleed last but fast.
The Economic Razor
Tuesday, July 14th 2015 10:11 am CDT
The minutes from the June Federal Reserve do indeed mention the developing situation in Greece and, to a lesser extent, China. However, more importantly was their discussion on, you guessed it, productivity.
Specifically, ...."Other concerns were related to whether the apparent weakness in productivity growth recently would be reversed or continue. On the one hand, a rebound in productivity growth in coming quarters might restrain hiring and slow the improvement in labor market conditions. On the other hand, if productivity growth remained weak, the labor market might tighten more quickly and inflation might rise more rapidly than anticipated." This is, as they say, right in our bailiwick.
The lack of productivity growth is gaining more and more traction these days and will not go away any time soon. As you know, we believe productivity levels to be in surface and the lack of growth means that those levels are staying inert and not being transformed into actual kinetic energy. That is why we see charts like this one popping up all over the place.
I'll be honest it has gotten me thinking. No, not changing my mind thinking but how to better illustrate surplus productivity for what it is. I think I have a new idea on how to do that but I'm not ready to show it yet. (But rest assured, subscribers will be the first to see it and will offered an opportunity to 'name' it, that way we can share the Nobel ;))
Back to the Fed though, they must be having a hard time justifying this lack of productivity growth with their inflation models which the said 'still" showed a lack of consistency. Again, survey-based measures show higher inflation expectations than that of market-based. I'll stick with the market, thank you very much. Nonetheless, with market-based measures of inflation 'still low', it makes the Fed's rate-raising rhetoric just that, rhetoric. They can not raise rates (especially with regulations as tight as they are) in the current environment or the future for that matter. Once this is clearer to the investment community, longer-term Treasury yields will certainly run much lower than where they trade today.
Charting the Course
Tuesday, July 7th 2015 9:15 am CDT
The Treasury Yield Curve Difference (YCD) continues to lead all other indexes, especially that of the S&P 500. Today, it briefly fell lower to -26bps before bouncing higher to -21bps. We continue to argue that any drop below -26bps effectively takes a rate hike off the table and any drop below -40bps puts Large Scale Asset Purchases back on the radar.
The financial sector is struggling to maintain any momentum whatsoever and could easily falter under the stress of providing for the economy's massive surplus productivity-driven leverage needs. Expect a majority of the economic data to disappoint at least in the near-term based off of this development.
New Era Monetary Policy
Wednesday, July 8th 2015 2:14 om CDT
The Treasury Yield Curve Difference (YCD) has undergone some rather dramatic changes over the course of the last few decades, but none more pronounced than since the year 2000. I have identified 4 main points over the course of the 15 years that are essential to understanding the financial sector's role assisting the economy reach its potential.
Point 1 & 1a. signify a peak and then tumble with respect to the economy's momentum. At point 1, for example, the yield curves signaled that while the economy was growing, it was tapering with respect to keeping pace with its potential. Point 1a, subsequently, is the now-famous Alan Greenspan conundrum where he was misguided raising interest rates, further deleveraging the economy right when the economy needed leverage the most. The financial sector didn't stand a chance at this point.
Point 2 represents that fact seeing how although the economic curve (2yr/30yr) did not invert the financial curve did (3mo/10yr). This was the first time we have experienced such a yield curve phenomenon and led to the financial crisis just 6 month later.
Point 3 is a result of resetting monetary policy back to where it should have always been. At this point, though, it wasn't enough, so the financial sector began to lag. Point 3a., though, is significant because it, just like 1a., is when the Federal Reserve has become too cumbersome, this time though via too much regulations (not necessarily higher rates.
That lead to point 4, here the yield curves have bounced off the 175 basis point level which is just above the range of yield curve optimization (for an economy to grow consistently within its potential the curves needs to be in a range of 25 to 175 basis points). At the same time the YCD began to move lower after rising for much of the prior 2 years. This means that the economy is headed for more liquidity issues unless the Fed can do a 180 and lower regulations and increase accommodation quick enough.
Charting the Course
Monday, July 6th 2015 2:55 pm CDT
As we begin yet another 2-day FOMC meeting, Fed watch is well under way across the financial industry. Of course, all the attention will be almost exclusively on the bias that always accompanies the conclusion of the meeting. Many economists and analysts are expecting some change in the language that would indicate that the Fed is ready to begin raising its 24 hour overnight lending rate a quarter of a percent or just eliminate the range-bound nature of Fed funds (between 0.00 and 0.25 percent) that it has been under since December of 2008.
What is interesting though, is that this current financial environment is more akin to 2010 and 2011 than anything else. You might recall, it was during this period that the Fed introduced what it called 'operation twist' wherein it sold short-term debt and bought longer-term debt. This had a flattening affect on the shape of the 3mo/10yr curve but little in the way of impact on the 2yr/30yr curve.
The reason for this is because the 3mo/10yr curve directly measures the relative real-time health of the financial sector. The financial sector's job is to provide for the leverage needs of the economy. The economy's leverage needs are a direct result of its ability or inability to grow within an appropriate degree of its potential. Just like now, the economy was struggling to grow within its potential so operation twist actually confounded the situation by squeezing the financial sector.
The situation is almost parallel today except that it is the deleveraging nature of increased regulatory policy that is hampering the financial sector from being able to provide enough smart leverage to the economy. Should the Fed decide that it is going to raise rates or even just eliminate the range bound nature of Fed Funds, it will only cause this curve to collapse further.
So we see a tremendous amount of yield curve flattening in the 3mo/10yr curve going forward given the regulatory policy currently in place. The only question is, how much will the Fed complicate the matters should they make the awful mistake to tighten monetary policy as well.
Charting the Course
Monday, July 20th 2015 1:51 pm CDT
Since adjusting for the general price level the U.S. government has always used the a wage earner's CPI to calculate COLAs because, after all, wage earners are the ones funding the social transfer payments: i.e. social security.
Therefore, it behooves one to realize that the current trend in CPI-W is much weaker than that of CPI-U (the main CPI you hear and read about) due to stagnant wage growth. As such, time is running out for CPI-W to get above September 2014's level. If it doesn't, the government will not pay out a COLA for the fiscal year 2016.
This is becoming an increasingly big deal since fixed payments like these are making up a larger and larger portion of U.S. aggregate income. Therefore, if consumers won't be releveraged by higher incomes they will be releveraged by lower aggregate prices in the form of deflation.
The Philly Fed Manufacturing Index has always been a favorite of mine for a number of reasons. The two biggest, though, are: it is the first indicator of the current month and it is very reliable. Of the data, points I tend to mostly concentrate on trends in employment and prices. Today, I choose the latter by comparing the difference between the prices producers pay and the prices they receive when they sell.
The Economic Razor
Thursday, July 9th 2015 2:32 pm CDT
The current rout in the commodity markets has two significant threads. The first is the fact that all commodities are generally being affected in the same manner at the same time. The second is that the weakness coincides with a Federal Reserve that is intent on raising rates despite economic fundamentals to the contrary.
The commodity markets have been under the unwitting thumb of the Fed for most of the last decade. In fact, it was the conundrum of 2005 that sparked the introduction of massive leverage and speculation into the commodity markets. It was then, in 2007, when the markets peak as the Fed not only pushed rates too high but held them at those levels for too long.
Now, as the Fed attempts to raise rates too high (any rate raise is too high right now) the markets are reacting exactly how one would expect. Should the Fed choose to ignore this liquidity warning, it will be forced to act in a swift and stronger opposite manner later down the road. At that time, though, liquidity in the commodity markets might not actually exist leaving the Fed to bail out those markets.
The Economic Razor
Friday, July 17th 2015 11:31 am CDT
In fact, if you take out that cluster of abnormally positive differences from late 2009 through 2011, you plainly see a more volatile downward trend in the margin between what a producer pays for something and what they can sell it for. This is not the kind of scenario that is easily reversible nor one that can withstand any sort of monetary policy tightening.
My struggles to explain new surplus productivity have been amplified in recent months given the increase popularity of the topic of lacking productivity growth (which would seem to stand counter to surplus productivity, but doesn't).
I think I may have stumbled on a better explanation in recent days, and am currently putting together an in-depth piece on the subject. I drew this diagram in the hopes that you see it for what it's worth right now. If I can communicate this clear enough, this could be a relatively big breakthrough.
Despite the volatility in the Treasury market today, the Yield Curve Difference remains in the -18bos to -26 bps range. Below this, things get interesting as -45 basis points would be the inflection point from talking about raising rates to talking about Large Scale Asset Purchasing (LSAP).
Productivity In Action
Thursday, July 9th 2015 10:14am CDT
The Treasury and equity markets continue to signal a growing lack of sufficient liquidity in the economy, reflecting an economy that continues to underwhelm its potential. The idea, of course, is that surplus productivity is pushing potential wider whereas the lack of enough smart financial leverage is disallowing enough of that potential to be transformed into actual productivity gains. You can also think of it as a lack of acceleration.
That brings us to today's durable goods report which was confusing from the standpoint of the headline data but also quite alarming from a widening output gap perspective. While orders did indeed grow last month, and more than expected for that matter, it is important to realize that this data is measured in dollar-volume. That means that prices (whether marked to market or market to cost) play a very big role in the actual measurement of the goods levels. For example, if prices rise fast enough, orders can also rise even though the actual amount of goods doesn't change. Conversely, orders can rise if quantity increases faster than prices fall. It appears that the latter might have been the case this past month.
Looking at recent trends in the PCE implicit price deflators (latest through QI 2015), prices of goods have been falling on a whole with nondurable goods up about 1.4 percent per year since 2009 while durable goods have contracted by 1.5 per year. The overall deflation in the price of goods leaves only service prices as exhibiting remote price growth. The increase in the value of the dollar only compounds the situation in the current situation.
The increase in orders means that supply has picked up dramatically in the last month without any real pick-up in demand. This flood of goods only serves to put downward price pressure on items already in the aggregate economy. In an environment of little to no pricing power, this can produce more discounts, increasing more supplies and rallying the dollar (through increased trade activity - as measured by quantity) further. As you probably suspect, today's number not only doesn't help the Fed bolster its rate hiking case, it actually works against it.
With leverage already scare (most of it by tighter regulations) even a 25 basis point rate hike will have some rather grave long-term implications for the economy.
The Economic Razor
Thursday, July 16th 2015 10:11 pm CDT
It is more like Janet Yellen laid down the gauntlet this week regarding a possible Fed rate hike by year's end but it remains unlikely that she will be able to do so. Therefore, expect her to discretely pick-up that gauntlet just as quietly as she laid it down.
Make no mistake about it, nothing insignificant exists with respect to any rate hike in this economic environment, even "just" 25 basis points. Given the extreme amount of unused economic potential that continues to accumulate, any and all tightening is a very big deal. A rate hike, at this juncture, would only serve to compound the deleverging implications that increased regulations are having on the economy today. The continued unexpected behavior of inflation expectations signify that this development remains more than entrenched in the broader economic landscape.
In her testimony to Congress, Yellen once again remarked that "Market-based measures of inflation compensation remain low--although they have risen some from their levels earlier this year--and survey-based measures of longer-term inflation expectations have remained stable." She did change up the language by saying that market-based expectations have "risen some" but looking at the chart about, that increase is spurious at best. Market-based inflation expectations - via TIPs Breakeven rates (this is the rate that CPI-based inflation would have to expand at each year in order for investors to be compensated for accepting a lower coupon on the TIP versus just buying the nominal Treasury straight out) - are scantly above historical lows. And if July is any indication, QIII'15 could return expectations to historical lows. As for survey-based measures - via the Survey of Professional Forecasters - these 10yr inflation expectations are notoriously lagging. They missed, additionally, the last major deflationary pocket altogether. Therefore, it is no wonder that the Treasury market believes that the Fed's case for a rate hike is built on sand.
Surplus productivity is all but handcuffing the Fed's ability to tighten rates in this economy. We should all be thankful for that.
Charting the Course
Thursday, July 9th 2015 1:36 pm CDT
New Era Monetary Policy
Tuesday, July 28th 2015 10:58 am CDT
New Era Monetary Policy
Thursday, July 23rd 2015 12:17 pm CDT
For those of you looking for a more appropriate market response to today's surprising retail sales numbers, look no further than the U.S. Treasury Yield Curves and their resulting difference.
The difference is down sharply, 6 basis points in fact, to come to the statistically significant -18 basis points level. It was at this level earlier in the year, for example, at which the YCD (Yield Curve Difference) made a strong, yet temporary, bottom. We broke through it again at the end of June only to rise above it a few days later. Here we are, however, testing -18bps again. This time, though, could be different.
The YCD is in a very strong downward channel, emphasized by today's bounce off of the top-line resistance. This is a lot different that the haphazard approach that happened in January. This signals that economic growth is getting relatively weaker in the near-run; relative, that is, to its potential.
Those who are claiming seasonal and holiday variation for the data are wrong to do so. Since mid-May, the YCD has been indicating economic congealing that should be enough to keep the Fed at bay for the time being with respect to rate hikes. If the Fed chooses to raise rates with the YCD falling, they will be well on their way to another Greenspan conundrum.
As for the equity market's reaction today, it is hard to decipher, I keep coming back to just two thoughts. Either the stock market is way ahead of the game and believes that the Fed will reverse current course which would open the door to more ill-timed buybacks and dividends. Or, equity investors are way behind the curve and are choosing to ignore the data in favor of corporate earnings which are trending higher but doing so on the back of cutting expenses, i.e. jobs.
The Treasury Yield Curve Difference (YCD) has undergone some rather strange movements in the last few days brought on by a stubborn 10yr Note and 'showing some signs of life' 3month T-Bill. As such, the YCD has broken the downward channel that it been riding in recent weeks but that doesn't mean we've reached a bottom. In fact, it could be quite the contrary.
Remember, the interplay of the two Treasury Yield Curves offers up some significant insight regarding the relative health of the economy and the financial sector's ability to provide for the resulting economy's need for smart or efficient leverage. When the difference is negative, it informs us that (a) the economy is growing way below potential, and (b) it has to do with the financial sector's inability to transform enough of that raw potential into actual productivity gains. Thereby leaving productivity in an inert state.
The recent correlation between the stock market and the YCD is extremely rare and highlights the Fed's increasing dominance on all things finance. It was in March of 2013, after all, that the two became correlated after spending the previous 35 years as polar opposites. March 2013 was also the first time the Fed began enforcing regulations under Dodd-Frank.
The volatility in the YCD in the last few days underscores a relatively big transition undertaking the economy and indicates that potential is again increasing without any real GDP growth to compensate. As such, deflation and illiquidity are bound to resurface in dramatic fashion.
For the last 47 years, a positive difference of 3.16 points has existed between the price a producer receives for their product versus what they pay for the inputs. However, with a standard deviation of 3.69 points, a little bit of a negative difference can be expected from time and again. However, price volatility is making its mark, mostly in a negative fashion. After all, even though June and July were above average positive months in 2015, May was significantly bad.
New Era Monetary Policy
Thursday, July 16th 2015 9:36 am CDT
I've purposely been holding off on updating this chart until the week played out, but I wanted to share it before it got too late in the afternoon.
If you scroll down to a few days ago, we were talking about that downward channel that took form with respect to the Yield Curve Difference (YCD). The channel broke down this week but the all-important '0' ceiling seems to be holding.
Throughout the course of the last 40 years of benchmark Treasuries, the '0' level in the resulting difference has reflected the relative health of the financial sector to that of the overall economy. Above '0', financial sector is 'doing its job' relatively well (The relative is found in the economy's current growth rate to that of its long-term potential).
The difference has been slipping rather pronouncedly as of late as the economy slips on the gears of its potential. The rise in the difference from March of 2013 to March of 2015 reflected just how much increased financial regulations had carved into potential, meaning it was easier for the financial to help the economy grow into that reduced potential. Now though, potential is beginning to rise again, meaning that more stress is building on the financial sector which ultimately translates into a heightened environment for liquidity issues and the deflationary forces that typically accompany them.
Charting the Course
Wednesday, July 22nd, 2015 9:58 am CDT
Surplus Productivity in the Chips
"It’s the innovation that’s driving the growth,” Chief Financial Officer Hugh Johnston said in an interview. “There’s fun value in that. These are social types of products.” PepsiCo Profit Tops Estimates on North American Snack Gains by Kevin Orland & Claire Boston Bloomberg News July 9th, 2015
Fun value. When is the last time you heard a CFO from a global Fortune 500 company extol the value of fun? I wouldn’t think too long and hard on that one because I bet the answer is probably never. (Remember this is the CFO, the numbers person, not the CEO who is the proverbial sales person)
The crux of the story, of course, is the fact that PepsiCo just delivered on its second quarter profits of $1.32 per shared which came in significantly above the street’s estimates of $1.24. Looking for the engine of growth, Mr. Johnston highlights the success of the “Roulette” type of Doritos nacho chips as a clear reason why the Frito-Lay North American snack division did so well last quarter. The Bloomberg article goes on to point out that the unit’s net sales “gained 1.9 percent”.
It wasn’t all sunshine and roses this quarter for PepsiCo. Cost containment due to a rally in the dollar and weakness in Quaker Foods compounded issues. But for the purposes of this piece, it is the relative success in Doritos Roulette that steals the show.
Doritos Roulette are comprised almost completely of the same nacho chips that you’ve come to know and love throughout the years. However, the difference is that 25 percent of the chips are coated in extra spicy powder. Therefore, adventure lures in every handful as one cannot tell a spicy chip from a regular one until it is, as they say, too late.
Doritos has an all spicy version of chips already on the shelf, but it is the anticipation of the mix that is the ‘innovation’ in the roulette brand. The CFO is right to call this innovation because innovation in a service economy dominated by surplus productivity is combining a living element with a physical thing. In this case, “suspense” meet “chip”.
Just as labor has productivity, so too do the ‘parts’ area of our service economy. The productivity that is coming out of things like nacho chips is brand new and wouldn’t have been as popular just a few decades ago when the economy was more balanced between agriculture, manufacturing, and service. Doritos Roulette is surplus productivity and it is delicious for investors and executives alike, if they dare to try it that is.
The Economic Razor
Monday, July 27th 2015 1:25 pm CDT