Friday, November 08, 2013

Flat Growth Numbers and Painting Ourselves into a Corner

At first look, the report from the Bureau of Labor Statistics looks good, with more than 212k in job growth and more than 19k growth in manufacturing jobs, and favorable revisions to last month's report.  While these numbers are nothing to write home about, they are almost an anomaly in the face of all other indicators that indicate a stagnant economy.

In just the past 48 hours before the labor report came out, there was a dramatic shift in the markets, with a lot of money coming out of stocks.  Some of it went into bonds, but a considerable amount just "went away." This is because many investors traders and speculators buy stocks "on margin," which means a lot of the money in the stock market is borrowed.  The money that just "went away" was simply paid back to the lenders. Some analysts consider this to be an increase in "cash positions." While this is an interesting phenomenon, demonstrating that the markets are, as we say "as nervous as a long tail cat in a room full of rocking chairs" the amount of changes in the market have been pretty small in the grand scheme of things.

The S&P 500 (SPX) posted its biggest loss since Aug. 27 yesterday, as faster-than-estimated U.S. growth fueled speculation the economy is strong enough to withstand a reduction in Fed support. The gauge has lost 0.8 percent so far this week,
In the global economy of the past few weeks, confidence in Europe (Germany, in particular) has been pretty high, and confidence in Asia pretty low. We are sitting at about middle ground. A sign that the gobal economy might be slowing down is copper (copper is a long term indicator for the health of the manufacturing sector), which is lower than it was this time last year, and this time the year before (despite slight increases in cost of mining the mineral).

With the overall economic slowdowns, and the impending appointment of Janet Yellen as the next Fed Chair, QE is likely to go on for some time (maybe for years, as I will point out below). While the injection of 1050 Billion Dollars a year into the economy should be creating a serious inflationary trend, inflation seems to be mute, indicating  that without the injection there would be another recession and deflation.

Here is something new to me:

The Fed may be painting itself into a corner.

The longer the Federal Reserve continues its bond-buying stimulus, the higher the odds it will face a year without any money to give the U.S. Treasury after taxpayers received a record $88.4 billion profit in 2012.

The Fed’s financial-crisis actions -- from acquiring debt in the 2008 rescues of Bear Stearns Cos. and American International Group Inc. to three rounds of quantitative easing -- have led so far to the record payments. Now, the prospect of a stronger economy and rising interest rates means the value of the Fed’s bond holdings will fall at the same time its funding costs climb because the central bank pays interest on the excess reserves it holds for banks.
So, now the Fed has a vested interest in keeping interest rates low?  Some of this is not new to me.  The Fed holds T-Bills that it bought, that will go down in "value" if interest rates rise, but that is only important if they sell them or if there is a lot of inflation.

 Dudley said Oct. 15 in Mexico City that the Fed’s “traditional monetary-policy framework” has helped assure the central bank’s budget independence and thus support its overall independence. A “key question” is how unconventional measures that have ballooned the central bank’s balance sheet to a record $3.85 trillion may have threatened that status, he said.

“The Fed is a lightning rod: It attracts withering criticism from the Republican base,” said Greg Valliere, chief political strategist at the Potomac Research Group in Washington. “So even after several years of turning huge profits over to Treasury, losses would embolden the Fed-haters.”

The Fed receives interest payments on its holdings of government securities and mortgage debt. It uses this and other income for the operations of its board of governors and 12 regional reserve banks, returning the remainder to the Treasury, where the funds are added to the department’s total receipts.
Fed Haters?  They may be talking about conspiracy theorists, but they are more likely talking about conservatives in general. We don't hate the Fed, but we recognize the behavior outlined in the first paragraph is quite a dangerous game to play, and is part of a larger concern about how much debt the US government is running up.
“If the balance sheet expands further from here, the possibility of a loss becomes more and more real,” said Roberto Perli, a partner at Cornerstone Macro LP in Washington and a former Fed economist.

At the current balance-sheet level, an interest rate of 4.9 percent would be sufficient to wipe out the Fed’s income, according to Perli’s calculations. If the balance sheet grows for another year, the rate that causes interest on reserves to produce a loss falls to 4.3 percent.

“It’s not dangerous yet, but it’s getting there,” said Perli. That’s because, in the longer-run, most Fed officials see their target rate rising to 4 percent.
This shows the "damned if we do, damned if we don't" corner The Fed is painting itself into.  Slowing or stopping its steady $85Billion a month buying of bonds will cause interest rates to rise, and continuing its course will lower the point at which they will begin to lose money. Stopping it now will send the economy into a tailspin and continuing it longer will mean they will, themselves, take a loss at some point in the future.  This is the same fix that China is in, that they will take a loss today if they sell their US T-Bills, but if they hold them they stand a better than 50-50 chance of taking a bigger loss in the future. But they can't bring themselves to the truth that they need to take the loss today.  (China does seem, however, to be a little honest on this course of action and are slowly divesting themselves of US T-Bills.)
Economists expect quantitative easing to go on for longer. The Fed won’t begin tapering its bond buying until March and will continue purchasing securities until October, according to the median estimate of 40 analysts in a Bloomberg News survey last month.

“The right way to think about it is -- what were the economic gains or benefits associated with the way the Fed manages the portfolio?” said Robert Shapiro, chief executive officer of Sonecon LLC, an economic advisory firm in Washington.

“Congress will ask about all these losses, if taxpayers will be on the hook? Well, taxpayers are on the hook for interest payments that rise with other interest rates, but that’s always the case,” said Shapiro, a former Commerce Department official under President Bill Clinton.

“Will they demand an accounting from Janet Yellen?” he said, referring to the Fed vice chairman, who was nominated by President Barack Obama to succeed Bernanke when his term ends Jan. 31. “They certainly could.”
No, they won't.  If things go well, this crisis will last longer than her term in office, and if things go badly, the taxpayers will be too busy trying just to stay alive to ask for an accounting of how we got into this mess.

Back to the Economy outside of The Fed.

Last month I said "the economy actually got measurably worse instead, with an increase of only 148k jobs (remember, we need 175k-200k to tread water)" but when I looked again, private sector jobs only increased 126k (revised to 150k), meaning the government grew by 22k jobs (the revisions don't really change this) in the month prior to the shutdown.  I also mentioned manufacturing was flat for the year, the Bureau of Labor Statistics reported a gain for Sep of only 2k(revised to 4k) jobs, which was essentially flat. 

My current forecasts are that the economy will grow at a modest pace from now till the end of 2014.  I have been forecasting that for the past few months and I see nothing in these numbers to make me change my mind.  Sometime beyond the end of 2014 (it may happen before that time, end of 2014 is just what it looks like to me) the economy will undergo a contraction, and it is likely to be a contraction of enormous consequences.  My current plan, and what I advise my friends to do, is to make money in this upswing, while making plans to deal with the disaster that lies ahead.

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