Wednesday, May 26, 2010

A Note On The Housing Market

A short Caribbean vacation will interfere with the posting of any new articles in the coming days. The next article will be posted on June 4th, discussing the employment report. - AK


The Mortgage Bankers Association's index of weekly new mortgage applications is often a more useful gauge of the state of the housing market than the monthly new and existing home sales reports. This point was validated again this morning with the release of both the latest weekly MBA data and the 14.8% surge in new home sales for April.

While the overall index new mortgage apps rose 11.3% in the week of May 21, this was the noisy result of a 17% spike in the refinancing component (the direct beneficiary of the rally in the Treasury market and associated fall in mortgage rates); the key purchase component of the index fell 3.3%- following sharp declines in the prior two weeks- to its lowest level in 13 years.


The behavior of the purchase component recently highlights two important issues regarding the underlying dynamic in the housing market:

a) The expiration of the home-buying incentives in April has caused a sharp drop-off in the demand for homes in May. This suggests that, taking into account both the tax incentive-related spike in mortgage applications for purchases in April and the subsequent sharp decline so far in May, "true" demand remains essentially moribund during the key spring season. The most that can be said is that some kind of a bottom is being formed but with no credible signs of a turnaround yet.

b) Contrary to the popularly held belief, demand for housing is poorly correlated with the level of mortgage rates. The average 30-year mortgage rate declined again last week to 4.80% from 4.83% in the prior week (and over 5% in April). Still, as evidenced by the string of declines in the purchase component in the last few weeks, demand for homes has been unresponsive. In fact, it is a point often missed by analysts, that the collapse of the housing market since 2006 has been accompanied by a strong downtrend in mortgage rates.

The explanation for this seeming paradox is a fairly straightforward one: Demand for homes is above all a function of levels of employment and income growth and not mortgage rates- the latter representing a largely peripheral (and, at times, irrelevant) factor. Differently put, when people are unemployed, or seriously concerned about their job security, they will not undertake the major decision to buy a house simply because mortgage rates are low. Even a 1% mortgage rate would do nothing to make it plausible for an unemployed person to buy a home.

In fact, it is somewhat ironic, but analytically sound, to argue that demand for homes will only strengthen when the economic recovery has been meaningful enough over a longer period (2-3 years), as employment levels improve, wage gains increase and mortgage rates are on the rise.

In the current environment, with unemployment levels still very high, despite the unmistakable turnaround in underlying labor market conditions, households remain reluctant, or unable, to make the leap to by a home, irrespective of the historically low mortgage rates. Combining this dynamic with a still heavy inventory of unsold homes in most regions of the country, it is unlikely that any material turnaround in the housing market is in the offing over the next 6 to 12 months.

Anthony Karydakis

Tuesday, May 25, 2010

The Consumer Remains Unfazed

Although hardly the most important item on the markets' mind this morning, the strength in the May Consumer Confidence Index deserves some attention, at least briefly.

The surge in the index to 63.3 from 57.7 in April is a testament to the steadily improving domestic economic environment and, particularly, of the consumer sector. The expectations component turned out the biggest increase, up 7 points to 77.4, while the current conditions component rose 2 points to 30.2. The spike is even more remarkable in that it took place in the midst of a period where the stock market's performance has been dismal.

Source: Action Economics

Both of the key barometers of consumer psychology (Conference Board's Consumer Confidence Index and the Reuters/University of Michigan Consumer Sentiment Index) are highly sensitive, on a short-term basis, to stock market behavior and sharp swings in gasoline prices. Over a somewhat longer period, perceptions of the job market situation tend to be more influential in driving those measures. While it is true that job market conditions have improved markedly in recent months, they have not done so in a spectacular enough way, as evidenced by the near cycle-high unemployment rate of 9.9%, to fully justify the decidedly upbeat consumer attitudes that evidently overrun any anxiety associated with the recent stock market turmoil.

All in all, this means only one thing, that is that there has been a dramatic turnaround in the way the economic environment is perceived by households, and this fuels a sense of optimism and growing confidence in the future. It appears that consumers are less willing, at this point, to let significant short-term noise in the stock market shape their view of where the economy is headed. This speaks volumes of the credibility of the economic recovery's forward momentum- at least for as long as the global financial market anxiety does not transform itself in to a full-fledged crisis.

Looking ahead, and as the economic recovery unfolds further, the Consumer Confidence Index is bound to move much higher from its current, historically low, levels. However, the series may still suffer a modest pullback in June, particularly if the unsettled stock market environment persists. Furthermore, the University of Michigan Sentiment Index for the entire month of May (to be released Friday) may slip from its early-month reading of 73.3 to 72.0 or so, under pressure from the ongoing stock market erosion.

Anthony Karydakis

Friday, May 21, 2010

Long-term U.S. Treasury Yields: Reaching For a 2% Handle?

The massive rally that has pushed long-term Treasury yields lower by over 85 basis points (as of this writing) since early April has spectacularly confirmed the unique status of that market as a safe haven in periods of anxiety and global financial turmoil. It has also set into motion a dramatically different dynamic and created a new reality on the ground.

What started as a localized fiscal crisis of a small, profligate, eurozone economy (Greece) morphed quickly into a major debt crisis engulfing a number of the bloc's economies. The turmoil that was set off in an expanded part of the sovereign debt market universe has shaken the foundation of the euro as a currency, calling into question the momentum of the economic recovery in many countries. In such a precipitously deteriorating environment, equity markets have taken a major hit around the world, making U.S. Treasuries the obvious place to be.

In an attempt to offer a perspective as to where this new dynamic may be leading the Treasury market, a number of points need to be recognized:

1) The underlying reasons that triggered the powerful Treasury market rally in the last several weeks are unlikely to disappear any time soon and an appreciable risk exists that they may actually become broader in scope and/or intensify. Although the headline risk related to the eurozone fiscal crisis as such may follow an "ebb and flow" pattern, the factors currently supporting Treasuries are multiple and intertwined, at the core of which is essentially a major repricing of global risk.

This leads to #2.

2) Even if one of those factors were to "normalize" somewhat in the coming weeks (say, a partial rebound of the euro or equities), any resulting damage to Treasuries is unlikely to be severe enough to send yields back close to their levels prior to the start of this rally. This was actually validated- on a smaller scale- on Thursday this week, where a rebound of the euro from its previously reached 4-year low against the dollar did not prevent Treasuries from pushing ahead with a strong rally for the day.

In other words, the current yield levels are slowly gaining legitimacy, as a reflection of broader concerns about the outcome of the deeply unsettled state of global financial markets, and may no longer be closely influenced by any single factor.

This paves the way for #3.

3) The key issue of whether the current financial market turmoil will end up having actually a significant adverse impact on the U.S. economic recovery (a view we do not fully subscribe to, yet: will require time to be sorted out, one way or another. Until then, the Treasury market participants will probably find "room" to front-run the prospect of an economic slowdown, which should continue to underpin the market.

And this brings us to #4.

4) There is a clear element of asymmetry as to how the Treasury market is likely to react to the various economic releases in the period ahead. Solid economic data will probably tend to be downplayed on the grounds that they do not yet reflect the slower growth that the market is implicitly pricing in. (This is especially likely to be the case if the unsettled conditions in equities, the euro, and sovereign debt markets persist). However, unexpectedly weak economic data will be quickly be viewed as validating the underlying narrative that the pace of the recovery is cooling.

Against that backdrop, and with the 10-year yield having already in its sights the 3% mark, regaining a 2% handle for the first time since April of last year is now a reasonable probability. Further continuation of the Treasury rally should continue to be led by the long end, leading to additional curve flattening, with the 2s/10s spread compressed to the 235-240 basis points range. The front end's upside potential will continue to be restrained by the fact that, after all is said and done, the fed funds rate is already at zero and there is an exit strategy somewhere looming in the horizon.

Anthony Karydakis

Wednesday, May 19, 2010

April CPI: The Disinflationary Trend Remains Intact

The April CPI highlights dramatically the reality that the nearly two-year old disinflationary dynamic remains very much in place. Although the 0.1% decline in the overall index can be summarily brushed aside as the direct effect of noise related to energy prices for the month (-1.4%), the impressive part of the report is the behavior of the core component, which was flat in April. A 0.1% drop in the key housing category (42% of the overall CPI) and another sizable decline in apparel prices (-0.7%) were instrumental in producing the flat reading in the core index last month.

In fact, the core CPI has remained essentially flat in the last three months and is now up only 0.9% on a year-on-year basis. Putting it in a context, the series has now dipped below its year-on-year gain recorded in the prior distinct disinflation episode in the 2002-03 period, where it never fell below 1%.

The ongoing downtrend in core CPI in recent months is hardly surprising, given the very nature of inflation as a lagging indicator and the enormous amount of slack that has resulted from the severity of the 2007-09 recession. Despite the credible economic recovery under way, it is inconceivable to imagine any negotiating power by labor that would put any upward pressure on wages and salaries (and, by extension, the "services" part of the CPI that accounts for 60% of the index). Moreover, any increase in production costs associated with the rising commodity prices recently is quickly absorbed by manufacturers and retailers in the form of narrower profit margins.

On that score, it is telling of the near uniform absence of even a hint of upward price pressures that both the "services" and "commodities, ex. food and energy" parts of the CPI have been up by only 0.8% and 1.2% respectively from a year ago.

At the very minimum, the April CPI data continue to provide ample room for the Fed to delay the timing of implementing the process of rate hikes, until the economic recovery has picked up enough momentum and the absorption of the current slack is well under way. Despite any possible changes in the language of the FOMC statement over the next couple of meetings in relation to the "extended period" part, the working assumption should remain that any rate hike by the Fed prior to the end of the year is a very low probability outcome.

Anthony Karydakis

Monday, May 17, 2010

The Beleaguered Euro

To say that the euro is experiencing its most serious existential crisis since its inception is a pretty salient statement by now, given the barrage of media coverage in the last two months in the midst of the eurozone's intensifying fiscal debt crisis.

In that environment, talk of a possible break-up of the euro bloc's common currency is gathering steam, and the resulting strong downward pressures exerted on the currency pushed it briefly today to a 4-year low against the dollar. While a euro break-up is no longer in the realm of fiction and is gaining increasing legitimacy as a possible outcome, it is always helpful to put the entire issue and its implications into some context.

Four points need to be highlighted:

1) If the eurozone member countries prove ultimately unable to regain the credibility demanded by markets that they will manage to enforce a true convergence of fiscal policies among all member-countries moving forward, then a real risk exists that the euro may disintegrate as a currency. However, the stakes for all countries involved are much too high for such an outcome to occur without all other measures to rescue the common currency have been exhausted first. Already loud voices have been raised from the powers-that-be (Germany and France) in support of a more centralized mechanism of coordinating fiscal policies for all member countries of the bloc.

In other words, any breakup of the euro is unlikely to be the result of panic and disarray within the eurozone in the midst of a crisis, but rather the product of a very deliberate and time-consuming process by the member-countries involved. The issues that need to be sorted out by each country in any decision to revert to their original national currencies are complex and multidimensional (setting new exchange rates, sorting out the payments on existing debt denominated in euros, handling of outstanding international trade transactions and contracts, and so on) and they can not be made in a rush. So, any suggestion that a euro break-up is a plausible outcome in the next few months is totally unrealistic (as Goldman Sach's Chief Global Economist, Jim O'Neil, has also pointed out; see link

2) Perhaps, a more likely, but considerably less disruptive, outcome of the current crisis in the euro zone would be that, at some point, some of the weaker member-countries of the bloc are forced, via some indirect process that will need to be put in place, to abandon the euro. Still, this is not a likely solution in the midst of the current intense phase of the bloc's fiscal crisis, as it would tend to add fuel to the already raging fire. First, the bloc will need to put out the fire (that is, stabilize the dismal debt picture of many of its member countries) and, then, at a later point, deal with potentially more radical measures that might involve the expulsion of some countries.

3) Despite its precipitous decline in the last three months or so, the euro is not remotely close to its lowest level reached against the U.S. dollar since its inception. Such a level was reached in 2000-01 at approximately 0.82, while the euro today stands around 1.23 (but with an admittedly downward momentum in place). So, the current levels of the euro against the dollar are not alarming per se; it is simply the persistence and intensity of the sell off that bear close monitoring in the weeks ahead.

Source: ECB

4) Much has already been made about the likely adverse effect that the slower pace of economic growth in the eurozone ahead will have on the U.S. economy (as the direct result of more fiscal austerity measures adopted by most member countries for this year and next ). While it is true that more than $15 billion a month of U.S exports have as their destination a eurozone country and that such exports will suffer somewhat, it is important to remember the following:

a) The main driving engine of the U.S recovery in this phase remain the consumer, capital spending, and the inventory cycle. Net exports, which represent a relatively modest amount of overall GDP (about 12%) to begin with, are unlikely to constitute a major risk of derailing the U.S economic recovery. The slower pace of GDP growth in the eurozone may represent an additional moderate headwind for the U.S economy but, most probably, not a defining factor. b) Although most of the focus so far has been on the contractionary effect of fiscal austerity on growth in the eurozone countries, it is often unrecognized that a portion of that will be offset by stronger exports from the bloc- the direct benefit of a weaker currency.

Anthony Karydakis

Friday, May 14, 2010

Consumer Spending Has Good Momentum (and a note on Deutsche Bank's Payroll Forecast for May)

The implications of this morning's retail sales data can be summarized as follows:

a) The o.4% increase in both overall retail sales and ex-autos, suggests a healthy momentum of personal spending entering the second quarter and broadly lays the foundation for an annualized gain of 3 1/4-3 1/2% in consumption in the current period. This points to another solid pace of GDP growth in Q2, which, at this distance, is tracking in the 3 1/2 to 4% range.

b) The revisions to the previous few months of retail sales point to an upward revision to first quarter's pace of personal consumption to 3.8% from 3.6% initially reported. This should lead to an upward revision to Q1 GDP growth to 3.5 or 3.6% from the earlier estimate of 3.2%.

c) Combining the above two points, GDP growth is on a 3 3/4% or so track in the first half of 2010, validating the premise of a recovery moving ahead at a sound clip.

d) The consumer remains unfazed in the face of still rising home foreclosures, a stubbornly high unemployment rate, and ongoing tightness in bank lending standards.


Our friends at Deutsche Bank put out a research note yesterday, that has already circulated extensively, predicting a 475,000 nonfarm payroll gain for May. The forecast is based on the entirely reasonable assumption that- given the pattern of hiring observed in the 2000 Census- census workers are likely to show a spike of 250,000, and possibly, more, in May. Then, essentially, this leaves the private payroll gain at about 250,000 for the month, similar to the 231,000 increase in April.

The "warning" for the risk of a high nominal payroll print in May is fair and understandable, but, in a way, the "point" should be almost "pointless" for market participants, as every one's true focus in the last few months has been the ex-census number, which is instantaneously subtracted from the overall print at the moment the data are released. In reality, the attention that the sensible, and obvious, point made by the Deutsche Bank note yesterday, was much ado about nothing, as no one was going to take a census-bloated payroll number in May as anything other than what it is- an utterly immaterial piece of noise.

The only question that remains is whether a 225,000-250,000 private payroll gain is indeed in the cards for May and the answer to that, based on overall labor market trends lately, is a qualified yes.

Anthony Karydakis

Wednesday, May 12, 2010

The Budget Deficit Is Stabilizing

Despite the biggest monthly budget deficit on record reported for April ($82.7 billion), the fiscal situation appears to be slowly stabilizing; in fact, an argument can be made confidently that it is already turning the corner.

A direct comparison of last month's deficit with April 2009 is somewhat disheartening, as it represents a nearly $62 billion deterioration- the combined result of a 8% decline in revenue and a 14% increase in spending. On the revenue side, the weakness in individual tax receipts (-$30billion) far exceeded a $9 billion gain in corporate receipts. On the spending side, the increase in April was, to a large extent, artificial due to the acceleration of payments certain payments to April 30th from May 1st, due to the involvement of a weekend.

In the first seven months of the current fiscal year, the deficit has totaled $799.7 billion, essentially identical to the cumulative $802 billion deficit in the first seven months of fiscal 2009. But the steadily improving pace of economic activity and the quick rebound of the corporate sector underway are all setting the stage for relatively robust June and September tax payments, which should help solidify the picture of the overall deficit having turned the corner. Adding to the broader improving fiscal dynamic is the dwindling pieces of last year's fiscal stimulus spending program.

Although it does not sound like a development worth celebrating, the budget deficit is at this point on track to total $1.3 trillion this year, versus $1.42 trillion last year. The risk, if anything is that it may turn out to be slightly below the $1.3 trillion mark. In fact, such an outcome would be fully in line with the Congressional Budget Office's most recent forecast issued in January.

As a direct result of that improvement, the recently announced reductions in the size of the Treasury's 3- and 10-year note auctions are likely to be expanded to cover other coupon maturities by the end of the third quarter. However, given the Treasury's underlying bias to increase its reliance on longer-maturity debt, its slowly declining borrowing needs in the coming months are likely to be manifested primarily in the short end of the yield curve. By the end of the calendar year, the cuts in the size of all auctions will have become more aggressive, given a deficit that is currently projected to be smaller by as much as 1/3 in 2011 compared to the current fiscal year.

Anthony Karydakis

Friday, May 7, 2010

April Employment: Solid Evidence of a Labor Market Rebound

The April employment report ( provides further strong evidence that labor market conditions are turning around in a convincing manner.

Not only did ex-census nonfarm payrolls increased by a robust 224,000 last month (overall payroll gain of 290,000, including 66,000 census workers) but both March and February were revised upward for a net cumulative gain of 121,000. The direct implication of these numbers is that in the last two months, nonfarm payrolls, excluding census workers, have averaged a gain of 203,000- which is very close to what can reasonably be expected to represent the medium-term trend in payroll growth in this expansion.

Nonfarm Payrolls (monthly seasonally adjusted, incl. census workers)

Source: BLS

Adding credibility to the picture of steadily improving labor markets, the gains in the establishment survey were broad-based among the various categories: an apparently irrepressible manufacturing sector added another 44,000 jobs (third consecutive gain), retail trade 12,000 (also third consecutive gain), leisure and hospitality 45,000, education and health services 35,000, even the troubled construction industry generated 14,000 jobs following a 26,000 gain in March.

The average workweek for all employees inched higher again to 34.1 hours, validating a steady uptrend since the beginning of the year, and pointing to the sustainability of the latest pick up in hiring in the months ahead. The index of aggregate hours worked also rose a healthy 0.4%, replicating its gain in March.

The seemingly disappointing rise in the unemployment rate to 9.9% is actually the result of a 805,000 surge in the size of the civilian labor force that overran an impressive gain of 550,000 in household employment last month and caused the rate to increase.

The expansion of the labor force in the early phase of an economic expansion is a classic phenomenon and should be viewed as evidence that perceptions about the state of labor market conditions among prospective workers are improving quickly, motivating them to start looking for employment (and, therefore, be counted as part of the labor force again). Employment, as measured by the household survey has actually soared by a total of 814,000 in the last two months, despite its spectacular inability to make the unemployment rate move in a more encouraging direction. Still, as the distortions related to the interplay between labor force growth and employment in this phase of the cycle runs its course, the unemployment rate should be on a decisive downward trend in the second half of the year.

The labor market has convincingly turned the corner, inasmuch as, given the enormous slack that has been created by the depth of the last recession, such an improvement can never come fast enough. Payroll growth though is acquiring a respectable momentum and, as the residual caution of the business sector's hiring plans slowly subsides, the potential clearly exists for payroll gains to remain on a 200,000+ path later this year.

Anthony Karydakis

Wednesday, May 5, 2010

Spain and Friday's Employment Report: A connection

In the last several days, Spain has surpassed Portugal as the next most vulnerable country in the Eurozone, stepping into the eye of the fiscal storm that is sweeping the bloc.

This development, on the face of it, is somewhat counter-intuitive, as Spain's total debt stands at a relatively benign 55% of its GDP, making it a rarity within the Eurozone as a country that is still in compliance with the requirement that such a ratio not exceed 60% of GDP. However, that ratio is rising quickly for Spain and, given the large current and anticipated budget deficits over the next couple of years, is expected to approach 80% of its GDP by 2013.

Still, even such prospect would not be particularly ominous, if it weren't for two highly disturbing characteristics of the Spain situation. First, the reluctance of the Spanish government to implement so far aggressive fiscal austerity measures to convey a reassuring message to global financial markets. This is the direct result of the country's extremely limited room for maneuver in the midst of the current crisis, given an already exorbitantly high unemployment rate of over 20%. Imposing a credible fiscal austerity package would send the unemployment rate sharply higher, with potentially cataclysmic consequences of social unrest. Second, the dramatic spike in Spain's borrowing costs in recent days, raises the specter of the country finding itself soon unable to access capital markets at an acceptable cost and approaching the downhill path that Greece was forced to take.

Spain may be at the threshold of another downgrade by the ratings agencies, which could actually come as early as Friday, adding more fuel to the already raging fire in the Eurozone's sovereign debt crisis. It is after all the fourth biggest economy in the Eurozone, accounting for approximately 12% of its output. Spain is not Greece and the entire fiscal crisis in the Eurozone may well be entering a new phase, if Spain finds itself effectively shut out of sovereign bond market financing.

All of this brings us squarely to Friday's employment report in the U.S.

Depending on the headlines on the Spain (and, to a somewhat lesser degree, Portugal) debt front by Friday, the U.S. Treasury market's response to April's nonfarm payroll data may deviate appreciably from the more "traditional" one. This means that the typically adverse reaction to a potentially above-consensus, "ex-census", payroll number may be mitigated by any negative developments on Spain's debt status. A deteriorating situation in Spain may well keep European sovereign bond and equity markets on the defensive, providing a bid for Treasuries that can overrun, or moderate, the natural instincts of the market to sell off on a strong employment report.

If the payroll report is underwhelming, as hinted at by the ADP number today (which, itself though, needs to be viewed somewhat cautiously, given its generally poor correlation with nonfarm payrolls) and Spain continues to slide over the next 48 hours, then the U.S. Treasury market may be set up for a potent rally, breaking through the lower end of its yield range since the beginning of the year.

Anthony Karydakis

Monday, May 3, 2010

The Trouble With the Savings Rate

In the flurry of economic reports released this morning, one particular piece of data received relatively attention: the decline of the personal savings rate to 2.7% in March.


Although the Q1 GDP report last Friday had already shown a drop in the savings rate to 3.1% for the entire quarter- from 3.9% in the prior two quarters and a cycle-high of 5.4% in Q2 2009- this morning's drop to the lowest monthly level in 18 months is a telling development.

The decline in the savings rate in March confirms a downward trajectory in the series over the last six to nine months and validates the earlier suspicion that the spike in the rate around the middle of 2009 was largely a reflection of circumstantial factors- namely, income transfers related to the fiscal stimulus, and a more defensive approach of households in the midst of a deepening recession.

As personal consumption started coming alive in the second half of last year and reached a robust annualized rate of 3.2% in the first quarter of 2010, the savings rate has been steadily drifting lower, gravitating again toward the disappointingly low 2.0 to 2.5% range that had prevailed for the better part of the last 10 years. The downtrend in the rate dispels any hopes expressed in some quarters last year that a new paradigm of an overall higher savings rate may be emerging, which, although it might act as a headwind for the fledgling recovery, would tend to correct one of the major imbalances in the U.S. economy in the last two decades.

At the time, we had expressed reservations as to whether a deeply entrenched into the psyche of the American consumer culture of spending was about to enter a truly new, more prudent phase ( Inasmuch as the savings rate is a notoriously revisable series (often after many years following the originally released data) it now appears that with the increasing recognition of an improving economic environment, consumers are slowly reverting to past habits, the only redeeming value of the latter being that they are helping to solidify spending and the impetus of the recovery at this juncture.

Anthony Karydakis