With Treasury yields standing essentially at their lows for the year, having declined by over 50 basis points in the long end over the last four weeks, the obvious question that emerges now is "what happens next?".
A few thoughts on this topic.
1) Although the Treasury market rally can be extended further under a certain set of circumstances, revisiting the post-Lehman low of nearly 2% for the 10-year (reached in December 2008) should not be viewed as the odds-on bet at this point. At the time, the driving forces that caused the 10-year briefly flirt with the 2% mark were pervasive fears that another Great Depression was around the corner, with deflation and a possible meltdown of the global financial system to boot. The realization that those outcomes were not likely to materialize caused a very sharp back-up in yields in the first quarter of 2009, the point being that such extraordinary low yield levels are of questionable sustainability and can be reached only as a result of a certain alignment of special factors at work simultaneously.
The current environment is fundamentally different, inasmuch as there are still some scattered voices promoting a double-dip story and there is a fairly cool-headed debate as to how elevated the deflation risk truly is. Against that backdrop, the Treasury market rally has been largely fueled by the loss of momentum in the economic recovery over the last few months, the ensuing pullback in equity prices, and the broader perception that Treasuries remain a safe haven for global investors even in the midst of a relative calm on the European sovereign debt front recently. In other words, there are sound, legitimate reasons sustaining this rally, but the intensity of those driving forces is no match for those prevailing in the fourth quarter of 2008.
Based on the above, Treasury yields may find it hard to penetrate the 2 1/4% or so barrier (10-year) in the foreseeable future. To do so successfully, the market will need some new favorable developments, most likely of the "headline" type, to provide fresh impetus to the rally.
2) It is admittedly not a uniquely insightful statement to make that the extension of the rally from these levels can only mean one thing: a further flattening of the curve. This is so because most of the price action over the coming weeks is bound to be concentrated in the outer part of the curve, given the very limited room for improvement in the front end against a 15-20 basis point fed funds rate and no prospect of a change there as far as the eye can see. (It is also important to keep in mind here that the possible implementation of any additional quantitative easing measures by the Fed is unlikely to have any direct, material impact on the fed funds rate itself). In that context, a continuation of the rally is tantamount to a clean piercing of the current 200 basis points spread in 2s/10s, probably headed for the 185-195 bp range.
3) At these levels, the market is quite vulnerable to any upside surprises in the August payroll data on Friday (say, private payrolls +70K), or a more resilient ISM on Wednesday (holding up around 55.0), or another sharp decline in initial claims (-25K or so) on Thursday. Any such data, or combination of those reports, would start raising the prospect that the soft patch is waning and the pace of economic activity may be regaining its footing, causing a loss of momentum in the rally as the market takes a step back.
As is always the case, the employment data can cut both ways in terms of its impact on the market and, a distinctly weak report, can provide the new impetus that the Treasury market rally needs to march on. A decline of more than 25,000 in private payrolls, with a little changed unemployment rate, and moderate downward revisions to the previous two months' numbers can certainly make the 10-year set its sights on the 2 1/4% mark
Anthony Karydakis
Tuesday, August 31, 2010
Friday, August 27, 2010
Bernanke At Jackson Hole
Here's some thoughts on Mr. Bernnake's much-anticipated speech at Jackson Hole this morning (http://www.federalreserve.gov/newsevents/speech/bernanke20100827a.htm).
1) His outlook for economic activity remains cautiously optimistic. This view is based on a combination of factors: ongoing repair of household balance sheets (as reflected in the higher savings rate), the corporate sector sitting on a lot of cash that can be gradually deployed for capital spending projects, and the continuing underpinning to growth from an exceedingly accommodative monetary policy moving forward). None of this sounds like an unreasonable premise. On the whole, we agree with his assessment that "preconditions for a pick up in growth in 2011 appear to remain in place". The term "double-dip" was conspicuously not mentioned at all, not even as a hypothetical risk that he does not envision.
2) He cast the Fed's recent decision to reinvest the proceeds of maturing MBS securities in its portfolio in coupon Treasuries as a defensive move designed to "avoid an undesirable passive tightening of policy that might have otherwise occurred". This is actually a fully accurate description of the recent Fed action, as it is essentially targeting the maintenance of the status quo in monetary policy and not the implementation of further accommodation.
3) Directly related to the above point is the realization- which seems to have flown mostly under the market's radar screen so far- that the weaker the pace of economic activity turns out to be over the coming months, the more aggressive the Fed's purchases of Treasuries are going to be, without any other change in Fed policy. This is so, because the further downward drift in rates that will result from any further weakening of economic activity will trigger a higher pace of mortgage refinancing activity and an accelerating rate of redemption in the Fed's MBS portion of its portfolio. Therefore, any further slowing in economic activity ahead will set into motion two powerful engines pushing long-term Treasury yields yields lower and causing a further flattening of the curve: the perception of a softening economy with the associated rising deflation risk plus the pick-up in the pace of Treasury purchases by the Fed.
4) Inasmuch as he discussed, in a fairly balanced fashion, the various pros and cons of some of the additional accommodative policy measures the Fed can consider in the future, he left no doubt that, if the pace of economic activity continues to degrade and the deflation risk is rising, the Fed will take additional action. At this point, he stated that there is no decision by the FOMC to activate any of the other possible such measures (increase the net size of the Fed portfolio, reducing the interest paid on bank excess reserves, or provide a specific time frame committing to a near zero rate policy in the FOMC statements).
Anthony Karydakis
1) His outlook for economic activity remains cautiously optimistic. This view is based on a combination of factors: ongoing repair of household balance sheets (as reflected in the higher savings rate), the corporate sector sitting on a lot of cash that can be gradually deployed for capital spending projects, and the continuing underpinning to growth from an exceedingly accommodative monetary policy moving forward). None of this sounds like an unreasonable premise. On the whole, we agree with his assessment that "preconditions for a pick up in growth in 2011 appear to remain in place". The term "double-dip" was conspicuously not mentioned at all, not even as a hypothetical risk that he does not envision.
2) He cast the Fed's recent decision to reinvest the proceeds of maturing MBS securities in its portfolio in coupon Treasuries as a defensive move designed to "avoid an undesirable passive tightening of policy that might have otherwise occurred". This is actually a fully accurate description of the recent Fed action, as it is essentially targeting the maintenance of the status quo in monetary policy and not the implementation of further accommodation.
3) Directly related to the above point is the realization- which seems to have flown mostly under the market's radar screen so far- that the weaker the pace of economic activity turns out to be over the coming months, the more aggressive the Fed's purchases of Treasuries are going to be, without any other change in Fed policy. This is so, because the further downward drift in rates that will result from any further weakening of economic activity will trigger a higher pace of mortgage refinancing activity and an accelerating rate of redemption in the Fed's MBS portion of its portfolio. Therefore, any further slowing in economic activity ahead will set into motion two powerful engines pushing long-term Treasury yields yields lower and causing a further flattening of the curve: the perception of a softening economy with the associated rising deflation risk plus the pick-up in the pace of Treasury purchases by the Fed.
4) Inasmuch as he discussed, in a fairly balanced fashion, the various pros and cons of some of the additional accommodative policy measures the Fed can consider in the future, he left no doubt that, if the pace of economic activity continues to degrade and the deflation risk is rising, the Fed will take additional action. At this point, he stated that there is no decision by the FOMC to activate any of the other possible such measures (increase the net size of the Fed portfolio, reducing the interest paid on bank excess reserves, or provide a specific time frame committing to a near zero rate policy in the FOMC statements).
Anthony Karydakis
Tuesday, August 24, 2010
The Opening Rift Within the Fed
Today's front page article in The Wall Street Journal (http://online.wsj.com/article/SB10001424052748703589804575446262796725120.html?KEYWORDS=Fed)
on the divergence of opinions within the Fed regarding the recent decision to prevent the gradual shrinking of its mortgage portfolio by reinvesting such proceeds in Treasuries, highlights a key undercurrent of the debate over this issue: that is, whether there is much the central bank can do at this point to prop up the struggling economic recovery.
The skepticism that was expressed by some FOMC members as to whether the Fed should proceed with the adoption of that measure at its most recent meeting was ostensibly based on the wisdom of assuming the risks implied by such action. The risks in question were not, at this stage, related to the injection of any additional liquidity into the system, but more to the implied message of lack of confidence that the Fed was expressing in the economic recovery's prospects. A directly associated risk was the perception that the Fed might be creating that this can be the prelude toward a second wave of asset purchases if the economic recovery continues to limp in the foreseeable future.
Perhaps underlying the skepticism as to the wisdom of proceeding with the announcement of the latest measure at the FOMC meeting is the premise that, after all, such steps are unlikely to make a real difference in reinvigorating economic activity. In other words, the unspoken message here is that a number of monetary policymakers do not essentially believe that there is much that the Fed can do to influence the direction of economic activity and any additional steps at this point are fraught mostly with risk and have no likely benefit.
The above is a view that we also share and have expressed in a recent article in this space (http://economistscorner.blogspot.com/2010_07_15_archive.html) but is one that is extremely difficult to be acknowledged by the Fed in public. It would be a highly problematic affair for a major central bank to openly state that there is not much left that it can do to jump-start a decidedly underwhelming economic recovery. It is in that context we should see the Fed's recent decision to reinvest the proceeds of maturing MBS securities in Treasuries and any other additional measure that may be announced in the coming months. It is more a reluctance to publicly acknowledge that its arsenal has been nearly depleted and that it will require quite some time until the economy and financial market conditions have fully healed from the highly traumatic experience of the last three years.
As Mr. Bernanke remains under steadily building pressure to show responsiveness to the recent "soft patch", he cannot afford total inaction, particularly if the upcoming stream of economic data remains unmistakably soft. As a result, the possibility of additional nominal measures by the Fed cannot be dismissed. However, such a course of action will, at the same time, almost guarantee a widening schism within the Fed and the opponents of that path are likely to become increasingly vocal. A taste of that became already apparent today with comments by Dallas Fed President Fisher, where he expressed skepticism as to whether the Fed will achieve anything with the new action it announced at the August 10 meeting or is simply "pushing on a string".
Mr. Bernanke has a very fine line indeed to walk on, between maintaining a posture of a Fed capable of still influencing the course of economic activity and causing a bigger rift within the institution that, at some point, can spill out into the open.
Anthony Karydakis
on the divergence of opinions within the Fed regarding the recent decision to prevent the gradual shrinking of its mortgage portfolio by reinvesting such proceeds in Treasuries, highlights a key undercurrent of the debate over this issue: that is, whether there is much the central bank can do at this point to prop up the struggling economic recovery.
The skepticism that was expressed by some FOMC members as to whether the Fed should proceed with the adoption of that measure at its most recent meeting was ostensibly based on the wisdom of assuming the risks implied by such action. The risks in question were not, at this stage, related to the injection of any additional liquidity into the system, but more to the implied message of lack of confidence that the Fed was expressing in the economic recovery's prospects. A directly associated risk was the perception that the Fed might be creating that this can be the prelude toward a second wave of asset purchases if the economic recovery continues to limp in the foreseeable future.
Perhaps underlying the skepticism as to the wisdom of proceeding with the announcement of the latest measure at the FOMC meeting is the premise that, after all, such steps are unlikely to make a real difference in reinvigorating economic activity. In other words, the unspoken message here is that a number of monetary policymakers do not essentially believe that there is much that the Fed can do to influence the direction of economic activity and any additional steps at this point are fraught mostly with risk and have no likely benefit.
The above is a view that we also share and have expressed in a recent article in this space (http://economistscorner.blogspot.com/2010_07_15_archive.html) but is one that is extremely difficult to be acknowledged by the Fed in public. It would be a highly problematic affair for a major central bank to openly state that there is not much left that it can do to jump-start a decidedly underwhelming economic recovery. It is in that context we should see the Fed's recent decision to reinvest the proceeds of maturing MBS securities in Treasuries and any other additional measure that may be announced in the coming months. It is more a reluctance to publicly acknowledge that its arsenal has been nearly depleted and that it will require quite some time until the economy and financial market conditions have fully healed from the highly traumatic experience of the last three years.
As Mr. Bernanke remains under steadily building pressure to show responsiveness to the recent "soft patch", he cannot afford total inaction, particularly if the upcoming stream of economic data remains unmistakably soft. As a result, the possibility of additional nominal measures by the Fed cannot be dismissed. However, such a course of action will, at the same time, almost guarantee a widening schism within the Fed and the opponents of that path are likely to become increasingly vocal. A taste of that became already apparent today with comments by Dallas Fed President Fisher, where he expressed skepticism as to whether the Fed will achieve anything with the new action it announced at the August 10 meeting or is simply "pushing on a string".
Mr. Bernanke has a very fine line indeed to walk on, between maintaining a posture of a Fed capable of still influencing the course of economic activity and causing a bigger rift within the institution that, at some point, can spill out into the open.
Anthony Karydakis
Friday, August 20, 2010
Next Week's Treasury Supply
The Fed's decision last week to start reinvesting the proceeds of its maturing MBS securities in Treasuries has triggered a significant rally in the government securities market with a sharp flattening of the yield curve- both entirely predictable developments.
In assessing today's yield levels, lower by nearly 30 basis points in the 10-year sector (and by about 35 basis points in the case of the long bond) since August 9, it is tempting to argue that the market may feel somewhat vulnerable ahead of next week's 2-, 5-, and 7-year auctions. After all, the three auctions represent a combined total of $102 billion of supply (supplemented by another $6 billion of a re-opened 30-year TIPS auction on Monday).
Still, that temptation should probably be resisted, for three reasons.
1) Supply per se has rarely been a factor that alters the direction of a trend in yields; it can cause hiccups, but not change the underlying dynamic of a potent move. The latter, in this case, is fueled by the sensible perception of a cooling momentum in the economic recovery. The economic data on next week's calendar are quite unlikely to challenge that perception, as existing/new home sales and durable goods orders are notoriously noisy and any unexpected strength in those reports is likely to be viewed cautiously and produce only a very limited reaction. Friday's University of Michigan consumer sentiment index is simply the final number for August and highly unlikely to deviate appreciably from its early-month reading of 69.6. This leaves us with initial claims, which, given their current level of 500,000, should be expected to show a decline of 15,000 to 20,000 anyway- a fairly uneventful development.
2) With the market's state of mind about a downshifting in economic growth likely to remain intact next week, the current yield levels can still be viewed as reasonably attractive, particularly for the 5- and 7-year sectors (although admittedly less so for the 2-year at 48 basis points). Despite the dramatic flattening of the curve since the day prior to the FOMC announcement, the 5- to 7-year sector remains attractive on a carry basis (roughly 120 and 180 basis points respectively over their financing costs). The cushion is substantial enough to absorb any backup of the market in the coming weeks associated with either a headline risk or a wickedly strong key economic report. Both maturities should continue to be underpinned in the coming weeks by their status at the center of the Fed's newly activated reinvestment program of its maturing MBS holdings.
3) With the plain vanilla carry trade already appealing in its own right, continuation of the recent stream of soft economic reports can keep the debate over deflation and/or a "double dip" scenario alive and cause the rally to be extended further, making the 7-year sector, in particular, well positioned (along with 10s) to capture that move.
Nervous as one always feels about a market going into heavy supply nearly at its highs, it is hard to come up with solid arguments about a meaningful back up in yields (not of the simple hiccup kind) that would make those who bought next week's auctions regret it in the next few weeks.
Anthony Karydakis
In assessing today's yield levels, lower by nearly 30 basis points in the 10-year sector (and by about 35 basis points in the case of the long bond) since August 9, it is tempting to argue that the market may feel somewhat vulnerable ahead of next week's 2-, 5-, and 7-year auctions. After all, the three auctions represent a combined total of $102 billion of supply (supplemented by another $6 billion of a re-opened 30-year TIPS auction on Monday).
Still, that temptation should probably be resisted, for three reasons.
1) Supply per se has rarely been a factor that alters the direction of a trend in yields; it can cause hiccups, but not change the underlying dynamic of a potent move. The latter, in this case, is fueled by the sensible perception of a cooling momentum in the economic recovery. The economic data on next week's calendar are quite unlikely to challenge that perception, as existing/new home sales and durable goods orders are notoriously noisy and any unexpected strength in those reports is likely to be viewed cautiously and produce only a very limited reaction. Friday's University of Michigan consumer sentiment index is simply the final number for August and highly unlikely to deviate appreciably from its early-month reading of 69.6. This leaves us with initial claims, which, given their current level of 500,000, should be expected to show a decline of 15,000 to 20,000 anyway- a fairly uneventful development.
2) With the market's state of mind about a downshifting in economic growth likely to remain intact next week, the current yield levels can still be viewed as reasonably attractive, particularly for the 5- and 7-year sectors (although admittedly less so for the 2-year at 48 basis points). Despite the dramatic flattening of the curve since the day prior to the FOMC announcement, the 5- to 7-year sector remains attractive on a carry basis (roughly 120 and 180 basis points respectively over their financing costs). The cushion is substantial enough to absorb any backup of the market in the coming weeks associated with either a headline risk or a wickedly strong key economic report. Both maturities should continue to be underpinned in the coming weeks by their status at the center of the Fed's newly activated reinvestment program of its maturing MBS holdings.
3) With the plain vanilla carry trade already appealing in its own right, continuation of the recent stream of soft economic reports can keep the debate over deflation and/or a "double dip" scenario alive and cause the rally to be extended further, making the 7-year sector, in particular, well positioned (along with 10s) to capture that move.
Nervous as one always feels about a market going into heavy supply nearly at its highs, it is hard to come up with solid arguments about a meaningful back up in yields (not of the simple hiccup kind) that would make those who bought next week's auctions regret it in the next few weeks.
Anthony Karydakis
Wednesday, August 18, 2010
Tracking the Recovery: Not All News Is Bad
With the momentum of the economic recovery having slowed visibly since late spring, the spotlight has remained consistently on the overall dispiriting tone of the various economic reports. The bond market's rally, the latest leg of which was fueled by the Fed's decision to re-invest the proceeds of its maturing MBS securities in Treasuries, has been based on the premise that the cooling of economic activity can be appreciable. Inevitably, some errand, but misguided, predictions of a "double dip" scenario have emerged as well.
In that environment, with the market focused almost single-mindedly on the downshifting in the pace of economic growth, it is easy to miss some low-key positive signals suggesting that things may actually be stabilizing. Two such pieces of information have, in fact, emerged since the beginning of the week that portend constructively for the underlying trajectory of the recovery.
The first such report was the Fed's Senior Loan Officers Survey conducted in July that showed that "on net, banks had eased standards and terms over the previous three months on loans in some categories". The survey included 57 domestic banks and 23 U.S. branches and agencies of foreign banks. In a key part of its summary conclusions, the report states that "Domestic survey respondents reported having eased standards and most terms of C&I loans to firms of all sizes, a move that continues a modest unwinding of the widespread tightening that occurred over the past few years. Moreover, this is the first survey that has shown an easing of standards on C&I loans to small firms since late 2006".
This is a potentially very significant shift taking place on the bank lending standards front that may start removing one of the major roadblocks for the fledgling economic recovery. Inasmuch as the survey also found that most of that improvement is concentrated at large domestic banks, versus smaller banks or U.S. branches of foreign institutions, its importance cannot be underestimated for its likely impact on both consumer and capital spending- and, by extension, the overall economic recovery- over the coming quarters.
Granted, that actual lending activity will naturally be a function of demand for such credit in the first place, and the survey found little change on that side of the equation in the latest period- presumably a reflection of lack of confidence of the business sector in the trajectory of the economic recovery. Differently put, easing of credit standards by banks is a necessary but not sufficient condition for robust business expansion plans and household spending. However, it represents an undoubtedly crucial positive development, following an approximately 3 1/2-year period during which the tightening of bank lending standards had become an albatross around the economy's neck.
The second encouraging report this week was the sharp increase in July's industrial production (+1.0%), which included a 1.1% surge in manufacturing output. While it is true that the latter benefited greatly from a 14.5% spike in vehicle production (largely the result of the industry's decision not to proceed with the seasonal shutdowns in July for retooling), the real value of the reports lies elsewhere.
Output of business equipment, a key category in manufacturing, rose an impressive 1.8% last month, following solid gains in the prior four months. Such strength demonstrates that there is still decent momentum left in manufacturing, despite the waning inventory cycle dynamic. The implication here is that the strong comeback of capital spending in the first half of the year (17% annualized in Q2, following a 7.8% increase in Q1) appears to be pushing ahead in Q3, representing one of the key pillars of growth for the recovery in the coming quarters.
Anthony Karydakis
In that environment, with the market focused almost single-mindedly on the downshifting in the pace of economic growth, it is easy to miss some low-key positive signals suggesting that things may actually be stabilizing. Two such pieces of information have, in fact, emerged since the beginning of the week that portend constructively for the underlying trajectory of the recovery.
The first such report was the Fed's Senior Loan Officers Survey conducted in July that showed that "on net, banks had eased standards and terms over the previous three months on loans in some categories". The survey included 57 domestic banks and 23 U.S. branches and agencies of foreign banks. In a key part of its summary conclusions, the report states that "Domestic survey respondents reported having eased standards and most terms of C&I loans to firms of all sizes, a move that continues a modest unwinding of the widespread tightening that occurred over the past few years. Moreover, this is the first survey that has shown an easing of standards on C&I loans to small firms since late 2006".
This is a potentially very significant shift taking place on the bank lending standards front that may start removing one of the major roadblocks for the fledgling economic recovery. Inasmuch as the survey also found that most of that improvement is concentrated at large domestic banks, versus smaller banks or U.S. branches of foreign institutions, its importance cannot be underestimated for its likely impact on both consumer and capital spending- and, by extension, the overall economic recovery- over the coming quarters.
Granted, that actual lending activity will naturally be a function of demand for such credit in the first place, and the survey found little change on that side of the equation in the latest period- presumably a reflection of lack of confidence of the business sector in the trajectory of the economic recovery. Differently put, easing of credit standards by banks is a necessary but not sufficient condition for robust business expansion plans and household spending. However, it represents an undoubtedly crucial positive development, following an approximately 3 1/2-year period during which the tightening of bank lending standards had become an albatross around the economy's neck.
The second encouraging report this week was the sharp increase in July's industrial production (+1.0%), which included a 1.1% surge in manufacturing output. While it is true that the latter benefited greatly from a 14.5% spike in vehicle production (largely the result of the industry's decision not to proceed with the seasonal shutdowns in July for retooling), the real value of the reports lies elsewhere.
Output of business equipment, a key category in manufacturing, rose an impressive 1.8% last month, following solid gains in the prior four months. Such strength demonstrates that there is still decent momentum left in manufacturing, despite the waning inventory cycle dynamic. The implication here is that the strong comeback of capital spending in the first half of the year (17% annualized in Q2, following a 7.8% increase in Q1) appears to be pushing ahead in Q3, representing one of the key pillars of growth for the recovery in the coming quarters.
Anthony Karydakis
Friday, August 13, 2010
Uneventful CPI and Retail Sales Data for July
While neither the retail sales nor the CPI data for July produced any surprises, they offer, in a low-key kind of fashion, a somewhat reassuring overall message that can be summarized as follows: despite concerns about a retrenchment in personal spending recently, consumption is not pulling back in a particularly ominous way, while the pace of the disinflationary process may be losing some steam.
The 0.4% increase in last month's retail sales was broadly in line with expectations and was largely boosted by a 1.6% surge in auto sales and a 2.3% spike in gas station sales- both items that are not usually considered as a credible indication of underlying consumer spending trends. In the last three months, total retail sales are up a fairly respectable 5.9% over the same three-month period in 2009, a comparison that admittedly benefits from the distinctly weak state of the economy in the first half of last year.
The more meaningful measure of retail sales, and the one that enters directly the GDP calculations is total sales less autos, building materials, and gas station sales. That measure edged lower by 0.1% in July, its third decline in the last four months.
Still, unimpressive as these numbers admittedly are, they remain consistent with growth rates of about 2 1/2-2 3/4% in both personal spending and GDP for the third quarter.
The 0.3% rise in the July CPI was entirely due to a 2.6% increase in energy prices (with gasoline prices, in particular, up 4.6% for the month), the first increase of that component since January. The energy category accounted for 2/3 of the gain in the overall CPI last month. Outside food and energy, the core index rose by a trend-like 0.1%, leaving its year-over-year increase unchanged at 0.9%.
The recent string of impressive monthly gains in used cars and trucks prices continued in July, with that component rising by 0.8%, following gains of 0.9% and 0.6% in the previous two months alone. On a year-over-year basis, used cars and trucks are up a stunning 17% and remain an important reason for which the disinflationary process in both the overall and core CPI has not been even more intense in the course of the last year
In a possible sign that the disinflationary dynamic may in fact be in the process of cooling somewhat, the shelter component (accounting for 30% of the overall CPI) rose 0.1% in July, its third consecutive such increase.
Anthony Karydakis
The 0.4% increase in last month's retail sales was broadly in line with expectations and was largely boosted by a 1.6% surge in auto sales and a 2.3% spike in gas station sales- both items that are not usually considered as a credible indication of underlying consumer spending trends. In the last three months, total retail sales are up a fairly respectable 5.9% over the same three-month period in 2009, a comparison that admittedly benefits from the distinctly weak state of the economy in the first half of last year.
The more meaningful measure of retail sales, and the one that enters directly the GDP calculations is total sales less autos, building materials, and gas station sales. That measure edged lower by 0.1% in July, its third decline in the last four months.
Still, unimpressive as these numbers admittedly are, they remain consistent with growth rates of about 2 1/2-2 3/4% in both personal spending and GDP for the third quarter.
The 0.3% rise in the July CPI was entirely due to a 2.6% increase in energy prices (with gasoline prices, in particular, up 4.6% for the month), the first increase of that component since January. The energy category accounted for 2/3 of the gain in the overall CPI last month. Outside food and energy, the core index rose by a trend-like 0.1%, leaving its year-over-year increase unchanged at 0.9%.
The recent string of impressive monthly gains in used cars and trucks prices continued in July, with that component rising by 0.8%, following gains of 0.9% and 0.6% in the previous two months alone. On a year-over-year basis, used cars and trucks are up a stunning 17% and remain an important reason for which the disinflationary process in both the overall and core CPI has not been even more intense in the course of the last year
In a possible sign that the disinflationary dynamic may in fact be in the process of cooling somewhat, the shelter component (accounting for 30% of the overall CPI) rose 0.1% in July, its third consecutive such increase.
Anthony Karydakis
Wednesday, August 11, 2010
Five Points On The Fed Announcement
There's a number of comments that need to be made regarding the Fed's announcement yesterday that it will start reinvesting principal payments from its mortgage portfolio in longer-dated Treasuries.
1) The amount of such proceeds is probably in the $250 billion range in the course of the next 12 months, but its exact size can vary appreciably from that number as it will depend on changes in the current prepayment rate of the mortgage portfolio. If the rally that was set off yesterday afternoon in the long end of the Treasury market has legs and MBS spreads over Treasuries remain tight, then the amount that the Fed will have available for reinvestment can quickly rise to $300 billion, or possibly higher.
2) There is no explicit promise by the Fed that this program will remain in effect over a full 12-month period ahead, but a reasonable assumption is that it probably will, as it allows for a gradual return of the Fed's portfolio to the normal "Treasuries only" content. However, if at any point along the way, the mortgage market shows evidence of serious strain as a result of the Fed's actions, then the program could be either slowed or suspended, as the Fed can hardly afford to destabilize a market that had only recently started healing from a highly traumatic experience in the previous couple of years. Any such mid-course correction in the Fed's plans would obviously result in a smaller total amount of Treasury purchases than the "penciled-in" $250 billion number above.
3) The reinvestment of the proceeds of maturing mortgages in coupon Treasury securities will be roughly in like with the overall lengthening of the duration of the Fed's Treasury portfolio, which currently stands at approximately 7 years from 3 1/2-years that prevailed in the pre-crisis period. However, no further extension of that duration is likely, as for that to happen the Fed would need to be buying exclusively 10-year paper- which is a highly unlikely prospect. In fact, the average duration of the Treasury portfolio may shorten very slightly, as a result, over the coming months.
4) Inasmuch as the average duration of its Treasury holdings will not be altered dramatically from its current level, the implication of those additional purchases ahead is that, when the moment down the road comes for the Fed to actually start shrinking its overall portfolio, there will be a more massive amount of selling of longer-dated coupon securities. It is reasonable to argue that this, viewed in a vacuum, would have a steepening effect on the Treasury curve. However, such sales intended to shrink the Fed's overall portfolio would by definition be taking place in an environment where the Fed is finally implementing its exit strategy, that is to say, tightening. As a result, the curve at that time would be coming under severe flattening pressure and the massive sales of the Fed's longer-dated Treasury portfolio would probably act more as a factor mitigating the degree of such curve flattening rather then cause an outright steepening per se.
5) All in all, the Fed's decision to gradually shift the composition of its overall portfolio away from MBS is arguably one of the least dramatic, or disruptive, measures that could have been adopted in response to the recent loss of momentum in the economic recovery. Its true effectiveness in helping the economy is very much an open question, once the Treasury market's initial reaction and front-running of the announcement plays out. But it allows the Fed to deflect the steadily growing pressure in recent weeks to show some responsiveness to the softer economic data on the ground, while quietly working toward restoring at least a more normal composition in its portfolio holdings.
Anthony Karydakis
Tuesday, August 10, 2010
The Dark Side of Productivity
Nonfarm business productivity declined 0.9% in Q2, following an upward revised gain of 3.9% in the first quarter; on a year-on-year basis, the series is up also 3.9%. Given that the productivity numbers are notoriously volatile on a quarterly basis, year-on-year comparisons should generally be viewed as more valuable.
Productivity usually rises sharply in the early phase of the business cycle, reflecting the sharp adjustments to the business sector's operational costs during a recession. This is a typical phenomenon that is described by the term "cyclical" productivity gains to differentiate it from the longer-term, "secular" trends of that measure.
Inasmuch as it is a much desired outcome for any economy to experience strong productivity gains of either kind (while, admittedly, the secular gains are generally considered more important), the flip side of robust productivity increases is that it represents an impediment to job growth. The concept here is that businesses can produce the same amount of output with less production resources- labor being a key such input.
So, against that backdrop, the views expressed last Friday by the head of the National Bureau of Economic Research, Robert Hall, that the slow pace of job creation may simply reflect strong productivity gains (http://www.bloomberg.com/news/2010-08-06/nber-s-hall-says-faltering-jobs-data-don-t-imply-another-u-s-recession.html) merits serious consideration.
The average productivity gain in the last five quarters (including the presumed last quarter of the recession in Q2 2009 and the first four quarters of the economic recovery since then) has been a stellar 4.9%, compared to gains of 3.7% in the comparable periods associated with the previous two recessions (2001 and 1990-91). One can argue that this was, to some degree, to be expected, given the severity of the last recession that may have led to somewhat stronger productivity efficiencies. Still, even if there is something to this argument, it does little to change the basic problem that the robust rise in productivity in recent quarters is an obstacle to a faster pace of job growth.
The trouble is that the above argument cannot be fully validated in real time, given that the productivity series is famously revised, often quite substantially, a long time after the quarterly data are released. The benchmark revisions of the series can sometimes alter very materially previously perceived productivity patterns. As a result, some caution would be prudent here before any unconditional adoption of this argument. However, with apparently solid productivity gains underway and private payroll growth frustratingly slow but not negligible, there is very little space open for any double-dip scenario to materialize.
Anthony Karydakis
Productivity usually rises sharply in the early phase of the business cycle, reflecting the sharp adjustments to the business sector's operational costs during a recession. This is a typical phenomenon that is described by the term "cyclical" productivity gains to differentiate it from the longer-term, "secular" trends of that measure.
Inasmuch as it is a much desired outcome for any economy to experience strong productivity gains of either kind (while, admittedly, the secular gains are generally considered more important), the flip side of robust productivity increases is that it represents an impediment to job growth. The concept here is that businesses can produce the same amount of output with less production resources- labor being a key such input.
So, against that backdrop, the views expressed last Friday by the head of the National Bureau of Economic Research, Robert Hall, that the slow pace of job creation may simply reflect strong productivity gains (http://www.bloomberg.com/news/2010-08-06/nber-s-hall-says-faltering-jobs-data-don-t-imply-another-u-s-recession.html) merits serious consideration.
The average productivity gain in the last five quarters (including the presumed last quarter of the recession in Q2 2009 and the first four quarters of the economic recovery since then) has been a stellar 4.9%, compared to gains of 3.7% in the comparable periods associated with the previous two recessions (2001 and 1990-91). One can argue that this was, to some degree, to be expected, given the severity of the last recession that may have led to somewhat stronger productivity efficiencies. Still, even if there is something to this argument, it does little to change the basic problem that the robust rise in productivity in recent quarters is an obstacle to a faster pace of job growth.
The trouble is that the above argument cannot be fully validated in real time, given that the productivity series is famously revised, often quite substantially, a long time after the quarterly data are released. The benchmark revisions of the series can sometimes alter very materially previously perceived productivity patterns. As a result, some caution would be prudent here before any unconditional adoption of this argument. However, with apparently solid productivity gains underway and private payroll growth frustratingly slow but not negligible, there is very little space open for any double-dip scenario to materialize.
Anthony Karydakis
Friday, August 6, 2010
Employment Picture: Frustrating But Not Totally Dismal
This morning's employment report was to a large extent uneventful and, as such, provided very little new insight into the underlying dynamic of the labor market.
While the unwinding of 143,000 Census workers dragged the headline payroll number down (-131,000), private payrolls rose by 71,000, which is roughly consistent with the number that the ADP survey on Wednesday would have suggested for July. One discouraging element in the data was the fairly substantial downward revision to June's private payrolls from an initially reported gain of 83,000 to an increase of only 31,000.
The implication of that downward revision is that in the first seven months of the year, private payrolls have now increased by 630,000, bringing their average monthly gain to 90,000 versus an average increase of 100,000 that was the case in the first six months of the year prior to this morning's release. Supporting the broader picture of a downshifting in the pace of economic activity in late spring is the fact that two thirds of the total increase in private payrolls so far this year took place in March and April.
Manufacturing jobs turned out a solid gain last month (+36,000) but they benefited considerably from fewer seasonal layoffs in the auto industry, the latter accounting for 21,000 of those jobs. A modest bright spot in the data was a small gain in retail jobs following sizable declines in the previous few months. However, given rising uneasiness expressed in recent days about back-to-school sales, it will be interesting to see whether a reversal in that jobs category is in order for this month.
The battered state and local governments shed a combined 48,000 jobs in July, underscoring the reality that the dismal state of their finances continues to represent a headwind for the prospect of an acceleration in both job creation and overall economic growth over the next few quarters.
A 0.1% gain the average workweek for all private employees to 34.2 hours helps maintain the series at the upper end of its range for the cycle, holding out the promise of a pick up in the pace of hiring in the coming months.
The unchanged unemployment rate at 9.5% was the result of relatively proportionate declines in both the size of the civilian labor force (-181,000) and household employment (-159,000) for the month. Given the current trajectory of job growth, and allowing for a modest improvement later in the year, the unemployment rate is on track to end the year around 9 1/4%, broadly in line with the Fed's most recently revised forecasts.
By failing to provide any surprises to the upside that would reinvigorate expectations of a significant pick up in the pace of hiring ahead, the employment report tended to solidify the perception of an economic recovery unable to build any measurable momentum, and it may have actually lost some in the late spring-early summer period. However, there is a need to maintain the sharp distinction between such an admittedly disappointing reality and the talk that has resurfaced recently about a double-dip scenario.
As we have argued before, the latter scenario remains a highly unlikely outcome, and, in our article yesterday in this space, we showed that, recent history suggests, that it takes considerably longer than just one year following the end of a recession for job growth to show any major acceleration (http://economistscorner.blogspot.com/2010/08/dispelling-misconception-about-payroll.html). Against that measure, the current pace of payroll growth is not particularly out of the ordinary for this phase of the economic recovery.
Anthony Karydakis
While the unwinding of 143,000 Census workers dragged the headline payroll number down (-131,000), private payrolls rose by 71,000, which is roughly consistent with the number that the ADP survey on Wednesday would have suggested for July. One discouraging element in the data was the fairly substantial downward revision to June's private payrolls from an initially reported gain of 83,000 to an increase of only 31,000.
The implication of that downward revision is that in the first seven months of the year, private payrolls have now increased by 630,000, bringing their average monthly gain to 90,000 versus an average increase of 100,000 that was the case in the first six months of the year prior to this morning's release. Supporting the broader picture of a downshifting in the pace of economic activity in late spring is the fact that two thirds of the total increase in private payrolls so far this year took place in March and April.
Manufacturing jobs turned out a solid gain last month (+36,000) but they benefited considerably from fewer seasonal layoffs in the auto industry, the latter accounting for 21,000 of those jobs. A modest bright spot in the data was a small gain in retail jobs following sizable declines in the previous few months. However, given rising uneasiness expressed in recent days about back-to-school sales, it will be interesting to see whether a reversal in that jobs category is in order for this month.
The battered state and local governments shed a combined 48,000 jobs in July, underscoring the reality that the dismal state of their finances continues to represent a headwind for the prospect of an acceleration in both job creation and overall economic growth over the next few quarters.
A 0.1% gain the average workweek for all private employees to 34.2 hours helps maintain the series at the upper end of its range for the cycle, holding out the promise of a pick up in the pace of hiring in the coming months.
The unchanged unemployment rate at 9.5% was the result of relatively proportionate declines in both the size of the civilian labor force (-181,000) and household employment (-159,000) for the month. Given the current trajectory of job growth, and allowing for a modest improvement later in the year, the unemployment rate is on track to end the year around 9 1/4%, broadly in line with the Fed's most recently revised forecasts.
By failing to provide any surprises to the upside that would reinvigorate expectations of a significant pick up in the pace of hiring ahead, the employment report tended to solidify the perception of an economic recovery unable to build any measurable momentum, and it may have actually lost some in the late spring-early summer period. However, there is a need to maintain the sharp distinction between such an admittedly disappointing reality and the talk that has resurfaced recently about a double-dip scenario.
As we have argued before, the latter scenario remains a highly unlikely outcome, and, in our article yesterday in this space, we showed that, recent history suggests, that it takes considerably longer than just one year following the end of a recession for job growth to show any major acceleration (http://economistscorner.blogspot.com/2010/08/dispelling-misconception-about-payroll.html). Against that measure, the current pace of payroll growth is not particularly out of the ordinary for this phase of the economic recovery.
Anthony Karydakis
Thursday, August 5, 2010
Dispelling a Misconception About Payroll Growth
Here's some important historical information regarding the behavior of payroll growth in the past, against which tomorrow's employment report should be evaluated.
One of the most constant complaints about the current economic recovery is that it has failed to generate enough job creation that would inspire greater confidence in the growth trajectory ahead. The hard numbers though question the validity of that perception head-on.
Irrespective of which month precisely the NBER will declare as representing the end of the latest recession, it is a fair expectation to have that it will most likely be the middle of last year (somewhere between June and August). This means that we are already about a year into this economic recovery. In the last six months (January through June 2010), private payroll growth has averaged 100,000 a month, a fairly reasonable pace but clearly below where we would like that number to be when the economic recovery finally reaches the point of operating on all cylinders.
In the first year of economic recovery following the previous two recession, job growth did not fair nearly as well compared to the current situation. In the second six-month period of the first year following the end of 2001 recession, private payrolls averaged approximately -9,000 (compared to the above mentioned 100,000 average monthly gain in the comparable period for the current recovery). Furthermore, if we consider the early phase of the economic recovery that followed the July 1990-March 1991 recession, private payroll growth during the second six-month period of that first year was -27,000.
Private Payroll Growth (monthly, 1982-June 2010)
Source: Bureau of Labor Statistics
Another critical part of that comparison is that, in the economic recoveries that followed both the 1990-91 and 2001 recessions, it took 3 to 4 years for the pace of private payroll growth to reach its peak pace (300,000+ a month in the first case and approximately 200,000+ in the second one) . While it is true that the experience with the labor market dynamic was quite different following the 1981-82 recession, when both the economy and private payroll growth roared ahead in 1983, no one has ever argued that the current economic recovery was meant to be compared with what is arguably one of the most impressive economic recoveries in modern history (that is, the one that followed the 1981-82 recession).
The message here is, that despite the frustration with the unimpressive pace of job creation so far, that pace is far superior to the one associated with the economic recoveries in the last two decades. It is also often missed, in the midst of such frustration, that, often, it does take a period considerably longer than a single year for the machine of job creation to get into full gear following a recession.
Differently put, by historical standards, there is nothing particularly wrong with the pace of employment growth in this recovery.
Anthony Karydakis
One of the most constant complaints about the current economic recovery is that it has failed to generate enough job creation that would inspire greater confidence in the growth trajectory ahead. The hard numbers though question the validity of that perception head-on.
Irrespective of which month precisely the NBER will declare as representing the end of the latest recession, it is a fair expectation to have that it will most likely be the middle of last year (somewhere between June and August). This means that we are already about a year into this economic recovery. In the last six months (January through June 2010), private payroll growth has averaged 100,000 a month, a fairly reasonable pace but clearly below where we would like that number to be when the economic recovery finally reaches the point of operating on all cylinders.
In the first year of economic recovery following the previous two recession, job growth did not fair nearly as well compared to the current situation. In the second six-month period of the first year following the end of 2001 recession, private payrolls averaged approximately -9,000 (compared to the above mentioned 100,000 average monthly gain in the comparable period for the current recovery). Furthermore, if we consider the early phase of the economic recovery that followed the July 1990-March 1991 recession, private payroll growth during the second six-month period of that first year was -27,000.
Private Payroll Growth (monthly, 1982-June 2010)
Source: Bureau of Labor Statistics
Another critical part of that comparison is that, in the economic recoveries that followed both the 1990-91 and 2001 recessions, it took 3 to 4 years for the pace of private payroll growth to reach its peak pace (300,000+ a month in the first case and approximately 200,000+ in the second one) . While it is true that the experience with the labor market dynamic was quite different following the 1981-82 recession, when both the economy and private payroll growth roared ahead in 1983, no one has ever argued that the current economic recovery was meant to be compared with what is arguably one of the most impressive economic recoveries in modern history (that is, the one that followed the 1981-82 recession).
The message here is, that despite the frustration with the unimpressive pace of job creation so far, that pace is far superior to the one associated with the economic recoveries in the last two decades. It is also often missed, in the midst of such frustration, that, often, it does take a period considerably longer than a single year for the machine of job creation to get into full gear following a recession.
Differently put, by historical standards, there is nothing particularly wrong with the pace of employment growth in this recovery.
Anthony Karydakis
Monday, August 2, 2010
The Message From the July ISM
The modest decline in the July ISM for manufacturing to 55.5 from 56.2 was hardly surprising, given the somewhat erratic tone of the other three regional manufacturing surveys so far (Philly Fed. Empire State, Chicago). Still it renders itself to a few observations.
Source: Bloomberg, Haver Analytics
The index, although it has retreated in the last few months from its cycle peak of 60.2 in April, remains at historically healthy levels. In fact, the mid-50s range for the ISM is decidedly above the levels that prevailed for the series in the two-year period of 2006-07 prior to the recession.
Some pullback from the spring levels was nearly inevitable, as the inventory replenishment cycle in the manufacturing sector is winding down. It is also true that a much-publicized pick-up in auto production in the last three months may have helped cushion the ISM's retrenchment during that period, in the wake of the waning push from inventories. So, as auto production has already probably peaked, the behavior of the series in the next couple of months could be quite telling of the remaining underlying momentum in manufacturing.
On that score, our expectation is that the ISM will probably dip a little lower into the fall months to the 53.0-54.0 area, as it will receive some support from the seemingly stronger than previously anticipated growth in Europe. The key point is that ISM levels in that range should still be viewed as consistent with a healthy manufacturing sector and an economic recovery plowing ahead.
Anthony Karydakis
Source: Bloomberg, Haver Analytics
The index, although it has retreated in the last few months from its cycle peak of 60.2 in April, remains at historically healthy levels. In fact, the mid-50s range for the ISM is decidedly above the levels that prevailed for the series in the two-year period of 2006-07 prior to the recession.
Some pullback from the spring levels was nearly inevitable, as the inventory replenishment cycle in the manufacturing sector is winding down. It is also true that a much-publicized pick-up in auto production in the last three months may have helped cushion the ISM's retrenchment during that period, in the wake of the waning push from inventories. So, as auto production has already probably peaked, the behavior of the series in the next couple of months could be quite telling of the remaining underlying momentum in manufacturing.
On that score, our expectation is that the ISM will probably dip a little lower into the fall months to the 53.0-54.0 area, as it will receive some support from the seemingly stronger than previously anticipated growth in Europe. The key point is that ISM levels in that range should still be viewed as consistent with a healthy manufacturing sector and an economic recovery plowing ahead.
Anthony Karydakis
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