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TJ Marta is Founder and Chief Market Strategist of Marta on the Markets, LLC. He is Editor and Publisher of the daily Morning Minute and a regular contributor to the Overnight Express. TJ is a respected strategist and speaker with more than 20 years of Wall Street and business experience. TJ has... More
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Marta on the Markets LLC
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Forex Analysis and Trading: Effective Top-Down Strategies Combining Fundamental, Position and Technical Analysis
  • The Economic Recovery is Here; the Real Problem is Financing 0 comments
    Nov 9, 2009 07:23 PM
    US data show ongoing recovery
     
    The vast majority of the data announced last week either beat expectations or at least pointed to an expanding economy. Manufacturing, housing, autos and the consumer all turned in impressive gains in important measures. In the manufacturing arena, the ISM beat expectations, jumping to its highest level since Apr’06 – before the recession started. Factory orders rose 0.9%m/m, well above the 0.1% average since Jan’00. The news on the services sector was a bit less rosy, as the ISM actually slipped from 50.9 to 50.6, while the consensus was for a gain to 51.5. However, the level is no longer recessionary, and the trend remains up. In the housing sector, pending home sales surged yet again in Sep, jumping 6.1% in another sign that buyers were attempting to move ahead of the expiration of the homebuyer assistance program (which has since been extended). As to autos, total sales for Oct jumped much more than expected, to 10.45m overall and 7.94m for domestic vehicles, suggesting that despite the distortion of cash for clunkers in the Aug figures, sales have likely bottomed and are forming an uptrend. Finally, consumer spending is showing signs of at least normalizing, as chain store sales rose 2.1%y/y, roughly equal to the long-term average of 2.11% since Jan’00.
     
    The labor data remains weak, but given that they are lagging indicators, the weakness does not make a case for worries about the economic recovery, and the trends in the various series are showing improvement. The ADP employment and non-farm payrolls reports both provided better than expected results due to upward revisions in the prior data. Initial jobless claims fell to 512K, a low since January. Unfortunately, the unemployment rate jumped 0.4 percentage points from 9.8 to 10.2%, a high since 1983.
     
     
    The Fed remains dovish
     
    The Fed not only left the Fed Funds rate on hold, but also retained the message that the rate would be kept exceptionally low “for an extended period”. The FOMC statement pointed specifically to “low rates of resource utilization, subdued inflation trends, and stable inflation expectations” as justifying its rate stance. These variables can be described through a variety of measures, and so we looked at a few ways to consider when the bank might begin tightening.
     
    For rates of resource utilization, consider the unemployment rate and capacity utilization. Since Greenspan took over the Fed, the bank has not begun hiking the target rate until the unemployment rate began falling, and the consensus of economists is that the unemployment rate will peak sometime during Q1’10. As to capacity utilization, the bank has not begun hiking until that percentage reaches between 77% and 82%. Currently, capacity utilization stands at 70.5%. The various trajectories that the rise in utilization has taken in past cycles suggest that the first Fed hike will take place in Apr’10 at the earliest.
     
    As to inflation trends, consider the core PCE y/y and core PPI y/y rate. In the four most recent tightening cycles, core PCE inflation had begun rising in only two cases (1986 and 2004). However, in only one case was the core PCE inflation rate below 2% (1999). Currently core inflation is at 1.3% and declining. The economist consensus is for core PCE inflation to bottom at 1.2% in Q2’10 and not reach 2.0% during 2010. As to the core PPI inflation rate, in only one of the previous four tightening cycles was inflation rising at the beginning of the hiking cycle (2004), but in three of the four cases, core PPI inflation was above 1.5%y/y (the exception was 1994). Currently, core PPI inflation is falling but stands at 1.8%.
     
    Regarding inflation expectations, consider the 5yr ahead expectations from the U. Mich. Consumer survey and the 5yr TIPs breakeven yields. The U. Mich. expectations are 2.9%, still below to 3-3.4% readings in place during 2005 to 2008. The TIPs breakeven yield stands at 1.59%, below the 1.91% high for 2009 and the long-term average of 1.97%. These time series support the Fed’s characterization of expectations as stable.
     
    In light of the above considerations, we see no reason to alter our view that the absolute earliest we can expect the Fed to begin hiking rates is Apr’10.
     
     
     
    The real problem is financing
     
    At the private entity level, the Great Deleveraging continues apace.
     
    The FDIC shuttered another 5 banks this past weekend, bring the total for 2009 to 120. Consumer credit fell by another $15bn in Sep, driving the total loss in credit since Aug’08 to $126bn. And the obvious reason for the decline is that bank lending remains anemic. Commercial bank loan and lease assets did manage to rise in the week ended Oct28 from $6.685tn to $6.697tn, the first increase since May, but the trend remains down and the level is near that last observed in Nov’07.
     
    The government is levering up, apparently oblivious to limits on funding availability
     
    Saturday, the House of Representatives passed a healthcare reform bill that will cost $1tn. Lawmakers hailed the bill as a historic follow up on the 1965 creation of Medicare. They apparently did not see, or believe investors can’t see, the irony that they are layering more government costs on a Medicare system that is already unsustainable. Separately, FNMA reported a Q3 loss of $18.9bn and stated that it required another $15bn in taxpayer funds to keep it solvent. The government sponsored agency has suffered combined losses of $56bn. State and local pensions are also in trouble, with the US Census Bureau reporting that assets at the major public employee retirement system totaled $2.2tn as of Jun’30, down from $2.9tn as of Dec’31, 2007. Orin Kramer of New Jersey’s Investment Council opined last week that 1) the shortfall could not be recouped by aggressive investments, 2) the shortfall would limit access of public entities to bond markets, and 3) that the shortfall would most likely have to be covered by a federal government guarantee.
     
     
    More bearish developments for sovereign debt prospects
     
    The idea that government largess can be funded by simply having the US Treasury issue debt is highly troubling. The Fed has now discontinued its purchases of US Treasuries, and so the demand curve for US Treasuries has shifted bearishly. Another ominous demand development for sovereign debt issuers was purchase by India’s central bank of 200 metric tons of gold from the IMF. The purchase drove the price of gold to a record level in terms of the Indian rupee and very close to a new record in US$ terms. Moreover, the purchase increased perceptions that central banks would increase their holdings of reserves in gold rather than sovereign debt of other countries.
     
    Unfortunately, the supply curve is also shifting bearishly, not only because of increased US Treasury issuance, but also greater issuance from other entities. Market anecdotes early last week suggested that issuance of state bonds by California had a negative impact on the Treasury market. But the competition for bond buyers is not limited to the US debtors. Russia is planning to tap the international bond market for the first time since it defaulted on its sovereign debt back in 1998. Last week, Ambrose Evans-Pritchard of the UK Telegraph wrote an article decrying the fiscal state of Japan, noting that the country’s $1.5tn state pension fund had to turn to net selling of JGBs for the first time in order to fund obligations to the aging populace. Furthermore, the IMF predicts that Japan’s gross public debt will increase from the current 218% to 246% by 2014. The IMF also projects that by 2014, G20 general government debt as a percent of GDP will reach 118.4%, up from 98.9% in 2009 and 78.2% in 2007 (pre-crisis).
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