May 10, 2005
GOING, GOING, GONE...
The Capital Spectator has moved to CapitalSpectator.com Please make a note of our new address. This site will no longer be updated, nor will subscriptions made on this site continue to work. Please resubscribe on our new site. Thanks!
The Capital Spectator has moved to CapitalSpectator.com Please make a note of our new address. This site will no longer be updated, nor will subscriptions made on this site continue to work. Please resubscribe on our new site. Thanks!
May 09, 2005
WE'RE FROM THE GOVERNMENT AND WE'RE HERE TO HELP YOU...REVALUE YOUR CURRENCY
Some in the United States believe that letting the Chinese yuan find its true value in the foreign exchange market will deliver a quick boon to America’s economy. Perhaps. But there’s reason for doubt.
Embedded in the optimists’ notion is the presumption that the yuan is undervalued by way of Beijing’s “manipulations,” otherwise known as a peg of one dollar to 8.28 yuan that’s prevailed since 1995. Opening up this corner of forex to the light of free trade will satisfy certain members of Congress and more than a few industries that have previously taken it on the chin in competing with the Middle Kingdom. We’re all for free trade and fair prices, to the extent forex can actually deliver on such promises, but one should always go into such constructs with eyes wide open.
That starts with recognizing that there may be a few downsides looming in a sudden upward revaluation of the yuan, at least from the perspective of the U.S. Consider the possibility that if this currency strategy comes to fruition, a result may be that one of the main sources of U.S. imports these days will effectively raise its prices by strengthening its currency. Given the Federal Reserve’s growing concern with inflation, one might reasonably wonder if revaluing the yuan upward, under pressure from the U.S. government, and thereby adding that much more pressure to already rising import prices passes the smell test as enlightened economic policy at this juncture.
Enlightened or not, the powers that be in Washington want a stronger yuan. Reuters reports that the U.S. Treasury seems to be moving China’s central bank forward in terms of favorably reviewing a revaluation scheme. A meeting between Chinese officials and the representatives from Treasury is the catalyst for such thinking in the latest news cycle. "[The Chinese] have made continuous, steady progress on the necessary reforms to introduce flexibility," Treasury spokesman Tony Fratto said today. "They've made continued progress on their ability to do that. Along that continuum they've made sufficient progress to introduce flexibility now. And yes, this meeting furthered that."
Treasury Secretary John Snow weighed in on the subject as well, advising, “I don't have a timetable for it, but I'm encouraged that the Chinese have made enormous strides to put in place improvements to their financial system that will'' pave the way for the yuan to become more flexible, Snow said, according to Bloomberg News.
Sounds like they’re reading from a talking points memo. But whether the comments are inspired or not, the philosophical assumptions for thinking that a floating yuan is a short-cut to curing America’s various macroeconomic ills is misguided. Or so asserts Steven Hanke, a professor at Johns Hopkins University and a longtime observer of forex, in an op-ed piece in today’s Wall Street Journal (subscription required.) Similar currency schemes were tried with the Japanese yen in the 1980s, and with little to show for it, Hanke advises along with his co-author Michael Connolly, a professor at the University of Miami.
“The clamor for a yuan revaluation is loud. At one time or another, everyone from President Bush to the G-7 has had a hand in the noisemaking,” Hanke and Connolly write. “But the yuan quick fix might just be neat, plausible and wrong.” What’s more, killing the peg probably wouldn’t shrink the U.S. trade deficit, they warn, the true motivation for trying to get China to revalue. “After a yuan revaluation, the U.S. demand for foreign goods would simply be shifted from China to other countries.”
Free markets, in short, can be a double-edged sword. Perhaps someone should tell the folks in Treasury, and the U.S. Congress.
Some in the United States believe that letting the Chinese yuan find its true value in the foreign exchange market will deliver a quick boon to America’s economy. Perhaps. But there’s reason for doubt.
Embedded in the optimists’ notion is the presumption that the yuan is undervalued by way of Beijing’s “manipulations,” otherwise known as a peg of one dollar to 8.28 yuan that’s prevailed since 1995. Opening up this corner of forex to the light of free trade will satisfy certain members of Congress and more than a few industries that have previously taken it on the chin in competing with the Middle Kingdom. We’re all for free trade and fair prices, to the extent forex can actually deliver on such promises, but one should always go into such constructs with eyes wide open.
That starts with recognizing that there may be a few downsides looming in a sudden upward revaluation of the yuan, at least from the perspective of the U.S. Consider the possibility that if this currency strategy comes to fruition, a result may be that one of the main sources of U.S. imports these days will effectively raise its prices by strengthening its currency. Given the Federal Reserve’s growing concern with inflation, one might reasonably wonder if revaluing the yuan upward, under pressure from the U.S. government, and thereby adding that much more pressure to already rising import prices passes the smell test as enlightened economic policy at this juncture.
Enlightened or not, the powers that be in Washington want a stronger yuan. Reuters reports that the U.S. Treasury seems to be moving China’s central bank forward in terms of favorably reviewing a revaluation scheme. A meeting between Chinese officials and the representatives from Treasury is the catalyst for such thinking in the latest news cycle. "[The Chinese] have made continuous, steady progress on the necessary reforms to introduce flexibility," Treasury spokesman Tony Fratto said today. "They've made continued progress on their ability to do that. Along that continuum they've made sufficient progress to introduce flexibility now. And yes, this meeting furthered that."
Treasury Secretary John Snow weighed in on the subject as well, advising, “I don't have a timetable for it, but I'm encouraged that the Chinese have made enormous strides to put in place improvements to their financial system that will'' pave the way for the yuan to become more flexible, Snow said, according to Bloomberg News.
Sounds like they’re reading from a talking points memo. But whether the comments are inspired or not, the philosophical assumptions for thinking that a floating yuan is a short-cut to curing America’s various macroeconomic ills is misguided. Or so asserts Steven Hanke, a professor at Johns Hopkins University and a longtime observer of forex, in an op-ed piece in today’s Wall Street Journal (subscription required.) Similar currency schemes were tried with the Japanese yen in the 1980s, and with little to show for it, Hanke advises along with his co-author Michael Connolly, a professor at the University of Miami.
“The clamor for a yuan revaluation is loud. At one time or another, everyone from President Bush to the G-7 has had a hand in the noisemaking,” Hanke and Connolly write. “But the yuan quick fix might just be neat, plausible and wrong.” What’s more, killing the peg probably wouldn’t shrink the U.S. trade deficit, they warn, the true motivation for trying to get China to revalue. “After a yuan revaluation, the U.S. demand for foreign goods would simply be shifted from China to other countries.”
Free markets, in short, can be a double-edged sword. Perhaps someone should tell the folks in Treasury, and the U.S. Congress.
May 06, 2005
SEEING IS BELIEVING
The bond market's been reluctant to see the world through Fed-colored glasses of late, which is to say glasses that see monetary tightening as salvation from encroaching inflation. But after today's jobs report for April, the fixed-income set is starting to focus on the world as seen by the central bank.
A dramatically stronger-than-expected rise in nonfarm payrolls has the power to move otherwise immovable perceptions. The dismal scientists were calling for something on the order of a gain of 175,000 in nonfarm employment for April; the actual number rolled in materially higher at 274,000, reports the Labor Department. That's in the upper range for monthly gains in recent years.
There's more than just a strong number here. The payroll gain for April raises fresh questions about whether the weaker-than-expected first-quarter GDP report was a fluke. Indeed, the bond market took no small measure of confidence last month from the news that the economy rose at 3.1% during January through March of this year as opposed to the 3.8% logged in the previous quarter. The bond ghouls, of course, live for weak economies since that drives up the prices of bonds, which in turns drives yields down. That, in short, is nirvana in fixed-income land.
But nirvana for fixed-income traders has been put on hold. How long is anyone's guess, but optimism took a breather today. Accordingly, the yield on the benchmark 10-year Treasury shot higher, closing out the session at roughly 4.26%, the highest since April 26. Some discouraged bond investors even started mumbling that 1Q GDP revision scheduled for release on May 26 may be headed back up close to 4%.
Meanwhile, another observer captured the spirit of the day in an interview with Reuters, suggesting in so many words that yesterday's assumptions once again are destined for the circular file. "So much for soft spots, unless you think it is possible to create 700,000 jobs in the past three months and not have a solid economy," economist Joel Naroff of Naroff Economic Advisors said.
But with employment momentum rolling along, the question of what that means for inflation, and the Fed's next FOMC meeting on June 30, is back to center stage. The bond market understands that—once again, as does Kurt Brunner, a money manager with the Swarthmore Group in West Chester, Pa. "We like to see job growth, but now questions about inflation are going to be more front and center,'' he told Bloomberg News today. The Fed will "continue to tighten a little bit so that may mean it's still kind of a difficult road for stocks."
Perhaps, although by the standard of today's action in stocks Mr. Market's not quite sure what to make of the muscular employment picture in April. Indeed, the S&P 500 slipped ever so slightly today while the Nasdaq Composite inched higher.
But move on to where? Junk bonds, perhaps, which were clearly unimpressed with today's jobs report. The yield on the KDP High Yield Index rose by the smallest of margins on Friday, adding one basis point to 7.63%. The 337-basis-point spread over the 10-year, as a result, remains largely unchanged, albeit after rising sharply over the last two months from around 200 basis points in mid-March.
Indeed, the widening spread was the byproduct of the elevation in the KDP yield and the decline in the 10-year Treasury's yield. Did junk know something that Treasury traders didn't? If so, does today's calm reaction in the high-yield market signal that the storm in government bonds is over?
Definitive answers remain elusive in the here and now, but fresh clues for making slightly more educated guesses are just around the corner. That includes next week's trade balance report for March, one of the searing numbers of late among economic releases. When we last visited with this variable, the U.S. was in the red on international trade to the tune of -$61.036 billion for February—an all-time monthly low.
The dollar, it seems, is expecting something more favorable when the trade balance report hits the streets on Monday. Indeed, the U.S. Dollar Index jumped sharply today, putting the gauge within shouting distance of its 2005's highs. Of course, the dollar's strength of late is also a reaction to rising interest rates generally, including the fact that Fed funds at 3% represents a sizable premium in recent history relative to the equivalent 2% rate for the European Central Bank. And then there's today's impressive jobs report for April, which no doubt inspired more than a few dollar bulls too.
The dollar's strength, in short, is now being fueled by rising interest rates and a strong jobs reports. How long can such trends last? Good question, although an even more pressing one might unfold as follows: What are the investment implications if that combo does in fact persist? Jay Suskind, head trader at Ryan Beck & Co., was thinking along those lines when he bared his financial soul today to AP via BusinessWeek:
The bond market's been reluctant to see the world through Fed-colored glasses of late, which is to say glasses that see monetary tightening as salvation from encroaching inflation. But after today's jobs report for April, the fixed-income set is starting to focus on the world as seen by the central bank.
A dramatically stronger-than-expected rise in nonfarm payrolls has the power to move otherwise immovable perceptions. The dismal scientists were calling for something on the order of a gain of 175,000 in nonfarm employment for April; the actual number rolled in materially higher at 274,000, reports the Labor Department. That's in the upper range for monthly gains in recent years.
There's more than just a strong number here. The payroll gain for April raises fresh questions about whether the weaker-than-expected first-quarter GDP report was a fluke. Indeed, the bond market took no small measure of confidence last month from the news that the economy rose at 3.1% during January through March of this year as opposed to the 3.8% logged in the previous quarter. The bond ghouls, of course, live for weak economies since that drives up the prices of bonds, which in turns drives yields down. That, in short, is nirvana in fixed-income land.
But nirvana for fixed-income traders has been put on hold. How long is anyone's guess, but optimism took a breather today. Accordingly, the yield on the benchmark 10-year Treasury shot higher, closing out the session at roughly 4.26%, the highest since April 26. Some discouraged bond investors even started mumbling that 1Q GDP revision scheduled for release on May 26 may be headed back up close to 4%.
Meanwhile, another observer captured the spirit of the day in an interview with Reuters, suggesting in so many words that yesterday's assumptions once again are destined for the circular file. "So much for soft spots, unless you think it is possible to create 700,000 jobs in the past three months and not have a solid economy," economist Joel Naroff of Naroff Economic Advisors said.
But with employment momentum rolling along, the question of what that means for inflation, and the Fed's next FOMC meeting on June 30, is back to center stage. The bond market understands that—once again, as does Kurt Brunner, a money manager with the Swarthmore Group in West Chester, Pa. "We like to see job growth, but now questions about inflation are going to be more front and center,'' he told Bloomberg News today. The Fed will "continue to tighten a little bit so that may mean it's still kind of a difficult road for stocks."
Perhaps, although by the standard of today's action in stocks Mr. Market's not quite sure what to make of the muscular employment picture in April. Indeed, the S&P 500 slipped ever so slightly today while the Nasdaq Composite inched higher.
But move on to where? Junk bonds, perhaps, which were clearly unimpressed with today's jobs report. The yield on the KDP High Yield Index rose by the smallest of margins on Friday, adding one basis point to 7.63%. The 337-basis-point spread over the 10-year, as a result, remains largely unchanged, albeit after rising sharply over the last two months from around 200 basis points in mid-March.
Indeed, the widening spread was the byproduct of the elevation in the KDP yield and the decline in the 10-year Treasury's yield. Did junk know something that Treasury traders didn't? If so, does today's calm reaction in the high-yield market signal that the storm in government bonds is over?
Definitive answers remain elusive in the here and now, but fresh clues for making slightly more educated guesses are just around the corner. That includes next week's trade balance report for March, one of the searing numbers of late among economic releases. When we last visited with this variable, the U.S. was in the red on international trade to the tune of -$61.036 billion for February—an all-time monthly low.
The dollar, it seems, is expecting something more favorable when the trade balance report hits the streets on Monday. Indeed, the U.S. Dollar Index jumped sharply today, putting the gauge within shouting distance of its 2005's highs. Of course, the dollar's strength of late is also a reaction to rising interest rates generally, including the fact that Fed funds at 3% represents a sizable premium in recent history relative to the equivalent 2% rate for the European Central Bank. And then there's today's impressive jobs report for April, which no doubt inspired more than a few dollar bulls too.
The dollar's strength, in short, is now being fueled by rising interest rates and a strong jobs reports. How long can such trends last? Good question, although an even more pressing one might unfold as follows: What are the investment implications if that combo does in fact persist? Jay Suskind, head trader at Ryan Beck & Co., was thinking along those lines when he bared his financial soul today to AP via BusinessWeek:
"Today's report comes in, it surprises to the upside, and now the thought isn't about an economic soft patch. Now, we're thinking about interest rates, and that puts the Federal Reserve back in play. We've got oil higher, and we're fearful of the Fed dampening the party. So you got good news today, but it comes with drawbacks."
May 05, 2005
RETHINKING THE 10,950-DAY MATURITY FOR TREASURIES
Last month, the U.S. Treasury announced that Savings Bonds would no longer pay a variable rate. Now we hear that the defunct 30-year Treasury Bond (which was scratched several years ago when the everyone thought the government would run a budget surplus) may be making a timely (or should we say untimely?) return.
Maybe we're a bit sensitive, but this seems like one more signal to sell bonds. Indeed, the Treasury doesn't make such decisions without a reason. The only question: what's the reason?
In weighing the potential contenders we keep coming back to the subject of inflation. Indeed, why would the government suddenly want to sell you longer-term maturities debt instruments? Or take away the variable-rate option on savings bonds, for that matter? Because it thinks that inflation and interest rates are going down? If you believe that, you're on the short list to buy swampland in Arizona.
Then again, that's the Capital Spectator's take on the credit markets in the here and now, and that's a take that doesn't necessarily reflect the bond market proper. In fact, ours seems to be a view that's in direct contrast with fixed-income traders, to judge by today's action in the benchmark 10-year Treasury Note.
If you thought that today's news that 30-year Treasuries may be making a comeback would frighten the bond market into selling, you thought wrong. The yield on the 10-year slipped a bit today, which is to say that traders were buying the 10-year. With a current yield of roughly 4.15%, a 10-year Treasury, while not exactly priced for perfection, is still very much trading on the expectation that the future holds favorable news on the inflation front. Namely, inflation will remain "contained," to quote the Federal Reserve, and so fixed Treasury payouts will more or less hold their value in coming years.
Further isolating ourselves from the herd, we duly note that junk bond yields slipped a bit today as well, settling at 7.62% on the day, according to the KDP High Yield Daily Index.
No doubt the optimism on the fixed-income horizon was boosted a bit by today's nonfarm productivity release, which revealed that U.S. output per hour in the nonfarm business sector rose by 2.6% in the first quarter, up from 2.1% previously, according to the Labor Department. That's still a long way from the extraordinary 8.7% logged in the third quarter of 2003, although the rise in productivity generally gives aid and comfort to the notion that labor trends won't stoke the fires of inflation.
Or so goes this view of productivity, which is tied to the belief that greater output per worker helps keep a lid on inflation. Why? If Acme Widget can increase output without hiring another employee, that lessens inflationary pressures, at least if you subscribe to the once-dominant school of thought that falling unemployment boosts pricing power.
All which works back to the delight of bond investors because higher productivity at this juncture suggests slower growth in employment, which implies the economy's slowing and so interest rates won't rise as fast, if at all. In fact, unit labor costs inched higher in the first quarter over the fourth quarter, which arguably inspires companies to pull back on hiring. That's just what may be unfolding if one takes today's initial jobless claims report to heart: new fillings for jobless benefits rose last week to their highest in four weeks.
But one long-time pessimist on the U.S. economy and inflation isn't inclined to change his views based on today's numbers. Indeed, Peter Schiff of Euro Pacific Capital remains as bearish as ever when it comes to prospect for paper assets issued by the government. What's more, today's news on 30-year bonds only strengthens his distrust of the Treasury's motives, ulterior or otherwise.
"While it makes perfect sense for the government to borrow for 30 years," Schiff writes today on Euro Pacific's web site, "I would question the intelligence of any one foolish enough to lend," i.e., buy Treasuries.
By that assumption, there are more than a few fools around. No matter, Schiff is sticking to his analysis. "With short term rates now at 3%," he continues,
Arguably, the expected renaissance of the 30-year Treasury Bond must pass muster with the foreigners, a group that's been more than accommodating in buyer lesser-maturity instruments in recent years and thereby financing America's trade and fiscal deficits. Whether you agree or disagree with Schiff's pessimism on America's capacity to dig itself out of its red-ink hole, he makes a warning flag about the kindness of foreign investors, or the lack thereof, going forward:
Last month, the U.S. Treasury announced that Savings Bonds would no longer pay a variable rate. Now we hear that the defunct 30-year Treasury Bond (which was scratched several years ago when the everyone thought the government would run a budget surplus) may be making a timely (or should we say untimely?) return.
Maybe we're a bit sensitive, but this seems like one more signal to sell bonds. Indeed, the Treasury doesn't make such decisions without a reason. The only question: what's the reason?
In weighing the potential contenders we keep coming back to the subject of inflation. Indeed, why would the government suddenly want to sell you longer-term maturities debt instruments? Or take away the variable-rate option on savings bonds, for that matter? Because it thinks that inflation and interest rates are going down? If you believe that, you're on the short list to buy swampland in Arizona.
Then again, that's the Capital Spectator's take on the credit markets in the here and now, and that's a take that doesn't necessarily reflect the bond market proper. In fact, ours seems to be a view that's in direct contrast with fixed-income traders, to judge by today's action in the benchmark 10-year Treasury Note.
If you thought that today's news that 30-year Treasuries may be making a comeback would frighten the bond market into selling, you thought wrong. The yield on the 10-year slipped a bit today, which is to say that traders were buying the 10-year. With a current yield of roughly 4.15%, a 10-year Treasury, while not exactly priced for perfection, is still very much trading on the expectation that the future holds favorable news on the inflation front. Namely, inflation will remain "contained," to quote the Federal Reserve, and so fixed Treasury payouts will more or less hold their value in coming years.
Further isolating ourselves from the herd, we duly note that junk bond yields slipped a bit today as well, settling at 7.62% on the day, according to the KDP High Yield Daily Index.
No doubt the optimism on the fixed-income horizon was boosted a bit by today's nonfarm productivity release, which revealed that U.S. output per hour in the nonfarm business sector rose by 2.6% in the first quarter, up from 2.1% previously, according to the Labor Department. That's still a long way from the extraordinary 8.7% logged in the third quarter of 2003, although the rise in productivity generally gives aid and comfort to the notion that labor trends won't stoke the fires of inflation.
Or so goes this view of productivity, which is tied to the belief that greater output per worker helps keep a lid on inflation. Why? If Acme Widget can increase output without hiring another employee, that lessens inflationary pressures, at least if you subscribe to the once-dominant school of thought that falling unemployment boosts pricing power.
All which works back to the delight of bond investors because higher productivity at this juncture suggests slower growth in employment, which implies the economy's slowing and so interest rates won't rise as fast, if at all. In fact, unit labor costs inched higher in the first quarter over the fourth quarter, which arguably inspires companies to pull back on hiring. That's just what may be unfolding if one takes today's initial jobless claims report to heart: new fillings for jobless benefits rose last week to their highest in four weeks.
But one long-time pessimist on the U.S. economy and inflation isn't inclined to change his views based on today's numbers. Indeed, Peter Schiff of Euro Pacific Capital remains as bearish as ever when it comes to prospect for paper assets issued by the government. What's more, today's news on 30-year bonds only strengthens his distrust of the Treasury's motives, ulterior or otherwise.
"While it makes perfect sense for the government to borrow for 30 years," Schiff writes today on Euro Pacific's web site, "I would question the intelligence of any one foolish enough to lend," i.e., buy Treasuries.
By that assumption, there are more than a few fools around. No matter, Schiff is sticking to his analysis. "With short term rates now at 3%," he continues,
and the yield on 30 year bonds at about 4.5%, the savings between borrowing short and borrowing long are not nearly as great as when short rates were only 1%. As a result, the Treasury apparently realizes that it no longer makes sense to keep the maturity of its debts so short.
Arguably, the expected renaissance of the 30-year Treasury Bond must pass muster with the foreigners, a group that's been more than accommodating in buyer lesser-maturity instruments in recent years and thereby financing America's trade and fiscal deficits. Whether you agree or disagree with Schiff's pessimism on America's capacity to dig itself out of its red-ink hole, he makes a warning flag about the kindness of foreign investors, or the lack thereof, going forward:
In the end, not only will the federal government be confronted with far bigger budget deficits, but it will also need to finance them at considerably higher interest rates. The Treasury had better hope that Asian savers are willing to step up to the plate, for if they balk, default or hyper-inflation will be the only alternatives. Holders of U.S. Treasuries, or any U.S. dollar-denominated assets, be warned.
May 04, 2005
THE CAPITAL SPECTATOR'S MOVING!
The Capital Spectator is relocating to: www.CapitalSpectator.com
Please make a note of our new address.
For the foreseeable future, we'll continue to add new content to Caps.Blogspot.com and CapitalSpectator.com, but eventually all new posts will be published exclusively on www.CapitalSpectator.com.
Thanks for reading!
The Capital Spectator is relocating to: www.CapitalSpectator.com
Please make a note of our new address.
For the foreseeable future, we'll continue to add new content to Caps.Blogspot.com and CapitalSpectator.com, but eventually all new posts will be published exclusively on www.CapitalSpectator.com.
Thanks for reading!
May 03, 2005
THREE PERCENT AND COUNTING
The Federal Reserve raised interest rates again today. The Fed funds rate inched higher by 25 basis points to 3.0%, only just below inflation's pace, measured by the consumer price index, which advanced by 3.1% for the year through March. Twelve months previous, CPI was rising by 1.7% and the Fed funds rate was 1.0%. In short, the real (inflation-adjusted) Fed funds rate is close to being neutral, as opposed to negative, for the first time since 2002.
The catalyst for this hawkish monetary bias? Inflation is on the rise. We know because the Fed tells us so. "Pressures on inflation have picked up in recent months and pricing power is more evident," the Federal Open Market Committee announced today after raising the price of money.
Whether that inflation will be "contained," as the Fed expects, is at the center of the great debate. In particular, have Greenspan and company nipped the beast in the bud? Or is the creeping threat still creeping?
The bond market isn't quite sure how to answer if today's any indication. The yield on the benchmark 10-year Treasury closed virtually unchanged on the day, ending the session at around 4.20%. What happened to the supreme self-confidence of the fixed-income set?
The stock market, by contrast, was downright giddy, at least for a time. The S&P 500 at one point soon after the Fed announcement jumped three-quarters of a percentage point in the space of about 20 minutes. Alas, it was all light and heat. By the end of trading in New York, the S&P ended virtually unchanged, slipping by less than one-tenth of a percent.
Indecision may actually be a prudent stance for the moment. Although the Fed is showing determination when it comes to fighting current and future inflationary threats, maintaining that stance promises to get tougher to rationalize if momentum slows in the economy. With Greenspan's tenure set to end in January, the maestro is surely asking himself how he wants to go out? There are two basic choices. He can go out as the man who kept waging a war to contain inflation. Alternatively, he can keep the economy bubbling. Ah, but can he do both? Or does one fatally compromise progress on the other?
We may soon find out. Slowing momentum is just what the first quarter GDP report suggests by way of a real annualized advance of 3.1% during January through March vs. 3.9% in the previous quarter. Therein lies Greenspan's dilemma, namely, should he adjust interest rates going forward to address the first-quarter slowdown or instead stay focused on the uptick in consumer prices? For the moment, he seems to be choosing the latter.
That may prove to be the superior choice if one considers today's release of new orders for manufactured goods in March. Indeed, economists were forecasting a drop of 1.2% in factory orders, according to the Street.com. Instead, the orders advanced by 0.1%. Does that imply that first-quarter slowdown will be temporary?
Not necessarily. Although new orders generally inched higher, new orders for durable goods industries dropped sharply by 2.3% in March. If durable goods are indeed a bellwether for measuring the vigor of the economy, it's hard to dismiss the fact that this data series has been showing weakness for several months running.
The weakness in durables goods raises questions about second quarter GDP, says the chief economist for MFR Inc. via AFX. "This suggests that capital spending growth in the second quarter will be soft, lending support to the belief that second quarter real GDP growth is going to be on the weak side," opines Joshua Shapiro.
But there are many ways to slice the data ham. Optimists are inclined to note that new manufacturing orders excluding the transportation sector jumped 1.3% in March, the biggest monthly increase in a year.
No matter which bias you prefer, there's one statistic in today's factory orders numbers that sticks out like an oil derrick on Wall Street. In a sign of the times, orders for petroleum and coal products exploded skyward in March by 18%, which translates into a $5.6 billion rise—the largest on record, Bloomberg News reports.
The Federal Reserve raised interest rates again today. The Fed funds rate inched higher by 25 basis points to 3.0%, only just below inflation's pace, measured by the consumer price index, which advanced by 3.1% for the year through March. Twelve months previous, CPI was rising by 1.7% and the Fed funds rate was 1.0%. In short, the real (inflation-adjusted) Fed funds rate is close to being neutral, as opposed to negative, for the first time since 2002.
The catalyst for this hawkish monetary bias? Inflation is on the rise. We know because the Fed tells us so. "Pressures on inflation have picked up in recent months and pricing power is more evident," the Federal Open Market Committee announced today after raising the price of money.
Whether that inflation will be "contained," as the Fed expects, is at the center of the great debate. In particular, have Greenspan and company nipped the beast in the bud? Or is the creeping threat still creeping?
The bond market isn't quite sure how to answer if today's any indication. The yield on the benchmark 10-year Treasury closed virtually unchanged on the day, ending the session at around 4.20%. What happened to the supreme self-confidence of the fixed-income set?
The stock market, by contrast, was downright giddy, at least for a time. The S&P 500 at one point soon after the Fed announcement jumped three-quarters of a percentage point in the space of about 20 minutes. Alas, it was all light and heat. By the end of trading in New York, the S&P ended virtually unchanged, slipping by less than one-tenth of a percent.
Indecision may actually be a prudent stance for the moment. Although the Fed is showing determination when it comes to fighting current and future inflationary threats, maintaining that stance promises to get tougher to rationalize if momentum slows in the economy. With Greenspan's tenure set to end in January, the maestro is surely asking himself how he wants to go out? There are two basic choices. He can go out as the man who kept waging a war to contain inflation. Alternatively, he can keep the economy bubbling. Ah, but can he do both? Or does one fatally compromise progress on the other?
We may soon find out. Slowing momentum is just what the first quarter GDP report suggests by way of a real annualized advance of 3.1% during January through March vs. 3.9% in the previous quarter. Therein lies Greenspan's dilemma, namely, should he adjust interest rates going forward to address the first-quarter slowdown or instead stay focused on the uptick in consumer prices? For the moment, he seems to be choosing the latter.
That may prove to be the superior choice if one considers today's release of new orders for manufactured goods in March. Indeed, economists were forecasting a drop of 1.2% in factory orders, according to the Street.com. Instead, the orders advanced by 0.1%. Does that imply that first-quarter slowdown will be temporary?
Not necessarily. Although new orders generally inched higher, new orders for durable goods industries dropped sharply by 2.3% in March. If durable goods are indeed a bellwether for measuring the vigor of the economy, it's hard to dismiss the fact that this data series has been showing weakness for several months running.
The weakness in durables goods raises questions about second quarter GDP, says the chief economist for MFR Inc. via AFX. "This suggests that capital spending growth in the second quarter will be soft, lending support to the belief that second quarter real GDP growth is going to be on the weak side," opines Joshua Shapiro.
But there are many ways to slice the data ham. Optimists are inclined to note that new manufacturing orders excluding the transportation sector jumped 1.3% in March, the biggest monthly increase in a year.
No matter which bias you prefer, there's one statistic in today's factory orders numbers that sticks out like an oil derrick on Wall Street. In a sign of the times, orders for petroleum and coal products exploded skyward in March by 18%, which translates into a $5.6 billion rise—the largest on record, Bloomberg News reports.
May 02, 2005
TOUGH GUYS, TOUGH TALK & TOUGH CHOICES
Robert Portman, the newly minted U.S. trade representative, promises to get tough with China. Red ink is the reason.
"Part of [the U.S. trade] deficit is because the Chinese do not always play by the rules,'' he told the Senate Finance Committee via Bloomberg News a week before he received confirmation for ascension to the trade post from his former life as a Republican congressman from Ohio.
The presumption is that by getting tough with China, which includes forcing the Middle Kingdom to float its currency, the U.S. trade deficit will fade, if not disappear. That, in turn, will remove pressure from the beleaguered buck and lessen the momentum for raising interest rates to maintain the dollar's competitive allure in foreign exchange markets.
Indeed, the dollar's been rising this year in part because interest rates in the United States have been increasing on a relative and an absolute basis. Fed funds today stand at 2.75%, and presumably will move to 3.0% tomorrow once the Federal Open Market Committee all but confirms the much-anticipated 25-basis-point rate hike planned for Tuesday.
Oh, how things have changed. A year ago, Fed funds were 1%, while the equivalent European Central Bank rate was 2.0%. The ECB rate remains at 2%, which is to say America now leads Europe in the category of yield premium for short-term rates. That explains some, if not most of the zing in the 4.5% rise in the U.S. Dollar Index this year, and in the process reverses the euro's former aura of destiny in marching over the greenback.
But better living through higher interest rates has its limits. The Fed can't raise rates too far, too fast without risking a recession. And in light of last week's lower-than-expected GDP report, recession is suddenly a topic of renewed focus in circles economic.
On the other hand, there are many tools at the government's disposal beyond the monetary levers, and pressure is building on Portman and others in the administration to use a few of them. One school of thought seems to be that if China's growing imports are the problem, the answer must be to float the Chinese yuan and thereby nip the problem in the bud.
Clearly, artificial intervention by China has kept its currency weaker than it otherwise would be relative to the dollar. That's no great surprise, considering that the Chinese economy was growing some three times as fast vs. the U.S. economy.
There's a method to China's madness, namely, engineering a weak currency keeps imports flowing to the U.S., and keeps them flowing at prices lower than they'd be if the yuan was allowed to seek the higher level that it almost surely would aspire to in a free market.
That higher level in fact is the immediate goal for the Coalition for a Sound Dollar, which represents more than 100 American manufacturing and agricultural trade groups. The industries represented by those trade groups are invariably being squeezed by imports generally, and Chinese imports into the U.S. in particular. Or so one assumes based on comments issued by the Coalition—like this one from April 22:
The China Currency Coalition is another group similarly disposed. “The undervalued yuan continues to push the bilateral deficit to record heights, depressing employment in the manufacturing sector and threatening the global financial system” David A. Hartquist, spokesperson for the coalition, recently stated. "Global markets cannot sustain the accelerating imbalances that result, in large part, from China’s undervalued exchange rate."
Perhaps, but one could reasonably ask if the United States economy sustain a revaluation of the yuan to market rates?
Revaluing the yuan upwards would almost certainly reprice Chinese goods upward as from a dollar-based perspective. And higher prices, presumably, would shift more demand to U.S. companies at the expense of Chinese companies.
But there are no free lunches in the global economy, least of all from a free-floating yuan. For starters, it's not clear that reduced Chinese imports to the U.S. will result in an automatic increase in sales for domestic firms. As Kristen J. Forbes, a former member of the President's Council of Economic Advisers, said in testimony to Congress last month via The Washington Post: Increased imports from China "largely reflect decreased imports of the same goods from other countries. In fact, much of China's recent increase in U.S. import share has come largely at the expense of Japan." What's more, employment in the United States has risen as imports from China have increased.
But that's not necessarily going to sway the Bush administration. U.S. Under Secretary John Taylor seems eager to have China float its currency. "We have very much stressed that they can begin to have a flexible exchange rate right now," he says courtesy of Reuters. That's diplomatic speak for suggesting that Beijing float sooner rather than later.
Perhaps the biggest risk for the United States from a free-floating yuan is the creation of new incentives, or should we say disincentives, for China when it comes to buying dollar-based assets above and beyond what prudent economic thinking dictates. China, you may have heard, is the second-largest foreign holder of Treasuries after Japan. This despite the falling greenback, which eats into the value of China's Treasury portfolio.
So, you may ask, why would China engage in self-imposed losses? That is, why would China continue to buy and hold Treasuries when such holdings have shown a clear and distinct pattern of losing money in recent years? Because holding those Treasuries keeps the yuan's value from rising in dollar terms, which promotes Chinese exports, which in turn more than offsets any losses from dollar holdings.
China, in other words, wants to sell us goods at below-market rates by financing the country's budget and trade deficits through Treasury purchases. Some in the United States are upset with that arrangement and would prefer to pay more for those goods as a short-cut to shifting production back to U.S. companies. Even assuming that outcome is likely, the "solution" risks becoming a Pyrrhic victory if China rethinks its seemingly irrational Treasury purchases.
Ergo, America depends heavily on the willingness of foreigners to finance a large chunk of its economic momentum, such as maintaining the all-important consumer spending machine by way of keeping interest rates lower than they'd otherwise be. Perhaps it's time to ask, If not China, who? Maybe Japan could pick up the slack and buy more Treasuries. Indeed, the Land of the Rising Sun already harbors some $700 billion of the Treasuries paper. How soon could Tokyo assume another $200 or so billion that now reside in China?
Arguably, some in Congress haven't asked that question, or perhaps they've already dismissed it, based on the recent introduction of the Chinese Currency Act of 2005, legislation designed to make "China accountable for the serious adverse impact that its exchange-rate manipulation and resultant currency undervaluation have on imports into the United States from China."
Paul Kasriel, director of economic research at Northern Trust, has thought long and hard about just these issues and written more than a few times on the implications. But that doesn't mean he's not perplexed by the legislation intended to force the yuan to float. "It's amazing that our Congress putting pressure on Chinese to do this," Kasriel tells CS.
No matter, Kasriel and others think the dollar's going to fall regardless over time. But if some in Congress and the administration have their way, it may fall faster and deeper than they expect.
The yuan is surely destined to be a free-floating currency. Exactly when is anybody's guess. But as China becomes increasingly dependent on capitalism, a fixed currency won't, can't last forever. But forcing Beijing's hand in the here and now may not be the smartest trick in the book at this juncture. It's probably not even likely for the time being. No matter, a government "rescue" may be coming one day, like it or not.
Robert Portman, the newly minted U.S. trade representative, promises to get tough with China. Red ink is the reason.
"Part of [the U.S. trade] deficit is because the Chinese do not always play by the rules,'' he told the Senate Finance Committee via Bloomberg News a week before he received confirmation for ascension to the trade post from his former life as a Republican congressman from Ohio.
The presumption is that by getting tough with China, which includes forcing the Middle Kingdom to float its currency, the U.S. trade deficit will fade, if not disappear. That, in turn, will remove pressure from the beleaguered buck and lessen the momentum for raising interest rates to maintain the dollar's competitive allure in foreign exchange markets.
Indeed, the dollar's been rising this year in part because interest rates in the United States have been increasing on a relative and an absolute basis. Fed funds today stand at 2.75%, and presumably will move to 3.0% tomorrow once the Federal Open Market Committee all but confirms the much-anticipated 25-basis-point rate hike planned for Tuesday.
Oh, how things have changed. A year ago, Fed funds were 1%, while the equivalent European Central Bank rate was 2.0%. The ECB rate remains at 2%, which is to say America now leads Europe in the category of yield premium for short-term rates. That explains some, if not most of the zing in the 4.5% rise in the U.S. Dollar Index this year, and in the process reverses the euro's former aura of destiny in marching over the greenback.
But better living through higher interest rates has its limits. The Fed can't raise rates too far, too fast without risking a recession. And in light of last week's lower-than-expected GDP report, recession is suddenly a topic of renewed focus in circles economic.
On the other hand, there are many tools at the government's disposal beyond the monetary levers, and pressure is building on Portman and others in the administration to use a few of them. One school of thought seems to be that if China's growing imports are the problem, the answer must be to float the Chinese yuan and thereby nip the problem in the bud.
Clearly, artificial intervention by China has kept its currency weaker than it otherwise would be relative to the dollar. That's no great surprise, considering that the Chinese economy was growing some three times as fast vs. the U.S. economy.
There's a method to China's madness, namely, engineering a weak currency keeps imports flowing to the U.S., and keeps them flowing at prices lower than they'd be if the yuan was allowed to seek the higher level that it almost surely would aspire to in a free market.
That higher level in fact is the immediate goal for the Coalition for a Sound Dollar, which represents more than 100 American manufacturing and agricultural trade groups. The industries represented by those trade groups are invariably being squeezed by imports generally, and Chinese imports into the U.S. in particular. Or so one assumes based on comments issued by the Coalition—like this one from April 22:
The Coalition for a Sound Dollar today commended President George Bush and Treasury Secretary John Snow for their statements this week asserting that China must act now on currency reform. “We view this as a very significant change in remarks by the Administration,” said Patricia Mears, spokesperson for the Coalition. “This is a shift from ‘China should do it sometime” to ‘They should do it now.’
Mears said the next step is for the Treasury Department, in its report to Congress due later this month, to cite China publicly for manipulating its currency and immediately proceed to initiate negotiations on an expedited basis, as required by statute, to press them to eliminate the undervaluation of their currency that burdens their trading partners' economies as well as their own.
The China Currency Coalition is another group similarly disposed. “The undervalued yuan continues to push the bilateral deficit to record heights, depressing employment in the manufacturing sector and threatening the global financial system” David A. Hartquist, spokesperson for the coalition, recently stated. "Global markets cannot sustain the accelerating imbalances that result, in large part, from China’s undervalued exchange rate."
Perhaps, but one could reasonably ask if the United States economy sustain a revaluation of the yuan to market rates?
Revaluing the yuan upwards would almost certainly reprice Chinese goods upward as from a dollar-based perspective. And higher prices, presumably, would shift more demand to U.S. companies at the expense of Chinese companies.
But there are no free lunches in the global economy, least of all from a free-floating yuan. For starters, it's not clear that reduced Chinese imports to the U.S. will result in an automatic increase in sales for domestic firms. As Kristen J. Forbes, a former member of the President's Council of Economic Advisers, said in testimony to Congress last month via The Washington Post: Increased imports from China "largely reflect decreased imports of the same goods from other countries. In fact, much of China's recent increase in U.S. import share has come largely at the expense of Japan." What's more, employment in the United States has risen as imports from China have increased.
But that's not necessarily going to sway the Bush administration. U.S. Under Secretary John Taylor seems eager to have China float its currency. "We have very much stressed that they can begin to have a flexible exchange rate right now," he says courtesy of Reuters. That's diplomatic speak for suggesting that Beijing float sooner rather than later.
Perhaps the biggest risk for the United States from a free-floating yuan is the creation of new incentives, or should we say disincentives, for China when it comes to buying dollar-based assets above and beyond what prudent economic thinking dictates. China, you may have heard, is the second-largest foreign holder of Treasuries after Japan. This despite the falling greenback, which eats into the value of China's Treasury portfolio.
So, you may ask, why would China engage in self-imposed losses? That is, why would China continue to buy and hold Treasuries when such holdings have shown a clear and distinct pattern of losing money in recent years? Because holding those Treasuries keeps the yuan's value from rising in dollar terms, which promotes Chinese exports, which in turn more than offsets any losses from dollar holdings.
China, in other words, wants to sell us goods at below-market rates by financing the country's budget and trade deficits through Treasury purchases. Some in the United States are upset with that arrangement and would prefer to pay more for those goods as a short-cut to shifting production back to U.S. companies. Even assuming that outcome is likely, the "solution" risks becoming a Pyrrhic victory if China rethinks its seemingly irrational Treasury purchases.
Ergo, America depends heavily on the willingness of foreigners to finance a large chunk of its economic momentum, such as maintaining the all-important consumer spending machine by way of keeping interest rates lower than they'd otherwise be. Perhaps it's time to ask, If not China, who? Maybe Japan could pick up the slack and buy more Treasuries. Indeed, the Land of the Rising Sun already harbors some $700 billion of the Treasuries paper. How soon could Tokyo assume another $200 or so billion that now reside in China?
Arguably, some in Congress haven't asked that question, or perhaps they've already dismissed it, based on the recent introduction of the Chinese Currency Act of 2005, legislation designed to make "China accountable for the serious adverse impact that its exchange-rate manipulation and resultant currency undervaluation have on imports into the United States from China."
Paul Kasriel, director of economic research at Northern Trust, has thought long and hard about just these issues and written more than a few times on the implications. But that doesn't mean he's not perplexed by the legislation intended to force the yuan to float. "It's amazing that our Congress putting pressure on Chinese to do this," Kasriel tells CS.
No matter, Kasriel and others think the dollar's going to fall regardless over time. But if some in Congress and the administration have their way, it may fall faster and deeper than they expect.
The yuan is surely destined to be a free-floating currency. Exactly when is anybody's guess. But as China becomes increasingly dependent on capitalism, a fixed currency won't, can't last forever. But forcing Beijing's hand in the here and now may not be the smartest trick in the book at this juncture. It's probably not even likely for the time being. No matter, a government "rescue" may be coming one day, like it or not.
April 29, 2005
JUNK SALE
If the high-yield bond market is the fixed-income equivalent of the fat lady singing, the diva appears to be yodeling. Just what she's saying, and what it means for the markets is debatable, but there's no doubt that there's a whole lot of singing going on.
The yield on the KDP High Yield Daily Index has risen sharply over the last month. As of yesterday, this measure of yield for low-grade bonds touched 7.67%, the highest since June 2004. It was only in early March that the index was yielding around 6.5%--more or less the lowest in a generation.
A lot can change in a month, as suggested by the longest sustained rise in junk yields in nearly a year. Is this so-called early warning sign a reliable indicator of things to come in the price of money? Or is the lady singing for reasons that have little to do with the wider world beyond junk?
One reason for pausing before answering comes from the signals in the far-more influential 10-year Treasury Note, which is showing no comparable signs of stress of late. The benchmark government bond yields around 4.2%, and has been falling for much of the past month after reaching roughly 4.65% in late March.
In the wake of yesterday's weaker-than-expected report on economic growth, it's hardly a shock to learn that traders of government debt are in no rush to dump the securities. The slowdown implied by the first quarter GDP rise of 3.1%, down from 3.8% in the fourth quarter, is giving new life to the notion that Treasuries are again worth buying. The rationale is that interest rates will cease rising, if not start falling again, in the face of a slowing economy. Of course, that assumes that the Fed will ignore the growing inflation signals. But we digress.
In any case, who's about to argue against the idea that the economy's set to further slow? Certainly not the oil market, at least not today. A barrel of crude closed below $50 in New York today for the first time since February. The implication: marginal demand growth for energy is cooling, and that is easily reversed engineered to conclude that the economy's slowing.
If that's the accepted wisdom, is the junk market in agreement? Hard to say, although this is clear: junk yields are rising on a relative as well as absolute basis. The spread in high-yield debt over the 10-year Treasury is nearly 360 basis points, the highest since May 2004.
Is the divergence significant, or just an anomaly? Only time will tell, but in the meantime some pundits are reminding of the lessons imparted by history when it comes to junk yields. "Historically, the debt market, especially the high-yield market, has frequently served as an early warning signal for broader weakness in the capital markets," Dun Yin, an analyst with high-yield-oriented broker/dealer CRT Capital Group, tells AP via BusinessWeek.
But hold on a minute. We learned today from the government that Joe Sixpack spent more in March than economists expected. What's more, Joe earned more than the dismal science predicted. Certainly that takes off a bit of the gloom imparted in yesterday's GDP report. What's more, the personal spending and earnings news helped light a small fire on Wall Street, pushing the S&P 500 up by more than a percent.
So where does junk fit into all this? Maybe nowhere. It's possible that the high yield market's adjusting to ills of its own making. One economist who follows junk says the recent back-up in yields reflects trends specific to the market. "The recent corporate spread widening was precipitated by a handful of company-specific problems,'' Dana Saporta, an economist at Stone & McCarthy Research, recently wrote in a report, according to Bloomberg News.
Indeed, some news stories circulating note that the presumed ongoing decline in the credit status of GM (it's currently just one notch above junk) and other companies will soon dump an excess supply of low-grade debt on the market. That threat, runs the logic, is pushing down prices (and yields up) in anticipation of the future supply rush. "Profit warnings from the world's top two auto groups, General Motors and Ford, have cast a pall over the high-yield credit markets," says Jeremy Field of Credit Suisse in London, according to a recent story in the International Herald Tribune. "Both companies are teetering on the edge of investment grade, and investors are justifiably concerned about the impact of over $200 billion in debt entering the high-yield market. A blow-up in the auto sector will not just affect dollar bonds; it will reverberate across every credit market and currency."
Junk bond investors are already feeling the reverberations, whatever the ultimate source. High-yield bond funds have reported net outflows of nearly $1 billion in the two weeks through April 27, reports AMG Data Services. That follows $4.3 billion of outflows from the sector in March.
But one veteran junk-bond watcher, Martin Fridson, who publishes Leverage World, dismisses this notion that this is all about anxieties over a coming supply wave. "Investors are overstating the potential impact of a GM downgrade," he advised in a recent newsletter, AP reports. "Fears of the high-yield market being crushed by new supply of fallen-angel debt are not justified."
Perhaps, but we'll still be keeping a close eye on GM and Ford in the weeks ahead for any clues about which way the wind's blowing, and which song the fat lady's singing.
If the high-yield bond market is the fixed-income equivalent of the fat lady singing, the diva appears to be yodeling. Just what she's saying, and what it means for the markets is debatable, but there's no doubt that there's a whole lot of singing going on.
The yield on the KDP High Yield Daily Index has risen sharply over the last month. As of yesterday, this measure of yield for low-grade bonds touched 7.67%, the highest since June 2004. It was only in early March that the index was yielding around 6.5%--more or less the lowest in a generation.
A lot can change in a month, as suggested by the longest sustained rise in junk yields in nearly a year. Is this so-called early warning sign a reliable indicator of things to come in the price of money? Or is the lady singing for reasons that have little to do with the wider world beyond junk?
One reason for pausing before answering comes from the signals in the far-more influential 10-year Treasury Note, which is showing no comparable signs of stress of late. The benchmark government bond yields around 4.2%, and has been falling for much of the past month after reaching roughly 4.65% in late March.
In the wake of yesterday's weaker-than-expected report on economic growth, it's hardly a shock to learn that traders of government debt are in no rush to dump the securities. The slowdown implied by the first quarter GDP rise of 3.1%, down from 3.8% in the fourth quarter, is giving new life to the notion that Treasuries are again worth buying. The rationale is that interest rates will cease rising, if not start falling again, in the face of a slowing economy. Of course, that assumes that the Fed will ignore the growing inflation signals. But we digress.
In any case, who's about to argue against the idea that the economy's set to further slow? Certainly not the oil market, at least not today. A barrel of crude closed below $50 in New York today for the first time since February. The implication: marginal demand growth for energy is cooling, and that is easily reversed engineered to conclude that the economy's slowing.
If that's the accepted wisdom, is the junk market in agreement? Hard to say, although this is clear: junk yields are rising on a relative as well as absolute basis. The spread in high-yield debt over the 10-year Treasury is nearly 360 basis points, the highest since May 2004.
Is the divergence significant, or just an anomaly? Only time will tell, but in the meantime some pundits are reminding of the lessons imparted by history when it comes to junk yields. "Historically, the debt market, especially the high-yield market, has frequently served as an early warning signal for broader weakness in the capital markets," Dun Yin, an analyst with high-yield-oriented broker/dealer CRT Capital Group, tells AP via BusinessWeek.
But hold on a minute. We learned today from the government that Joe Sixpack spent more in March than economists expected. What's more, Joe earned more than the dismal science predicted. Certainly that takes off a bit of the gloom imparted in yesterday's GDP report. What's more, the personal spending and earnings news helped light a small fire on Wall Street, pushing the S&P 500 up by more than a percent.
So where does junk fit into all this? Maybe nowhere. It's possible that the high yield market's adjusting to ills of its own making. One economist who follows junk says the recent back-up in yields reflects trends specific to the market. "The recent corporate spread widening was precipitated by a handful of company-specific problems,'' Dana Saporta, an economist at Stone & McCarthy Research, recently wrote in a report, according to Bloomberg News.
Indeed, some news stories circulating note that the presumed ongoing decline in the credit status of GM (it's currently just one notch above junk) and other companies will soon dump an excess supply of low-grade debt on the market. That threat, runs the logic, is pushing down prices (and yields up) in anticipation of the future supply rush. "Profit warnings from the world's top two auto groups, General Motors and Ford, have cast a pall over the high-yield credit markets," says Jeremy Field of Credit Suisse in London, according to a recent story in the International Herald Tribune. "Both companies are teetering on the edge of investment grade, and investors are justifiably concerned about the impact of over $200 billion in debt entering the high-yield market. A blow-up in the auto sector will not just affect dollar bonds; it will reverberate across every credit market and currency."
Junk bond investors are already feeling the reverberations, whatever the ultimate source. High-yield bond funds have reported net outflows of nearly $1 billion in the two weeks through April 27, reports AMG Data Services. That follows $4.3 billion of outflows from the sector in March.
But one veteran junk-bond watcher, Martin Fridson, who publishes Leverage World, dismisses this notion that this is all about anxieties over a coming supply wave. "Investors are overstating the potential impact of a GM downgrade," he advised in a recent newsletter, AP reports. "Fears of the high-yield market being crushed by new supply of fallen-angel debt are not justified."
Perhaps, but we'll still be keeping a close eye on GM and Ford in the weeks ahead for any clues about which way the wind's blowing, and which song the fat lady's singing.
April 28, 2005
THE SCIENCE WAS A BIT MORE DISMAL TODAY
The economy expanded at its slowest pace in two years in the first quarter, the government reported today, handing pessimists one more piece of ammunition for claiming that a slowdown is upon us.
Economists were generally expecting a real annualized rise in first-quarter gross domestic product (GDP) of around 3.5%. Instead, the number came in at 3.1%, the Bureau of Economic Analysis advised. That's a long way from the 3.8% logged in the fourth quarter.
For those intent on seeing the glass still half full rather than half empty there was this tidbit: the all-important personal consumption expenditures (PCE) fared slightly better, rising 3.5%. That's down from 4.2% in the fourth quarter, but the fact that PCE's still advancing above GDP’s pace keeps hope alive that Joe Sixpack hasn't written off trips to Wal-Mart and Home Depot just yet.
Meanwhile, the oil market extracted the obvious conclusion from the GDP number early on in today’s trading session. For a time, a barrel of crude changed hands for under $50. Oil prices rebounded later on, but the message remained clear: the threat of decelerating economic growth in the world’s leading consumer of oil has the potential to take the wind out of the energy’s market sails.
But like radiation treatment for cancer and carpet bombing, a slowdown is a blunt instrument for cooling off the high-flying oil market. Blunt maybe, but effective nonetheless. And who says the patient has to die in the process? Not Eric Green, a money manager with Penn Capital Management who spoke with Bloomberg News. “We were bound to slow down, but the outlook for the market looks good,” he reasons. Perhaps, but the stock market seems to think otherwise, considering the S&P 500’s sharp fall today in the wake of the GDP report. Yet Green dismisses today’s market action as “overreaction,” explaining that an economy that’s still growing above 3% gives the bulls incentive to keep buying.
In a perfect world, a slowing economy will bring down the price of oil and yet keep enough momentum going for corporate earnings increases. But is such a sweet spot a reasonable expectation?
Maybe, but it’s going to take more than a day or two to muster confidence on that question. For the moment, the market needs to digest a few additional economics reports to figure out which way the economics winds are blowing. Indeed, the first-quarter GDP casts doubt over the investment outlook. Fresh data in coming weeks will either provide support for the first-quarter snapshot or sow reason for thinking it was less than representative of the morrow.
Hope, in short, doesn’t die quite so easily given the strength of earnings reports in recent quarters. The possibility of one more leg up in stock prices keeps more than a few pundits looking for another rally, or so suggests one analyst looking at the U.S. from an outsider’s perspective in Canada. “You have better than expected earnings, there's a lot of concern about the economy and the Fed is raising rates, albeit slowly so when you look at the price action in the broad market, it seems to want to move higher but it can't,” John Johnston, chief strategist at The Harbor Group at RBC Dominion Securities, tells
CBC News.
Can’t or won’t? It’s worth noting that today’s GDP report also reveals that business spending slowed sharply to 4.7% in the first quarter from a blistering 14.5% rate in last year’s fourth quarter. And then there’s the price deflator gauge, a measure of inflation, which accelerated to 3.2% from 2.3%.
Hmmm, slowing business spending, a consumer showing signs of a bit more shopping fatigue, oil prices that remain defiantly over $50 a barrel, and one more indication that inflation’s continuing to inch higher add up to a mix that broadcasts something less than confidence on Wall Street. Looks like the stagflation scare, real or imagined, still has legs.
With that cue, all eyes now turn the Federal Reserve’s interest-rate decision next week.
The economy expanded at its slowest pace in two years in the first quarter, the government reported today, handing pessimists one more piece of ammunition for claiming that a slowdown is upon us.
Economists were generally expecting a real annualized rise in first-quarter gross domestic product (GDP) of around 3.5%. Instead, the number came in at 3.1%, the Bureau of Economic Analysis advised. That's a long way from the 3.8% logged in the fourth quarter.
For those intent on seeing the glass still half full rather than half empty there was this tidbit: the all-important personal consumption expenditures (PCE) fared slightly better, rising 3.5%. That's down from 4.2% in the fourth quarter, but the fact that PCE's still advancing above GDP’s pace keeps hope alive that Joe Sixpack hasn't written off trips to Wal-Mart and Home Depot just yet.
Meanwhile, the oil market extracted the obvious conclusion from the GDP number early on in today’s trading session. For a time, a barrel of crude changed hands for under $50. Oil prices rebounded later on, but the message remained clear: the threat of decelerating economic growth in the world’s leading consumer of oil has the potential to take the wind out of the energy’s market sails.
But like radiation treatment for cancer and carpet bombing, a slowdown is a blunt instrument for cooling off the high-flying oil market. Blunt maybe, but effective nonetheless. And who says the patient has to die in the process? Not Eric Green, a money manager with Penn Capital Management who spoke with Bloomberg News. “We were bound to slow down, but the outlook for the market looks good,” he reasons. Perhaps, but the stock market seems to think otherwise, considering the S&P 500’s sharp fall today in the wake of the GDP report. Yet Green dismisses today’s market action as “overreaction,” explaining that an economy that’s still growing above 3% gives the bulls incentive to keep buying.
In a perfect world, a slowing economy will bring down the price of oil and yet keep enough momentum going for corporate earnings increases. But is such a sweet spot a reasonable expectation?
Maybe, but it’s going to take more than a day or two to muster confidence on that question. For the moment, the market needs to digest a few additional economics reports to figure out which way the economics winds are blowing. Indeed, the first-quarter GDP casts doubt over the investment outlook. Fresh data in coming weeks will either provide support for the first-quarter snapshot or sow reason for thinking it was less than representative of the morrow.
Hope, in short, doesn’t die quite so easily given the strength of earnings reports in recent quarters. The possibility of one more leg up in stock prices keeps more than a few pundits looking for another rally, or so suggests one analyst looking at the U.S. from an outsider’s perspective in Canada. “You have better than expected earnings, there's a lot of concern about the economy and the Fed is raising rates, albeit slowly so when you look at the price action in the broad market, it seems to want to move higher but it can't,” John Johnston, chief strategist at The Harbor Group at RBC Dominion Securities, tells
CBC News.
Can’t or won’t? It’s worth noting that today’s GDP report also reveals that business spending slowed sharply to 4.7% in the first quarter from a blistering 14.5% rate in last year’s fourth quarter. And then there’s the price deflator gauge, a measure of inflation, which accelerated to 3.2% from 2.3%.
Hmmm, slowing business spending, a consumer showing signs of a bit more shopping fatigue, oil prices that remain defiantly over $50 a barrel, and one more indication that inflation’s continuing to inch higher add up to a mix that broadcasts something less than confidence on Wall Street. Looks like the stagflation scare, real or imagined, still has legs.
With that cue, all eyes now turn the Federal Reserve’s interest-rate decision next week.
April 27, 2005
DURABILITY TEST
One freshly published number in the dismal science can mean a lot these days when it comes moving investor sentiment. The case du jour comes to us from The U.S. Census Bureau, which reported this morning that durable goods orders posted an unexpected March decline—and a sharp decline at that.
New orders for manufactured durable items, which are defined as pricey goods that are made to last several years or more, dropped 2.8% last month. That's the steepest slump since September 2002. Transportation equipment was the big loser. In fact, transportation-related orders have been descended now for four months in a row.
Transportation equipment orders are an economically sensitive group, and volatile too, and so economists like to remove them from the mix to assess trend. Alas, even after this adjustment there was still a fair amount of red ink left on the table. In fact, durable goods-ex transport fell by 1.0% in March, the most since last October.
Does this mean the economy's slowing? The bond market was only too quick to make that conclusion. The yield on the 10-year Treasury Note slipped today, falling to 4.23%.
But the stock market wasn't quite so sure. The S&P 500 rose a bit today, effectively shrugging off the news in durable goods. Or was the modest equity rally more of a sigh of relief in seeing oil prices fall?
In any case, as troubling as today's durable goods number appears to be, it's actually worse if you consider that last week's major piece of economic news came in the form of rising consumers prices. Indeed, the CPI index revealed itself to be increasing at an accelerating pace in March: up 0.6%, the fastest since October.
Assume for a minute that today's durable goods order is the definitive sign that economy's slowing. Next, take that assumption and mix it vigorously with last week's inflationary CPI report. What do you get?
Stagflation. Paul Krugman made that argument last week in his New York Times column. And while more than a few pundits took issue with Krugman's analysis, he's found one more reason in today's economic news to stand by his column.
Nonetheless, inflation is not yet of the "runaway" variety nor is the economy anywhere near failing on all cylinders. "To get into a stagflation regime you would have to have inflation expectations unhinged, and we definitely don’t have that,” Sheryl King, senior economist at Merrill Lynch, tells MSNBC.
But if it's too early to say definitively if stagflation's a legitimate threat, neither is it premature to draw up a list of trends that could provide aid and comfort to stagflation's forces. That includes higher energy prices and rising import prices, courtesy of a falling dollar. For a nation with a growing appetite for things foreign, that's not an encouraging sign. Indeed, import prices jumped by 7% for the year through March, or more than double the rate of increase in the government's consumer price index.
Tomorrow's first estimate on the first-quarter GDP from the Commerce Department will play into investors fears, or optimism, depending on what the numbers show. The consensus outlook is for an economy that advanced by 3.5% during January through March, according to TheStreet.com.
GDP reports, on the other hand, are hopelessly lagging indicators. For better or worse, the first-quarter GDP release will be the last major piece of statistical evidence published before the Federal Reserve convenes next Tuesday and debates whether to raise or not to raise the price of money.
One freshly published number in the dismal science can mean a lot these days when it comes moving investor sentiment. The case du jour comes to us from The U.S. Census Bureau, which reported this morning that durable goods orders posted an unexpected March decline—and a sharp decline at that.
New orders for manufactured durable items, which are defined as pricey goods that are made to last several years or more, dropped 2.8% last month. That's the steepest slump since September 2002. Transportation equipment was the big loser. In fact, transportation-related orders have been descended now for four months in a row.
Transportation equipment orders are an economically sensitive group, and volatile too, and so economists like to remove them from the mix to assess trend. Alas, even after this adjustment there was still a fair amount of red ink left on the table. In fact, durable goods-ex transport fell by 1.0% in March, the most since last October.
Does this mean the economy's slowing? The bond market was only too quick to make that conclusion. The yield on the 10-year Treasury Note slipped today, falling to 4.23%.
But the stock market wasn't quite so sure. The S&P 500 rose a bit today, effectively shrugging off the news in durable goods. Or was the modest equity rally more of a sigh of relief in seeing oil prices fall?
In any case, as troubling as today's durable goods number appears to be, it's actually worse if you consider that last week's major piece of economic news came in the form of rising consumers prices. Indeed, the CPI index revealed itself to be increasing at an accelerating pace in March: up 0.6%, the fastest since October.
Assume for a minute that today's durable goods order is the definitive sign that economy's slowing. Next, take that assumption and mix it vigorously with last week's inflationary CPI report. What do you get?
Stagflation. Paul Krugman made that argument last week in his New York Times column. And while more than a few pundits took issue with Krugman's analysis, he's found one more reason in today's economic news to stand by his column.
Nonetheless, inflation is not yet of the "runaway" variety nor is the economy anywhere near failing on all cylinders. "To get into a stagflation regime you would have to have inflation expectations unhinged, and we definitely don’t have that,” Sheryl King, senior economist at Merrill Lynch, tells MSNBC.
But if it's too early to say definitively if stagflation's a legitimate threat, neither is it premature to draw up a list of trends that could provide aid and comfort to stagflation's forces. That includes higher energy prices and rising import prices, courtesy of a falling dollar. For a nation with a growing appetite for things foreign, that's not an encouraging sign. Indeed, import prices jumped by 7% for the year through March, or more than double the rate of increase in the government's consumer price index.
Tomorrow's first estimate on the first-quarter GDP from the Commerce Department will play into investors fears, or optimism, depending on what the numbers show. The consensus outlook is for an economy that advanced by 3.5% during January through March, according to TheStreet.com.
GDP reports, on the other hand, are hopelessly lagging indicators. For better or worse, the first-quarter GDP release will be the last major piece of statistical evidence published before the Federal Reserve convenes next Tuesday and debates whether to raise or not to raise the price of money.
April 26, 2005
THE BUYING GAME
There was no news yesterday at President Bush's ranch in Crawford, Texas, but there was plenty of talk when the head of the world's biggest oil-consuming country chatted with his counterpart from the world's biggest supplier.
After playing host to Prince Abdullah, the working leader of Saudi Arabia, the President explained that "a high oil price will damage markets and he knows that," according to AP via SignOnSanDiego.com. Bush also observed that "one thing is for certain: The price of crude is driving the price of gasoline. The price of crude is up because not only is our economy growing, but economies such as India and China's economies are growing."
Growth, it seems, is a challenge as much as an opportunity to the global economy. Not to worry, though; the Saudis have a plan. What is it? Well, they plan to pump more oil, at first by squeezing their ever-thinning spare capacity down to the nub. In the longer term, they'll invest billions to bring new fields online is the silver bullet. Promises, promises.
In any case, all of this has been widely discussed before the prince set foot in the Lone Star State, but "the plan" nevertheless impressed White House National Security Adviser Stephen Hadley. "Clearly, the news that came out of the meeting today ought to be good news for the markets and we would hope that and other factors would result in some positive news, in terms of the price fronts," Hadley said of the Bush-Abdullah meeting in a briefing to reporters on Monday.
But for all the optimism, there seems to be some disagreement as to whether Saudi Arabia is pumping as much as it could in the spring of 2005. "The problem in the oil markets now is a perception that there is inadequate capacity…" Hadley told said. Meanwhile, Reuters TheStreet.com reports that Prince Abdullah's Foreign Policy Adviser Adel al-Jubeir said that the oil markets are adequately supplied. Someone it seems needs a perception adjustment.
Oil traders, however, are going with the Saudi's viewpoint. Consider that when the nearby oil futures contract closed in New York last week, a barrel of crude changed hands for well over $55. By the end of today's session, the price was roughly $54.
Tomorrow, next month, next year, and beyond, however, is another matter. Indeed, while much of the world, along with Wall Street, is focused on where the price of oil is headed in the short run, strategic thinkers in the energy business are casting their votes on the long haul in the here and now.
The smoking guns can be found in recent decisions of big oil (ChevronTexaco's purchase of Unocal) as well as in the domestic refinery business, as witnessed by Monday's news that Valero Energy Corp. plans to buy oil refiner Premcor Corp.
Valero is already the nation's biggest refiner, and the deal promises to further consolidate Valero's leading presence in the industry. Consolidation and economies of scale, in other words, is the name of the game from here on out.
Indeed, the acquisition news sent the remaining refinery stocks higher on the reasoning that additional takeovers are coming. Shares of Tesoro Corp., for instance, temporarily shot up in the wake of the Valero announcement on Monday before pulling back today.
But for all the bullish anticipation about refinery stocks, there's still skepticism about Valero's decision to buy Premcor. The Street, as if you needed another reminder, still isn't sure about the notion of oil as a scarce commodity in the long haul. The Wall Street Journal (subscription required) today suggests as much by pointing out that the string of profits in recent years in running a refinery is temporary and therefore due for a correction a la the 1980s. Jay Saunders, a Deutsche Bank analyst, is quoted as saying that Valero's acquisition of Premcor represents a "significant risk." Why? Valero's paying a 19% premium for Premcor shares.
Indeed, refinery stocks are a recent arrival to the halls of optimism. As recently as 2002, shares of Valero were trading at below book value. No more: the top indy refiner now trades at two-and-a-half-times book.
Risk or not, Saunders still rates Valero a "buy," the Journal notes, suggesting that some on the Street are torn by this energy bull market. Ok, so why the "buy"? Reviewing the nation's refinery capacity of late may yield a clue. Echoing the Saudi output situation, there is little spare capacity at the moment in U.S. refineries. In January, for example, refinery capacity was running at 91.3%; for December 2004, it was 95%, the Energy Department reports.
Ninety-percent-plus capacity is nothing new in the refinery game of late, but it wasn't always so. In the early to mid-1980s, refinery capacity was around 70% for a number of years.
But the economy has since grown, and is growing. The bottom line: demand for gasoline and other refined oil products ascends too. Yet new refineries have become an extinct species, prompting the Energy Department to warn, as it did last year, that surplus U.S. refinery capacity is disappearing. No wonder that gasoline imports have been trending higher. This past January, gasoline imports were running at the equivalent of 803,000 barrels a day, up by a third from a year earlier.
Yes, there are risks to Valero's purchase of Premcor, just as there were risks when Sunoco purchased a large refinery from El Paso Corp. last year. But in a world of rising gasoline demand and dim prospects for building new refineries any time soon, buying is the only game left in town.
Indeed, buying rather than developing seems to be a theme throughout the energy business of late. A number of large oil companies have been buying existing production in addition to developing it from scratch. Why? A clue comes from a Reuters story about declining production at BP.
The dearth of new refineries in the United States is a self-imposed limitation courtesy of NIMBY (not in my backyard) while the reportedly declining opportunities to develop large, new oil fields globally is a byproduct of geological constraint. In either case, the path of least resistance leads to a common conclusion: buy up the competition. In fact, the buying game has only just begun.
But don’t confuse consolidation of refineries with increasing production output. The dwindling number of players is no short cut to increasing supply. Only God can make a tree, and only a new refinery can materially expand gasoline production.
Lower prices from refinery consolidation probably aren't imminent either. Or so Senator Ron Wyden (D-Oregon) tells The Deal today. "We know that concentration of the oil industry is already squeezing consumers at the pump, and this proposed acquisition by Valero of Premcor would create the biggest U.S. refiner and tighter concentration in a number of areas."
Wyden is an outspoken critic of mergers in the refinery business, but does he realize that the government has been instrumental in driving consolidation. As Lynne Kiesling of Knowledge Problem writes today of the Valero/Premcor deal, "I continue to think that this merger pattern is consistent with the fact that environmental regulation has broken apart the economies of scale in petroleum refining, making it more costly, and that the mergers are a way to recapture those economies of scale."
Perhaps when the refinery industry devolves into a true state of oligopoly (if it's not there already), the government will promote the development of the nation's first new, major refinery since 1976. Either that or hand out bicycles. Till then, the refinery stocks are in play.
There was no news yesterday at President Bush's ranch in Crawford, Texas, but there was plenty of talk when the head of the world's biggest oil-consuming country chatted with his counterpart from the world's biggest supplier.
After playing host to Prince Abdullah, the working leader of Saudi Arabia, the President explained that "a high oil price will damage markets and he knows that," according to AP via SignOnSanDiego.com. Bush also observed that "one thing is for certain: The price of crude is driving the price of gasoline. The price of crude is up because not only is our economy growing, but economies such as India and China's economies are growing."
Growth, it seems, is a challenge as much as an opportunity to the global economy. Not to worry, though; the Saudis have a plan. What is it? Well, they plan to pump more oil, at first by squeezing their ever-thinning spare capacity down to the nub. In the longer term, they'll invest billions to bring new fields online is the silver bullet. Promises, promises.
In any case, all of this has been widely discussed before the prince set foot in the Lone Star State, but "the plan" nevertheless impressed White House National Security Adviser Stephen Hadley. "Clearly, the news that came out of the meeting today ought to be good news for the markets and we would hope that and other factors would result in some positive news, in terms of the price fronts," Hadley said of the Bush-Abdullah meeting in a briefing to reporters on Monday.
But for all the optimism, there seems to be some disagreement as to whether Saudi Arabia is pumping as much as it could in the spring of 2005. "The problem in the oil markets now is a perception that there is inadequate capacity…" Hadley told said. Meanwhile, Reuters TheStreet.com reports that Prince Abdullah's Foreign Policy Adviser Adel al-Jubeir said that the oil markets are adequately supplied. Someone it seems needs a perception adjustment.
Oil traders, however, are going with the Saudi's viewpoint. Consider that when the nearby oil futures contract closed in New York last week, a barrel of crude changed hands for well over $55. By the end of today's session, the price was roughly $54.
Tomorrow, next month, next year, and beyond, however, is another matter. Indeed, while much of the world, along with Wall Street, is focused on where the price of oil is headed in the short run, strategic thinkers in the energy business are casting their votes on the long haul in the here and now.
The smoking guns can be found in recent decisions of big oil (ChevronTexaco's purchase of Unocal) as well as in the domestic refinery business, as witnessed by Monday's news that Valero Energy Corp. plans to buy oil refiner Premcor Corp.
Valero is already the nation's biggest refiner, and the deal promises to further consolidate Valero's leading presence in the industry. Consolidation and economies of scale, in other words, is the name of the game from here on out.
Indeed, the acquisition news sent the remaining refinery stocks higher on the reasoning that additional takeovers are coming. Shares of Tesoro Corp., for instance, temporarily shot up in the wake of the Valero announcement on Monday before pulling back today.
But for all the bullish anticipation about refinery stocks, there's still skepticism about Valero's decision to buy Premcor. The Street, as if you needed another reminder, still isn't sure about the notion of oil as a scarce commodity in the long haul. The Wall Street Journal (subscription required) today suggests as much by pointing out that the string of profits in recent years in running a refinery is temporary and therefore due for a correction a la the 1980s. Jay Saunders, a Deutsche Bank analyst, is quoted as saying that Valero's acquisition of Premcor represents a "significant risk." Why? Valero's paying a 19% premium for Premcor shares.
Indeed, refinery stocks are a recent arrival to the halls of optimism. As recently as 2002, shares of Valero were trading at below book value. No more: the top indy refiner now trades at two-and-a-half-times book.
Risk or not, Saunders still rates Valero a "buy," the Journal notes, suggesting that some on the Street are torn by this energy bull market. Ok, so why the "buy"? Reviewing the nation's refinery capacity of late may yield a clue. Echoing the Saudi output situation, there is little spare capacity at the moment in U.S. refineries. In January, for example, refinery capacity was running at 91.3%; for December 2004, it was 95%, the Energy Department reports.
Ninety-percent-plus capacity is nothing new in the refinery game of late, but it wasn't always so. In the early to mid-1980s, refinery capacity was around 70% for a number of years.
But the economy has since grown, and is growing. The bottom line: demand for gasoline and other refined oil products ascends too. Yet new refineries have become an extinct species, prompting the Energy Department to warn, as it did last year, that surplus U.S. refinery capacity is disappearing. No wonder that gasoline imports have been trending higher. This past January, gasoline imports were running at the equivalent of 803,000 barrels a day, up by a third from a year earlier.
Yes, there are risks to Valero's purchase of Premcor, just as there were risks when Sunoco purchased a large refinery from El Paso Corp. last year. But in a world of rising gasoline demand and dim prospects for building new refineries any time soon, buying is the only game left in town.
Indeed, buying rather than developing seems to be a theme throughout the energy business of late. A number of large oil companies have been buying existing production in addition to developing it from scratch. Why? A clue comes from a Reuters story about declining production at BP.
The dearth of new refineries in the United States is a self-imposed limitation courtesy of NIMBY (not in my backyard) while the reportedly declining opportunities to develop large, new oil fields globally is a byproduct of geological constraint. In either case, the path of least resistance leads to a common conclusion: buy up the competition. In fact, the buying game has only just begun.
But don’t confuse consolidation of refineries with increasing production output. The dwindling number of players is no short cut to increasing supply. Only God can make a tree, and only a new refinery can materially expand gasoline production.
Lower prices from refinery consolidation probably aren't imminent either. Or so Senator Ron Wyden (D-Oregon) tells The Deal today. "We know that concentration of the oil industry is already squeezing consumers at the pump, and this proposed acquisition by Valero of Premcor would create the biggest U.S. refiner and tighter concentration in a number of areas."
Wyden is an outspoken critic of mergers in the refinery business, but does he realize that the government has been instrumental in driving consolidation. As Lynne Kiesling of Knowledge Problem writes today of the Valero/Premcor deal, "I continue to think that this merger pattern is consistent with the fact that environmental regulation has broken apart the economies of scale in petroleum refining, making it more costly, and that the mergers are a way to recapture those economies of scale."
Perhaps when the refinery industry devolves into a true state of oligopoly (if it's not there already), the government will promote the development of the nation's first new, major refinery since 1976. Either that or hand out bicycles. Till then, the refinery stocks are in play.
April 25, 2005
TURNING OVER ROCKS IN MR. MARKET'S GARDEN
Is the market efficient? Efficiency as in prices reflect all known and relevant market information. By those terms, prices are by definition efficient, which is another way of saying that neither hidden value nor veiled excess lurk in the shadows.
If the market is efficient, then whatever Mr. Market tells us is the start and finish of any investment conversation. One of the ways that Mr. Market talks is by assigning market capitalizations to the various sectors. If the market is truly efficient, then sectors with the largest capitalizations are presumably also the ones with the brighter futures compared with those of lesser values.
But if the market's efficient, would Mr. Market's assessment of the morrow in a given sector differ radically across market-cap spectrums?
The question comes up these days when you peruse the world of large-cap stocks relative to their small-cap brethren. In particular, the S&P 500, representing large caps in one corner, and the S&P 600, a proxy for a cross-section of small companies, in the other.
In the large-cap realm of the S&P 500, the financials industry continues to command the lion's share of the market capitalization. Taking 19.8% of the total S&P 500 market cap, financials enjoy all the hope and faith that Wall Street can muster. Indeed, financials have been at or near the top of the feeding chain for some time. The likes of Citigroup, Bank of America rule the hill here. Never mind that interest rates may go up in the months and years ahead and cut into this sector's bread and butter. That's a distant fear at the moment. Instead, the financial behemoths are presumed to be winners come hell or high water, or so Mr. Market suggests.
But Mr. Market is not of one mind when it comes to financials. Indeed, there's a different perspective over in the small-cap market, where stodgy industrials comfortably lead the market-cap race. Taking an 18.3% share of the S&P 600's market cap, industrials have been the darlings within the small-cap universe. We're talking of names like Oshkosh Truck Corp. and Roper Industries, which manufactures various industrial instruments.
On the surface, the two sector leaders seem to be prudent choices. In both the large-cap financials and small-cap industrials, earnings have been advancing nicely. Yet the big-cap financials have the edge in terms of a lower projected valuation. Based on Standard & Poor's numbers, the expected price-earnings ratio for the financials in the S&P 500 will be 11.3 once 2005 earnings are reported. The comparable p/e for the small-cap industrials will be materially higher at 16.8, based on projected 2005 earnings.
The notion of higher earnings overall is no pie-in-the-sky dream. A survey released today by the National Association for Business Economics gives reason for expecting growth to remain a force for some time in the American economy. “Hiring plans continue to improve, capital spending appears healthy, and profit margins are strong by historical standards," says Jim Meil, chief economist for the Eaton Corp., via NABE's survey. Although there are signs that the pace of growth may be slowing, there are no smoking guns that suggest anything like a recession is imminent, the NABE report suggests.
Economic growth, capital spending, and the like, of course, help boost earnings. As such, it's no wonder that Wall Street expects both large-cap financials and small-cap industrials to report higher earnings by the time the final reports for 2005 go into the history books.
But growth doesn't mete out its benefits in equal doses. In support of that notion, we cite today's report from Richard Berner, a Morgan Stanley economist who's charged with keeping an eye on the United States. "Labor markets have firmed noticeably over the past two years, judging by traditional cyclical metrics such as the unemployment rate and the median duration of unemployment," he writes. "Together with rising inflation, I think tighter labor markets will soon push up nominal compensation growth in time-honored, cyclical fashion."
Meanwhile, a number of economists are saying that when April's payrolls numbers are released early next month, the month will show some progress over March's slim payroll gains of 110,000. Among the numbers being thrown about by dismal scientists is a gain of 175,000 for April. Hardly a roaring economy, if it comes to pass, but neither is it low enough to dismiss Berner's worries.
In a world where economic growth is chugging along, but so too is inflation, it doesn't take much to expect that more interest rate hikes are in the cards. If so, will financials remain the darlings along with industrials?
Already there are reasons to wonder. Although the S&P 500's financials are expected to have the lower p/e relative to the S&P 600's industrials, it is the small-cap industrials that are projected to raise earnings by 25% vs. 8% for big-cap financials. On a relative basis as well, the small-cap industrials seem to have the edge as well: the sector's 25% earnings growth rate predicted for this year is near the top among the S&P 600's sectors. The S&P 500's financials' 8% earnings advance, by contrast, is near the bottom among big-cap projected earnings growth rates.
Mr. Market, once again, will have to prove his efficiency, and dismiss quite a lot of historical baggage in the process.
Is the market efficient? Efficiency as in prices reflect all known and relevant market information. By those terms, prices are by definition efficient, which is another way of saying that neither hidden value nor veiled excess lurk in the shadows.
If the market is efficient, then whatever Mr. Market tells us is the start and finish of any investment conversation. One of the ways that Mr. Market talks is by assigning market capitalizations to the various sectors. If the market is truly efficient, then sectors with the largest capitalizations are presumably also the ones with the brighter futures compared with those of lesser values.
But if the market's efficient, would Mr. Market's assessment of the morrow in a given sector differ radically across market-cap spectrums?
The question comes up these days when you peruse the world of large-cap stocks relative to their small-cap brethren. In particular, the S&P 500, representing large caps in one corner, and the S&P 600, a proxy for a cross-section of small companies, in the other.
In the large-cap realm of the S&P 500, the financials industry continues to command the lion's share of the market capitalization. Taking 19.8% of the total S&P 500 market cap, financials enjoy all the hope and faith that Wall Street can muster. Indeed, financials have been at or near the top of the feeding chain for some time. The likes of Citigroup, Bank of America rule the hill here. Never mind that interest rates may go up in the months and years ahead and cut into this sector's bread and butter. That's a distant fear at the moment. Instead, the financial behemoths are presumed to be winners come hell or high water, or so Mr. Market suggests.
But Mr. Market is not of one mind when it comes to financials. Indeed, there's a different perspective over in the small-cap market, where stodgy industrials comfortably lead the market-cap race. Taking an 18.3% share of the S&P 600's market cap, industrials have been the darlings within the small-cap universe. We're talking of names like Oshkosh Truck Corp. and Roper Industries, which manufactures various industrial instruments.
On the surface, the two sector leaders seem to be prudent choices. In both the large-cap financials and small-cap industrials, earnings have been advancing nicely. Yet the big-cap financials have the edge in terms of a lower projected valuation. Based on Standard & Poor's numbers, the expected price-earnings ratio for the financials in the S&P 500 will be 11.3 once 2005 earnings are reported. The comparable p/e for the small-cap industrials will be materially higher at 16.8, based on projected 2005 earnings.
The notion of higher earnings overall is no pie-in-the-sky dream. A survey released today by the National Association for Business Economics gives reason for expecting growth to remain a force for some time in the American economy. “Hiring plans continue to improve, capital spending appears healthy, and profit margins are strong by historical standards," says Jim Meil, chief economist for the Eaton Corp., via NABE's survey. Although there are signs that the pace of growth may be slowing, there are no smoking guns that suggest anything like a recession is imminent, the NABE report suggests.
Economic growth, capital spending, and the like, of course, help boost earnings. As such, it's no wonder that Wall Street expects both large-cap financials and small-cap industrials to report higher earnings by the time the final reports for 2005 go into the history books.
But growth doesn't mete out its benefits in equal doses. In support of that notion, we cite today's report from Richard Berner, a Morgan Stanley economist who's charged with keeping an eye on the United States. "Labor markets have firmed noticeably over the past two years, judging by traditional cyclical metrics such as the unemployment rate and the median duration of unemployment," he writes. "Together with rising inflation, I think tighter labor markets will soon push up nominal compensation growth in time-honored, cyclical fashion."
Meanwhile, a number of economists are saying that when April's payrolls numbers are released early next month, the month will show some progress over March's slim payroll gains of 110,000. Among the numbers being thrown about by dismal scientists is a gain of 175,000 for April. Hardly a roaring economy, if it comes to pass, but neither is it low enough to dismiss Berner's worries.
In a world where economic growth is chugging along, but so too is inflation, it doesn't take much to expect that more interest rate hikes are in the cards. If so, will financials remain the darlings along with industrials?
Already there are reasons to wonder. Although the S&P 500's financials are expected to have the lower p/e relative to the S&P 600's industrials, it is the small-cap industrials that are projected to raise earnings by 25% vs. 8% for big-cap financials. On a relative basis as well, the small-cap industrials seem to have the edge as well: the sector's 25% earnings growth rate predicted for this year is near the top among the S&P 600's sectors. The S&P 500's financials' 8% earnings advance, by contrast, is near the bottom among big-cap projected earnings growth rates.
Mr. Market, once again, will have to prove his efficiency, and dismiss quite a lot of historical baggage in the process.
April 22, 2005
THE NEW NEW GOLDEN AGE OF OPEC
The House of Representatives has embraced the much-debated energy bill, or as it's known formally in the hallowed halls of Congress, H.R. 6. But don't hold your breath that this creation of politicians will provide delivery into the promised land of energy independence or affordable prices for oil and its byproducts. H.R. 6 is legislation, not divine intervention, and as legislation goes, it leaves more than a few things to be desired.
Sure, the bill opens the door for drilling in the Arctic National Wildlife Refuge (ANWR) in Alaska. If the Senate gives the green light to the legislation—a big "if"--America will have access to oil that was formerly off limits. But how much oil are we talking about? A middle-of-the-road estimate is around 10 billion barrels, according to the Energy Department.
Make no mistake, 10 billion barrels is nothing to sneeze at. What's more, the American economy needs it, to judge by the line of SUVs at the local gas station. Until and if we have a viable, economically reasonable source of alternative fuel arriving on the scene, the United States is looking at an oily future, like it or not.
Meanwhile, conservation warrants a role, and the country needs to do more of it. But let's be clear about the limits of conservation: as a practical matter there are limits, starting on the political and social fronts. Translated, few politicians want to push too hard to compel Joe Sixpack to turn down the thermostat and drive a smaller car. Joe, being an American, is only too happy to go along with Washington's policy of Don't Ask, Keep Driving. Jimmy Carter, you may recall, tried that, and look where it got him. No wonder there's not a lot of politicians running around in cardigan sweaters yelling, "Drive less, turn off the heat, and save America from doom." That's not a message that resonates with the American public. Of course, if and when oil reached $100 a barrel, maybe the resonance would be a bit more compelling.
In any case, saving energy isn't the same thing as producing it. Or, as House Resources Committee Chairman Richard Pombo says, via the San Francisco Chronicle, "We cannot conserve our way out of an empty tank of gas."
Fair enough, but neither can we pump our way out of the current energy challenge with ANWR. The United States is now consuming 20 million barrels a day, if not more. At that rate of consumption, ANWR would be depleted in about a year and a half. In practice, of course, ANWR's supply will take years if not decades to fully deplete because the U.S. has multiple sources of supply.
In fact, it's those multiple sources that are at once the current solution and the long-term burden. A solution because the growing share of foreign imports of oil provide energy that is otherwise lacking in domestic supply; a burden because a variety of geopolitical and geological trends threaten to complicate the business of importing oil as the years go by.
Neil McMahon, the oil analyst in residence in the London office of Sanford C. Bernstein Ltd., puts his rhetorical finger on the core challenge for the global economy in a research note yesterday by wondering where additional global supply will come from in the years ahead. The focus of late has generally been on demand, and how all the usual suspects are sparing no expense to slake their respective oily thirsts. But demand must be met with supply, or so one hopes.
No matter how you slice it, China is front and center on the subject. As it happens, the world's most populous country with an economy to match just happened to report that it's oil imports rose dramatically in March by 23%, according to ChinaView.com.
Who can satisfy a 23% rise in oil demand? The answer, increasingly, is Opec. Non-Opec oil, by contrast, threatens to suffer diminishing status in relative and absolute terms. "Ever since crude prices hit $30/bbl in 2003," writes McMahon and his team, "most have presumed that higher prices would be a sufficient market signal for producers to increase supply and act as the natural mechanism to bring prices lower. However, even now at $50/bbl pricing, all evidence suggests that, outside of OPEC and the FSU [former Soviet Union], no supply response from the oil industry heartlands has been forthcoming."
McMahon charges that the International Energy Agency and others have been "overestimating the supply response to oil prices above $40/bbl…." In fact, the IEA may be on track to overestimate to the tune of 500,000 barrels a day, or about half of the expected growth in global supply for 2005.
The problem is that bringing large quantities of new, non-Opec supply on line is difficult and expensive. It also takes time. Exactly how much and how soon, if every, any new, non-Opec supply will find its way into the economies of consuming nations is debatable. But for the moment there's full transparency in the fact that this silver bullet isn't forthcoming. Even high prices don't seem to coaxing non-Opec supply increases, Bernstein observes. Even at $50 a barrel, non-Opec supply increases (excluding the former Soviet Union) are notable by their absence. What's more, that's atypical. In the past, high prices have brought new non-Opec supply on line. This time around, nada. Based on the past dozen years of oil history, the current absence of new non-Opec supply hikes "marks a distinct departure from historic price/supply relationships."
That leaves Opec in the driver's seat, a status that's geologically preordained for the cartel. But even Opec won't be able to flip a switch and materially raise output any time soon. In support of that fact, Saudi Arabia, which claims the world's biggest oil reserves and the most spare capacity at the moment, has announced plans to double its investment in energy development in the next five years to $50 billion, according to the Wall Street Journal (subscription required).
Indeed, the game has changed for Saudi Arabia in that the kingdom has scrapped the illusion of sticking to Opec's oil production quotas. Rather, the new rule is sell every barrel of oil that you can get your hands on. The age of subtlety in oil diplomacy is over.
Let's call it the fallout from the realization that Saudi Arabia's current production ceiling, said to be around 11 million barrels a day, will be woefully insufficient in just a few years, if it isn't already.
Meanwhile, inquiring minds want to know what $50 billion of new investment will buy in the way of increased output from the kingdom. The Journal cites no less an authority than Ali Naimi, Saudi Arabia's oil minister, who projects that his country's production will rise to 12.5 million barrels a day by 2009, or about 25% higher than current levels.
But 2009 is a long way off, all the more so when you learn that China's on track to import the equivalent of an entire ANWR in 15 years at the most.
Perhaps the Chinese economy will slow, and give the world's oil producers time to catch up. Then again, perhaps not. China's GDP expanded at an unexpectedly strong 9.5% in the first quarter. To quote Agence France-Presse via Taiwan News, "China's runaway economy showed no signs of slowing in the first quarter…."
The House of Representatives has embraced the much-debated energy bill, or as it's known formally in the hallowed halls of Congress, H.R. 6. But don't hold your breath that this creation of politicians will provide delivery into the promised land of energy independence or affordable prices for oil and its byproducts. H.R. 6 is legislation, not divine intervention, and as legislation goes, it leaves more than a few things to be desired.
Sure, the bill opens the door for drilling in the Arctic National Wildlife Refuge (ANWR) in Alaska. If the Senate gives the green light to the legislation—a big "if"--America will have access to oil that was formerly off limits. But how much oil are we talking about? A middle-of-the-road estimate is around 10 billion barrels, according to the Energy Department.
Make no mistake, 10 billion barrels is nothing to sneeze at. What's more, the American economy needs it, to judge by the line of SUVs at the local gas station. Until and if we have a viable, economically reasonable source of alternative fuel arriving on the scene, the United States is looking at an oily future, like it or not.
Meanwhile, conservation warrants a role, and the country needs to do more of it. But let's be clear about the limits of conservation: as a practical matter there are limits, starting on the political and social fronts. Translated, few politicians want to push too hard to compel Joe Sixpack to turn down the thermostat and drive a smaller car. Joe, being an American, is only too happy to go along with Washington's policy of Don't Ask, Keep Driving. Jimmy Carter, you may recall, tried that, and look where it got him. No wonder there's not a lot of politicians running around in cardigan sweaters yelling, "Drive less, turn off the heat, and save America from doom." That's not a message that resonates with the American public. Of course, if and when oil reached $100 a barrel, maybe the resonance would be a bit more compelling.
In any case, saving energy isn't the same thing as producing it. Or, as House Resources Committee Chairman Richard Pombo says, via the San Francisco Chronicle, "We cannot conserve our way out of an empty tank of gas."
Fair enough, but neither can we pump our way out of the current energy challenge with ANWR. The United States is now consuming 20 million barrels a day, if not more. At that rate of consumption, ANWR would be depleted in about a year and a half. In practice, of course, ANWR's supply will take years if not decades to fully deplete because the U.S. has multiple sources of supply.
In fact, it's those multiple sources that are at once the current solution and the long-term burden. A solution because the growing share of foreign imports of oil provide energy that is otherwise lacking in domestic supply; a burden because a variety of geopolitical and geological trends threaten to complicate the business of importing oil as the years go by.
Neil McMahon, the oil analyst in residence in the London office of Sanford C. Bernstein Ltd., puts his rhetorical finger on the core challenge for the global economy in a research note yesterday by wondering where additional global supply will come from in the years ahead. The focus of late has generally been on demand, and how all the usual suspects are sparing no expense to slake their respective oily thirsts. But demand must be met with supply, or so one hopes.
No matter how you slice it, China is front and center on the subject. As it happens, the world's most populous country with an economy to match just happened to report that it's oil imports rose dramatically in March by 23%, according to ChinaView.com.
Who can satisfy a 23% rise in oil demand? The answer, increasingly, is Opec. Non-Opec oil, by contrast, threatens to suffer diminishing status in relative and absolute terms. "Ever since crude prices hit $30/bbl in 2003," writes McMahon and his team, "most have presumed that higher prices would be a sufficient market signal for producers to increase supply and act as the natural mechanism to bring prices lower. However, even now at $50/bbl pricing, all evidence suggests that, outside of OPEC and the FSU [former Soviet Union], no supply response from the oil industry heartlands has been forthcoming."
McMahon charges that the International Energy Agency and others have been "overestimating the supply response to oil prices above $40/bbl…." In fact, the IEA may be on track to overestimate to the tune of 500,000 barrels a day, or about half of the expected growth in global supply for 2005.
The problem is that bringing large quantities of new, non-Opec supply on line is difficult and expensive. It also takes time. Exactly how much and how soon, if every, any new, non-Opec supply will find its way into the economies of consuming nations is debatable. But for the moment there's full transparency in the fact that this silver bullet isn't forthcoming. Even high prices don't seem to coaxing non-Opec supply increases, Bernstein observes. Even at $50 a barrel, non-Opec supply increases (excluding the former Soviet Union) are notable by their absence. What's more, that's atypical. In the past, high prices have brought new non-Opec supply on line. This time around, nada. Based on the past dozen years of oil history, the current absence of new non-Opec supply hikes "marks a distinct departure from historic price/supply relationships."
That leaves Opec in the driver's seat, a status that's geologically preordained for the cartel. But even Opec won't be able to flip a switch and materially raise output any time soon. In support of that fact, Saudi Arabia, which claims the world's biggest oil reserves and the most spare capacity at the moment, has announced plans to double its investment in energy development in the next five years to $50 billion, according to the Wall Street Journal (subscription required).
Indeed, the game has changed for Saudi Arabia in that the kingdom has scrapped the illusion of sticking to Opec's oil production quotas. Rather, the new rule is sell every barrel of oil that you can get your hands on. The age of subtlety in oil diplomacy is over.
Let's call it the fallout from the realization that Saudi Arabia's current production ceiling, said to be around 11 million barrels a day, will be woefully insufficient in just a few years, if it isn't already.
Meanwhile, inquiring minds want to know what $50 billion of new investment will buy in the way of increased output from the kingdom. The Journal cites no less an authority than Ali Naimi, Saudi Arabia's oil minister, who projects that his country's production will rise to 12.5 million barrels a day by 2009, or about 25% higher than current levels.
But 2009 is a long way off, all the more so when you learn that China's on track to import the equivalent of an entire ANWR in 15 years at the most.
Perhaps the Chinese economy will slow, and give the world's oil producers time to catch up. Then again, perhaps not. China's GDP expanded at an unexpectedly strong 9.5% in the first quarter. To quote Agence France-Presse via Taiwan News, "China's runaway economy showed no signs of slowing in the first quarter…."
April 21, 2005
THE DECLINE & FALL OF JOBLESS CLAIMS
The Labor Department this morning delivered another wake-up call to the Federal Reserve regarding its still-negative real (inflation-adjusted) Fed funds rate. The buzzer sounded with the release of the weekly report on initial jobless claims, a widely followed number for gauging economic momentum, or lack thereof.
Today, it was all about momentum, however: upward and onward. The consensus forecast for initial jobless claims was 329,000, but the economy offered 296,000 instead. The magnitude of the better-than-expected news on the number of folks filling for jobless claims last week could hardly be more stark relative to recent history. Indeed, last week's 296,000 is tied with an earlier report issued in February as the lowest weekly number since late-2000.
One weekly gauge of unemployment claims doesn't say much, of course, although it speaks a little louder coming a day after the higher-than-expected rise in consumer prices for March. What's more, this morning's jobless claims number is the third consecutive weekly drop.
Ah, but there's the ever-present mitigating circumstance, which in this case is reportedly "seasonal adjustment issues" connected with the Easter holiday. Nevertheless, it's hard to spin today's jobless claims number as something other than another piece of evidence that the economy's still expanding.
"The report indicates that the economy continues to grow at a solid pace, but this is contradicted by other data," Tony Crescenzi, chief bond market strategist at Miller Tabak, explains in MarketWatch.com.
But the stock market wasn't focused on "other data" today. The S&P 500 took wing, climbing roughly 2% on the day. The bond market was apparently reading from the same script, albeit with a different though hardly unexpected result. The 10-year Treasury Note sold off sharply, elevating the 10-year's yield up above 4.3% for the first time in more than a week.
Does all of this suggest that the Federal Reserve will hike interest rates again when the Federal Open Market Committee meets again on May 3? Only if you ignore the "other data" that Crescenzi refers to, starting with the release today of the so-called leading economic indicator (LEI), which fell by 0.4% in March, according to the Conference Board.
Of the ten components in the leading indicator, which is said to be a measure of future economic activity, only two were positive contributors last month: the interest rate spread and manufacturers' new orders for consumer goods and materials.
The decline in the LEI last month represents the biggest stumble in over two years. Signs of things to come? Perhaps, suggests Jason Schenker, the economist following matters domestic for Wachovia, in a research note today. "The decline in the LEI in March resulted in the index going negative year-over-year for the first time since April 2003," he writes. "Although the index is only down -0.5 percent year-over-year, a protracted period of negative year-over-year rates has historically been associated with recession."
Nonetheless, Schenker believes the economy is still "solid" and opines that "we are merely moving from recovery into the more moderate growth phase of expansion…."
That's his story and he's sticking to it. Indeed, more than a few observers of the economic scene say as much. That growth bias may very well remain intact until the market gets its first peek at first-quarter GDP estimates, which will be released at 8:30 a.m. New York time on April 28. The consensus projection calls for 3.5%, down slightly from 3.8% logged in the fourth quarter.
Yes, Virginia, the quarterly GDP numbers are always woefully lagging snapshots, but that doesn't mean they can't be market-moving events when and if they deviate from the best guesses of the dismal scientists.
The Labor Department this morning delivered another wake-up call to the Federal Reserve regarding its still-negative real (inflation-adjusted) Fed funds rate. The buzzer sounded with the release of the weekly report on initial jobless claims, a widely followed number for gauging economic momentum, or lack thereof.
Today, it was all about momentum, however: upward and onward. The consensus forecast for initial jobless claims was 329,000, but the economy offered 296,000 instead. The magnitude of the better-than-expected news on the number of folks filling for jobless claims last week could hardly be more stark relative to recent history. Indeed, last week's 296,000 is tied with an earlier report issued in February as the lowest weekly number since late-2000.
One weekly gauge of unemployment claims doesn't say much, of course, although it speaks a little louder coming a day after the higher-than-expected rise in consumer prices for March. What's more, this morning's jobless claims number is the third consecutive weekly drop.
Ah, but there's the ever-present mitigating circumstance, which in this case is reportedly "seasonal adjustment issues" connected with the Easter holiday. Nevertheless, it's hard to spin today's jobless claims number as something other than another piece of evidence that the economy's still expanding.
"The report indicates that the economy continues to grow at a solid pace, but this is contradicted by other data," Tony Crescenzi, chief bond market strategist at Miller Tabak, explains in MarketWatch.com.
But the stock market wasn't focused on "other data" today. The S&P 500 took wing, climbing roughly 2% on the day. The bond market was apparently reading from the same script, albeit with a different though hardly unexpected result. The 10-year Treasury Note sold off sharply, elevating the 10-year's yield up above 4.3% for the first time in more than a week.
Does all of this suggest that the Federal Reserve will hike interest rates again when the Federal Open Market Committee meets again on May 3? Only if you ignore the "other data" that Crescenzi refers to, starting with the release today of the so-called leading economic indicator (LEI), which fell by 0.4% in March, according to the Conference Board.
Of the ten components in the leading indicator, which is said to be a measure of future economic activity, only two were positive contributors last month: the interest rate spread and manufacturers' new orders for consumer goods and materials.
The decline in the LEI last month represents the biggest stumble in over two years. Signs of things to come? Perhaps, suggests Jason Schenker, the economist following matters domestic for Wachovia, in a research note today. "The decline in the LEI in March resulted in the index going negative year-over-year for the first time since April 2003," he writes. "Although the index is only down -0.5 percent year-over-year, a protracted period of negative year-over-year rates has historically been associated with recession."
Nonetheless, Schenker believes the economy is still "solid" and opines that "we are merely moving from recovery into the more moderate growth phase of expansion…."
That's his story and he's sticking to it. Indeed, more than a few observers of the economic scene say as much. That growth bias may very well remain intact until the market gets its first peek at first-quarter GDP estimates, which will be released at 8:30 a.m. New York time on April 28. The consensus projection calls for 3.5%, down slightly from 3.8% logged in the fourth quarter.
Yes, Virginia, the quarterly GDP numbers are always woefully lagging snapshots, but that doesn't mean they can't be market-moving events when and if they deviate from the best guesses of the dismal scientists.
April 20, 2005
GREAT EXPECTATIONS
The bond market decided to err on the side of optimism again today—optimism, that is, from a bond trader's perspective. Whatever you call it, there was a fair amount of it in and around trading of the benchmark 10-year Treasury Note, which now yields 4.20%, the lowest in more than two months.
The continued decline in the 10-year's yield is particularly striking in light of today's report on consumer prices. The news on that front was less than encouraging in the battle to contain inflation. But the bond market was unimpressed and instead was in a buying mood. No mean feat in the wake of the consumer price index's rise of a stronger-than-expected 0.6% last month, the Labor Department reports. Although there have been increases of that magnitude in recent history, 0.6% is the highest in five months, representing the top end of monthly increases for some time. Indeed, you have to go back to 1999 to find a higher monthly jump in CPI.
What's more, core CPI is now surprising on the upside too. Unlike yesterday's calm in the March core wholesale price report, consumer prices for March excluding food and energy jumped by 0.4%, the highest in nearly two years.
Why is the bond market so nonchalant in the wake of bad news on inflation? Perhaps yesterday's sharp drop in housing starts has something to do with the recent incarnation of confidence among debt investors. Indeed, the government reported that housing starts hit a brick wall in March, falling 17.6% from February. That's the biggest drop since 1991.
Yes, Virginia, housing starts surged to an all-time high in February. As a result, even after the March decline, housing starts are still at a level that prior to 2004 was thought to be nosebleed terrain.
Yet the housing industry saw fit to put on the breaks. Is this the start of the much-discussed popping of the real estate bubble? If so, maybe the bond bulls aren't so crazy after all. A serious, sustained decline in the housing market has the potential to take the wind out of the economy's sails, and in the process making everyone but a bond trader miserable.
But more than a few analysts aren't ready to throw in the towel on the real estate boom just yet. "It's too early to get excited about this. You are coming off huge numbers in January and February," David Wyss, chief economist for Standard & Poor's, tells Knight-Ridder. Mark Zandi, chief economist at Economy.com, is similarly skeptical that this is the end, explaining to the Washington Post that the drop in housing starts is a "head fake. The [real estate] market isn't slowing at all."
If true, that implies that the Fed will continue tightening the monetary screws. Or so the futures markets for Fed funds predicts. The June '05 contract for Fed funds is priced for a 3.0% rate. That, of course, is speculation. Truth at the moment is 2.75%, although that rate will be officially reassessed when the Federal Open Market Committee gathers for its next regularly scheduled meeting on May 3.
If gold prices and the U.S. Dollar Index have any influence on May 3 confab, another rate hike is coming. The precious metal inched up in Wednesday trading, holding fast to the 1.6% gain logged yesterday. Meanwhile, the U.S. Dollar Index slipped to its lowest in nearly a month.
Getting the buck back into an ascending mode will take some convincing from the Fed, and 25 basis points may not be enough to do the trick. John Rothfield, a currency strategist at Bank of America, sees pressure building for another rate hike of some degree. "Market expectations for the pace of Fed tightening are still down fairly aggressively over the past month,'' he tells Bloomberg News. "We expect the dollar to keep drifting lower.''
Rothfield's not alone. Whether that has any impact on the Fed remains to be seen. But as we go into the next FOMC with a CPI report that's raising warning flags, it's only a question of time before the bond market catches on that the risk in fixed-income may be higher than suggested in the 10-year's yield trend of late.
The bond market decided to err on the side of optimism again today—optimism, that is, from a bond trader's perspective. Whatever you call it, there was a fair amount of it in and around trading of the benchmark 10-year Treasury Note, which now yields 4.20%, the lowest in more than two months.
The continued decline in the 10-year's yield is particularly striking in light of today's report on consumer prices. The news on that front was less than encouraging in the battle to contain inflation. But the bond market was unimpressed and instead was in a buying mood. No mean feat in the wake of the consumer price index's rise of a stronger-than-expected 0.6% last month, the Labor Department reports. Although there have been increases of that magnitude in recent history, 0.6% is the highest in five months, representing the top end of monthly increases for some time. Indeed, you have to go back to 1999 to find a higher monthly jump in CPI.
What's more, core CPI is now surprising on the upside too. Unlike yesterday's calm in the March core wholesale price report, consumer prices for March excluding food and energy jumped by 0.4%, the highest in nearly two years.
Why is the bond market so nonchalant in the wake of bad news on inflation? Perhaps yesterday's sharp drop in housing starts has something to do with the recent incarnation of confidence among debt investors. Indeed, the government reported that housing starts hit a brick wall in March, falling 17.6% from February. That's the biggest drop since 1991.
Yes, Virginia, housing starts surged to an all-time high in February. As a result, even after the March decline, housing starts are still at a level that prior to 2004 was thought to be nosebleed terrain.
Yet the housing industry saw fit to put on the breaks. Is this the start of the much-discussed popping of the real estate bubble? If so, maybe the bond bulls aren't so crazy after all. A serious, sustained decline in the housing market has the potential to take the wind out of the economy's sails, and in the process making everyone but a bond trader miserable.
But more than a few analysts aren't ready to throw in the towel on the real estate boom just yet. "It's too early to get excited about this. You are coming off huge numbers in January and February," David Wyss, chief economist for Standard & Poor's, tells Knight-Ridder. Mark Zandi, chief economist at Economy.com, is similarly skeptical that this is the end, explaining to the Washington Post that the drop in housing starts is a "head fake. The [real estate] market isn't slowing at all."
If true, that implies that the Fed will continue tightening the monetary screws. Or so the futures markets for Fed funds predicts. The June '05 contract for Fed funds is priced for a 3.0% rate. That, of course, is speculation. Truth at the moment is 2.75%, although that rate will be officially reassessed when the Federal Open Market Committee gathers for its next regularly scheduled meeting on May 3.
If gold prices and the U.S. Dollar Index have any influence on May 3 confab, another rate hike is coming. The precious metal inched up in Wednesday trading, holding fast to the 1.6% gain logged yesterday. Meanwhile, the U.S. Dollar Index slipped to its lowest in nearly a month.
Getting the buck back into an ascending mode will take some convincing from the Fed, and 25 basis points may not be enough to do the trick. John Rothfield, a currency strategist at Bank of America, sees pressure building for another rate hike of some degree. "Market expectations for the pace of Fed tightening are still down fairly aggressively over the past month,'' he tells Bloomberg News. "We expect the dollar to keep drifting lower.''
Rothfield's not alone. Whether that has any impact on the Fed remains to be seen. But as we go into the next FOMC with a CPI report that's raising warning flags, it's only a question of time before the bond market catches on that the risk in fixed-income may be higher than suggested in the 10-year's yield trend of late.
