Copper Is At Critical Support

Notice the incredibly weak position of the copper ETF.  It's trading near 1-year lows; prices are below the 200 day EMA (which is also moving lower).  All the shorter EMAs are below the 200 and moving lower.  Momentum is incredibly weak. 

On the weekly chart, prices are right around the 36-37 level, which has provided critical technical support for the last three and a half years. 

BOJ's Initial Actions Effective

The above charts shows the currency problem faced by the BOJ: even as their interest rates were at record lows and their economy was barely growing, the yen was strengthening.  The ETF rose from 90 in mid-2008 to 130 at the end of 2011, for a percentage gain of 44%.  The banks recent moves to double the currency base has effectively told the markets the central bank intends to have the yen drop in value -- which it clearly has.  It's moved from from the high of 130 to 94 earlier this year, for a drop of 27.4%. 

1% increase in interest rates: necessary but not sufficient for recession

- by New Deal democrat

At this point probably everybody who pays attention knows that interest rates have backed up a full 1% in the last month. That it will have a strong negative impact on mortgage refinancing and some negative impact on the purchase of houses also has been widely remarked.

But is it enough to bring on a recession? No, or at least, not yet.

As it turns out, while recessions in the last 50 years have always been preceded by a 1% YoY increase in interest rates, a backup in interest rates is not a sufficient signal by itself to forecast a recession. I've shown this in the below graph of 10 year treasuries. The values are inversted so an increase shows up as a decrease. I've also added 1 to the values, so that a +1% increase in interest rates shows up exactly at zero:



Interest rates have backed up at least 1% YoY 15 times in the last 50 years. In 7 of those cases, a recession has folloed within the next 2 years. So the increase in rates is a necessary but not sufficient marker of recession.

What has made a difference is the duration of the increase, at least since the beginning of the great decline in interest rates over 30 years ago. Below is a graph that I posted a little over one year ago, showing conventional mortgage rates since their peak in 1980. The red sections represent those periods of time where mortgage rates have failed to make a new low for at least 3 years:



As you can see, all three of the recessions since 1982 have been immediately preceded by a 3 year or longer period where interest rates failed to make new lows.

Interest rates on mortgages made new lows about 1 year ago. So while the rise in interest rates is a definite concern, it hasn't lasted long enough to trigger a warning of a new recession. We'd need to see the increased rates continue for another year or even two before a recession would likely occur.

Market/Economic Analysis: Australia

While I've previously been bearish on Australia, my position is now changing to neutral.  There are two reasons for this change.  First, the ETF has already fallen 20%, which is a bug move for an economy that is still printing decent GDP growth.  Second, the LEIs have now printed a positive number for four straight months.  This is from the latest Conference Board release:

The Conference Board LEI for Australia increased in April for a fourth consecutive month, with money supply and stock prices making the largest positive contributions. Between October 2012 and April 2013, the leading economic index increased 0.7 percent (about a 1.5 percent annual rate), up from a decline of 0.4 percent (about a -0.8 percent annual rate) during the previous six months. Additionally, the strengths among the leading indicators have remained more widespread than the weaknesses in recent months.

Here is a copy of the components:

In general, we see a positive contribution from most components over the last 4-5 months with two exceptions: building approvals and the sales to inventory ratio.  All other points are doing well.  Let's now turn to the CEIs:

Like the LEIs, the CEIs are now printing mostly positive numbers.

Here's the assessment of the economy from the latest meeting minutes of the central bank:

Exports had grown further in the March quarter. Resources exports, particularly of bulk commodities, had grown strongly over the past year, while services exports had resumed growth more recently. 

Available information indicated that business investment had declined in the March quarter. According to the latest ABS capital expenditure survey, the decline had been in both the mining and non-mining sectors. The fall in capital imports since the beginning of the year was consistent with a decline in investment in the first quarter, although recent data showed that capital imports had bounced back somewhat in April.

According to the ABS survey of firms' capital expenditure plans, non-mining investment was expected to show moderate growth over the next year or so. While the survey also continued to imply further growth in mining investment, in the past actual annual capital expenditure by mining companies had often differed by a wide margin from their forecasts as reflected in the ABS survey. Based on public statements by mining companies and information from the Bank's liaison, it seemed likely that mining investment was near its peak but would probably remain at a high level for the next year or so. However, members observed that there was considerable uncertainty about mining investment beyond that period. In particular, changes in production and exports of energy commodities in other countries were making it more difficult to assess the potential for new projects in the gas sector in Australia. Overall, conditions in the business sector remained somewhat subdued, with survey measures for all industries at, or below, average levels.

Household spending appeared to have picked up early in 2013, after having slowed late in 2012 and having been supported by higher asset prices. In the March quarter, growth of retail sales volumes was strong across most categories, amid a decline in retail prices. Liaison suggested that the pace of retail spending might have eased somewhat more recently, while measures of consumer confidence fell back to around average levels in May.

Members observed that the effects of low interest rates had been evident in a range of housing market indicators. Building approvals for both higher-density and detached dwellings had increased over recent months. The Bank's liaison contacts were generally becoming more positive about the outlook for dwelling investment. Also, loan approvals had grown more strongly in recent months, including for new housing, and auction clearance rates were well above average in Sydney and had picked up to be a bit above average in Melbourne. While measures of dwelling prices had been relatively flat over recent months, they were still higher than the previous year.

Labour market conditions remained somewhat subdued. The monthly employment data continued to be volatile, with a large increase in employment in April following a sizeable decrease in March. Looking through this volatility, employment growth had not been as fast as growth of the labour force, which had led to the unemployment rate drifting higher over the past year, to 5½ per cent. Job advertisements had stabilised earlier in the year, but had edged down in recent months. Overall, leading indicators of employment pointed to continued moderate employment growth.

The wage price index had increased by 0.7 per cent in the March quarter, a little less than had been expected, and year-ended wage growth was below the average of the past decade. The easing in wage growth had been broad based across industries and states, with notable declines in areas related to the mining sector. While the decline in the pace of wage growth in recent quarters had been most pronounced in the private sector, growth in public sector wages continued to slow in the March quarter and remained relatively subdued, consistent with ongoing fiscal restraint.

What we see in general is a business sector split between natural resource and non-natural resource sectors.  The former is in flux as a result of the Chinese re-balancing, while the latter is OK.  Consumers are still spending thanks to the wealth effect of higher asset prices.  The Central Bank also has room to lower rates further if needed.

Let's turn to a few Australian ETFs, starting with the equity markets.

Prices have dropped almost 20%, from their high of 28.15 to yesterday's close of 22.60/  Prices are now below the 200 day EMA; they've brought the shorter EMAs with them.  Also note the slight increase in volume and negative MACD and CMF.  Prices are right at the 38.2% Fib reading from the June-May rally.

Like the equity markets, the Aussie dollar has also dropped sharply, falling about 12.66%.  Like the equity market, the technicals are very negative.  However, prices have made a 100% retracement from their May move last year, indicating this might be the end of the sell-off.

Did the Fed move the target?

. - by New Deal democrat

There's been some blowback in the last few days about whether the Fed actually introduced any uncertainty, or changed from a data-responsive to a calendar-responsive regime. After all, Bernanke must understand the consequences of higher long term interest rates, so he will hold off, or reverse course, if it looks like the economy is faltering.

But this confidence ought to evaporate if, in fact, the Fed has moved the goalposts, as a writer at Naked Capitalism thinks:

For those who arent refinancing their mortgages and without financial investments, it’s hard to say what the Fed has accomplished; their earlier stated targets were to lower unemployment to 6.5%, and to allow short term inflation to reach 2.5% in order to stimulate growth. Now, however, ..., they say they’ll be satisfied with 7% unemployment, and despite inflation fears accompanying the quadrupling of the Fed’s balance sheet, core PCE inflation was at a record low in April. From here, it seems they just want to get out ....

If the Fed has moved its unemployment and inflation targets, that hardly inspires confidence that it is being data driven. It sounds more like the Fed wants to get out of the QE business, and soon, and is willing to lower the standards however necessary to get there.

So, has the Fed moved the goalposts? Here's the Fed statement from half a year ago establishing the unemployment and inflation markers:

...the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

Did you catch the distinction? The Fed hasn't necessarily changed the standards for raising interest rates.. What is different is that the Fed has established new, looser criteria for ending QE. So if you thou thought the Fed was going to keep its entire zero lower bound regime in place till its previously disclosed criteria were met, silly you! You weren't reading closely enough.

Feel reassured now?

Yes, Handoffs Are Messy

The Reformed Broker makes the following point about the markets:

Should rates get totally out of control, the Fed will come right back in and swamp the bond market with cash. Should stocks pick up more steam to the downside, Treasurys will get a bid out of fear and this will halt the fear over rising rates (because rates will come down as a result of the panic buying). To some extent then, this will be a self-correcting spiral in the end, even if it is an unpleasant one.

This is a very well-articulated point that deserves further development and explanation.

The Fed has influenced a number of market aspects.  Perhaps more importantly is the impact on market psychology, as traders knew the Fed was on their side and was attempting to have a positive impact on the economy as a whole.  It is difficult to understate the importance of this effect; when the market had fallen out of bed, it literally got brokers back in the game willing to take on risk when the economy was weak.  As the market rose, this effect did not wear off; in fact, it increased as the Fed upped its game, adding programs as they saw fit.  And finally, the public communication of hard targets for their interest rate decision (the 6.5% unemployment, 2.5% inflation factors) have had the effect of putting their foot on the market's gas pedal.

These support programs have become a fundamental component of market psychology for the last 3-4 years.  In the economic world, that's a hell of a long time.  More importantly, we can look at this time period with an asterisk, reminding us the market's rise was aided by a Fed that was literally doing everything it could and then some to help the economy.  Asset purchases are hardly part and parcel of standard Fed policy; they only occur when the Fed is trying to keep the economy out of the economic abyss.   But these programs have altered the psychological make-up of market participants in a very atypical way.  As a way of explaining it, imagine starting the semester with a professor telling you the lowest grade you'll get is a "B."  It's an action that simply changes the way you view things in a very fundamental way. 

Regardless of whether you agree or disagree with the Fed's decision (and I strongly agree with it), there is no mistaking that we now have a fundamentally different market environment.  The biggest effect is on the bond market, which has had a permanent bid for the last three years, which in turn has kept yields low.  The stock market has also had a profound rally from these programs.  And the dollar has been weaker -- although it has hardly crashed as some commentators speculated.  All of these markets will now readjust to a new reality -- one potentially without the Fed helping it along.

But Josh makes a key point; there seems to be an assumption that if things go to hell the Fed will simply say, "we told you we were backing off now; go it without us."  That's not the case.  If the economic and market fundamentals really start to deteriorate, the Fed will jump back in the market with something.  Bernanke has already said as much in his statements.  The question, or course, is when that will happen.  Frankly, I don't think Bernanke knows at this point.  But the possibility is always there.

  

Market/Economic Analysis US

Let's review last week's economic news and market action, starting with the numbers:

The Good

The  NAHB index hit a milestone: Builder confidence in the market for newly-built single-family homes hit a significant milestone in June, surging eight points to a reading of 52 on the National Association of Home Builders/Wells Fargo Housing Market Index (HMI) released today. Any reading over 50 indicates that more builders view sales conditions as good than poor.  This number indicates the housing market is definitely improving.

Inflation is contained: The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.1 percent in May on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.4 percent before seasonal adjustment.  While I'm sure there will still be the clarion calls for a massive bought of inflation from the typical idiots, the data indicates that inflation is well contained and under control.

Housing continues to be a strong component of the recovery:  Housing starts increased 6.8%.  While permits declined 3.1%, remember there was a big bump (12.9%) in the previous month's number, meaning we're simply seeing a natural drop after a period of heightened activity.  Existing home sales increased 4.2%.  Perhaps more importantly, inventory increased for the fourth straight months.
 
The Philly Fed manufacturing index increased from -2 to 12.5.  Unlike the NY Fed number, the internals of this number also increased.  "The demand for manufactured goods as measured by the current new orders index increased, from ‑7.9 to 16.6. The shipments index also moved back into positive territory, rising 13 points to 4.1." 

The LEIs increased .1%.  However, the increases were all attributable to financial market developments: a positive credit spread, a positive credit indicator and a strong stock market.   The non-financial numbers (ISM, average workweek, initial claims) were neutral in the index.

The Markit "flash" index for US manufacturing came in at 52.3%.  The internals for this report were also positive.  I do not know why this number is stronger than the ISM number.


The Bad:

Although the headline number was positive, the internals were very weak.  "New orders, at minus 6.69, are down for a second straight month with contraction in backlog orders very deep, at minus 14.52. Shipments are at minus 11.77 with inventories at minus 11.29 in what are also deep rates of monthly contraction." 

Let's turn to the markets:

Despite all the panic and concern exhibited last week, prices were actually pretty disciplined.  There's a large red candle on Thursday, but a far smaller on on Friday, but of which find support at the early April level around 159.  This level also has support in the form of the top Fib fan.  There is noticeably higher volume, indicating the depth of the sell-off is strong.  Finally, the MACD and CMF readings are very weak.

The is where the real action occurred last week.  The belly of the treasury curve finally broke key through support in a meaningful way.  The IEIs moved through the 122 level and the IEFs moved through the 105 level.

 
The dollar rallied at the end of last week, largely because of higher US interest rates and the potential for stronger growth.

Market outlook: slightly negative.  Stocks are still dealing with the Fed pulling back QE.

Two questions for Sunday: in re Fed policy...

- by New Deal democrat

I have two questions that I would really like to see academic economists answer, based on past and intended Fed policies:

1. Professor Brad DeLong this morning faults Ben Bernanke for failing to create credible inflation expectations significantly over 2%.

My question is, What would an average wage-earner, who has seen his/her wages go up on average 1.5% or so for the last few years, do if they actually believed that 3%, 4%, or 5% price inflation was around the corner? I believe they would actually spend less and save more to guard against the coming diminution of their earning power. Does anybody have any historical examples of what has happened when wages stagnated in the face of increasing inflation? I seem to recall reading that this has happened a number of times in Latin America, and the outcomes were not pleasant. If so, why do you believe the outcome would be different here?

2. There's a reason Mish is on the sidebar, even though I disagree with a large majority of his opinions. And that is because, especially when he digs into the data, he always makes me think. Three weeks ago he posed a challenge specifically to Prof. Paul Krugman: "When does it [quantitative easing] stop Paul? When?"

I think this is actually an excellent question. Is there an academic model for when quantitative easing should end? Empirically the Fed can ease off, and if the economy falters, start back in, but that is rather like feeling around in an unfamiliar room in the dark.

Krugman and others have quantiative academic models for when quantitative easing is necessary (the zero lower bound) and the forms it might take. But at what level or trend in employment, unemployment, wages, interest rates, or other relevant parameters should it be scaled back? How should it be scaled back? When can it be completely ended? I'm not aware of any such mathematical model, and if one doesn't exist, now would be an excellent time for academic economists to consider one.

Weekly Indicators: 2 long leading indicators turn negative edition

 - by New Deal democrat

May monthly data reported this past week included the Index of Leading Indicators, up 0.1 and showing no imminent recession, the Empire State and Philly manufacturing indexes, both of which improved, consumer prices up slightly, housing starts and existing home sales up, and permits down. The 6 month trend in housing is up, but at a more muted pace than over the previous year.

Prof. Geoffrey Moore identified 4 long leading indicators, which take over a year to feed into the general economy: bond interest rates, real M2 money supply, housing permits, and corporate profits after taxes. Three of the four (using purchase mortgage applications as a reasonable proxy for permits) are updated in our look at the high frequency weekly indicators, so let's start with them:

Interest rates and credit spreads

•  5.11% BAA corporate bonds up +0.12%


• 2.20% 10 year treasury bonds up +0.08%


• 2.91% credit spread between corporates and treasuries up +0.04%

Interest rates for corporate bonds had generally been falling since being just above 6% in January 2011, hitting a low of 4.46% in November 2012. Treasuries previously were at a 2.4% high in late 2011, falling to a low of 1.47% in July 2012, but in the last few days have retreated back to that high. Spreads have varied between a high over 3.4% in June 2011 to a low under 2.75% in October 2012. After being close to that low 6 weeks ago, interest rates have backed up significantly.

Housing metrics

Mortgage applications from the Mortgage Bankers Association:

• -3% w/w purchase applications


• +12% YoY purchase applications


• -3% w/w refinance applications

Refinancing applications have decreased sharply in the last month due to higher interest rates. Purchase applications have also declined, although they continue their slightly rising YoY trend established earlier this year.

Housing prices

• YoY this week +7.9%

Housing prices bottomed at the end of November 2011 on Housing Tracker, and averaged an increase of +2.0% to +2.5% YoY during 2012. This weeks's YoY increase made yet another 6 year record.

Real estate loans, from the FRB H8 report:

• +0.4% w/w


• up +1.1% YoY


• +2.7% from its bottom

Loans turned up at the end of 2011 and averaged about 1% gains YoY through most of 2012.  In the last several months the comparisons have completely stalled, although this week was positive.

Money supply

M1

• -4.4% w/w


• +1.8% m/m


• +11.4% YoY Real M1

M2

• +0.1% w/w


• +0.4% m/m


• +5.6% YoY Real M2

Real M1 made a YoY high of about 20% in January 2012 and had generally been easing off since, but recently has increased again.  Real M2 also made a YoY high of about 10.5% in January 2012.  Its subsequent low was 4.5% in August 2012. It increased slightly in the first few months of this year and has stabilized since.

Employment metrics

American Staffing Association Index

• 93 up 1 w/w, down -0.5% YoY

Initial jobless claims

•   354,000 up +20,000


•   4 week average 348,250 up +3000

Tax Withholding

• $111.9 B for the first 14 days of June vs. $103.5 B last year, up +8.4 B or +8.1%


• $151.0 B for the last 20 reporting days vs. $140.1 B last year, up $10.9 B or +%7.8

In the 6 weeks month, the ASA has deteriorated to being negative compared with last year. After having a great 20-day comparison several weeks ago, for the third time in a row this week tax withholding had a relatively poor YoY comparison. Initial claims remain within their recent range of between 325,000 to 375,000, and have flattened out just as they have in the last 3 springs and summers.

Transport

Railroad transport from the AAR

• +1500 or +0.5% carloads YoY


• +1900 or +1.1% carloads ex-coal


• +4300 or +1.7% intermodal units


• +5900 or +1.1% YoY total loads

Shipping transport

• Harpex unchanged at 403


• Baltic Dry Index up 127 to 1027

Rail transport has been both positive and negative YoY in the last several months. This week it was positive. The Harpex index has been improving slowly from its January 1 low of 352. The Baltic Dry Index increased sharply this week and is close to a 52 week high.

Consumer spending

• ICSC +0.3% w/w +2.5% YoY


• Johnson Redbook +2.9% YoY


• Gallup daily consumer spending 14 day average at $93 up $23 YoY

Gallup's YoY comparisons remain extremely positive, as they have been for the last half a year.  The ICSC varied between +1.5% and +4.5% YoY in 2012, while Johnson Redbook was generally below +3%. The ICSC has trended towards the lower part of its range recently, but Johnson Redbook has been close to the high end of its range.

Oil prices and usage

•  Oil $93.69 down -$4.16 w/w


• Gas $3.63 down -$0.03 w/w


• Usage 4 week average YoY -0.4%

The price of a gallon of gas, after declining sharply in March and April, rose again in May, steadied in early June, and has declined for the last week. The 4 week average for gas usage remained slightly negative.

Bank lending rates

• 0.23 TED spread unchanged w/w


• 0.193 LIBOR up +0.003% w/w

The TED spread is still near the low end of its 3 year range.  LIBOR rose slightly from its new 3 year low established last week.

JoC ECRI Commodity prices

• down -1.88 to 121.33 w/w


• +6.53 YoY

Noteworthy this week is the continuing spike in interest rates, as well as the decline in mortgage activity. Both of these are long leading indicators and so raise a warning flag for next year. The third long leading indicator, however, real money supply remains positive. The only other outright negative indicator is temporary staffing, which has been problematic for over a month.

Positives included strong consumer spending once again. More positives included house prices, YoY purchase mortgage applications, overnight bank rates, both rail and shipping transport, and gas prices. Jobless claims and commodity prices rate as neutrals this week.

The sharp rise in interest rates is definitely of concern, but it hasn't lasted long enough to seriously signal a recession next year. Housing is weakening but still positive. In terms of coincident indicators of the economy, consumer spending is still quite positive, and initial jobless claims, while trending sideways for the last month or so, show no signs of rolling over.

Have a nice weekend.

Weekend Weimar, Beagle and Pit Bull

It's that time of the week. I'll be back on Monday; NDD will be here over the weekend. Until then:

Bernanke Drops the Ball

OK -- it's been a few days, and in the meantime the markets have decided to hyperventilate about the Bernanke presser.  So, let's take a minute to look at exactly what he said and what it means.

Starting about 4:30, Ben explains the two programs the Fed is using.  The first is interest rate policy, which is still going to be low for a long time.  Here's the exact wording from the Fed statement: In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

So, we have a three-pronged set of factors to use when evaluating when rates may increase: unemployment about 6.5%, future inflation is lower than 2.5% and inflation expectations are well anchored.  Ben specifically notes these are thresholds, not targets, so even if we do hit those targets, rates could stay low.

Let's turn to the asset purchase program, which he starts explaining at 8:00.  Currently, the Fed is purchasing assets at the following monthly pace: $45 billion in Treasuries and $40 billion in agencies.  The fed may moderate this later in the year, with the potential to end the program by next summer.  He notes the pace is not predetermined, but instead is highly dependent on incoming economic information.  If the economy improves, the pace will quicken; if the economy slows, the pace will slow or the program will end entirely.

Let's place the asset purchase program in historical perspective by looking at the 10-year CMTs interest rate:

The 30-year bull market in bonds is still intact.  We do see a slight uptick on the long-term chart, which is better analyzed using a shorter time frame:

 Rates have moved about 2% and are now approaching 2.5%.  While this rate is still low, that lowness is relative.  In comparison to our recent rate experience, it's actually getting high.

Also note the Fed will continue to reinvest maturing principle (see statements beginning at 9:30).  This could be a key point, as the Fed may think they have enough financial ammunition already on their books to keep rates low. 

For more on the overall effect, see NDDs piece below.

Now let's entertain the question of whether or not this is a good idea right now, starting with an obvious although overlooked point: asset purchases have to end sometime, it's a matter of when.  Now -- is this time the appropriate time?  Ben notes that unemployment has dropped since the plan was initiated.  He also sees current moderate growth.

Here's where I think he makes a big mistake, quoting from the Fed release. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall.  I don't think this is the case at all.  Consider the following points.

The fed admits that we're facing fiscal headwinds thanks to the bozos in Washington ("fiscal policy is restraining economic growth.").  Manufacturing is slowing thanks to a slow international environment and general tentativeness domestically.  One of the key bright spots in the economy is housing, which the Fed's move will hurt by increasing interest rates.  Wages aren't going to meaningfully increase in a 7.5% unemployment environment and refis -- which have been proving a fair amount of the financial fuel for consumer purchases (see NDD below) -- are going to drop in a higher rate environment.

And the international environment is terrible.  The EU -- which is the second largest economic region after the US -- is in a depression.  China is clearly slowing, which is having a pronounced negative effect on the developing world.   The three other BRICs are all experiencing their own problems: India has slower growth, high current account deficits, systemic political paralysis and high inflation.  Brazil's growth is slowing and their inflation in far higher than preferred, meaning their central bank can't lower rates to stimulate growth.  And Russia is fast becoming a basket case.

In short, I think the Fed is dropping the ball on this one.

 

Should average Americans care about the "Taper?" Yes

- by New Deal democrat

You may have heard on your car radio or on television last night after you came home from work that the stock market had a bad day, dropping about 2.5%. Probably the newscaster said something about it being a reaction to the Federal Reserve Bank's announcement that it expects to "taper" its purchases of long term bonds in the near future. While the daily gyrtions of the stock market are not worth getting excited about, IF the "taper" happens, it likely will affect you. Let me explain why.

First of all, let's put the stock market decline of the last two days in perspective. Here's a daily graph of the S&P 500 since the beginning of this year:



Note that the market rose almost 20% since January 1. Even with the 5% selloff over the last 2 days since Bernanke confirmed that the Fed intends to start "tapering" soon, it is still up over 10% for the year.

While I don't presume to read traders' (or trading computers') minds (see Barry ritholtz' note this morning about ex post facto rationalizations), generally speaking there is concern that the "taper" of long term bond purchases will cause bond yields (the percent of interest paid on them) to rise. When bond yields rise, the market price to purchase or sell those bonds falls. When most traders expect prices to fall in the future, what do they do? They sell the assets now, causing prices to fall immediately, rather than in the future! That's exactly what has happened over the last month, as shown in this graph of the yield on the 10 year US treasury bond for the last year (keep in mind that yields going up means prices going down):



This is a sharp move, although as we'll see in the next graph, from a longer-term perspective, it is little more than a blip. That being said, there's a pretty good chance that last summer's low in long term interest rates may be the lowest you will ever have seen in your whole life.

The reason average Americans should care about the "taper" is that higher interest rates on bonds also means higher interest rates on things like mortgages. One of my constant points on this blog for the last several years has been that households' refinancing of their mortgage debt at lower and lower rates has put more money in their pockets for spending and for paying down debt. This next graph is an update of one from Mortgage News Daily that I've run a number of times over the last couple of years, comparing the amount of mortgage refinancing (yellow) with mortgage interest rates (blue):



The graph starts in 2008 at the depths of the recession. Note that refinancing was at its low ebb. Since then and especially in late 2011 and 2012, with record low mortgage rates refinancing has boomed. At the far right of the graph you can see the last month's spike in mortgage rates, and the steep decline in refinancing back to mid-2011 levels.

Simply put, the more the "taper" causes interest rates to rise, the less refinancing of mortgages we will see. We'll probably also see a decline in the amount of purchases of new homes as well, since purchasers will also be faced with hgher mortgage rates.

And mortgage refinancing has been one of the most important reasons why the economy has continued to move forward in the last few years, despite the stagnation in real wages, which is what is show in this next graph of average hourly wages divided by consumer prices to give us "real hourly wages":



Real hourly wages have improved over the last 12 months, but they are still below where they were all through 2009 and 2010.

So average Americans should care about the "taper." To the extent it causes interest rates to rise, interest rates you pay on any new debt are likely to go up. Refinancing of old debt will pretty much vanish. Further, at 7.5% unemployment, it is unlikely that real wages are likely to appreciate significantly, to say the least! Interest sensitive sectors of the economy, like home building, will likely deteriorate. With manufacturing already stagnant, the likelihood of falling into a new recession next year increases greatly (remember that interest rates are a long leading indicator, and increases tend to take a year or more to be felt in the real economy).

Finally, let me point out that in the above analysis, I am being like the Ghost of Christmas Future in "A Christmas Carol." I am not showing you what will be; only what might be. All of those bonds I mentioned above, being sold by traders? Other traders bought every single one. There are some people who think the upward move in interest rates is overdone, and they see a buying opportunity. In other words, there is no certainty that the Fed "taper" will cause interest rates to move higher than they already have. Even more importantly, Bernanke premised the "taper" on unemployment moving to 7% or below. If the economy slows because of anticipated or real higher interest rates, we won't see unemployment moving under 7%, and then the Fed is likely to reconsider and not "taper" at all! In other words, it could be a self-unfulfilling prophecy.

But the ultimate conclusion remains that average Americans are deeply and negatively affected by rising interest rates (not to mention what it means for interest paid on new national debt). If the "taper" means a rise in those rates, average Americans should be aware and should care.

Market/Economic Analysis: South Korea

From the latest SK GDP report:

First, we see a nice bump in GDP during the first quarter with the .8% Q/Q print.  But notice the big change in the composition of growth.  PCEs declined .1%.  To make up for the loss, we see increases in in capital formation  of 3.8% and exports of 3%.

Let's look at this data on a year over year basis:

The real issue on the year over year basis is the drop in facilities investment, which contracted at a very sharp 11.9% reate.  PCEs are also weak at 1.5% which is partially explained by the high level of household debt that currently stands at 160% of annual incomes.  Government spending is also weak at a 1.3% increase.  

As a result of slower growth, the government has issued a supplementary budget to stimulate the economy:

South Korea unveiled a Won17.3tn ($15.4bn) supplementary budget on Tuesday to support the stalling economy, as domestic consumption remains sluggish while exports slow because of the weaker yen and cooling global demand.

The supplementary budget was larger than expected, mainly because it contained plans to raise debt to make up for anticipated tax revenue losses resulting from the slowing economy, and delays to the attempted sale of state holdings in two banks.

Also causing problems is the South Korean's dependence on exports, which the Central Bank noted in their latest policy announcement:

In Korea, consumption and facilities investment have declined but the Committee appraises economic growth to be continuing, albeit weakly, as exports have improved and construction investment has increased to a great extent. On the employment front, the number of persons employed has increased, centering around the 50-and-above age group and the service sector. Due to a slowdown in the uptrend in employment in the manufacturing sector, however, the increase was smaller in May than in the previous month. Going forward there is no change to the Committee’s forecast that the domestic economy will show a negative output gap for a considerable time, due mostly to the slow recovery of the global economy.

There are no signs of an imminent collapse.  But it does appear the SK economy is entering a slow growth phase.

Let's take a look at the South Korean ETF:

Over the last week, prices have fallen to near nearly lows on a declining momentum and CMF reading.  The strong moves lower over the last few days are all the result of the Fed tapering talk.  The rest is about a slowing economy. 

The Pied Piper of Doom: "I only mentioned a double dip once." BWAHAHAHAHAHA!!!

. - by New Deal democrat

Over at the Great orange Satan, there is presently a little kerfluffle over who or what should get credit for the recovery. I think most people who also read this blog as well won't be surprised that I think the truth is more multifaceted and nuanced.

New Deal and Great Society programs like Social Security, food stamps, unemployment insurance, and disability did not prevent the great recession, and they didn't cause the recovery. On the other hand, they acted as stabilizers, to some extent cushioning the impact of the Hard Times.

Further, it is widely accepted that the 2009 stimulus did have a positive multiplier effect. It certainly helped, but many believe it should have been larger, and some points were poorly designed -- "rim shots" as Atrios called them -- but did help. Tax cuts may not have been the best approach, for example, but spending by the 75th to 95th percentile is where the biggest boost was to be found.

UPDATE: The biggest kudos, though, should probably go to Ben Bernanke. The Fed's quantitative easing program brought long term interest rates down enough and long enough for millions of homeowners to refinance at lower mortgage rates, freeing up money for spending on other items and paying down other debts.

The rest I'll leave to the partisan activists, but I can't let pass without heaping well deserved derision on the Pied Piper of Doom's claim that he only brought up the possibility of a double dip recession once, reporting neutrally on and certainly not embracing or touting ECRI's recession call in September 2011.

Oh, puh-LEEEZE. A cursory google search finds the PPoD heralding the imminent arrival of a double dip recession in August 2009, in January 2010, in July 2010, in August 2010, and as recently as April of last year. That last one is a real gem, because it includes a comment saying:



Which is recommended by the PPoD along with a note that there is no housing recovery -- right at the moment that YoY house prices turned positive and haven't looked back since.

BWAHAHAHAHAHA!!!

European Depression Grinds On

From the latest Market Manufacturing Report:

The Markit Eurozone PMI® Composite Output Index rose from 47.7 in May to 48.9 in June, according to the flash estimate, indicating the smallest downturn in business activity since March last year.

The sub-50 reading nevertheless rounded off another weak quarter. At 47.8, the average reading for the three months to June is only marginally higher than the 47.7 average recorded in the first three months of the year, suggesting that the eurozone’s recession will have dragged into a seventh successive quarter.
 
Although activity continued to decline overall, the third consecutive monthly rise in the PMI in June indicated that the rate of contraction is on a moderating trend. Manufacturing output fell in June at the slowest rate in the current 16-month sequence, registering only a very modest decline, and services business activity showed the joint-weakest fall since March 2012.
 
Adding to the picture of the downturn moderating, new business fell at the slowest rate for five months, the rate of decline having eased for the third month in a row. New orders in manufacturing fell only marginally, registering the smallest decline for two years, while the services sector saw the smallest fall for five months.

Expect a fair amount of hype about the slowing trend in the downturn, along with a special emphasis on the possibility of the EU coming out of the depression in the second half of 2013.  Don't believe the hype.  First, this is the sixth quarter of negative growth.  We're now entering the possibility that a continued slow pace of expansion is the new norm.  The region is not only still experimenting with the incredibly backward idea of austerity but their export markets are growing modestly at best.  And the political leadership has absolutely no foresight.

  

Market/Economy Analysis: China

China has been one of the primary economic drivers of the last 10-15 years; it is the primary force in the "south-south" trade, where raw material exporters (Australia, Canada, most of South America) sell their raw materials to China who then converts them into final products for shipment to the west.  However, China's growth is slowing.  Consider the following data points released since June 1:

Manufacturing

After adjusting for seasonal factors, the HSBC Purchasing Managers’ Index™ (PMI™) – a composite indicator designed to provide a single-figure snapshot of operating conditions in the manufacturing economy – posted at 49.2 in May, down from 50.4 in April. This signalled the first deterioration in operating conditions in seven months, albeit at only a marginal pace.

Despite operating conditions worsening, manufacturing output rose for the seventh month in a row during May, albeit marginally. Behind the meagre expansion of output, total new orders declined modestly and for the first time since last September. Demand from abroad also weakened over the month, with new export orders falling for the second month in a row. A number of panellists suggested reduced client demand, particularly in the US,

Here's a chart of the relevant data:

Note that the index spent most of 2012 below 50, indicating contraction.  Now traders are concerned we're seeing that trend start again.

Services:

Output continued to expand across both the manufacturing and service sectors for the seventh consecutive month in May. However, production at manufacturing plants rose at the weakest pace since October 2012 and business activity at service providers increased at a modest pace. The latter was signalled by the HSBC China Services Business Activity Index, which posted 51.2 in May. This was broadly unchanged from April’s 51.1 and was one of the lowest readings in the series history.

Total new orders were relatively unchanged in May at the composite level, with sector data indicating differing trends. New work intake at manufacturing plants fell modestly over the month and for the first time since last September, while new business increased at service providers. However, the rate of growth was modest and remained historically weak in the service sector.

Here's a chart of the data:

While still positive,  we've seen a few months of lower prints.  This is hardly fatal, as this sector hasn't meaningfully contracted in over two years.  But it is something to keep your eye on.

Other recent data prints have also disappointed.  From Bloomberg:

China’s trade, inflation and lending data for May all trailed estimates, signaling weaker global and domestic demand that will test the nation’s leaders’ resolve to forgo short-term stimulus for slower, more-sustainable growth. 

Industrial production rose a less-than-forecast 9.2 percent from a year earlier and factory-gate prices fell for a 15th month, National Bureau of Statistics data showed today in Beijing. Export gains were at a 10-month low and imports dropped after a crackdown on fake trade invoices while fixed-asset investment growth slowed and new yuan loans declined. 
.....

Industrial production compared with the median estimate for a 9.4 percent increase, with growth the weakest for a January-May period since 2009. Fixed-asset investment excluding rural areas rose 20.4 percent in the first five months from a year earlier, down from a 20.6 percent pace in January-April, statistics bureau data showed. May’s retail-sales growth of 12.9 percent matched the median projection of analysts.

May exports rose 1 percent from a year earlier, down from 14.7 percent in April, while imports dropped 0.3 percent from a year earlier. The median estimates of analysts were for 7.4 percent export growth and 6.6 percent import gains. The $20.4 billion trade surplus compared with forecasts for $20 billion.

“This shows the real state of the Chinese export situation,” said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong. The data give a “pretty depressed” picture, with weak external demand and a yuan that has appreciated substantially against a trade-weighted basket of currencies, said Shen, who previously worked at the European Central Bank. 

Bear in mind that China needs rapid growth because of two inter-related factors: the world's largest population and its GDP per capita.  In order to create a large enough economic "pie" to spread out over its population and thereby raise people out of poverty, we need to see strong growth figures.  That's why industrial production prints of 9.4% are concerning to economists.  Now, let's also stipulate the Chinese slowdown is "relative" and no one is predicting a crash. These are still good numbers; they just indicate things are slowing relative to what we've seen.

But most importantly is that the traditional policy avenues to increase growth aren't there.  From the Financial Times:

The concern about China’s slowdown is grounded partly in the speed with which credit is growing in China. The figure for total lending, which includes the non-banks as well as the banks, hit nearly Rmb8tn ($1.3tn) in the first four months of the year, significantly higher than the Rmb4.85tn for the same period a year ago, according to JPMorgan. Today, China’s total credit is almost double its gross domestic product.

But more worrying is the declining efficacy of that credit. The amount of capital being put to work is swelling, but the productivity of that capital is plummeting. Five years ago, a dollar invested produced a dollar of GDP growth. But today it takes $3 to $4 of investment to produce a dollar of output – and the quality of that output is suspect. There is overcapacity across many Chinese industries, from shipbuilding to solar.

The decreasing efficacy of Chinese lending is a policy problem, because this is the preferred method for the Chinese government to goose economic growth.

The short version of the above data points is it is becoming more and more apparent that the Chinese growth story is changing.  And that has tremendous ramifications for the rest of the world.

The Chinese market is consolidating in a descending triangle formation, with the top part of the triangle connecting the early February and last May highs and the lows established on the 38.2% Fib level.  A break of the 2150 level would indicated a move lower.  Also note that prices are below the 200 day EMA with the shorter EMAs moving lower.

The beginning of a sea change in household deleveraging

- by New Deal democrat

The Federal Reserve's report on household debt burdens was released earlier this week covering the January - March quarter. I have been watching these series since before the Great Recession. Indeed, when household debt burdens started to decline, that was one of the final signs that the Recession was about to start. Further, I long suspected that, before this cycle was over, households would set new all time lows for debt service. With the exception of one quarter in 1980 (as to total financial obligations), that happened in the final quarter of last year.

First, a refresher. According to the Federal Reserve,

The household debt service ratio (DSR) is an estimate of the ratio of debt payments to disposable personal income. Debt payments consist of the estimated required payments on outstanding mortgage and consumer debt.

The financial obligations ratio (FOR) adds automobile lease payments, rental payments on tenant-occupied property, homeowners' insurance, and property tax payments to the debt service ratio.

I've combined the two measures into a single graph. Total financial onligations are in blue and debt service payments are in red:



I have noted a number of times that refinancing increased in 2011 and 2012 with new record lows in mortgage rates, and probably played a major role in keeping the economy from tipping back into recession.

Now, for the first time in four years, household deleveraging has stopped. Whether we have already hit the absolute bottom or not is impossible to say, but it certainly appears that the bottoming process has begun.

It's also worth noting that the willingness of households to re-leverage, even slightly, bespeaks increasing confidence about the future. Recall that this has also shown up in recent consumer confidence readings, which have made 5 year highs, and in Gallup's consumer spending data, which has been strong ever since last December, even in the face of the payroll tax increase. This is also of a piece with the new post-recession lows in the savings rate.

I believe thie is the beginning of a very slow sea change.

A note about the CPI

. - by New Deal democrat

Consumer prices for May were reported on Tuesday as having risen +0.1%, in line with my prediction based on gas prices of +0.2% +/-0.1%.

I haven't been making these forecasts just as an exercise in crystal ball gazing (well, okay, maybe just a little), but also as a way of elaborating on a theme I've been writing about for a long time -- the major but largely unremarked impact of the secular increase in gas prices on the consumer economy.

What I've been trying to show, among other things, is that the relative change in gas prices has been the driving determinant in whether wages fall behind, keep up with, or increase vs. the general price level since gas prices bottomed in 1999. With gas prices finally plateauing or even declining slightly in the last year, real wages have started to increase again.I believe this is an important reason why the economic expansion has so far survived both the payroll tax increase and Sequestration.

Will Oil Finally Break Through the 98 Price Level?

The 98 price level has provided strong resistance for oil prices this year.  Yesterday prices closed at 98.58.  Let's see if the upward momentum continues today.

Condolences to Professor Thoma

Professor Thoma of Economists View just announced that his wife has passed away.  On behalf of all here at the Bonddad Blog, we want to extend our deepest sympathies.