The World Is Not Ending (Yet)

Investors have become unhinged.The increased volatility and dramatic market moves challenge even the most robust investment strategies. This sets off a chain reaction of money and risk management that further amplifies the price action, like an echo chamber. Then a cottage industry of reporters, analysts and bloggers offer explanations often without distinguishing the initial sound from the echo.

At the same time, that which we have come to think of as terra firma has turned into quicksand. Interest rates are bounded by zero. Of course, there had been a few exceptions, like when Germany and Switzerland in the 1970s discouraged speculative foreign inflows, but it was not a generalized phenomenon. Now it is widespread. German and Japanese yields are negative out eight to nine years while Switzerland has negative rates through 15 years. All told more than $8 trillion of debt has a negative yield.

Negative yields in Europe and Japan complement the expansion the central banks’ balance sheets. Such extremely accommodative monetary policy is associated with depreciating currencies. Yet, the yen has surged, and the euro has rallied against the greenback, despite the dollar being backed by higher interest rates.

In 2008, when oil prices were near $150 a barrel, and peak oil was the rage, the concern was that it was a major headwind on growth. Oil prices have plunged since mid-2014. They have fallen below $30 a barrel, but now this has been associated with weaker economic activity. Capital expenditures have slumped. Industrial output has fallen. Even Japan, which imports nearly all of its energy (slowly a few nuclear plants have re-opened) has not benefited.

In fact, Japan Q4 15 GDP will be released in the week ahead, and it will likely confirm that the economy is still struggling to find any positive traction. The world’s third-largest economy contracted in Q2 15 while the contraction that was initially reported for Q3 was revised away. However, weakness in consumption and residential investment likely more than offset the stronger foreign demand, pointing to a contraction of around 0.2% in Q4.

Nearly a year after the Federal Reserve wound down its asset purchase program, it raised interest rates. However, the world’s largest economy nearly stagnated in Q4 15, and neither the decline in oil and gasoline prices nor still low interest rates and a very accommodative Federal Reserve have deterred recession talk.

The pendulum of market psychology has swung too far. China is not seeking a large devaluation, and to the contrary is spending billions of dollar resisting pressure, some of which is clearly coming from speculators and hedge funds that take to the airwaves talking their position. A similar attempt to sell the bonds of the largest debtor in the world, Japan, failed miserably as the 10-year yield briefly fell below zero last week.

The decline in oil prices is, in fact, good for consumers. US consumption rose 3.1% last year, the most in a decade. American consumers also bought a record number of autos and light trucks. Even if the recovering labor market and low interest rates helped, so did the drop in oil and gasoline prices. European growth, which seemed to approach what many economists consider trend growth (1.0%-1.25%) was boosted more by domestic demand than exports.

The pessimists have confused Wall Street with Main Street. It is true that the sharp drop in equities, rising risk premiums, and the tightening of lending conditions can undermine the real economy. It is too early to reach that conclusion. There have been many dramatic losses in the equity markets that did not drag the economy down.

Indeed after nearly stagnating in Q4 15, the US economy is reaccelerating in Q1 16. Despite the market turmoil, more people are working for slightly better pay, and longer hours in January, and they went shopping. Core retail sales (excluding autos, gasoline, and building materials) rose 0.6% in January.

The poor Q4 15 growth in the US cannot be laid at the Fed’s feet, as it did not raise rates until the quarter was nearly over. In her testimony before Congress, Yellen showed no remorse for the Fed’s unanimous decision to hike rates last December. The Atlanta Fed’s GDPNow tracker projects Q1 16 GDP to be near 2.7%. The Fed’s 25 bp hike did not derail the US economy.

In the week ahead, the US is expected to report housing starts rose in January after falling in December. Industrial output likely snapped a four-month slide, with the consensus call for a 0.4% rise. Manufacturing output is expected to post its first increase since October.

What of inflation? The unorthodox monetary policies in Japan, Sweden, and the eurozone is more about achieving the central banks’ inflation targets rather than growth per se. The US and UK report CPI figures in the week ahead. In the US, core CPI trended higher last year, despite the dollar’s appreciation and the drop in oil prices. In January, the core rate is expected to be unchanged at 2.1%.

UK headline CPI appears to have bottomed last year slightly in negative territory (-0.1%). It finished last year at 0.2% and is expected to have ticked up to 0.3% in January in part due to a favorable base effect. The core rate may have slipped to 1.3% from 1.4%. Airfare and apparel prices may be the culprit. Past sterling strength may also be feeding through. Separately, the UK’s labor market report will likely show a continued easing of wage pressures.

The pendulum of market psychology has swung toward pricing in a modest chance of a rate cut by the Bank of England. The March short-sterling futures contract implies a yield of 60 bp. However, all the contracts through March 2017 are implying lower yields, with the September 2016 contract indicating a 20% chance of a cut.

Some may be seeking protection in case of Brexit rather than “betting” on a rate cut. Supply and demand may be the more important driver than expectations. Nevertheless, further tightening in the labor market (the ILO measure of unemployment is expected to slip to 5.0% from 5.1%) and a healthy retail sales report may help sentiment recover. January UK retail sales, excluding auto fuel, are expected to have risen by 0.7% after the 0.9% fall in December.

The US, UK, Japan, and Germany have near full employment, by the respective central banks’ reckoning. Yet the upward pressure on wages is marginal at best. This remains another economic anomaly. To be sure, economists have offered various reasons, including that wages did not fall as much as “they should have” during the crisis, and hence, the rebound is less than what “it should be”. Other economists suggest that the labor market may have greater slack than is being reported.

The decision by a large UK-headquartered bank to abandon its plan of less than two weeks to freeze pay this year is instructive. The decision to freeze wages was not a comment about average or marginal productivity. Nor was the decision to reverse itself driven by productivity or inflation considerations. It is about power. The disparity of income (and wealth) reflects asymmetries of power.

Employers are reluctant to pay more for an input cost (labor) than they are compelled to. In Japan, where corporations are reporting record profits and have cash-rich balance sheets, wages rose 0.1% year-over-year in December 2015. Despite the moral suasion by government officials and central banks, the division of present (as well as past) productivity gains between profits and wages favors the former and will until forced otherwise, but that does not appear to be on the near-term agenda.

The Federal Reserve releases the minutes of last month’s meeting in the middle of the week.That the Fed left rates on hold was not surprising after the December hike. The market will be looking for some insight into how worried the Fed is by the market turbulence. The FOMC statement said officials were still trying to determine if their growth outlook or risk assessment needed to be changed.

Some observers saw this as a sign that the Fed was so bewildered that it did not offer a risk assessment. We read the FOMC statement differently. Since the Fed did not change its assessment, the previous one, articulated when it hiked rates in December was still operative. Yellen’s testimony seemed to lend credibility to our reading. The FOMC minutes may shed more light.

The record of the ECB’s January meeting will be published the next day. The issue here is the extent that the risks sketched out by Draghi in December, when a modest rate cut and extending of the asset purchase program was announced to the disappointment of many, have materialized. The market is anticipating, at least, a 20 bp rate cut next month and, perhaps, the introduction of a tiered deposit rate scheme, like many other central banks, including the Bank of Japan and the Swiss National Bank.

However, the ECB’s record, which has not been much of a market-mover in its brief history, may be overshadowed by the EC Summit of the heads of state. The Netherlands holds the rotating presidency, and two issues dominate the agenda: negotiations of the measures to avoid a UK exit, and the refugee/immigration challenge. Both issues are thorny, and there is risk that neither issue sees closure.

If there is no resolution, it puts more pressure on the March Summit. Indeed next month is shaping up to be critical. The ECB will most likely ease. The BOJ may ease. While the Federal Reserve won’t hike rates, it will revise its forecasts (dot plots) but is unlikely to abandon all the rate hike projections as the market has done.

Seeking Alpha

7 Comments on "The World Is Not Ending (Yet)"

Apneaman on Sun, 14th Feb 2016 6:11 pm 



Another econ 101 schooled white guy with a 100% confidence and certainty level droning on and on about his chosen religion cause that’s what white men do. They “know” things. Did y’all know economics is a science just like physics, chemistry and biology? No really it is. There’s Keynesian physics, and Austrian physics, ‎Marxist physics and many more.

: What did universities learn from the financial crash? A: Nothing
Most finance education is morally bankrupt. We must stop peddling dangerous lies to our students

“The answers are damning. Most finance academics have continued as before, spinning theories (which really are ideologies) of the importance of greed, profit, wealth maximisation and free markets for efficiency and risk-hedging. There is virtually no teaching about history, culture or ethics. Accounting and finance are researched and taught as if they are acultural, apolitical and ahistorical technical disciplines.

The reasons for this go back to the neo-liberal origins of the discipline, and the ways its research is controlled by a conservative elite suite of journals, whose ideology is based on extreme capitalism and wealth creation.

The research excellence framework (REF) has put even more pressure on finance academics to be conservative and toe the line of these journals, thus making students’ experiences even more alienating. We have already seen rebellions in economics teaching, and we may soon see similar moves in accounting and finance, as young people learn about corporate tax avoidance, financial exploitation and the corruption of politics and banking culture. At present, most of this learning is taking place on social media and through groups like Occupy, rather than in university classrooms or lecture theatres.”

“The complexity of the subject has been used to disguise the underlying ethics and values of experts and the academy, and to influence the practice and industry of finance. In his book Debt: The First 5,000 Years, Professor David Graeber of the London School of Economics explores the human history of finance and finds that it is a cultural construct, grounded in social relationships and exchange.

It is only in the past 35 years that finance lost this grounding and become a tsunami which, although shaped by humans through the creation of markets and institutions, is now out of control, and is controlling ordinary people instead. Graeber argues that states have lost the power or the will to shelter their people from high finance and its slavery. They have lost the language and means to resist, as the technical complexity is too much for them.”

http://www.theguardian.com/higher-education-network/2016/feb/02/q-what-did-universities-learn-from-the-financial-crash-a-nothing

Davy on Sun, 14th Feb 2016 6:45 pm 



Marc Chandler (seeking Alpha) was not very convincing in the above article. He was trying to put on a brave face but you can tell his heart is not in it. He is trying to wish life into something that is dying. The world is ending as we know it but some just don’t know it yet.

makati1 on Sun, 14th Feb 2016 7:03 pm 



If that doesn’t work lets try…

Nothing like negative interest rates, banning cash, quantitative easing, printing money, liar loans, etc. to show how desperate they are getting.

Today’s version of blood letting, garlic necklaces, torture, burning at the stake and other sacrifices to their god, Unearned Money.

The sooner capitalism crashes and burns, never to rise again, the better for all of us trying to stay alive. Meanwhile, convert that paper into things of necessity and real value.

Anonymous on Mon, 15th Feb 2016 1:38 am 



Sound advice, buying tangible things of real value with fake money. Of course, most of the things money can buy are made like shit-and fall apart so fast you need to keep making fake money to buy deliberately shoddily made goods to replace the ones that fell apart previously. Too bad things are so poorly made, even repairing them is seldom of much help (YMMV), but a repair-ware world, we don’t live in.
Of course, if there is no economy to buy the industrial economies poorly made shyte, then what? Learn how to make your own stuff?

Davy on Mon, 15th Feb 2016 6:02 am 



What we have to be watching is what is happening in the triad of the US, China, and the rest of the world. China is the key component of physical demand and without Chinese demand the ROW will be unable to recover. The US without China and the ROW cannot recover. I am saying recover because the US is clearly in a down slope on all metrics from a macro of relative all-time highs in valuation. We know the shadow stats are bad but now even the manipulated headline stats are showing stress. The US lives with the dollar and the dollar lives in a huge global foreign exchange market no nation can control.

The last global bright spot has been the levitated US financial system created by Wall Street and the Fed. This will surely continue to decline with drops in China and ROW. By the end of 2016 I imagine we will see a 30% further reduction in US metrics at least. That reduction with the current recent drops is far in excess of a correction. This will happen because pent up price discovery that had been discarded by momentum investing is naturally reappearing. We now have real markets again because we have latent panic and sober analysis that come from a down slope. People’s minds focus when markets drop.

This will surely keep oil prices dampened. Oil may spike from any of a number of the usual reasons but how much can prices spike with a crippled global economy? We then must ask what further damage spiking oil prices will have on an already damaged global economy if they occur? A Syrian war is just such an opportunity. We are now in the vicious cycle of demand and supply destruction clearly seen with oil, physical trade and the global financial system. It is momentum now that cannot be stopped.

“China Exports Crash Most In 6 Months Despite “Devalued” Yuan”
http://www.zerohedge.com/news/2016-02-14/china-exports-crash-most-6-months-despite-devalued-yuan

“Despite the weakening of the Yuan, China exports collapses 6.6% YoY in January (massively missing the 3.6% increase expected). Imports continued their 15 month series of collapses with a 14.4% plunge (again drastically worse than the 1.8% increase expected). This pushed the trade balance to a record surplus CNY406bn. In Yuan terms it’s ugly… Both imports and exports were worse than the lowest forecast of all professional economists.”

Davy on Mon, 15th Feb 2016 6:31 am 



Clintons initiated the rot we have today. Not alone of course but it was the Clintons leadership who for 8 years along with Greenspan tenure started what lead us to where we are now. In fact I would go as far as saying it allowed China its excesses. All this has led to the destruction of the world at all levels sooner than later. It was the Clintons leadership along with Greenspan that began the global bubble we see today. This process of overshoot could have taken longer without this internationalization of private profit at the global public’s expense. How the hell can another be allowed in the White house after such sins? To be fair one needs to point to GW Bush who destroyed America’s credibility and empire in 03 with the invasion of Iraq post Clinton.

“The Role That the Clintons Played in Enabling the 2008 Economic Crisis and Financial Coup d’Etat”
http://jessescrossroadscafe.blogspot.com/2016/02/robert-scheer-how-clintons-fostered.html

“The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. “

“If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time.”

“I do not have to read Robert Scheer’s account to understand it; I saw this happening with my own eyes, almost in slow motion, as one might watch the events leading up to a train wreck. The actions of the participants were deliberate, and focused solely on amassing enormous fortunes for themselves and their friends, and damn the people and the consequences.”

Further reading:
The ‘Clinton Bubble’: How Clinton Democrats Fostered the 2008 Economic Crisis
By Robert Scheer
http://www.truthdig.com/arts_culture/item/the_great_american_stickup_is_bush_really_20100916

Davy on Mon, 15th Feb 2016 6:38 am 



“Who Said It 13 Years Ago?: “Mr. Greenspan, You Are Way Out Of Touch”
http://www.zerohedge.com/news/2016-02-14/who-said-it-13-years-ago-mr-greenspan-you-are-way-out-touch

“Now that Bernie Sanders has emerged as a very serious contender for The White House and now that the world has suddenly woken up to the fact that central bankers may have no idea whatsoever about what they’re doing, we thought this an opportune time to bring you the following blast from the past, in which Bernie Sanders lambasts Alan Greenspan (the “maestro” of all that’s wrong with the American economy) in a truly epic diatribe that will have you torn between your hatred for central bankers and your aversion to socialism.”