The Week Ahead

We have a week loaded with releases, ending with the Jan Payroll print, Feb/3.

Personal Income and Consumption starts us off and with all eyes of the so-called PCE deflator as the Fed just made a point of targeting this number.  Past years this release packed little market-moving muscle and one reason is that the deflator comes after CPI (The two indexes differ by formula and component. The PCE uses a chain index which accounts for consumer pattern change due to prices; the CPI uses a fixed basket with fixed component weights).

We also have several Dec manufacturing surveys, vehicle and chain store sales for Jan, the Q4 Employment Cost Index (Dept of Labor measure in the growth of wages and benefits) then Dec Factory Orders and Jan Payroll on Friday.

Let’s pause just a moment for the “Manufacturers’ Shipments, Inventories and Orders Report” - so-called Factory Orders. This is not a key FI or FX mkt mover as the Durables component, roughly half of the report, has already been released. Non-durables are then added. Equity investors are usually more interested in this report as it shows trends within industries, something the Durables report does not (instead of just computers for example, it will show component breakdown - monitors, semiconductors, hardware, etc,).

Finally, we have Jan Payroll, part coincident indicator, part leading but prime market mover nevertheless. We have had job creation as a client anchor, meaning that economists would under-estimate related vigor. As a fit, the Dec headline print at 200M, with private sector jobs at 212M,  flattened estimates. Earnings and hours worked were also a tad better, and also through expectations.   Naturally we are not booming; job creation has been moderate. Our view is that it will simply extend the pace, H1. Few are looking for amazing strength on Friday.  Fine.  But if there is disappointment we recommend a pause, and then a strike by the way of any of the earlier recommended strategies.

And one of these strategies of course can be equity related.  Indeed, it is no coincidence that the S&P 500 has soared over 22% since October, a time when it looked to many as if the US was headed for a double dip. As just a very few of us predicted at the time, the US economy was about to get a whole lot better.


Robert Craven

Week in Review

We have known that observers would under-estimate US vigor. This worked nicely through Q4.  Naturally they won’t miss on every release but if we have the trend, we then have a more accurate look at the economic landscape just ahead, and thus a better opportunity to capture price change.

Such a flaw does not always exist; that is, consensus is sometimes well linked to reality ahead. Or, sometimes the flaw is minor, to be left alone.  Three or four times per year however the flaw is one of major proportions. It is our primary task to isolate these events, that is, to close the pattern ahead of other observers.

Naturally the US is not booming.  Some point to today’s GDP print as proof of that as 2/3's of the growth is in inventories. Fine. We are not interested in absolutes.  Only consensus, that which is priced in at a given moment in time, and, our understanding of reality ahead; our understanding of reality just ahead is that business spending, a revived consumer and continued improvement in the labor market will drive growth through expectations, H1.

Clients were advised early on to set trades with our anchors in mind, using any correction as an entry point.  That is, we wanted to exploit “weak” releases; we still do. Thus, any substantial market move related to yesterday’s Dec Home sales print or today’s Q4 GDP release was/is to be exploited. (Yesterday’s Dec Durables print did fit our anchor as it reflected strong capital goods orders, thus better business investment ahead.)  Only operate at the margin, never in a rush for goodness sake and certainly not in this environment. In the broadest sense, trades can be applied through FX, or equity, or, if and when the E-Z situation defuses, more by the way of FI.

For example, look for opportunity to own the term structure, it having been artificially depressed by E-Z events. Course of least resistance for Q1 is wider. We have that trade open from Oct/11, the trade moving nicely early on, then being put back a tad by flight from E-Z problems, now expanding again.  We cannot predict for example Portugal’s near term fate, other wild card events, but certainly in no shape manner or form do clients want to execute the reverse trade because Fed generosity in the face of “surprising” vigor is the recipe for a steeper curve. We can recommend 5 - 10, which was put on at 101, expanded nicely, then back in to 101 give or take, late Dec, last 117.  We can look for a near term target of 130 on this spread, perhaps 315, 2-30.

Finally, we predicted earlier that the US would distance other developed credits (Canada the exception) and that clients were to set trades with that in mind.  We especially isolated Germany and predicted a “surprising” slowing Q4, understanding early on that she was not immune. We also highlighted that the E-Z banks’ response to the new Tier I cap standard would be to simply shrink their books. Today’s release shows the Dec flow of loans to E-Z firms in a near free fall. Some dismiss this release as history, meaningless, being pre-ECB generosity. They are mistaken. It is to be the trend, H1.

Robert Craven

US Update

For a trail map through the thicket of key releases and events this week, N America, the UK and E-Z and the best advised route for survival and profit, see the Hades Weekly nearby.

In that piece clients were reminded that observers have now come a long way to catching on to US resilience, a resilience we highlighted in October while most were looking in the other direction.

Now the view among most economists is that, ok, we undershot a bit, but certainly now the US must be in for a pause; these types site last week’s Claims and Sales prints as evidence of that, combined with what they (incorrectly) understand to be more-than-moderate contagion from the E-Z.

Instead, course of least resistance is that the US real sector will continue to deliver, on the whole, more growth than expected for Q1.

Thus, the preferred route for us this week in approaching the US release stream is to let vigor go and to exploit weakness as such “weakness” will not be trend.

As was illustrated in the Weekly, assume a disappointing Dec Starts release, Jan/19. For the first time in over a year, all eyes are on housing; there is great hope for a linchpin recovery - housing as the propellant. If the number is strong, fine.  Let it go (clients should still be positioned for surprising US vigor anyway, because we have not released our anchors). If that number, or tomorrow’s Dec Production number for example come in far south of expectations, let the market adjust, then strike given the adjustment is enough to make it worth your time.  That is, if the Mar - Mar Euro calender spread comes in by 10 ticks or more to perhaps even; if the curve flattens, say 5 - 10 to 98 or so, then perhaps a strike is in order. Or, perhaps even sample, if at depressed levels, an equity index if such a move is linked to a general view on the US real sector.

This then should represent the general posture of the desk.  Given the E-Z wild card don’t be in much of a hurry to do anything, simply striking at the margin from time to time.


Robert Craven

Bernanke. Obama. Now Sit on Your Hands. Good Boys!

If either or better yet, both of these individuals were to do nothing, nothing at all through Q1 it would almost guarantee a rapid rebound.  They apparently simply cannot help themselves, cannot stop their fidgeting.

Obama and other partisans went a long way in creating the mess of ‘08, then Obama went right on ahead and made it much worse. The stimulus nonsense was, as we had predicted before a cent was wasted, like taking water out of one end of the pool and pouring it into the other, and, on a very hot day as not quite as much made it to the other end.  That is, the whole mess was a retardant on margin.

Next, being a leveler, ever-apologetic of American greatness and looking to ape the social democracies of Europe, Obama created a galaxy of regulations, each one of which scared the pants right off free enterprise. Forbes notes that, “.. studies estimate the total costs of regulation in the economy to be rapidly rising towards $2 trillion per year, or $8,000 per employee.  That is close to10 times the corporate income tax burden, and double the individual income tax.  When the resulting effects on the economy are considered, the total losses due to regulatory burdens may total $3 trillion, or one fifth of our entire economy.”   Nice work Obama.

Then for good measure and to secure himself a place in history as the greatest obstructionist of all time, Obama has secured tax increases in the year 2013 for nearly every federal tax. It happens that Obamacare tax hikes hit then,and the Bush cuts expire. As Forbes had is figured, “... if the Bush tax cuts just expire for these upper income taxpayers, along with the Obamacare taxes, in 2013 the top two income tax rates will jump nearly 20%, the capital gains tax rate will soar by nearly 60%, the tax on corporate dividends will nearly triple, and the Medicare payroll tax will leap by 62% for those disfavored taxpayers. This is on top of the U.S. corporate income tax rate, which is virtually the highest in the industrialized world.”  Nice, very nice.

Finally to Bernanke. He can’t hold still either. He too figures it’s bad PR to sit and do nothing. He’s not looking to create mediocrity as is Obama, but the result is identical. As a central banker he knows the masses can be taken with stuff that bores them to death, at least for a while before they catch on to what in this case amounts to meddling. The QEII hatched Nov/2010 was ruinous, exactly as we predicted it would be. It distorted markets and, aided by the Arab Spring, lifted commodity price inflation, bringing the consumer and thus the US economy to a near halt Q1, and as a bonus, punishing world consumers (most commodity pricing is in dollars).

The US recovers in spite of, not because of Obama or Bernanke. An activist, interventionist president and central banker can separately do harm but in combination can do a great deal of harm.

From a past member of the grievance industry we can understand the lack of interest but why in the world the chair of the Federal Reserve, one who considers himself a student of things economic, never bothered to become acquainted with F.A.Hayek, is beyond us.


Robert Craven

The Week Ahead

We have a full release schedule this week, including manufacturing surveys, price data (PPI / CPI), Industrial Production, and housing data (Starts and Existing Home sales).  Key - Response will be muted for any news that might otherwise cheer the markets; market reaction to any disappointing reads will be exaggerated.

It is important for traders to understand this dynamic, which is driven by 1) the view that last week’s Sales and Claims reads were telling (they were not) and 2) that recent events in Europe greatly expand the threat of a world slowdown by the way of contagion (doubt it).  Fine.

Still, it’s awfully easy to be right, but, at the wrong time.

Therefore, the approach we recommend will be to let strength alone.  Clients should already be set for that anyway, including worrying price data.  However, exploit weakness either through FX, or FI perhaps (although distortions there have left us a tad bored). Or, even equity if you are so inclined providing you are doing this tagged to surprising US vigor ahead.

To be more specific, assume that Thursday’s Dec Starts are far inside of expectations.  The market has been abuzz past few weeks with the surprising strength in Starts (attributed to multis). And most analysts see a genuine recovery hinged only on a housing recovery and related activity.  So now that all eyes are on housing releases, and for the first time in a year, the market crowd will be greatly disappointed.  Therein resides opportunity. Pause on a weaker dollar or, much stronger10yr, or much flatter curve, or narrower Mar - Mar Euro calender spread, and then strike before the week is out.

Robert Craven

The Market Crowd Demands a God

The financial media today cannot get enough of the story that the Fed missed the housing debacle in 2006, as those transcripts are now out. “Fed officials look extra dumb...,” is one headline. 

We’re not defending the Fed but these are shots from the cheap seats by individuals, 99% of whom missed it themselves.

What is instructive about this story is certainly not the Fed miss.  For serious students of market dynamics, those who wish to understand price movement, it is key that they capture the key point - the market crowd, any crowd demands a leader, a god.  And when that crowd feels betrayed by that god, they grow vengeful. 

Fed officials are just like any of us who make our living peering at the economy, some a tad more gifted, some not so, but all mortals and none gifted with the powers of a seer.  Within the FOMC crowd,  the Fed presidents tend to be a tad more qualified, having come up the hard way.  Governors, more political promiscuous, less so.

Under the Greenspan Fed every effort was taken to hide the decision making process for the simple reason that it was seat-of-the pants; that is not how gods are supposed to behave. The jig is up with the 2006 release (Bernanke has just taken over) but it can only be petty to criticize.  Best is to learn, coming to grips with market-crowd behavior; that is the lesson be extracted from this frenzy.

Robert Craven

The Week in Review - Party Over?

Given that this week’s job-related (Claims) and consumer-related (Dec Sales) releases were disappointing, could it be that the party’s over, that anchors set earlier to provide a tether for clients’ trading or planning activities are now skating over the seabed, useless?  No.  Economists world wide will continue to miss relative strength in consumption, jobs and manufacturing activity, Q1.  Knowing this up front provides a considerable leg up to desk operations.

First, unemployment applications are at their lowest level in three years.  A bounce now and then can be forgiven, as long as we recognize it is not trend.  And it is not.  From a recent news story,
“Boeing is bringing in more than 100 union machinists a week for a 60 percent boost in output by 2014. Nissan Motor Co. (7201) will expand in Tennessee with 1,000 people making lithium-ion batteries. And a GE executive was at a Kentucky appliance plant before dawn this month to greet some of 500 new employees.”  Bloomberg concludes, “The hiring reflects optimism among CEOs that the economy will continue to strengthen and more workers will be needed to meet demand.”

Next, has the consumer decided to withdraw?  No.  December was a dud but after all, 2011 was an all time record year for retailers.  That doesn’t sound too bad.  In a couple of regions, as the Fed noted, consumer activity is down right robust; in most areas it is not but it is more active than most ever imagined given poor wage gains. The consumer is optimistic. The consumer has moved the E-Z mess to the “norm” category. It is key for observers to understand this. Finally, the consumer will be cheered as wage gains follow better employment soon to come.

Next, we saw some evidence this week that Canada will do just fine, H1. Part due to her policy of energy development, part, linkage to the US and a good chunk is an administration which supports lower corporate taxes, fiscal discipline and free trade. And Canada surprised most analysts this am as she posted a trade surplus of $1 bln+ in November; exports jumped to a three-year high on booming energy shipments.

We saw further evidence this week that the E-Z will fall far behind the US and Canadian economies, 2012.  (Even Germany will put in a surprisingly weak Q4, something we had predicted earlier.) Political solutions or not, the E-Z is going nowhere because bank credit will be withdrawn, H1, and likely beyond. We saw evidence of that this week as potential borrowers complain of bank reticence to lend. Of course they won’t lend; they’ll shrink their books to make way for the 9% tier 1 capital requirement set to be met by mid year.


Robert Craven

Ooops

We received two key US releases today, Claims and Dec Retail Sales.  We expected that both would cheer the market, Claims inside of expectations, Sales through expectations.  In fact, it was just the reverse. We’ll miss a few and missed these two in a major way.  Now, what if anything has changed?

Today’s results do not indicate a trend.

We have established consumer activity, jobs-related activity and manufacturing as desk anchors, meaning observers have underestimated those sectors and clients should take advantage of this fact.  Through Q4, with just an occasional miss here and there - nothing in a straight line - these held well.

We expect these will continue to hold through Q1.

Next, we have told clients to expect the US and Canada (thanks partly to US linkage and partly to an enlightened Harper administration) to move away from other developed credits, including  Germany.  We noted late October and through early November that German growth, Q4 and Q1, would disappoint, falling below forecasts.  That is working as planned.

We also noted in October that even given a E-Z solution, the new core capital requirement for banks would translate into a significant retardant, this region.  Recent evidence shows that it already has; banks are parking most of the ECB’s generosity right back with the ECB, as Euribor prints indicate. E-Z banks have no intention to either make loans or to raise capital, on the whole.  They intend instead to shrink their books.  Going without banks in the US would not be as crippling as it will be in the E-Z; US companies have many other venues to acquire funds; E-Z firms are without that flexibility.


Robert Craven

US Consumer

US Consumer

It has been key for clients for many weeks to understand that while not alight, consumer activity would still flatten estimates, Q4 (and H1).  Most observers badly underestimated their projections, taken in because average income has not kept up with inflation and the home equity bank has folded.

We instead noted that the consumer would remain buoyant (short of $120 crude and, or an E-Z meltdown).  That is, the US consumer would neutralize E-Z day-to-day noise as a normal, which is exactly what they did.  Finally, appetite in place  they would borrow if needed to fuel it. There has been too much fuss made over de-leveraging.

Today we find that Consumer Credit soared in November to $20.4 bln vs expectations of $7bln. Wait for December!

Revolving debt increased by the largest amount in 3 ½ years in November. It is of course true that households have de-leveraged from the peak in June/05 (24.4%, debt vs disposable), just not anywhere near enough to put them into a comma. And they’re done with it. We’re a tad through 21% now, no doubt the trough this cycle.

Look for more ahead from the world’s #1 engine.


Robert Craven

The Week Ahead

US vigor will continue to surprise street economists, world investors and Fed officials alike.

Look for the few scheduled releases next week to cooperate.

Clients have had a firewall of sorts built around their trading, investment or corporate planning activity. They have known through Q4 to trade the US as if every surprise was to be one of relative strength, not weakness. Most were. Jobs-related and consumer activity were key.  And these will hold through Q1. Stronger import orders suggest good demand for consumer goods; the trend in Claims suggest better payroll numbers ahead.

Then on Dec/15 we added Manufacturing, noting that “economists will miss the boat because they will under-estimate export demand, thinking it to be completely dried up.”

Indeed, from the ISM manufacturing index and to almost everyone’s surprise, export orders rose in December to the highest level in three months; overall orders were the best since April. Thank you very much.

Next, clients were not only prepared for improvement in the US but also vs other major world credits. That too has worked well as economist after economist discovers what most call, with the sense of original discovery, a de-coupling.  ISM manufacturing data did show just that - the US continued to pull away from Europe and China, with a bigger increase, to a higher level than any of the others.

In a nutshell, we can get along without the E-Z; they don’t have to solve all of their problems for us to do well (however, we could do without a meltdown!). And that related panic has limited trading our insight through the FI market.   Our view would “normally” be best worked with the curve, Eurodollar calender spreads, options and the like. In fact, the next major move in the US curve will be steeper, tagged to vigor and Fed accommodation.  But we may have to wait a bit for that.

FX has provided a convenient tool however, as our most recent recommendation, short the Euro to the US$ has demonstrated.

We can also look to Canada for opportunity. We know that Canada will tag along. Selecting a window is key.  That could have been provided by last week’s Canadian Payroll results; they were not at all buoyant as they were expected to be. Partly as a result of that, the C$ slumped to a two-week low. But Canada is our biggest trading partner by far; by understanding economic reality ahead for the US, we pretty much have it for Canada. So we can expect their economy and currency to do well, H1, and that despite severe budget cuts scheduled by the Harper administration. Thus, one will want to look to sell the Euro and buy the C$ against that, at the next convenient window.

Robert Craven

Fed Policy Intent and the Term Structure

We are now all acquainted with the Fed’s effort to sculpt the term structure, the newest tool for that purpose the decision to publish the FF’s target rate.

As noted in an recent sketch, few at the Fed understand the dynamics impacting the curve. They might get lucky but eventually will get in real trouble.

To see just how much trouble they can get into, let us return to an earlier time, May 16 1994, the day before the FOMC meeting of May/17. The Fed was fighting the reverse battle then, but the example is useful nevertheless.


From our Report of May/16: “We are raising our estimate of the chances for a ½ % lift in the FF’s target from 60% to 70%.  The discount rate will follow but is of little consequence. Gov Lindsey has seen the ‘tactical advantage’ for such a lift. Our sources indicate that other policy makers may have finally come to understand that the markets, having been so thoroughly de-stabilized by recent Fed policy (or lack of), now cry out for direction. Markets ask the Fed to decisively demonstrate control, showing that it can deliver the needed discipline, as any good parent should understand is necessary.

Impact: Observers’ prediction for a ½ % lift have increased. As a result the shocking power of such a lift has diminished.  In a sense, the market is now dictating such a lift to the FOMC. On 2/4, 3/22 or 4/18 a ½ % hike would have resulted in a pronounced flattening of the curve, kicking the legs from under the inflation beast. Now, its flattening impact will be smaller. And one more lift of 1/4% will provide only irritation, steepening the curve and pushing the bond to 7.75%.

Greenspan fails to understand the fatal trap set by gradualism; he fails to understand that timidity in policy making almost always backfires. Reserves at the banks (Fed credit) have expanded through 1994 at an alarming rate because each time the FF’s target is lifted by a small increment, banks, conditioned to gradualism, increase the pace of borrowing in anticipation of the next modest lift.”


Back to the Bernanke Fed. Now Bernanke will look to flatten the curve, but not with a wallop, but with generosity.  Generosity in the short end can just as easily have the exact reverse effect. It all depends on the degree of tension in the system. Fed officials were slow learners in 1994; we see no reason to expect anything different now.

Our task then over the intermediate term will be to isolate this dynamic, and recommend to clients how best to convert policy to the bottom line.


Robert Craven

The Week in Review

We’re not booming but we learned this week that we’re clipping along at a far better pace than expected, that is, than was priced in, even a few weeks ago, let alone early Q4 when we highlighted this reality.

We’ve seen this week that manufacturing activity growth accelerated in December to its best pace since June.  It’s not booming, but improving. And it will continue to improve.

We’ve seen this week that business activity in the services, construction and government sectors accelerated modestly in December.  It’s not booming either but pretty good given the headwinds.

Finally, we saw today that jobs-related activity is accelerating. (Cynics accuse the administration of cooking the books. A fairy tale.)

The Dec unemployment rate dropped but joblessness is still relatively high, with 13.1MM people officially unemployed, and 8.1MM working part time, but only because they can’t find full time.  That will come.

Next, although improving, hourly earnings are still not beating consumer inflation. This did not stop the consumer however, Q4, and now, we expect hourly and weekly earnings to improve, and at an accelerating rate, into H2.

Next, we saw today that job creation in December was improved; nothing spectacular but better. There is little evidence that overall hiring is accelerating (gov’t job declines) but it is clear that private sector employment is accelerating, a very good thing. That’s certainly better than was expected early Q4.

Finally, some suspect a whiff of seasonality to today’s report, suggesting that strength may not carry into 2012. Doubt it.

In summary then, we can repeat guidelines set out earlier for our clients. First, continue to rely on our anchors - Spending, Jobs activity and Manufacturing. That means, when there is a relevant release, go into that release expecting a broach.  Know that even now, any major surprises to the US real sector to be to the side of relative vigor, not weakness. And finally, know that the US (and Canada) will continue to distance - at an accelerating rate - other developed credits.

These dynamics will continue to support our insight from early November to sell the Euro vs US$.  For more on that topic, see the sketch below.

Robert Craven

Fed Policy and Opportunity

Bernanke’s Fed further endorsed transparency with the decision to publish their target FF’s rate - how long they plan to keep short-term rates at current levels.  The first will be announced after the Jan 24/25 meeting.

Greenspan’s paranoia of transparency came from his terror that the decision-making process would be found out; that is, that policy makers would be found to be simply human, not the anointed after all.

At least Bernanke has moved to make the stealth operation less stealth. But with this new policy there are two problems for the Fed, and, two seeds of opportunity for clients.

First, the Fed is mediocre at best at forecasting. Next, this bunch are even worse at judging how a change in short rates may impact the curve. We will be able to identify 1) economic reality just ahead better than they, and 2) we will be better able to judge the impact of any projected FF’s target on the term structure. And of course Bernanke will expect to use this new policy as a tool to impact just that - the term structure.

In Greenspan’s time there were occasions when he grew downright despondent because the movement in long term yields was just the reverse of his policy intent. Timidity, a modest lift in FF’s simply provided an irritant in an environment of price pressure - if you strike a king you had better kill him. Long rates went higher when he thought they should have gone lower.  Too much.

Judging change in the term structure is not linked to a rule, model or formula; it is too elusive, too fluid for that.  We’ve done rather well past years (although our last US example, set Oct/11, was hindered by mass world flight to sanctuary) and expect further opportunities to be birthed by this policy change.

Robert Craven

Preparation for Tomorrow’s US Dec Payroll Print

Clients should have strategy in place set for “surprising” vigor in US jobs creation. That is, we have known for several weeks that job-related activity would eclipse Street estimates.  (It does not matter that the activity is not a barn burner. It only matters that we capture that which is not on the radar screen; in such a way we capture price change.)

However, having missed this key turn economists may now over-correct, not wanting to be rolled twice.  Thus, many are predicting a burst tomorrow in private payroll, in hours and in earnings.  All of this will come in Q1 but maybe not just this quickly. Fine. If tomorrow’s print does not live up to expectations, use any correction to add to, or establish trades in FX, equity or FI (not much here given E-Z panic) which you may feel will do well, given what we know to be reality ahead.

In the larger sense clients are to remain very constructive on the US.  Our several anchors (jobs / spending / manufacturing) will continue hold through Q1.


Robert Craven