The US - Into Year End

Today’s advance Q3 GDP print was unusual for this series because it was actually instructive.

The report was freighted with two major clues pertaining to job creation ahead; here they are – consumer spending accelerated at 2% and business investment declined by 1.3%. 

US GDP well through 2% depends primarily on increased jobs creation. Chicken or the egg you may say? No. The demand side of the equation is there; this despite woes offshore.  We are the primary economic engine; we don’t need China or anyone else to break 3%. We stated a while back that consumer appetite would surprise to the upside Q3 – nothing resounding naturally, but pretty darn good considering the circumstances.

So on the margin, forget exports. We have more than enough domestic pent up demand to kick the world’s lead engine out of first gear.

What is needed then to break 3%?  

Those of us who are listeners have the answer. It is not conjecture but from the horse’s mouth – interventionist policies have scared major employers half to death, with Obamacare at the top of the list.  Which brings us to the 1.3% decline in business investment – it’s not worth the risk, or hasn’t been.

However, we know that when CEO’s have once again encountered a level playing field, a game where the rules don’t change every Qt, they will hire, and quickly. This is economic reality ahead, or hopefully will be. 

Thus, any serious FI trading operation will look to Nov/6.   And what is to be done when the failed experiment is rejected?  You will sell US debt to the UK and the E-Z; you will own the US term structure and the Euro strip. 

From neighbor Vic Hansen, “As we see in New Jersey, Ohio, Texas, and Wisconsin, the cure for the present economic malaise is not rocket science — a curbing of the size of government, a revision of the tax code, a modest rollback of regulation, reform of public employment, and holding the line on new taxes. Do that and public confidence returns, businesses start hiring, and finances settle down. Do the opposite — as we see in Mediterranean Europe, California, or Illinois over the last decade — and chaos ensues.”

Easy.


Robert Craven

Navigating the UK

The last post on the UK was 10/9. This sketch provides an update.

The flaw to most economists’ models remains in place – to understand this reality is to be better equipped to capture fixed income price change over the near-to-intermediate term.

We all have our method.  Ours is the reverse of most others. We assign a risk-of-result to key releases. Historically this has worked very well.

Economists / analysts are like members of any crowd; they share the same characteristics.  Into the fall most observers, holding hands together, shouting out in the dark could only see reason for real sector weakness; they were overwhelmed. Into the fall, most observers assigned too much relevance to sentiment measures, consumer and business – always a hazardous practice. Finally, into the fall, observers sold the Administration short – on public finances and fiscal consolidation, and on various schemes such as the regional growth fund.  

So once we understand how the consensus is flawed, we have captured price change just ahead. We had/have an anchor and in the case of the UK it was/is this – most analysts will miss most key releases to the side of weakness.  That is exactly what happened. Not every key print, but most. Naturally the UK is not strong in the absolute sense but we are only concerned with economic reality vs expectations.

We are not journalists; rhetoric is not enough; we need to convert to the bottom line. For purposes of this blog we generally revert to the simplest of spreads – the term structure (there are a galaxy of other ways traders may have converted our insight). Knowing then that the UK real sector would just outperform, and knowing the view remains in place for additional Bk of Eng firing ahead, it was simple – own the curve.

Results have been nothing spectacular for goodness sake – 5-10, 95 / 2-30, 268, mid July recommendation  / last, 105, 292 – but worth the effort. And this spread has never run against those entry levels.

Do not look for the opportunity to sell this spread.  The course-of-least resistance to remain wider into year end.  But key to any operation is to understand the flaw built into most models.


Robert Craven
 

Politics and the Bottom Line

Most economists avoid politics like the plague.  That’s fine, but anyone responsible for the bottom line better not.

Making satisfactory FI strategy could be accomplished without politics as part of the mix, or at least with it confined backstage, earlier years.  Not now.

In the US for example, one key is this - understanding job creation ahead. We have maintained for two years that the #1 retardant to job creation is Obama. This was not our invention; we had it from the source – CEO’s.

A very recent source is Steve Wynn, CEO of Wynn Resorts.  Wynn created 250,000 jobs in Nevada according to that state’s figures. Wynn in a recent interview, “I’m afraid of the president.  I have no idea what goofy idea, what crazy anti-business program this administration will come up with. I have no idea. And I have to tell you Jon that every business guy I know in the country is frightened of …Obama and the way he thinks.”

 This is the norm in America, not the exception. Left-leaning observers may argue with this.

Be our guest, but that won’t do much for your track record.


Robert Craven

The UK Just Ahead

In the broadest sense we can expect the UK real sector to just out-perform, Q4; that is, to do a tad better than UK economists expect it will – not every print, but most. This is because models are flawed, omitting as they do the spark provided to job creation and consumer attitude through the administration’s example.

George Osborne is now very quickly becoming a role model for responsible leadership. He told the Conservative Party Conference in Birmingham the truth about the UK economy; and he told them what to do about it – 80% spending cuts vs 20% tax hikes.

Granted the UK economy is not going anywhere very quickly, yet. The Sep All-Sector PMI index indicated just that. In a nutshell, the modest growth of the service sector is perhaps 75% offset by less-than-modest manufacturing and construction reads.

Fine. Those who drive at 90 mph with their eyes in the mirror come to an unwelcomed end.

We are concerned with FI price change just ahead, either intra UK or vs other credits. Our intra-UK general strategy has been the right one – own the term structure (clients have on several variations of that trade as we keep our blog illustrations to a minimum). Wider is the course-of-least resistance into yearend for this spread. The trade will be assisted by the view for further central bank accommodation. We say the “view,” not necessarily the reality.

Next, as much of a fan of Osborne as we may be, we want to sell the US to the UK, and to do so before the election.

Obama has done more to discredit the Keynesian notion of correct economic policy than Milton Friedman and FA Hayek could have done in 100 lifetimes.  Employers will be cheered by a Romney victory – the likely result; that will quickly translate into better numbers.


Robert Craven

What if ?

Many of us poor souls in California are paying north of $5 for a gallon of petrol this weekend, the recent premium tagged primarily to supply constraints. This experience however provides a fascinating little window into the “what if's” of world events.

Gasoline at $5 has a profound psychological impact on the US consumer (except in Hawaii). We don’t know that as an economist, we know that as a consumer. A quick survey today of three local restaurants is all we needed. Business this week dropped like a rock.  No surprise.

A national average of $5 for an extended term would take perhaps 1 1/2% from GDP, probably more. So “what if”?

A good portion of the impact of a strike on Iran is priced in.  Not all of it naturally because we cannot be certain just how much of the noise from our mullah pals is just that. We suspect very little is substantive; nevertheless, no one knows for sure if the mullahs will strike the Saudi fields within the first five minutes; no one knows if they can close the Strait within the first thirty.  So this potential event remains a bit of a wild card, and thus a threat; one capable of putting US growth at 0%.

But we may be spared that. We have argued that the preferred method to rid Iran of these troglodytes is the one from within.  After the masses suffer enough, they will oust these clowns.  They tried to do just that two years ago but were abandoned by our administration.  Now, they may not need our help.

The quickest way to a solution from within is to blockade gasoline exports to Iran. Because Iran can only refine about half of what it needs, this would put the consumer in a very bad mood.  We saw a year or two back just what happens when gasoline is scarce – they burn gas stations to the ground. So that would work.  But wait!  A depreciated currency may serve the same purpose.

The rial hit an all-time low of 35,500 to the dollar last Tuesday, down from 24,000 a couple of days earlier. Iranian’s are not one bit happy and have taken to the streets.

The rial’s decline is due to a combination of gov’t mismanagement and the bite from sanctions; this is not lost on the consumer. Only the mullahs stand in the way of a new pair of Levis.

Key is to make day-to-day life so uncomfortable for Iranian consumers – every one of whom wishes to ape Western style and values - that they complete the inside job, sparing Israel the alternative, and, sparing the US a 0% GDP print anytime soon. 


Robert Craven
 

7.8%

7.8%?

Is this a fix?  Not a chance.

We respect Jack Welch but on this occasion – claiming today’s number was gamed by the Obama camp - he came untethered.

The truth is that the 7.8% is part quirk, due to sampling volatility, and, part due to a declining labor force the past year (1.1MM folks disappeared).

There is no change in the labor picture – consistent with about 1.8% growth.

There will be a change in the labor picture however given the end to Obama’s interventionist policies.


Robert Craven

Broad Guidelines - US / UK FI Strategy

UK – Coming into summer, economists, caught up in the rush of the crowd, built a collective error into their models, a slight underestimation of real-sector activity. Thus, we recommended that clients look to own the UK term structure, the simplest method to transfer this insight. That has worked moderately well, from 270 to the present 292; 5 -10, from 95 to 104.  A slight error remains to the consensus view vs. economic reality just ahead. Thus, as we have warned earlier, do not look for the opportunity to sell this spread as course-of-least resistance is to remain wider into year end.

US – Here we had a little fun with the crowd, catching them at their most vulnerable after the announcement of so-called QEIII.  Clients were to sell (S-B) the US curve Sep/14, then 116, 5-10 and 285, 2-30.  This came in nicely and clients were advised in our Sep/27 sketch to take this spread in (then 100, 254); under no circumstances to take the position into today’s NFP. Last, 106, 270. 

We did not have the numbers to today’s print naturally but we had the risk for something more than expected. Leave it alone at the moment but look for the opportunity to get long (L – S) at the next bout of “weakness.” 

The US engine will just out-perform into year end.


Robert Craven

Interested in the Bottom Line? Watch tonight's debate.

This time, politics is key to understanding FI price change ahead.

We have a radical at the helm, the first such experiment of our generation (given that McGovern was rejected). If we were simply journalists we would mourn our present situation. We are strategists and thus responsible for something aside from noise.

Haven spoken personally with a few CEO’s , most notably Paul Otellini of Intel (and having worked closely with his brother, Monsignor Otellini) we have known the key hindrance to US vigor, that prime retardant – employer disgust with administration policy.

All of us received the results of the recent Business Roundtable, NAM and NFIB surveys in which respondents cited gov’t policies such as taxes and regulatory changes as their biggest concerns.  We knew that but it is nice to hear it from the horse’s mouth. This has them putting off hiring and spending decisions because they don’t know what to expect in the months ahead.

Thus, put considerable stock in the November results. Otellini and other corporate leaders will be cheered by a Romney win.  They will be discouraged given the reality of another 4 years of Obama.


Robert Craven