TUESDAY, SEPTEMBER 7, 2010
Hatzius of Goldman on QE2 (according to him, it's coming)
1. The headlines for last week’s first-tier US economic data releases were above expectations. And at least the employment report was genuinely better, with faster than expected private payrolls growth, significant upward revisions to past months, a 0.3% wage gain, and a firm household survey. The trends are still consistent with the gradual slowing in employment and wage income growth implied by our forecast, so the news is far from good in any absolute sense, but at least for now the deterioration in the labor market no longer looks as precipitous as it did after the last report. The somewhat better claims data of the past two weeks send a similar message.
2. The ISM picture was much less good, however. Although the manufacturing composite edged up from 55.5 to 56.3, the new orders/inventories gap fell again and taken by itself now points to a composite of clearly below 50 in a few months. Moreover, the nonmanufacturing composite dropped sharply, led by new orders, and the all-industry composite showed its largest month-to-month decline since November 2008.
3. The numbers over the next few weeks are likely to look decent. That’s partly because of the direct implications of the employment numbers for industrial production and personal income, partly because the housing indicators are likely to bounce from their extremely depressed current levels, and partly because the bottom-up indications for retail sales—the most important release in the next few weeks—are reasonably firm.
4. Overall the news is sufficiently mixed to make a big “QE2” announcement at the September 21 FOMC meeting unlikely. Although we suspect that the FOMC and the Fed staff will revise down their growth forecasts once more, the size of the revision is unlikely to be large enough to qualify as the “significant weakening of the outlook” identified by Chairman Bernanke as one key trigger for additional easing in his Jackson Hole speech. (The other was a meaningful drop in inflation and/or inflation expectations.)
5. Later this year or early next, however, we do expect a return to unconventional monetary easing. This is because we strongly disagree with the notion that the recent slowdown in activity is a temporary “soft patch” in an otherwise fairly decent recovery, which seems to underlie the Fed’s forecast of a reacceleration in 2011 after a modestly slower period in 2010H2. On the contrary, we believe that the stronger growth of late 2009/early 2010 was a temporary “firm patch” in an otherwise extremely anemic recovery, and there is a sizable (25%-30%) risk of a renewed recession. As this becomes clear, Fed officials are likely to act.
6. The most likely policy shift involves purchases of US Treasuries, although changes in the forward-looking language are also a possibility. Ultimately, any new purchases are likely to total at least $1 trillion, but today’s NYT interview with outgoing Vice Chairman Kohn suggests that Fed officials may only announce a smaller amount upfront and then adjust their plans in response to new information (seehttp://www.nytimes.com/2010/09/06/business/economy/06fed.html?_r=1&ref=business). The advantage of such a policy is that it may be an easier “sell” to skeptical officials, although the risk is that the markets will view it as half-hearted.
7. How effective is a return to QE likely to be? The uncertainties are enormous, butJari Stehn’s analysis of the first round of QE in late 2008/early 2009 concluded that it pushed down 10-year Treasury yields by 25bp and eased the GSFCI by 80bp per $1 trillion in purchases. We suspect the next round would be less effective in terms of easing financial conditions, not because of a smaller impact on riskless long rates but because there is much less room for spread compression in the credit markets. So a 50-60bp easing in the GSFCI (relative to what would happen without QE) may be a more realistic expectation. Based on historical linkages, this is worth about ½ percentage point on growth, or a bit less given that the mortgage refinancing channel of transmission is clogged by the large number of households in negative equity. If this is the right order of magnitude, a $1 trillion purchase would not have a dramatic effect on growth, but would not be insignificant either. Of course, Fed officials could buy more and/or supplement the purchases with changes in the Fed statement to reinforce the effect.
8. In the runup to QE2, communications will remain a challenge for the Fed. The problem is twofold. First, the FOMC is far from united, and participants (especially regional bank presidents) who are skeptical of the need for further action will continue to make their views known. This causes confusion in the markets, even if it ultimately has little bearing on the outcome. Second, the leadership wants to signal that more easing is on the table without talking too pessimistically, for fear of “scaring” those market participants who believe that the Fed has a privileged perspective on the fundamental outlook for the economy. The results are sometimes a bit odd—for example, the statement in the August 10 minutes that “…no member saw an appreciable risk of deflation…” which came just a few weeks after one member (President Bullard) had presented an analysis that strongly implied just such a risk. Given the range of different opinions and the conflicting objectives, the risk of further communication hiccups and resulting bouts of bond market volatility is high.
2. The ISM picture was much less good, however. Although the manufacturing composite edged up from 55.5 to 56.3, the new orders/inventories gap fell again and taken by itself now points to a composite of clearly below 50 in a few months. Moreover, the nonmanufacturing composite dropped sharply, led by new orders, and the all-industry composite showed its largest month-to-month decline since November 2008.
3. The numbers over the next few weeks are likely to look decent. That’s partly because of the direct implications of the employment numbers for industrial production and personal income, partly because the housing indicators are likely to bounce from their extremely depressed current levels, and partly because the bottom-up indications for retail sales—the most important release in the next few weeks—are reasonably firm.
4. Overall the news is sufficiently mixed to make a big “QE2” announcement at the September 21 FOMC meeting unlikely. Although we suspect that the FOMC and the Fed staff will revise down their growth forecasts once more, the size of the revision is unlikely to be large enough to qualify as the “significant weakening of the outlook” identified by Chairman Bernanke as one key trigger for additional easing in his Jackson Hole speech. (The other was a meaningful drop in inflation and/or inflation expectations.)
5. Later this year or early next, however, we do expect a return to unconventional monetary easing. This is because we strongly disagree with the notion that the recent slowdown in activity is a temporary “soft patch” in an otherwise fairly decent recovery, which seems to underlie the Fed’s forecast of a reacceleration in 2011 after a modestly slower period in 2010H2. On the contrary, we believe that the stronger growth of late 2009/early 2010 was a temporary “firm patch” in an otherwise extremely anemic recovery, and there is a sizable (25%-30%) risk of a renewed recession. As this becomes clear, Fed officials are likely to act.
6. The most likely policy shift involves purchases of US Treasuries, although changes in the forward-looking language are also a possibility. Ultimately, any new purchases are likely to total at least $1 trillion, but today’s NYT interview with outgoing Vice Chairman Kohn suggests that Fed officials may only announce a smaller amount upfront and then adjust their plans in response to new information (seehttp://www.nytimes.com/2010/09/06/business/economy/06fed.html?_r=1&ref=business). The advantage of such a policy is that it may be an easier “sell” to skeptical officials, although the risk is that the markets will view it as half-hearted.
7. How effective is a return to QE likely to be? The uncertainties are enormous, butJari Stehn’s analysis of the first round of QE in late 2008/early 2009 concluded that it pushed down 10-year Treasury yields by 25bp and eased the GSFCI by 80bp per $1 trillion in purchases. We suspect the next round would be less effective in terms of easing financial conditions, not because of a smaller impact on riskless long rates but because there is much less room for spread compression in the credit markets. So a 50-60bp easing in the GSFCI (relative to what would happen without QE) may be a more realistic expectation. Based on historical linkages, this is worth about ½ percentage point on growth, or a bit less given that the mortgage refinancing channel of transmission is clogged by the large number of households in negative equity. If this is the right order of magnitude, a $1 trillion purchase would not have a dramatic effect on growth, but would not be insignificant either. Of course, Fed officials could buy more and/or supplement the purchases with changes in the Fed statement to reinforce the effect.
8. In the runup to QE2, communications will remain a challenge for the Fed. The problem is twofold. First, the FOMC is far from united, and participants (especially regional bank presidents) who are skeptical of the need for further action will continue to make their views known. This causes confusion in the markets, even if it ultimately has little bearing on the outcome. Second, the leadership wants to signal that more easing is on the table without talking too pessimistically, for fear of “scaring” those market participants who believe that the Fed has a privileged perspective on the fundamental outlook for the economy. The results are sometimes a bit odd—for example, the statement in the August 10 minutes that “…no member saw an appreciable risk of deflation…” which came just a few weeks after one member (President Bullard) had presented an analysis that strongly implied just such a risk. Given the range of different opinions and the conflicting objectives, the risk of further communication hiccups and resulting bouts of bond market volatility is high.
What the Hero of the Big Short likes now.
http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=ayR3PjEbMErM
SUNDAY, SEPTEMBER 5, 2010
Dylan Grice, SocGen
Excerpt:
The pedestrian ‘push’ buttons at New York’s intersections don’t actually work. They were deactivated in the 1970s when computer-controlled automatic traffic signals were installed but left in place because removing them is too costly. Apparently most ‘close door’ buttons in lifts don’t work either. But give us a button and we’ll press it, not because the button works but because the sense of being in control makes us feel good (when subjects are crammed into a lift for example, those closest to the controls show lower stress levels). Feeling in control doesn’t mean that we are in control, but who cares? As Slartibartfast said in Hitchiker’s Guide to the Galaxy, “I’d rather be happy than right!”
Goldilocks is carrying a concealed weapon
Dangerous Defeatism is taking hold among America's economic elites
GOLDILOCKS HAS PLAYED A TRICK ON AMERICA. GROWTH IS NOT WARM ENOUGH TO PREVENT HARD-CORE UNEMPLOYMENT CLIMBING TO POST-WAR HIGHS AND STICKING AT LEVELS THAT CORRODE THE BODY POLITIC, BUT NOT YET COLD ENOUGH TO OVERCOME THE FIERCE RESISTANCE OF THE FED'S REGIONAL HAWKS FOR A FRESH BLAST OF STIMULUS.
Double Trouble
No defence left against double-dip recession, says Nouriel Roubini
THE UNITED STATES, JAPAN AND LARGE PARTS OF EUROPE HAVE EXHAUSTED THEIR POLICY ARSENAL, LEAVING THEM DEFENCELESS AGAINST A DOUBLE-DIP RECESSION AS RECOVERY SLOWS TO ‘STALL SPEED’.NOURIEL, CLICK HERE
SATURDAY, SEPTEMBER 4, 2010
AS PAY FALLS, BORROWERS LOSE GROUND. NYTIMES
http://www.nytimes.com/2010/09/05/realestate/05mort.html
WEDNESDAY, SEPTEMBER 1, 2010
Jeffries on the FOMC minutes....quite good
From: DAVID ZERVOS (JEFFERIES & CO., INC)
At: 9/01 9:20:13
This is the key passage from the minutes on the thought process driving the reinvestment strategy decision – “members generally saw both employment and inflation as likely to fall short of levels consistent with the dual mandate for longer than had been anticipated. Against this backdrop, the Committee discussed the implications for financial conditions and the economic outlook of continuing its policy of not reinvesting principal repayments received on MBS or maturing agency debt. The decline in mortgage rates since spring was generating increased mortgage refinancing activity that would accelerate repayments of principal on MBS held in the SOMA. Private investors would have to hold more longer-term securities as the Federal Reserve's holdings ran off, making longer-term interest rates somewhat higher than they would be otherwise. Most members thought that the resulting tightening of financial conditions would be inappropriate, given the economic outlook. However, members noted that the magnitude of the tightening was uncertain”.
So the idea was that an estimated 20b/month in mortgage paydowns (which I would say is very much on the high side) was about to wreck the long of the bond market (excuse me???). Immediate action was apparantly necessary to stem this “massive” flow which equates in duration terms to about half of a monthly 5 year note auction!!! This was needed even though a few members correctly - “worried that reinvesting principal from agency debt and MBS in Treasury securities could send an inappropriate signal to investors about the Committee's readiness to resume large-scale asset purchases” (ya think??). The decision for the committee was to stem this HUGE leak in the balance sheet and not wait another month to look at the data and better prepare the market for more material changes if they were needed. I stand by my earlier assessment that this was one of the top 10 worst communication decisions in FOMC history. It just makes no sense to confuse a fragile market over something so small and meaningless from a policy perspective. The probability of sending the wrong signal was way too high, as only a few of the clued in Committee members acknowledged.
So let’s look at what this signally move actually accomplished. Did the FOMC “ease” financial conditions as they had seemingly hoped to do?? NO, they tightened them. Equities are lower, credit spreads are wider and the dollar is stronger since August 10th – NICE JOB. Further, and more importantly, break-even inflation expectations have fallen 30bps and REAL short term rates (4/13 Tips) are 20bps HIGHER in yield, while longer term real rates are flat. The FOMC managed to raise the real short rate with this "easing" move - it is mindblowing how bad this decision really was! The probability of sending the wrong signal with this decision was not just high it was 1!
I will requote my favorite line ever from a Ben Bernanke speech in 2003 – “when nominal interest rates are at or near zero, the central bank can lower the real rate of interest only by creating expectations of inflation on the part of the public”. Ben alluded to this in his speech last Friday so I remain hopeful that we will see something from the FOMC in coming months on a plan for potential easing action that does not involve buying loads of long term US Treasuries. Hopefully the Committee is looking at what they did to real rates and inflation expectations after this meeting as a signal back to them that this was a horrific communication decision. From my perspective, the only truly effective easing strategies from the Fed going forward involve the funding and/or purchasing of riskier assets. Fed buying of government bonds outright (or promising to buy them in the event the economy slows further) will only fuel a bond bubble that feeds off of rapidly increasing deflation expectations. This is the Japanese path!
Finally, turning to one of my other favorite topics, Im doing a little work on breaking down the effective mortgage rate outstanding by product type (conforming fixed, conforming adjustable, prime, alt a, subprime etc etc). Tomorrow I should have some really interesting numbers for everyone to chew on. Also, I have been reading research from a lot of other dealers that suggests only congress can generate a government induced refi wave. I will discuss tomorrow why that logic is flawed. Good luck trading.
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