Tower Private Advisors
Capital Markets Recap
Portugal seems like a lost cost, and no ones seems too worried about it. Ireland was dealt with a while ago. Italy is sitting on the sidelines. Greece is done for now, although its bonds yield something like 16%, which isn’t exactly a confidence-inspiring interest rate for a sovereign nation. Spain, however, is quickly becoming the country to worry about. Here is what its Prime Minister had to say this weeek:
April 4 (Bloomberg) — Prime Minister Mariano Rajoy said Spain’s situation is one of “extreme difficulty” and signaled that his budget cuts are less painful than a bailout would be, as demand for the nation’s debt slumped at an auction.
“Spain is facing an economic situation of extreme difficulty, I repeat, of extreme difficulty, and anyone who doesn’t understand that is fooling themselves,” Rajoy told a meeting of his People’s Party today in the southern coastal city of Malaga.
Rajoy raised the threat of an international bailout for the second time this week as he sought to defend the deepest austerity moves in at least three decades. While “no one likes” the budget presented last week, he said “the alternative is infinitely worse.”
As you know, Credit Default Swaps are insurance against default, and their pricing–for CDSs of equivalent tenor (e.g. 5-years)–allows for apples to apples comparisons. Recently default insurance on Spanish sovereign debt exceeded that on Italian debt, reversing the normal pattern of the two, which can be seen below.
With that, Spain moved into the #3 slot in the world’s list of nations most likely to default on their 5-year debt, as can be seen below. Do you notice something incongruous? Spanish debt is rated A by S&P, A3 by Moody’s, and A by Fitch, while its PIG peers are rated BBB. I think some downgrades are coming.
Something isn’t right in the oil patch. This week, data released for last week showed that crude oil inventories nearly reached their highest levels since before the first Gulf War, as can be seen below, yet there’s talk of releases of petroleum from strategic reserves. What’s that all about? Votes? Awww, come on…
Using a simple linear regression fitted to the relationship between inventories and crude oil prices, shown below, we can see that West Texas Intermediate crude oil ought to be selling for little more than $80, indicated by the red arrow. It’s called a simple regression for a good reason, however: it leaves out a lot of stuff. The R2 figure in the lower right-hand corner of the chart indicates that inventory levels explain just 24.5% of prices.
Historically, inventory levels have not been predictive of oil prices, as shown in the chart below; they’re just one factor. The thing that will be a catalyst for oil moving either direction will be Iran.
It’s the first week of a new month, and that means it’s time for the monthly Nonfarm Payrolls report. For a while now–basically, since the beginning of the year–economists have been too optimistic; they’ve been overestimating the strength of the economy. That’s shown below where the Citigroup Economic Surprise index has rolled over and is heading downhill.
That really came home to roost today, when economists totally whiffed on the release. Instead of the 205,000 that the lemmings had expected, the actual release was 120,000. (The most bearish economist expected 175,000 jobs to have been added.) Instead of 215,000 Private Payrolls increase, the release was 121,000. (Who can blame them? ADP’s Employment Change index, released on Wednesday, said 209,000 private payroll jobs had been added, better than the expected 206,000.) Initial Jobless Claims hit another four-year low this week, as shown below.
There is no joy in Mudville today, as it’s difficult to put a positive spin on things. The Average Work Week declined modestly. The Household Employment survey showed a decline of (-)31,000 jobs, in marked contrast to February’s 428,000 gain. To be fair, there was good news in Manufacturing Payrolls, which rose by 37,000 versus an expectation of 20,000, but that’s just 0.026% of the number of folks employed.
Through the magic of math, however, the Unemployment Rate fell to 8.2%, from 8.3% in February. Here the formula, in all its conspiratorial glory:
Of course, U.S. stock markets are closed today…sorta. So while they are, let’s conduct a thought experiment, something of which Einstein was fond. The talking heads of financial television and other outlets attributed Wednesday’s drop in stocks (and bonds) to the minutes of the March 13 meeting of the FOMC. Those minutes apparently threw cold water on the notion of Quantitative Easing, Round 3 (aka QE3).
NEW YORK (Dow Jones)–The Treasury bond market Tuesday suffered the biggest selloff in nearly three weeks as a report from the Federal Reserve put a damper on the prospects of a new bond-buying program to stimulate the economy.
The Federal Open Market Committee minutes for the Fed’s policy-setting committee’s March meeting showed no rush to add to its unconventional monetary stimulus that has been a key supporter of the Treasury bond market. As a result, bond prices tumbled across the board, led by the seven-year to 10-year maturities.
The benchmark 10-year Treasury yield, which moves inversely to its price, shot up to as high as 2.299%, the highest in more than a week, from 2.18% right before the release.
“There are definitely quantitative easing bets being taken off the table,” said Anthony Cronin, a Treasury bond trader at Societe Generale SA in New York, who correctly bet that bond prices would fall on the minutes.
If you’re from Mars, here’s what quantitative easing is. In short, the Federal Reserve buys stuff, usually bonds, and interest rates decline. Two things just happened. First, somebody’s now got cash, which earns zero. Second, savers are earnings less on their deposits. That cash presumably goes in search of higher yields. Perhaps the folks with cash go and buy corporate bonds, for example. That results in lower corporate bond yields and, all else equal, as it never is, it now costs corporations less to borrow, thus stimulating the economy. Faithful savers get tired of earning 0.01% on their deposits and, in a fit of madness, go and buy junk bond funds. As in our example above of all-else-equal-but-it-never-is the economy is stimulated.
Here’s a far better–and far more entertaining–explanation of what quantitative easing. If you’ve heard the phrase, “The Ber-nank,” this is where it comes from. It’s old, circa 2010, so you might already have seen it. It’s not new.
Now, back to our thought experiment. The market allegedly sold off on Wednesday because the Federal Reserve thought the economy was too strong to merit another dose of QE. If the economy’s weak, therefore, the Federal Reserve ought to favor more QE, and that ought to be favorable for stocks, right? Wrong. While markets are closed today, the S&P e-mini contract traded until 9:30 this morning, and it was off by 15.3 points (-1.101%), while the Dow Jones Industrial Average was down by (-)131 points (-1.009%). It went straight down after the payrolls figure was released.
Once again, the commentators got it wrong. There was also news, Wednesday, of trouble brewing in Spain, yet the FOMC Minutes got the credit/blame. Covering for itself, Bloomberg news reported today that the reason that stocks (futures) fell today was because of weakness in the economy.
Faster employment growth that leads to bigger wage gains is necessary to propel consumer spending that accounts for about 70 percent of the economy. Today’s data also showed Americans worked fewer hours and earned less on average per week, helping explain why Fed policy makers say interest rates may need to stay low at least through late 2014.
Key indicators to watch
- NFIB Small Business Optimism
- JOLTS – Job Openings Labor Turnover Survey
- Federal Reserve Beige Book
- Producer Price Index
- Consumer Price Index
- University of Michigan Consumer Sentiment
Graig Stettner, CFA, CMT
Chief Investment Officer
Tower Private Advisors