ColinTwiggs, Author at the patient investor

September 30, 2016

Why would the Fed raise interest rates when the economy is slowing?

10-Year Treasury yields have rebounded off their all-time low, shown here on a monthly chart, but remain in a secular down-trend. Only recovery above 3.0 percent (a long way off) would signal that the long-term down-trend has reversed.

10-Year Treasury Yields

The 5-year breakeven inflation rate (5-year Treasury Yield – 5-year TIPS yield) suggests that the long-term outlook for inflation is low. But growth in Hourly Non-Farm Earnings and Core CPI (excluding Food and Energy) has started to rise.

5-year Breakeven rate & Hourly Non-Farm Earnings Growth

One would expect the Fed to be preparing for another rate increase to tame inflationary pressures. But there are still concerns about the strength of the recovery.

Growth in estimated total weekly Non-Farm Earnings has been declining since early 2015; calculated by multiplying Average Hourly Earnings by Average Weekly Hours and the Total Non-Farm Payroll.

Estimated Weekly Non-Farm Earnings

If we examine the breakdown, growth in the Total Non-Farm Payroll is slowing and Average Weekly Hours Worked are declining.

Non-Farm Payrolls & Average Weekly Hours

Not what one would expect from a robust recovery.

September 28, 2016

Fed easing continues

Quantitative easing (QE3) ended in the second half of 2014 after the Fed announced it would taper asset purchases in December 2013. The graph below shows that total assets leveled off at $4.5 trillion and have been maintained at that level since.

Fed Total Assets and Excess Reserves on Deposit

But the graph also shows that the Fed continues to drip-feed the financial system by running down excess reserves on deposit from a high of $2.7 trillion in August 2014 to $2.25 trillion in August 2016.

Commercial banks are required to hold certain reserves at the Fed but in times of financial stress will deposit excess reserves at the Fed, when trust in the interbank market breaks down. The Fed commenced paying interest on reserves in October 2008 and increased the rate to 0.50% in December 2015. This has encouraged banks to retain excess reserves at the Fed where they earn a risk-free rate of 0.50%.

Fed Total Assets and Excess Reserves on Deposit

By raising or lowering the rate payable on excess reserves the Fed can attract or discourage deposits, tightening or easing the availability of funds in the interbank market. Banks have withdrawn $450 billion in excess reserves over two years, which suggests that they can achieve more attractive risk-reward ratios elsewhere. The Fed has not responded, indicating that they are happy for this back-door easing to continue.

Only when the red and blue lines in the first graph converge will the Fed have commenced monetary tightening. That still appears some way off.

September 28, 2016

Government aims for wrong target on debt | MacroBusiness

Macrobusiness quotes LF Economics’ submission to the House of Representatives Budget Savings (Omnibus) Bill 2016:

….It is critical policymakers reign in exponentially-growing private sector debts as this consists of a major source of future financial instability. Australia’s household debt to GDP ratio is the highest in the world, at 125% and rising. Ironically, by ignoring private debt expansion which has generated a housing bubble, public debt will inevitably rise to stimulate the economy to counteract the economic downturn when it bursts.

Source: Government aims for wrong target on debt – MacroBusiness

September 25, 2016

Kevin Andrews and the challenges for Australian conservatism

By William Hill:

The Liberals …have to decide how to confront the anti-business, anti-immigration trend that is developing on their right flank.

John Howard was able to manage One Nation by moderating his criticism and by appearing to assuage some of their concerns. On the BBC Howard responded to a criticism of his refugee policy by arguing that the handling of the former helped to mitigate opposition to orderly migration.

Concerns are real and perceived but the economic insecurity confronting so many Australians and their children is a palpable thing. Some people voice their frustration by voting for a moderate protectionist such as Nick Xenophon and others hitch themselves to One Nation’s more assertive and aggressive style. The Liberals are in difficulty when so many of its natural voters are suspicious of capitalism and the importation of more and more people into the country.

……The supporters of Hanson, Xenophon, Lambie and Katter do not feel that the present arrangements in parliament are working for them and we should not rush to dismiss them. We should also give these voters the benefit of the doubt that they do not share the faults and naiveties of the people they have elected. Andrews advocates a more conciliatory approach when it comes to Hanson’s supporters:

“You have to listen to their concerns, the fact that a person votes for One Nation doesn’t mean that they are a racist, redneck, homophobic whatever. Some might be but usually there is an underlying concern about the direction of the country and the direction of the economy that’s motivating them.”

That underlying concern is nothing less than their fear for their economic wellbeing and that of the next generation. If the Liberal Party is going to defend free enterprise, free trade and immigration against protectionists and nationalists then it had better do as Howard did successfully and give the concerns of the latter fair hearing.

Source: Kevin Andrews and the challenges for Australian conservatism after Hanson – On Line Opinion – 21/9/2016

September 24, 2016

Australian banks rally

The ASX 200 is headed for another test of resistance at 5600. Bearish divergence on Twiggs Money Flow warns of selling pressure. Breakout above 5600 is unlikely and breach of the lower trend channel would warn of a test of primary support at 5000/5100.

ASX 200

* Target calculation: 5400 + ( 5400 – 5100 ) = 5700

The ASX 300 Banks Index formed a bullish higher trough above 7200 and is again testing resistance at 8000. Declining Twiggs Money Flow, however, warns of selling pressure. Respect of resistance remains likely. Breakout, however, would signal a primary up-trend.

ASX 300 Banks Index

September 24, 2016

Flattening yield curve & low bank interest margins

The Yield Differential, calculated by subtracting 3-month from 10-year Treasury Yields, is trending lower. This warns that the yield curve is flattening but we are still above the danger area below 1.0 percent.

Yield Differential: 10-Year minus 3-Month Yields

A flat yield curve squeezes bank interest margins and often precedes a credit contraction.

Large US Banks: Net Interest Margins

But there is little sign of slowing credit growth so far.

US Bank Loans & Leases: Annual Growth

The St Louis Fed Financial Stress Index (STLFSI) continues to indicate low market stress.

St Louis Fed Financial Stress Index

The STLFSI measures the degree of financial stress in the markets and is constructed from 18 weekly data series: seven interest rate series, six yield spreads and five other indicators. Each of these variables captures some aspect of financial stress. Accordingly, as the level of financial stress in the economy changes, the data series are likely to move together.

September 24, 2016

Dow selling pressure

The S&P 500 is retracing for a test of short-term support at 2150. Respect of the rising trendline would signal a test of 2200. Breakout above 2200 would complete an inverted scallop (or fish hook) with a target of 2400*. Declining Twiggs Money Flow, however, warns of selling pressure. Breach of 2050 would test medium-term support at 2100.

S&P 500 Index

* Target calculation: 2100 + ( 2100 – 1800 ) = 2400

The Dow Jones Industrial Average also displays a potential inverted scallop on the weekly chart. Follow-through above 18600 would confirm but bearish divergence on Twiggs Money Flow again warns of selling pressure. Tall shadows on the last two candles also suggest short-term selling pressure. Breach of support at 18000 would warn of a test of primary support at 17000.

Dow Jones Industrial Average

* Target medium-term: 18500 + ( 18500 – 18000 ) = 19000

September 24, 2016

More inverted scallops

Dow Jones Global Index respected the new support level at 316/320, confirming another advance. Follow-through above 325 would complete an inverted scallop (or inverted fish hook) with a target of 345*. Momentum troughs above zero flag trend strength.

DJ Global Index

* Target calculation: 315 + ( 325 – 295 ) = 345.
Note this is more conservative than Thomas Bulkowski’s target which is calculated 325 + ( 325 – 295 ) = 355

September 24, 2016

India: Sensex spinning tops

India’s Sensex is consolidating below medium-term resistance at 29000. Spinning tops and dojis signal indecision. Breakout above 29000 is likely and would test the 2015 highs at 30000. Expect strong resistance at 30000. Penetration of the lower trend channel would warn of a correction.

SENSEX

September 24, 2016

Gold respects support

10-Year Treasury yields are retracing to test the recent support level at 1.60 percent but the trend remains upward.

10-Year Treasury Yields

The Chinese Yuan is easing against the US Dollar, with USDCNY in a gradual up-trend as the PBOC manages the decline in order to conserve foreign reserves. This is likely to alleviate immediate selling pressure on the Yuan, both from capital flight and borrowers covering on Dollar-denominated loans.

USDCNY

Spot gold respected support at $1300/ounce. Breakout above the falling wedge (and resistance at $1350) would signal another advance.

Spot Gold

* Target calculation: 1375 + ( 1375 – 1300 ) = 1450

Rising interest rates and low inflation are bearish for gold but uncertainty over US elections, Europe/Brexit, and the path of the Chinese economy contribute to bullish sentiment.

Gold stocks serve as a useful counter-balance to growth stocks in a portfolio. If there are positive outcomes and a return to economic stability, growth stocks will do well and gold is likely to underperform. If there is instability and growth stocks do poorly, gold stocks are likely to outperform.