Analysis of the global economy
From WSJ:
The pace of job creation remained robust in February, with payrolls rising by a seasonally adjusted 235,000 new jobs, the Labor Department said.
Evidence of continued health in the U.S. labor market likely cleared the way for the Federal Reserve to raise short-term interest rates next week. The unemployment rate ticked down to 4.7%, as both workforce participation and employment rose….
Source: Robust Job Growth, Higher Wages Show Solid Labor Market – WSJ
Interesting chart from UBS (via Macrobusiness). Movement between 2002 and 2016 for a number of Developed and Emerging Market (DM and EM) countries in the ratio of bank credit to GDP and bank debt to credit.
The good guys are in the top left corner and the bad guys bottom right.
Australia and China are testing record levels of bank credit to GDP, tracing a similar path to Spain. We all know how that ended.
Source: Can Australia dodge the great deleveraging? – MacroBusiness
From WSJ:
Federal Reserve Chairwoman Janet Yellen signaled the central bank is likely to raise short-term interest rates at its March meeting and suggested more increases are likely this year if the economy performs as expected.
“At our meeting later this month, the [Federal Open Market] Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate,” Ms. Yellen said in remarks prepared for delivery at the Executives’ Club of Chicago.
The Dollar Index rally continues to meet resistance, with tall shadows on the last three weekly candles signaling selling pressure. Rising interest rates would strengthen the advance, with bearish consequences for gold.
Spot Gold hesitated at $1250/ounce. Rising interest rates also increase the opportunity cost of holding precious metals. Reversal below $1200 would warn of another decline but recovery above $1250 remains more likely and would signal an advance to $1300.
Motor vehicle sales are strong, according to the Federal Chamber of Automotive Industries:
Motor vehicle sales across Australia got off to a solid start in January, with the month’s sales nudging ahead of the same period last year and showing a rise in activity among private purchasers.
Total sales for January, including passenger cars, SUVs, light and heavy commercial vehicles totalled 84,910 for the month, 0.6 percent up on the same month in 2016.
Within the segments, light commercials fell 3.9 per cent, passenger car sales declined slightly (down 0.8 per cent), while SUVs continued their consistent growth pattern with a gain of 3.2 per cent….
But retail sales growth is slowing.
While housing is slowing after a surge in high-density units over the last five years.
Resources exports have been performing well but a slow-down in Chinese housing sales could act as a hand-brake on future growth.
Retail sales are surging, with Retail & Food (ex-Motor Vehicles) growing above 5% a year for the first time since 2012.
Light vehicles sales are back at their 2000-2006 norm of 17.5 million units a year, reflecting consumer confidence.
Housing remains soft but growth in new starts and building permits continues.
Durable goods orders are also soft but unlikely to remain so if retail sales growth continues.
Inflationary pressures are likely to rise. Which is why the Fed expects to increase the pace of interest rate hikes in 2017.
Two interesting graphs on inflation from Niels Jensen at Absolute Return Partners:
….similarities between the story unfolding in the UK and the one in the US. Core inflation in both countries is significantly higher than it is in the Eurozone – just above 2% in the US and just below 2% in the UK whereas, in the Eurozone, it is only 0.9%. Furthermore, services are very much the engine that drives core inflation in both the UK and the US (exhibit 6).
Exhibit 6: The drivers of core inflation (US only)Source: The Daily Shot, BEA, Bureau of Labor Statistics, Haver Analytics, February 2017. Data as of December 2016
To a very significant degree that is down to rising medical care costs (exhibit 7). As the populace ages, this can only get worse – at least in the US, where almost all healthcare is provided privately and paid for by insurance companies.
Exhibit 7: US personal consumption expenditures by component (%)
Source: The Daily Shot, BEA, Haver Analytics, February 2017
Source: A Note on Inflation: Is it here or isn’t it? – The Absolute Return Letter
Elliot Clarke at Westpac reports that home price growth in tier-1 cities “slowed materially” in January 2017:
From 29%yr in September 2016, tier-1 new home price growth has slowed to 23%yr. Similarly for the tier-1 secondary market, price momentum has slowed from 33%yr to 26%yr since September.
Tier-2 and tier-3 cities have far lower annual growth rates: 12% and 9% respectively for new homes and 9% and 6% for existing dwellings.
When we compare tier-1 price growth to Sydney and Melbourne, the Chinese bubble is in a different league. From CoreLogic: “Sydney home prices surged 15.5 per cent and Melbourne’s 13.7 per cent over the year [2016]”.
It is hard to imagine a soft landing when property prices have been growing at 30% a year.
Even 15%….
RBA governor Phil Lowe recently made a speech comparing the experiences of Australia and Canada over the last decade. Both have undergone a resources and housing boom. Four charts highlight the differences and similarities between the two countries.
Australia’s spike in mining investment during the resources boom did serious damage to non-mining investment while Canada’s smaller boom had no impact.
Immigration fueled a spike in population growth in Australia, adding pressure on infrastructure and housing.
Both countries are experiencing a housing bubble, fueled by low interest rates and lately by export of China’s property bubble, with capital fleeing China and driving up house prices in the two countries.
Record levels of household debt make the situation more precarious and vulnerable to a correction.
Hat tip to David Llewellyn-Smith at Macrobusiness
The yield curve is one of the best predictors of US economic recessions. Every time the yield curve has turned negative in the last fifty years, a recession has followed.
First of all, what is a yield curve? It is the plot of yields on bonds, normally Treasuries, against their maturities. Long maturity bonds are expected to have higher yields than short-term bills, to compensate for the increased risk (primarily of interest rate changes). If you tie your money up for longer, you would expect a higher return. Hence a rising yield curve.
A rising yield curve is a major source of profit to the banks as their funding is mostly short-term while they charge long-term rates to borrowers, pocketing a healthy interest margin.
When the Fed steps into the market, however, restricting the flow of money into the economy, then short-term rates rise faster than long-term rates and the yield curve can invert (referred to as a negative yield curve).
Bank interest margins are squeezed — it is no longer profitable to borrow short and lend long — and they restrict the flow of new credit.
Credit is the lifeblood of the economy and activity slows.
The chart below compares US recessions to the yield differential: the difference between 10-year Treasury yields and the yield on 3-month T-bills. The yield differential falls below zero when 3-month T-bills yield more than 10-year T-notes.
You can see that every time the yield differential dips below zero it is followed by a gray bar indicating a recession. There is one exception: the phantom recession of 1966 when the S&P 500 fell 22%. This was originally certified as a recession by the NBER but they later changed their mind and airbrushed it out of history.
You can also see that the yield differential is declining at present but, at 2.0%, it is a long way from a flat or negative yield curve. This supports my argument last week that current Fed rate hikes are more about normalizing interest rates than about monetary tightening.
That could change in the future but at present the bull market still appears to have plenty in the tank.
Corporate bond spreads — the yield difference between high-grade corporate bonds and the risk-free Treasury rate — are another useful indicator of the state of the economy.
Wide bond spreads indicate increased risk of corporate default. Investors are concerned about the state of the economy and demand a higher premium for taking credit risk.
Narrow spreads suggest that credit premiums are low and confidence in the economy is good.
If we examine the chart below, bond spreads are declining, indicating confidence in the US economy, with even the lowest investment grade BBB dipping below 150 basis points (or 1.50%). This is synonymous with a bull market.
Australian corporate bond spreads are higher than the US, with BBB still at 200 bps. They have also declined over the last year but seem to be trending upward from their 2013 low. This is not conclusive as the current trough is not yet complete, but a higher low would warn that credit risk is rising.
Only when the tide goes out do you discover who’s been swimming naked.
~ Warren Buffett
