Category: Economy

Analysis of the global economy

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Market lifts despite weak global economy

Minutes of the September FOMC meeting highlight growing unease with the strong US Dollar and a weak global economy. The market read this as “low interest rates” and commenced a buying spree. Last year the quarter-end sell-off ended on October 9th after a 4.2% fall. This year’s correction fell 4.7%, lasting 13 days (so far) compared to 15 days in 2013.

Roberto Dominguez at NY Daily News reports:

“The start of earnings season, with companies including Costco and Alcoa reporting quarterly profits that beat forecasts, also helped push the S&P 500 to its biggest rally in a year.”

While Cullen Roche writes that the US fiscal deficit is shrinking:

“…tax receipts have surged by 7.7% year over year and are up 48% over the last 5 years. And while some of this is due to tax increases the vast majority is due to a healing private sector.”

Bellwether transport stock Fedex continues its primary up-trend, signaling improved economic activity.

Fedex

No doubt boosted by a falling outlook for crude oil.

Nymex and Brent Crude

With positive news about, we should be careful not to forget the Fed’s concern with a weak global economy. While this may drive oil prices even lower, the impact on international sales of major exporters will be closely watched.

S&P 500 recovery above 2000 would indicate the correction is over, while follow-through above 2020 would signal another advance. A 21-day Twiggs Money Flow trough above zero would signal a healthy up-trend. Reversal below 1925 is unlikely, but would test primary support at 1900/1910.

S&P 500

* Target calculation: 2000 + ( 2000 – 1900 ) = 2100

CBOE Volatility Index (VIX) retreated to 15%, indicating low volatility typical of a bull market.

VIX Index

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QE: The end is nigh?

I have read a number of predictions recently as to how stocks will collapse into a bear market when quantitative easing ends. The red line on the graph below shows how the Fed expanded its balance sheet by $3.5 trillion between 2008 and 2014, injecting new money into the system through acquisition of Treasuries and other government-backed securities.

Fed Assets and Excess Reserves on Deposit

Many are not aware that $2.7 trillion of that flowed straight back to the Fed, deposited by banks as excess reserves. So the net flow of new money into the system was actually a lot lower: around $0.8 trillion.

The Fed has indicated they will end bond purchases in October 2014, which means that the red line will level off at close to $4.5 trillion. If excess reserve deposits continue to grow, that would cause a net outflow of money from the system. But that is highly unlikely. Excess Reserves have been growing at a slower rate than Fed Assets for the last three quarters, as the graph of Fed Assets minus Excess Reserves shows. If that trend continues, there will be a net injection of money even though asset purchases have halted.

Fed Assets and Excess Reserves on Deposit

Interest paid on excess reserves is a powerful weapon in the hands of the FOMC. The Fed can accelerate the flow of money into the market by reducing the interest rate, forcing banks to withdraw funds on deposit in search of better returns outside the Fed. Alternatively, raising interest paid above the current 0.25% p.a. on excess reserves would have the opposite effect, attracting more deposits and slowing the flow of money into the market.

The Fed is likely to use these tools to maintain a positive flow into the market until the labor market has healed. As Janet Yellen said at Jackson Hole:

“It likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after our current asset purchase program ends.”

That’s Fedspeak for “Read my lips: there will be no interest rate hikes.”

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Market turbulence

A Coincident Economic Activity Index above 0.2 indicates the US recovery is on track. Produced by the Philadelphia Fed, the index includes four indicators: nonfarm payroll employment, the unemployment rate, average hours worked in manufacturing, and wages and salaries. Bellwether stock Fedex also suggests rising economic activity.

Coincident Economic Activity Index

But contraction of the ECB balance sheet by € 1 Trillion over the last two years has pitched Europe back into recession.

Weakness in Europe and Asia has the capacity to retard performance of US stocks despite the domestic recovery.

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How Laissez-Faire Made Sweden Rich | Libertarianism.org

From Johan Norberg:

…But in one century, everything was changed. Sweden had the fastest economic and social development that its people had ever experienced, and one of the fastest the world had ever seen. Between 1850 and 1950 the average Swedish income multiplied eightfold, while population doubled. Infant mortality fell from 15 to 2 per cent, and average life expectancy rose an incredible 28 years. A poor peasant nation had become one of the world’s richest countries.

…And so Sweden—a small country of nine million inhabitants in the north of Europe—became a source of inspiration for people around the world who believe in government-led development and distribution.

But there is something wrong with this interpretation. In 1950, when Sweden was known worldwide as the great success story, taxes in Sweden were lower and the public sector smaller than in the rest of Europe and the United States.

Read more at How Laissez-Faire Made Sweden Rich | Libertarianism.org.

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Irrational Exuberance Down Under | Bloomberg View

From William Pesek:

Lindsay David’s new book on Australia deserves a medical disclaimer: Reading this will greatly raise your blood pressure.

In “Australia: Boom to Bust” David sounds the alarm about an Australian housing bubble he argues makes the 12th-biggest economy a giant Lehman Brothers. His thesis can be boiled down to the number 9 — the ratio of home prices to income in Sydney. The multiple compares unfavorably to 7.3 in London, 6.2 in New York and 4.4 in Tokyo. Melbourne is 8.4.

Read more at Irrational Exuberance Down Under – Bloomberg View.

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Amir Sufi: Who is the Economy Working For? The Impact of Rising Inequality on the American Economy

Amir Sufi, professor of Finance at the University of Chicago, testified before the U.S. Senate Committee on Banking, Housing and Urban Affairs Subcommittee on Economic Policy. His statement titled “Who is the Economy Working For? The Impact of Rising Inequality on the American Economy” makes interesting reading.

“Only 76% of Americans aged 25 to 54 currently have jobs, compared to 80% in 2006 and 82% in 1999…..How did we get into this mess?”

The gist of his argument is:

“Richer Americans save a much higher fraction of their income, ultimately holding most of the financial assets in the economy: stocks, bonds, money-market funds, and deposits. These savings are lent by banks to middle and lower income Americans, primarily through mortgages.”

…And collapse of the housing market caused disproportionate harm to the middle and lower-income groups.

It is true is that middle and lower-income groups have a higher percentage of their wealth invested in their homes and are also far more exposed to mortgages than richer Americans. The source of funding for these mortgages, however, is not the wealthy — who are primarily invested in growth assets such as stocks — but the banks who create new credit out of thin air. The collapse of the housing market caused disproportionate hardship to middle and lower-income Americans because their wealth is concentrated in this area. The rich suffered from a collapse in stock prices, but the market has recovered to new highs while housing remains in the doldrums. That is one of the causes of rising wealth inequality.

Where I do agree with Amir is that credit growth without income growth is a recipe for disaster.

“A tempting solution to our current troubles is to encourage even more borrowing by lower and middle-income Americans. This group of Americans is likely to spend out of additional credit, which would provide a temporary boost to consumption. But unless borrowing is predicated on higher income growth, we risk falling into the same trap that led to economic catastrophe.”

The graph below compares credit growth to growth in (nominal) disposable income:

Credit and Disposable Income

The ratio of credit to disposable income rose from 2:1 during the 1960s to almost 5:1 in 2009.

Credit to Disposable Income

There is no easy path back to the stability of the 1960s. A credit contraction of that magnitude would destroy the economy. But regulators should aim to keep credit growth below the rate of income growth over the next few decades, gradually restoring the economy to a more sustainable level.

The worst possible policy would be to encourage another credit boom!

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What Ukraine needs most now – Evidence from Slovakia Reforms | VoxUkraine

From Ivan Mikloš (former Minister of Finance and deputy Prime Minister of the Slovak Republic):

…Twenty-five years ago Slovakia produced antiquated Soviet tanks and another heavy military equipment but not one car. Today we are the number one producer of cars in the whole world, per capita. The most important reason for that success is reforms. Let me illustrate this by comparing convergence success of the Visegrad countries from 2004 until 2008. Over those four years, GDP per capita in PPP in comparison with the EU average improved in Hungary by 1%, Czech Republic by 3%, Poland by 5% and Slovakia by 16%. These were the first four years of EU membership for all of these countries, therefore the big difference among their convergence progress has to have had different reasons. This reason is reforms.

Slovakia during 2003 prepared, and from the beginning of 2004 implemented, a very bold and complex package of deep structural reforms. In 2004 Slovakia was named the most reformist country globally by the World Bank. I am not writing this in order to praise my country or myself. I am writing this because of two main reasons. Firstly, it shows that reforms work. It shows that if country is able to implement a deep and comprehensive package of reforms it will bring relatively quick results. Secondly, I think that our experience shows Ukraine now has a real chance to achieve similar success and progress if necessary reforms are implemented.

Read more at VoxUkraine.

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Bad Has Never Looked So Good – Russia

Again from Energy Burrito at Oilprice.com:

…the Russian ruble has been gradually depreciating throughout this year amid rising geopolitical tension in Ukraine. It has now dropped 12% versus the US dollar in 2014.

Yet while a falling ruble hurts Russian imports as they become increasingly more expensive to buy, Russia reaps the rewards when it comes to exports. And it is seeing the greatest benefit from its largest export: oil. To the tune of 7 million barrels a day.

Hence, while crude prices in US dollars have dropped 12% in value since the beginning of July, crude oil in rubles has only dropped 3.4%. For Russian coffers, it is good for the ruble to be bad…

Read more at Bad Has Never Looked So Good.

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