NEW$ & VIEW$ (30 JULY 2015): Housing; Fed’s Lowflation Dilemma; Breathless Technicians.

U.S. Pending Home Sales Slip in June 

The National Association of Realtors said Wednesday its index of pending home sales fell by 1.8% to a seasonally-adjusted 110.3, the lowest level since March, but 8.2% higher than June 2014.

Pending home sales rose 0.4% in the Northeast and 0.5% in the West from May. They fell by 3% in the Midwest and South.

The trend remains up: pending home sales rose 4.5% YoY in Q2 after rising 3.1% in Q1.

Sequentially, Q2 sales are up 1.5% or 6.1% annualized. Regionally, sales are all over the map with sales up 16.8% QoQ in the Northeast (+16.0% YoY), +0.6%  in the Midwest (+8.6%), –2.4% in the South (+10.3%) and +0.7% in the West (+11.7%). (Charts from Haver Analytics)

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A new report from Pew Research Center shows that a higher percentage of millennials, a group defined by Pew as adults born 1981 or later, is living with parents than in 2010, despite the ongoing recovery.

In the first third of 2015, 26% of millennials lived with their parents, up from a prerecession 22% in 2007 and 24% in 2010, when the recovery began. That translates to 16.3 million young adults in their family homes, compared with 13.4 million in 2007. (…)

Of course, many millennials are living independently: 42.2 million of them in 2015. But that’s slightly fewer than the 42.7 million who lived independently in 2007. (…)

A study from the Federal Reserve Board also points to one factor that, unlike the labor or housing market, has resisted cyclical trends: student debt. As the Pew study notes, the recession drove many young adults towards higher education. (…)

But all that schooling came with a serious price tag. Lisa Dettling and Joanne Hsu, economists at the Federal Reserve Board, found that mean balances on student loans rose to $12,000 by early 2014, up from $5,300 in early 2005. By analyzing individual-level credit data, Ms. Dettling and Ms. Hsu show that each additional $10,000 in student loan debt makes someone 4.6% more likely to move in with a parent.

Even if student loans are a proxy for upward mobility (higher earnings might be more likely with a degree or credential), “any income effects signaled by large loan balances are swamped by a behavioral effect wherein large balances incentivize moving in with a parent,” they wrote. (…)

Parsing the Fed: How the July Statement Changed from June

Fed Statement Tracker

Information received since the Federal Open Market Committee met inApril suggestJune indicates that economic activity has been expanding moderately after havin recent months. Growth in household spendingchanged little during the first quarter. The pace of job gains picked up while the unemployment rate remained steadys been moderate and the housing sector has shown additional improvement; however, business fixed investment and net exports stayed soft. The labor market continued to improve, with solid job gains and declining unemployment. On balance, a range of labor market indicators suggests that underutilization of labor resources has diminished somewhat. Growth in household spending has been moderate and the housing sector has shown some improvement; however, business fixed investment and net exports stayed softince early this year. Inflation continued to run below the Committee’s longer-run objective, partly reflecting earlier declines in energy prices and decreasing prices of non-energy imports; energy prices appear to have stabilized. Market-based measures of inflation compensation remain low; surveybased measures of longer-term inflation expectations have remained stable. (…)

Jon Hilsenrath rightly focuses on lowflation:

Federal Reserve officials face a conflict as they plan to start raising interest rates later this year: There has been a lot of progress in their goal for U.S. job growth, but little in their objective of modestly rising consumer prices.

The central bank on Wednesday left its benchmark short-term interest rate near zero—for the 2,417th straight day—but dropped several hints after a two-day policy meeting that it is near seeing enough improvement in the job market to prompt officials to raise the rate as early as September.

At the same time, the Fed flagged nagging concerns in its postmeeting statement that inflation remains too low, which is making officials hesitant on the timing for liftoff and inclined to raising rates very gradually after the first increase.

So, China has become a factor in Fed policy:

The ripple effects of China’s market woes

(…) There could be several big ripple effects. First, the wild oscillations have shaken faith in the competence of China’s technocrats. For years, bureaucrats have defied doom­sayers predicting that China’s hybrid system of central planning and market forces would collapse under its own contradictions. Now the bureaucrats don’t look so good. Initially, they pumped up the market in what looks like an ill-conceived effort to enact what has been called the world’s biggest debt-to-equity swap. Worried that loans made to companies as part of a massive stimulus programme would turn sour, technocrats encouraged a stock market binge. Their subsequent actions to stop the bubble from bursting have looked anachronistic and heavy-handed. They have virtually criminalised selling stocks, banning anyone who owns more than 5 per cent of a company from offloading shares.

“This has set the Chinese stock market back 10 years,” says one close observer of China’s capital markets. Not only have such blunderbuss tactics revealed panic and outmoded instincts, they have not worked. (…)

Second, the assumption that China will gradually move towards a more market-based system might need to be reassessed. Recent events could persuade authorities they have been moving too fast. That could have an impact on everything from the pace at which China opens its capital account and makes the renminbi convertible to how fast it liberalises domestic interest rates. (…)

“What this reveals is that there is still a fundamental tension in China between a desire to intervene and a desire to let market forces operate,” says Fred Neumann, chief Asia economist at HSBC. That could affect whether the International Monetary Fund includes the renminbi in its special drawing rights, or whether China’s A-shares gain access to the MSCI Emerging Market index. Certainly, the clumsy intervention by authorities has had a chilling effect on global sentiment. Larry Fink, chief executive of BlackRock, said foreign investors would need to reassess.

The third possible impact is on China’s growth. True, it is not obvious how a market fall will spill over into the real economy. China has bucked sharp stock market slides before. This time, though, the risks are higher. Many in­ves­tors have borrowed heavily to buy shares. If authorities cannot stop a slide, some banks and brokerages could be at risk. The confidence-sapping oscillations are also taking place against the background of a much softer economy, one probably growing more slowly than the official 7 per cent figure suggests. If another point or two were shaved off growth, it could send very real tremors around the globe. Since 2008, China has been the motor of the world. The travails of its stock market add to evidence that this motor is spluttering.

China’s stock market regulator began its most recent press briefing with a telling instruction for the mostly local journalists in attendance. “We have a requirement concerning speculative reports,” said the China Securities Regulatory Commission. “They must first be confirmed by the CSRC in order to prevent the spread of false information and market disturbance.”

The warning was a reminder that as a “national team” comprised of largely state-owned entities struggles to shore up China’s stock market, the government is orchestrating an equally important cheerleading campaign involving a broad array of state media outlets. (…)

The 8.5 per cent fall on July 27 left the SCI just 200 points above 3,500 — the level at which the government’s rescue effort began in earnest on July 8.

A move below the intervention point would be embarrassing for the national team led by China Securities Finance, the CSRC vehicle fronting a rescue effort estimated to be worth at least Rmb2.2tn ($350bn). (…)

In terse late night statements, posted in question and answer format, the CSRC has pledged to pursue all “relevant clues” as it pursues stock “dumping” in contravention of its July 8 decree banning listed companies’ large shareholders and directors from selling their shares.

Investors have also been urged to report any such “malicious” activity to official hotlines, in a throwback to the Cultural Revolution and other political campaigns in which the Chinese Communist party encouraged people to monitor and inform on their neighbours. (…)

China’s ripple effects on commodity prices…

…and world trade:

(…) a slowdown in China could have a profound effect on prices for U.S. consumer goods, depressing them even further. And further weakening in Chinese demand for commodities and other globally traded goods could cool inflation even further. So while the Fed might be confident the U.S. can keep growing, it would also worry that if the economy gets dented, very low inflation could turn into deflation.

China keeps exporting deflation. Now, commodity prices, in general, are also seriously deflating. While the USD keeps rising…


Technicians are out of breadth:

From Barron’s:

(…) Now, we have a serious breakdown in the small-capitalization Russell 2000 index interrupted by an oversold condition and a small upside reversal pattern Tuesday (see Chart 1). Even with Wednesday’s gains that breakdown is still in effect.

Investors may not be familiar with the Russell’s completed pattern. As we can see in the chart, the index formed and broke three trendlines originating at last October’s low. Called a “fan lines” pattern, it resembles a folded paper fan. But what it represents is a transition from bull to bear. We can even see two lines broken in the relative performance chart, as well, to confirm the change.

When the first and second lines broke, the index fell but then rallied back to test the now-broken lines, even setting a new high in the process. But the index was slowly rolling over and unable to sustain rallies. When the third line broke the sell signal was given.

Many traders wait for a more traditional break of horizontal support with the index taking out its May low. Indeed, there is a good deal of support in the zone between 1211.50 and 1220.50, which runs through several turning points formed over the past 29 months (the index traded near 1227 Wednesday afternoon). Coupled with a touch of the 200-day moving average and oversold short-term momentum indicators thanks to the steep late July selloff the rebound should not have been a surprise.

While small and midsized stocks have broken, the big-cap S&P 500 has not, at least not in its traditional formulation. This index is capitalization weighted so the biggest stocks carry the most influence, and this shows up quite well in the equal-weighted version. However, it is the cap-weighted version on which most people focus, and it also bounced off its 200-day average (see Chart 2). That keeps it officially in its year-to-date trading range and one of the few reasons I am suppressing my inner grizzly for now.

The bounce this week was not entirely because certain technical levels were reached but rather due to the phoenix-like awakening of some of the market’s worst sectors. Energy led the rebound Tuesday with basic materials and industrials close on its heels. This worst-to-first phenomenon is really just a snapback in beaten-down sectors. In my experience, it is more likely that if the market is going to resume its advance it will be the sectors that resisted the decline best that should lead the way.

I also find it disturbing that the Consumer Staples Select Sector SPDR exchange-traded fund (ticker: XLP ) is trading at 52-week highs while technology stumbled significantly over the past two weeks. Staples are defensive stocks that tend to lead when times are uncertain or bearish. Technology is one of the expected leaders in any bull market.

The semiconductor sector in particular is in trouble, with the iShares PHLX Semiconductor ETF ( SOXX ) down more than 13% from its June 1 peak and solidly below its 200-day average.

In short, the technical evidence available now, from sector action to declining market breadth, suggests cash is still a very good idea.

From NBF:

While the S&P has rebounded over the past couple of days it is notable that the IBD 50 fund ETF of leading stocks has not participated. As the accompanying chart indicates, the leading stocks as a group closed lower than they did two days ago. In other words, no rebound in the face of a bounce on the S&P. The chart has made a secondary high and appears set to test lower levels.


Meanwhile, new daily 52-week lows on the three major U.S. exchanges hit 735, the highest number since October 2014. More of the same internal deterioration.

The relative performance of leading stocks is starting to falter. A ratio chart of the IDB 50 ETF/ S&P made a lower high and is ready to break a prior low.


  • 285 companies (67.5% of the S&P 500’s market cap) have reported. Earnings are beating by 6.0% (6.1% last Tuesday) while revenues have positively surprised by 0.3%.
  • The beat rate is 74% (75%) . Ex-Financials: 78%.
  • Expectations are for revenue, earnings, and EPS of -3.7%, 0.0% (-0.2%), and +1.4% (+1.1%). EPS growth is on pace for 3.4% (3.5%), assuming the current 6.0% beat rate for the remainder of the season. This would be 8.2% (8.4%) on a trend basis (ex-Energy and the big-5 banks).

The big surprise among all surprises is that Industrials’ beat rate is 85% with 74% of companies already in. Their miss rate is only 8% in spite of the slow economy, slow exports and the dollar.



(…) Weekly oil-output estimates from the EIA started to show falling production in April. Separate EIA reports on shale-oil drilling have forecast production declines for months. But the EIA’s monthly figures, which are released on a two-month delay, threw the market a curveball by showing that production hit a 44-year high in April and that previous months’ production was higher than initial forecasts.

U.S. crude prices have dropped 18% this month, reversing a spring rally. Some investors who entered the year betting on an oil-price rebound have responded with complaints that the U.S. data aren’t up to the task of providing an accurate picture of domestic drilling conditions. (…)

Why the discrepancy between weekly and monthly results? The EIA’s weekly production numbers are based on a forecasting model, not reported output, which underlies the monthly reports.

(…) The EIA, a wing of the Energy Department focused on data collection and analysis, says its current figures are accurate and reliable, adding that the discrepancies between its initial reporting and later revisions haven’t widened this year.

The next monthly oil report, which will include data through May, is due Friday. (…)

Alternatives abound, but even forecasters concede there is as much art as science in many of these calculations. Consulting firm PIRA Energy Group recently told clients that the U.S. produced about 9.3 million barrels a day in April, 400,000 barrels a day less than the government figures show.

PIRA’s April data accounted for lower Texas production due to flooding, while the EIA’s didn’t, said Gary Ross, head of global oil at PIRA.

“We’re all trying to bring exactness to this business that doesn’t really exist,” Mr. Ross said. (…)

Nerd smile Maybe people should look at other sources for better data. Since most of the shale oil production is transported by rail, U.S. rail carloads of petroleum and petroleum products, while not the perfect data, has the merit of being accurate and timely. These charts from the AAR are through June 2015 and July data will be out next week.

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Carloads peaked during Q1’15 and have declined 2.5% YoY during Q2. They were up –1.1% YoY in April, +0.5% in May and –7.3% in June. Production has also started to drop in Canada as Canadian carloads of petroleum products, up 3.3% YtD through June, were down 4.5% in May and down 4.9% in June.

The reduction could begin as soon as September and would amount to about 200,000 to 300,000 barrels a day, bringing production to about 10.3 million barrels a day, the people said. Saudi Arabia told the Organization of the Petroleum Exporting Countries that it produced 10.56 million barrels a day in June, a record high.

“It is purely based on the [domestic] demand situation,” one of the people said, adding that “production is likely to hover around” 10 million barrels until the end of the year. (…)

The planned reduction likely wouldn’t affect exports and demonstrates that at least part of the kingdom’s recent production figures were related to its domestic-energy needs. Much of the recent production went to Saudi Arabia’s domestic refineries, including the two 400,000 barrels a day refineries it recently brought online with France’s Total and China’s Sinopec. (…)

Already faced with recession and sanctions, a further drop in crude might force the country’s central bank into an emergency rate hike — after four cuts already this year —  according to 65 percent of economists surveyed by Bloomberg from July 24-29. Thirty-nine percent of analysts said the government might impose Greek-like capital controls and 22 percent predicted a takeover of at least some of the country’s banks.

When asked about the central bank’s own analysis of the $40-per-barrel oil scenario, which found a roughly 600 billion ruble capital deficit and two-fold increase in the share of non-performing loans, 69 percent of economists said it has accurately estimated the risks to the Russian economy and banking sector.

The impact on growth from $40 oil would be particularly severe, weakening the ruble to 65 against the U.S. dollar by end-2015 and causing the economy to contract by 5 percent this year and 1 percent in 2016. Compare that to the far less pessimistic baseline consensus provided by Bloomberg’s monthly economic survey, which currently forecasts a 3.5 percent contraction in 2015 and a 0.5 percent expansion in 2016.

NEW$ & VIEW$ (29 JULY 2015): Housing; World Growth; Earnings; Oil

Homeownership rate down but vacant dwellings also falling

According to just-released data, the homeownership rate in the U.S. declined to 63.4% in Q2, its lowest level since 1967. As today’s Hot Charts show, the weakness is not limited to the youngest cohort which has been particularly hit by the deterioration of the labor market during the last recession. All other age groups reached a multi-year low in Q2 perhaps a legacy of the 2008-2011 housing crash (which hurt confidence or changed preferences) and tighter lending standards.

That said, not everything is bleak in this report. Household formation (all renters in Q2) resumed its upward trend pushing down the vacancy rate in the rental market to a 30 year low, while the homeowner segment was also down approaching its historical average. Which such low level of vacant dwellings, the stronger labor market and the U.S demographic profile, housing starts could easily improve to a pace of 1400K annualized units (was 1174K in June) over the coming years. (NBF)image

“Easily” at the low point? (Chart from Doug Short)

Home Ownership Rate

Thumbs up Maybe yes, as rents are rising fast:

  • Rising Rents Outpace Wages in Wide Swaths of U.S. The cost of renting a home is rising faster than wages across wide swaths of the country, a problem that has become especially acute in the past year, putting a big squeeze on many household budgets.

The situation is particularly noticeable in long-pricey areas across the West and in big cities like New York, where the average household pays more than 40% of its gross income for rent, according to online real-estate database Zillow. But rising prices also have spilled over into cities like Denver, Atlanta and Nashville.

Much of the problem is attributable to simple supply and demand. The job market has improved and millennials are entering the labor pool in force, boosting household formation. But in a structural shift for the real-estate market, new households are much more likely to be renters than buyers. (…)

In the first quarter of 2015, the number of U.S. households was up by almost 1.5 million from a year earlier, the second consecutive quarter of relatively strong growth following years of only tepid gains.

But the net increase was entirely due to renters, while the number of owner-occupied households fell slightly. That’s broadly been the case since the housing bust, with new household formation consistently coming from renters rather than buyers. (…)

From 2003 to 2013, the share of renters aged 25 to 34 who are considered cost-burdened increased from 40% to 46%, according to a recent report by Harvard University’s Joint Center for Housing Studies. (…)

MPF Research, which tracks occupancy and rental rates, found second-quarter rents rose 5.2% from a year earlier nationwide, a 15-year high. (…)

Thumbs down Maybe no, as house prices have risen even faster…

The S&P/Case-Shiller Home Price Index, covering the entire nation, rose 4.4% in the 12 months ended in May, slightly greater than a 4.3% increase in April.

The 10-city and 20-city indexes saw similar increases in May as in April. The 10-city index gained 4.7% from a year earlier, slightly stronger than a 4.6% increase in April. The 20-city index gained 4.9% year-over-year, identical to the increase in April.

After seasonal adjustment, the national index was unchanged and the 10- and 20-city composites were both down 0.2% over the month. Ten of the 20 cities in the index reported month-over-month decreases in prices, after seasonal adjustment. (chart from CalculatedRisk):

…and first-time buyers are skittish (chart from Ed Yardeni)…

…perhaps explaining that mortgage apps remain weak (chart from CalculatedRisk)…


…even with record low mortgage rates?

  • How Much Do Homebuyers Care About Interest Rates?
  • It’s a common belief that rising interest rates are bad for the housing sector. The Federal Reserve Bank of New York recently decided to test the validity of that notion by asking people how much they would be willing to pay if they were forced to buy a home comparable to their current one. The researchers also gave respondents access to calculators that showed the monthly payments they would incur if they bought a house for a certain price at a certain mortgage rate.

    On average, the amount people were willing to pay dropped just 5 percent in a scenario where mortgage rates rose from 4.5 percent to 6.5 percent.

    Down payment requirements, however, had a much larger effect. When respondents were told they had to put just 5 percent down on their hypothetical new home, they were willing to pay 15 percent more than when they were required to put 20 percent down. Renters were willing to pay 40 percent more for a home if they only had to make a 5 percent down payment. Confused smile

  • Add this (from The Urban Institute)

    Why will the overall homeownership rate continue to fall in 2020 and 2030? Possible contributors include the following:

    Hispanics and blacks have lower homeownership rates than whites, and both groups are growing as shares of the population. But changes in racial/ethnic and age composition alone do not account for the drop in the homeownership rate..

    Real wages have been very flat since 1996, and have actually declined among adults ages 25–34. This stagnation makes it much harder for people at any age, particularly the young, to save enough for down payments. Even for young adults with good jobs, low vacancy rates and high rents make it more difficult to save.

    Student loan debt has increased from about $300 billion in 2003 to over $1.3 trillion in 2014. 

  • Rental Demand Supplies Home-Building Opportunity

In June, ground was broken on the most multifamily-housing units since 1986. Meanwhile, the number of permits issued for units that construction hasn’t been started on yet also has swelled.

Banks have eased lending standards and as of mid-July had a seasonally adjusted $1.7 trillion in commercial real-estate loans outstanding. That is up 9% from a year earlier. Moreover, the housing market looks as if it is loosening up; this year’s spring selling season was the best since 2007. So many renters may soon become owners.

I don't know smile U.S MANUFACTURING: Fed Surveys vs ISM vs Markit

We now have 4 of the 5 regional Fed bank manufacturing surveys for July and all four are in contraction mode, setting the stage for some nervousness when the ISM is released next Monday.  Mind you, Markit’s flash U.S. manufacturing PMI rose to 53.8 from 53.6 and was accompanied with statements like

  • solid improvement in overall business conditions across the manufacturing sector
  • stronger rises in output and new business levels in July
  • strong rise in incoming new business, with the rate of expansion picking up to its fastest for three months
  • survey respondents cited improving domestic economic conditions and a general upturn in client demand
  • July data nonetheless indicated a marginal rebound in total new work from abroad

Markit’s preliminary survey was unequivocally pointing up, contrary to the four Fed surveys. Interesting.

The warning signs of trade stagnation (Stephanie Flanders, chief market strategist for Europe, JPMorgan Asset Management)

(…) The latest World Trade Monitor showed the volume of world trade falling in May by 1.2 per cent. It slid in four out of five months in 2015 and risen just 1.5 per cent in the past 12 months — less than the growth in global output and far below the long-term average of about 7 per cent a year.

The problem has been getting worse for some time. Trade bounced back fairly well in 2010 after the global recession but it has disappointed ever since, growing by barely 3 per cent in 2012 and 2013. Now it seems the world cannot manage even that.

(…) structural forces can explain why trade is growing more slowly — they cannot explain why it is barely growing at all.

In fact, there are three more short-term explanations for the weak trade numbers, which should demand the attention of policymakers.

The first is that global investment demand continues to fall short. For several years, emerging market economies bucked the trend but capital spending has now slowed in such countries as well. This translates into lower trade growth because capital goods are more trade-intensive. It matters because it does not just dampen growth today but could also limit growth in the future by further slowing growth in productivity.

Another warning from the trade data is that the recovery in domestic demand in the US and Europe this year is not being seen elsewhere. Latin America appears to have contracted between the end of March and the beginning of July, and JPMorgan estimates that Asian emerging market economies — excluding China — grew by just 1.4 per cent. China is doing better but not nearly as well as it was. This weakness is worrying at a time when many governments in such countries have less room to ease policy than they did before and are already dealing with weak commodity prices and a stronger dollar.

Last weekend, Beijing announced new measures to revive demand through stronger exports — including a slightly more flexible currency. I doubt the Chinese authorities are about to engineer a big depreciation in the renminbi when they are also trying to develop its role as a reserve currency, and Chinese companies have borrowed so much in dollars. But the pressures are clearly there.

That highlights the final lesson: in today’s global economy, governments should not be trying to reflate their economies on the back of a weak currency alone. Since coming to power in 2012, Shinzo Abe, the Japanese prime minister, has done much to help his country’s economy, but one thing Abenomics has not accomplished is to increase exports. Many European policy­makers think the weak euro has been the making of the eurozone recovery. But it has not yet. Net trade made a negative contribution to eurozone growth in the first three months of 2015 and trade’s contribution is likely to be barely positive for the rest of 2015.

For all the talk about the euro, the single most encouraging aspect of Europe’s recovery since the turn of the year has been the strength of domestic demand. But private capital investment in the eurozone is still flat and has been even weaker than in the US since 2010.

If consumption and investment firm up on both sides of the Atlantic, we should start to see global trade pick up as well. But policymakers should not kid themselves that trade is going to rescue them from their domestic economic travails, as it did in the past.

VW Lowers Sales Forecast as Russia, South America Falter

Volkswagen AG lowered its global sales forecast for this year amid growing concern among automakers about the slowdown in China, the world’s biggest car market.

Deliveries will be about at the 2014 level, the Wolfsburg, Germany-based carmaker said Wednesday in a statement that also cited challenging markets in Russia and South America. It had previously forecast a moderate increase in vehicle sales this year.

VW’s deliveries in China dropped for the first time in a decade in the first half. The year is shaping up to be no better for the industry as a whole, as China’s economic slowdown and volatile stock market coincide with curbs on auto registrations in some areas. Carmakers may see Chinese sales drop for the first time since 1998, Ford Motor Co. said Tuesday. (…)

PSA Peugeot Citroen, Europe’s second-biggest carmaker after VW, also cited the tough market in China when it reported results today. Despite more than tripling its first-half earnings, the French company didn’t raise earnings forecasts. Chief Executive Officer Carlos Tavares pinned that on an “unstable international environment,” and the company said it’s focusing on how to adapt to the steep slowdown in China.

Gavyn Davies What the leaked Fed forecasts tell us

(…) the economic staff’s projections indicate a worryingly pessimistic view of the supply side of the US economy, with only a small output gap at present, and very low productivity growth in the future. If validated by future data, this pessimistic view will involve a much lower medium-term growth rate for the US economy than has generally been assumed by official and private economists, and eventually that might start to worry the equity markets.

It also has implications for the likely path for interest rates. In the near term, a smaller margin of spare capacity in the economy might require higher policy rates in order to slow the economy and avoid inflation. In the longer term, however, a permanently lower gross domestic product growth rate is likely to involve lower equilibrium interest rates in the economy. The markets seem more convinced by this latter factor, which is why they are pricing a much lower path for policy (or short) rates than is implied in the FOMC’s dots charts.

But have they now found an unexpected ally in the shape of the Fed’s own economics staff? The answer is yes — the staff expects a much lower path for equilibrium interest rates in the next few years than the FOMC, and this translates into a much slower path for monetary tightening, especially in the years up to 2017.

(…) The conclusion, therefore, is that the FOMC is almost 100 basis points (1 per cent) more hawkish on rates than its staff in 2017, about two-thirds of which is due to a difference in the equilibrium interest rate assumed by the two parties. The gap diminishes to only 30 basis points by 2020.

This means that the staff is much closer to the markets’ dovish view in the next two to three years than it is to the FOMC’s officially stated path for “appropriate” policy. The reason (presumably) is that the staff believes that the “headwinds” that are holding down the equilibrium rate will fade away more slowly than the FOMC expects.

Ultimately, it is of course the FOMC, not the staff, that matters for policy. In the run up to this week’s policy meeting, the key members of the FOMC have seemed fairly determined to announce lift off in September. But, after that, it is debatable how far they will push their hawkish view of the appropriate path for the equilibrium rate, when they have both the markets and their own economics staff against them.


China is becoming very messy. Investor confidence is clearly broken. Beijing is tripping over itself in trying to arrest the rout. The economy is slower and slower. The Party is showing no leadership and looks more and more desperate.

China Business Cycle Index (NBS) collapsed to 60.7 in June, well below its 2009 low of 72. ISI’s company survey of China sales keeps falling.

  • 237 companies (60.5% of the S&P 500’s market cap) have reported. Earnings are beating by 6.1% (5.6% last Monday) while revenues have positively surprised by 0.2%.
  • The beat rate is 75%. Ex-Financials: 78%.
  • Expectations are for revenue, earnings, and EPS of -3.7%, -0.2% (-1.0%), and +1.1% (+0.3%). EPS growth is on pace for 3.5% (2.9%), assuming the current 6.1% beat rate for the remainder of the season. This would be 8.4% (7.8%) on a trend basis (ex-Energy and the big-5 banks).

Almost two-thirds of the way in terms of market cap and the earnings picture keeps getting better. Ex-Energy and Big Banks, trend earnings are running at a 8.4% pace YoY.

RBC Capital calculates that domestically sensitive companies have so far reported earnings growth of 9.0% while globally oriented companies’ earnings are up only 0.8%. Remarkable given the slow growth in the U.S. economy. In fact, domestic companies are showing revenue growth of only 1.7%, 0.6% below expectations as 50% have missed revenue estimates. Question is: how sustainable is this earnings trend given the weak top line growth?

Buybacks are clearly helping. S&P calculates that 72% of the companies that had reported last Thursday had a lower share count than last year (67% during Q1’15) and 22% had 4%+ lower shares YoY.

This is from Factset last week:


The blended earnings growth rate for the S&P 500 (ex-Energy) for Q2 2015 is 4.1%. For companies (ex-Energy) that generate more than 50% of sales inside the U.S., the blended earnings growth rate is 8.3%. For companies (ex-Energy) that generate less than 50% of sales inside the U.S., the blended earnings decline is -0.2%.

The blended sales growth rate for the S&P 500 (ex-Energy) for Q2 2015 is 1.8%. For companies (ex- Energy) that generate more than 50% of sales inside the U.S., the blended sales growth rate is 3.5%. For companies (ex-Energy) that generate less than 50% of sales inside the U.S., the blended sales decline is -2.1%. (Factset)


Ghost Liquidity worries reach US Treasuries Bond funds face spike in redemptions as rates increase

(…) Some fear that bond funds will be at the mercy of their clients, facing severe redemptions as rates increase, forcing them to liquidate portfolios to return clients’ cash. Most hold a float of liquid assets, such as US Treasury bills and other types of short-term debt, for this purpose. But a stampede for the exit could see many asset managers needing to sell at the same time, leading to volatile movements in prices. (…)

At the centre of the rapid evolution taking hold is the retrenchment by banks across fixed income, altering the traditional relationship between dealers and their clients.

Primary dealer holdings of high-grade debt, including Treasuries, mortgage-backed securities and corporate bonds, has fallen from $524bn at the end of 2007 to $170bn today, according to data from the Federal Reserve.

Anecdotally, traders say they used to step in during volatile price swings to help clients, with the aim of securing more business for when markets were calm. It was part of the client relationship. As banks have reduced balance sheets and declining fixed income revenues, the incentive to step in during market turmoil has been reduced. (…)

Saudis Expand Price War Downstream

The undisputed king of oil and gas is making some moves that could change the face of the global refining sector.

(…) As if being the world’s biggest exporter of oil was not enough, the desert kingdom is now looking to conquer the refining sector as it has quickly become the fourth largest refiner in the world. (…)

A refinery’s success is measured by its ‘gross refining margins’. The gross refining margin is nothing but the difference between the value of the refined products and price of the crude oil. In case of Saudi Arabia, the price of crude oil would be extremely low. “The crude is so cheap it’s pretty much free for them, the margins are going to be massive. It makes trade flows in products very different,” said Amrita Sen of Energy Aspects.

There is little doubt then as to why the Saudis are shifting their focus to domestic refining. Along with acquiring a controlling stake in Korea’s S- Oil, the desert kingdom is commissioning a new refinery in Jizan which would have a capacity of around 400,000 barrels per day when it begins operations in 2017. Jizan will come on top of Saudi Arabia’s two other 400,000 bpd- refineries at Yasref and Yanbu, and will turn the country into a major global player in the downstream sector, expanding its campaign for market share beyond just crude oil.


By offering almost 2.8 million barrels of low-sulphur diesel to Asian and European markets, the Saudis are directly competing with Asian refiners, potentially sparking a price war. In fact, at $5.60 the Asian refining margins have fallen by almost 50 percent from June this year and are expected to drop by a further 30 percent.

“We see refining margins weakening on worsening diesel fundamentals, particularly east of Suez, though gasoline should be supportive. A lot of diesel will be trapped in the Far East and this will lead to run cuts in places like Japan and South Korea as the arbitrage to the west will be closed by growing Middle Eastern supplies” said Robert Campbell of Energy Aspects.

On the other hand, it won’t be easy for Saudi Arabia – Chinese refiners are also producing more gasoline, for which demand is still strong. Moreover, Indian refiners are now moving away from Saudi Arabia which was previously India’s largest crude oil supplier. Indian refiners are now buying more crude oil from Nigeria, Iraq, Venezuela and Mexico. As a result, Saudi Arabia was forced to offer discounts on its heavy and sour grade of crude oil to its Asian customers.

Still, Saudi Arabia can likely wait out the competition. Just as they have kept their crude oil production levels intact, it is possible that the Saudis will maintain their current refining output in spite of falling refining margins and eventually end up winning the price war against Asian producers.

However, one cannot easily neglect the Indian and Chinese refiners. Let us consider the case of Indian private refiners Essar and Reliance, which are among the most complex refineries in the world (refineries which are capable of processing heavier and cheaper crude). These two refineries have seen great success recently, following the recent dip in oil prices after a deal was reached between the P5+1 and Iran, and are likely to build upon their already impressive refining margins (Gross refining margin for Essar refinery was $9.04 per barrel while that of Reliance was $8.70 per barrel in first quarter of 2015).

Given current market conditions, the Asian demand for diesel has reduced mainly due to the weakening Chinese market, while demand for gasoline is increasing in India, Pakistan, Thailand, the Philippines and Vietnam. The price for diesel is expected to fall, and gasoline prices will also continue to fall if there are no run cuts in the Asian refineries.

This all translates into lower prices of refined fuels will eventually benefit Asian customers who will pay less for transportation, basic commodities and essential services.


U.S. service providers signalled a slight rebound in business activity growth from the five-month low recorded in June. This was highlighted by a rise in the seasonally adjusted Markit Flash U.S. Services PMI™ Business Activity Index from 54.8 to 55.2 in July. The latest index reading – which is based on approximately 85% of usual monthly replies – was well above the crucial 50.0 no-change mark, but still weaker than the average for 2015 to date (56.3).


Higher levels of service sector output have been recorded by the survey in each month since November 2013, with the latest upturn attributed to improving U.S. economic conditions and an associated increase in client spending. July data indicated that overall growth of new work picked up to a three-month high, reflecting rising levels of business and consumer spending, alongside successful marketing strategies and new product launches.

Sustained new business growth, and a slight increase in backlogs of work, contributed to another upturn in payroll numbers in July. Higher levels of service sector employment have been recorded for almost five-and-a-half years, and the rate of staff hiring in July was faster than the average seen over this period.

Service providers are upbeat overall about their growth prospects over the next 12 months, with around 41% of the survey panel forecasting a rise in business activity and only 3% anticipating a reduction. However, at 65.3 in July, the resulting Future Activity Index was down from 69.0 in June and the lowest for just over three years. Anecdotal evidence suggested that uncertainty regarding the economic outlook both at home and abroad had weighed on some service providers’ projections for activity growth over the next 12 months.

The latest survey meanwhile pointed to a solid increase in average cost burdens across the service sector. That said, the rate of inflation eased from June’s 20-month high. Prices charged by service providers also increased at a slower pace in July, which survey respondents linked to softer cost pressures and competitive pricing strategies.

Markit Flash U.S. Composite PMI™

Adjusted for seasonal influences, the Markit Flash U.S. Composite PMI Output Index posted 55.2 in July, up slightly from 54.6 in June and above the neutral 50.0 threshold for the twenty-first successive month.

The latest reading signalled a rebound in U.S. private sector output growth from June’s five month low, helped by faster rises in both manufacturing and services activity.


NEW$ & VIEW$ (28 JULY 2015): Commodity Currencies; Silver’s Deflation Signal.

U.S. Durable Orders Up 3.4% in June

New orders for durable goods—products such as toaster ovens and aircraft carriers designed to last at least three years—rose a seasonally adjusted 3.4% in June from a month earlier, the Commerce Department said Monday. That marked the first increase since March.

Orders for capital goods excluding the volatile defense and aircraft categories climbed 0.9% in June, following two straight months of declines [totalling –1.1%].

Excluding transportation, new orders rose 0.8%, the largest increase since August 2014. Excluding defense orders, another volatile category, orders rose 3.8%.

Overall, new orders were down 2% in the first half of the year compared with the same period in 2014. Orders of core capital goods were down 3.4% in the first half.

For all of Q2, durable goods shipments totalled –0.5% (-2.0% a.r.) while inventories rose +0.4% (+1.6% a.r.). Another great chart from Doug Short:

Durable Goods Components

Weakness in Asia Batters Currencies Abroad The global commodities slump is testing the resilience of resource-driven economies, pushing currencies from Australia, Canada and Norway to lows not seen since the financial crisis.

(…) The loonie is down 8.1% against the U.S. dollar since May 14 in New York trading, making it one of the biggest victims of the steep decline in global commodity prices since then. In that same period, the Australian dollar is down 10% and the Norwegian krone, which is pegged to the euro, has dropped 9.8% against its U.S. counterpart. (…)

Oil prices are down more than half since last July, falling again below $50 a barrel amid growing concerns about global oversupply. The Canadian dollar has fallen by 17% over the same span.

Energy accounts for roughly 10% of Canadian economic output and a “disproportionate” amount of business investment, Bank of Canada Governor Stephen Poloz said. (…)

Across Canada, a promised export rebound has been slower than expected, raising questions about how low the loonie may have to fall before Canadian export volumes begin to pick up. About 75% of Canadian exports are to the U.S. (…)

  • Record Shorts Send Mexican Peso to All-Time Low

The Mexican peso’s virtue as the most-traded currency in emerging markets is also its biggest curse. The peso’s $135 billion in daily trading makes the market so much deeper than for other developing countries that investors use the currency as a general proxy for risk. Bought a Brazilian corporate bond? Sell pesos to hedge any losses. Stuck with a load of Treasuries? Buy pesos to blunt the pain if a risk-on environment sparks a rout. Correlations are high enough that the hedges often work, according to JPMorgan.

  • The Bloomberg Commodity Index is trading at a 13-year low and has plunged 61 percent since its peak in 2008, as of yesterday.

Ghost The Signal In Silver (Part II) (Charles Gave)

Last year I came up with a chart that I found rather intriguing. It showed that on every occasion in the last 100 years when the price of silver dropped more than 25% year-on-year, consumer price inflation in the US took a nose-dive soon afterwards.

These days silver is mostly an industrial metal. But down the decades it has retained some of its monetary characteristics. What’s more, for more than a century silver has traded freely in the market, unlike gold which only started to float in the 1970s.

Since 1915 there have been 10 occasions on which silver has fallen more than 25% YoY, and every time the annual rate of CPI inflation subsequently declined by at least 2pp. Last year, when the price of silver plummeted, I concluded there were two possible scenarios. The first was that all prices were going to decline, and by quite a lot. The second, and far more likely, hypothesis was that the price of oil was going to collapse. Sure enough, the oil price did collapse.

Now, a year later, I find myself flabbergasted: once again silver is down 25% over the last 12 months.

To revisit my previous remarks: either the price of oil is going to take another big fall, which Anatole thinks likely, or prices are going to decline across the board, with the prices of key goods and services each declining by 2% to 3%.

Given that US consumer inflation is currently running at just 0.1%, the second scenario would plunge us back into general deflation. If that sounds unreasonably pessimistic, take a look at how the prices of non-oil commodities have performed over the last year. Copper is down 27%, rubber 16%.

If we recall Gavekal’s four quadrants—inflationary boom, inflationary bust, deflationary boom, deflationary bust—silver is unequivocally signaling that we are in the bottom half of the plot, and that the choice is between deflationary boom and the deflationary bust.

Which is it? Alas, I am not especially optimistic about economic activity.

I hate to be bearish. I’ve always maintained that persistent bearishness betrays a fundamental weakness of imagination. So I’ll just say that I’m getting increasingly concerned.


  • 197 companies (53.2% of the S&P 500’s market cap) have reported. Earnings are beating by 5.6% (5.8% last Thursday) while revenues have positively surprised by 0.2% (0.3%).
  • The beat rate is 75% (76%) , ex-Financials 78% (80%).
  • Expectations are for revenue, earnings, and EPS of -3.7%, -1.0% (-1.3%), and +0.3% (+0.1%). EPS growth is on pace for 2.9% (3.0%), assuming the current 5.6% beat rate for the remainder of the season. This would be 7.8% (7.9%) on a trend basis (ex-Energy and the big-5 banks).