Market Update _ Time to pay attention

 

 

Is it time to pay attention?

It has been a long time since we sat around in this office talking about what the Fed might do at the next meeting.  It’s not been uncommon in recent months for us to realize only after the fact that the Fed was meeting at all.  Monetary policy has been very well telegraphed as of late so there hasn’t been much reason to pay attention on the FOMC announcement date.  There has been no need to pick up the phone after recent FOMC meetings and frantically call all of your customers to let them know that the Fed did nothing, just like they’ve been saying they would do for the last two months.

That has begun to change.  The buzz on the street lately is the concept of “Operation Twist”.  Interestingly the Fed hasn’t really been talking down the plan in public…which leads to speculation that it might actually be in the works.  What this plan entails is the Fed pushing their Treasury purchases further out along the yield curve to push interest rates lower.  You heard that correctly…the Fed is widely seen as contemplating a plan that would push rates even lower than today’s levels.

I don’t know about the rest of you, but from where I sit I don’t see our number one economic issue as being that interest rates are too high.  It’s not like we’ve got truck-loads of growth that could be unleashed if only rates were a little lower. 

We know that the powers that be would love to ignite a refi wave, and that interest rates need to drop for the refi math to work…but rates aren’t the only factor involved.  It’s important to remember that while interest rates have fallen… so have home prices and FICO scores. 

If the Fed is successful in lowering the 10-year Treasury rate to 1.50% (or even 1.25% as some are calling for) it is still difficult for me to see that it will help borrowers who are upside down on their current home loan or who have poor credit to begin with.  It strikes me as one more ill-conceived program that might help around the edges but won’t have a material impact on our economic outlook.

What does the twist mean to me?

If you are a fixed income investor then the twist is not good news for you.  If they conduct this exercise the Fed will put their own money to work on 7 to 30 year part of the Treasury curve, push those rates lower, and push the people that were already there out of Treasuries and into something else.  As those investors migrate out of the Treasury curve they will be going go MBS, CMO’s, Agencies, SBA’s, stocks, commodities and many other asset classes in an attempt to generate returns.  This means that prices will go up and yields will go down in those arena’s. 

I don’t have a lot of people telling me currently that they are overwhelmed by the amount of yield they can get on their investments.  Yields are low, and will likely be lower still if the twist plan goes into effect.

Got Savings?

As we’ve gone through this cycle I’ve kept a close eye on a metric that the Bureau of Labor Statistics produces titled “Personal Savings as a Percentage of Disposable Income”.  In a nation where consumers drive 2/3’s of GDP this strikes me as an important figure.  Econ 101 tells us that there are only two things you can do with money: 1 – Save it, or 2 – Spend it.

For many years we spent it, and spend it, and spent it.  Then that wasn’t enough so we borrowed and spent that too.  This continued until America as a nation was saving less than 1.00% of their disposable income. 

At that point we had a highly leveraged consumer with very little in the way of a cash cushion.  Then the Great Recession hit and a large swath of consumers who had relied on plastic for all of their needs suddenly found themselves jobless, cashless, and creditless.  This is the type of shock that changes behavior for generations. 

13.8 million of these consumers are now out of work (9.2% of a 150 million person work force).  A total of 24.3 million people are in the “Under-Employed” column.  This includes both the unemployed and those who have had their normal hours cut back due to economic factors.   The “Under-Employed” rate was reportedly 16.2% in August.

Why do I care?

If we are waiting on an American consumer to start generating 2/3’s of our GDP again then we need to get a good look at where that consumer is right now.  With 16.2% of your work force not making enough money to support their normal lifestyle, how much can you realistically expect them to contribute in terms of consumption?  Their credit cards are gone, what little cash they had is gone, and the bills are still there but their jobs aren’t.  This is not the crowd that’s going to generate enough demand to put 13 million people back to work.

The remaining 125.7 million workers still have their jobs, but they too have been shocked.  Many of them were also highly leveraged…but they were lucky enough to keep their jobs through this storm.   Many of these people are now what we call “savers”.  They are de-leveraging, they are paying down credit cards, and loans, and they are building up a cash reserve.  At some point these consumers will become comfortable that they are in a good spot and will begin to spend again…but this will take time.  It’s not a transformation that the government can make happen with just a wave of the fiscal wand.  This is consumer psychology at work…and it has its own pace. 

The chart below shows consumer saving as a percentage of disposable income.

 

 

The Personal Savings chart jumps out at me as two distinct time periods.  The first is the 1960 to 1985 period which saw an average savings rate of 9.2%.  The second period is the 1985 to present which has a 4.2% savings rate. 

The low water mark for Personal Savings was 0.90% in 2001 (if measured on a month over month basis we actually saw some negative savings rates).  In July of 2007 this rate was 2.00%.  Then we began to get hammered by bad news and the savings rate jumped up to a high of 8.3% in April of 2008 and since has settled down in the 5.00% range. 

When looking at the 1985 to current environment keep in mind that our current level of interest rates is historically low, yet we have a savings rate that is above the average for the period.  With rates this low consumers should be spending like drunken sailors using a stolen credit card, right?  Right…but they aren’t.

Ask yourself this question…with rates at historic lows, why would anyone in their right mind ramp up their savings?  It doesn’t pay to save…the Fed is absolutely punishing savers with near zero rates on the short end…yet consumer savings rates are up. 

 They aren’t saving because they enjoy the dismal returns they are getting…they are saving because they are scared and deleveraging. 

Everyone knows someone who has lost a job.  Many know someone who has lost their home too.  Nobody wants to find themselves in that position with no way to defend themselves so they save.  The game is now about staying power. 

The solution to our problems lies not with government programs, but with those who remain employed.  They will eventually deleverage to the point where they are comfortable spending again.  Once that happens producers will respond to the sustained increase in demand by increasing output, which will lead to hiring, which in turn will lead to a drop in the number of under-employed.  Good things follow from there to the housing market and every other corner of our economy…but it will take time. 

Any attempt to rush this process with fiscal or monetary policy tricks is simply a game that creates the illusion of demand creation when in reality all it does is shuffle demand around a bit.

As I watch all of the programs we have created over the last three years it reminds me of the old saying “Oh what a tangled web we weave, When first we practise to deceive!”  In my view the more we manipulate our markets the harder it will be to ever set them straight again. 

That’s my rant for the day…now it’s time to sit back and wait to hear from the Fed.  They release their statement at 2:15 PM Eastern.  I’ll be in touch after we hear their thoughts.  If you have any questions or if there is anything I can be doing for you just let me know.

Steve Scaramastro, SVP

800-311-0707

 

Market Udpate 9 9 11 _ It smells like coordination out there

 

The best laid plans

Last night I had big plans.  The President was making his highly anticipated “jobs” speech and the first NFL game of the season was on TV.  I figured I’d listen to the jobs speech, have a few beers, catch the game, then hit the rack around midnight.  I had no work to do…it was gonna be awesome.

Just as the jobs speech began I got an important and interesting e-mail.  This e-mail was full of questions that came out of yesterday’s Federal Reserve Symposium on Asian Banking and Finance.  Like the nerd version Batman I grabbed my iPad and a laptop and I sprang into action answering questions and addressing these timely issues.  Some amount of time later I hit save, then send, and when I looked up it was midnight.  I hadn’t seen the speech or the game…and I had consumed no beer.  Don’t feel too badly for me though, the exercise gave me some perspective, and if all goes well I’ll be fishing by this afternoon. 

Two years after the recession “ended” our economy is still stuck at stall speed and everyone in the world is talking about ways to improve the situation.  This just highlights the fact that things can stink pretty badly even if you’re not technically in a recession.  

The Fed has taken drastic steps over the past few years on the monetary policy side.  The Fed Funds rate is at zero, their balance sheet has swelled to over a trillion dollars, they just pledged to keep rates low through 2013…and they are STILL discussing ways to do more.

To their credit they have made a lot of noise about not being able to solve all problems with monetary policy.  Fed members have repeatedly urged the federal government to take the reins on the fiscal policy side of things.  It is no secret at this point that our current fiscal trajectory is unsustainable.  The path we are currently on has us landing in a spot that looks a lot like Greece sometime in the not-too-distant future.  Not the “Parthenon and Mediterranean” Greece…I’m speaking metaphorically about the “sovereign default and riots in the streets” Greece.

Fiscal Policy

Bernanke spoke recently on monetary and fiscal policy.  With respect to the fiscal policy side of things he said that while we need to alter our fiscal course, we don’t need to necessarily do it all at once.  Bernanke’s preferred method for altering our fiscal trajectory can be viewed in terms of changing lanes in your car.  You don’t change lanes by jerking the wheel and trying to get into the other lane immediately.  You use a turn signal and then you gradually move the wheel in the direction you want to go.  This results in a smooth and safe transition from one lane to the other.  I realize that there are exceptions to this rule for people that live in places like Los Angeles, DC, Miami, and Houston but please bear with me for the sake of the example.

In the Fed Chairman’s view this is what we need on the fiscal policy side…a smooth lane change. Government spending has to a large degree replaced private sector spending over the course of this recession.  Given that we are still in a place where the recovery is fragile, Bernanke doesn’t want to see an abrupt end to government spending that would add to the already stiff “headwinds” that are restraining the economic recovery.  This abrupt lane change would endanger our recovery and could very well cast us back into recession.

His preferred course of action would be a gradual shift with a turn signal.  The turn signal would allow everyone to see where you intend to go, then the gradual shift would allow you to get there without wrecking your car.  In practice this would call for the Government to signal that they are changing our fiscal trajectory, then to gradually shift toward that goal so that you don’t abruptly pull government spending away from a fragile and developing recovery. 

Monetary Policy

On the monetary policy side he began with the obligatory statements on how we got the car in the ditch.  From there he went on to describe how they originally thought that the slowness in the first half of the year was mainly due to transitory factors, and how they now recognize that some of those were actually persistent factors.  That is Fed-Speak for “we thought things just stank a little…but it turns out they stink a lot”. 

He names all of the usual suspects as drags on the economy in this speech; housing, unemployment, slow household spending, the downgrade of US Debt, etc.  What I found interesting in this speech was the mention of “sharp volatility and risk aversion in markets” in reaction to sovereign debt issues in Europe.  All of these items are mentioned to get the speech to this point: “…there seems little doubt that (these events) have hurt household and business confidence, and that they pose risks to growth.”  Linking European sovereign debt concerns to risks to domestic growth gets my mind working overtime. 

At this point I’m looking at the puzzle pieces arrayed before me and I’m trying to figure out how they fit together.  Two years into the “recovery” we have yet a new plan to generate jobs, a Fed stating that they have more tools in their monetary policy arsenal, sovereign debt problems raging in Europe, and a Fed drawing linkages between Europe’s problems and our problems.  It has the look and feel of an environment that could bring about another round of coordination among the world’s major economic powers. 

You might recall that in the aftermath of the Lehman Brothers failure we saw massive global coordination aimed at keeping the world’s financial markets from freezing.  One such program had the Fed making enormous dollar denominated swap lines available to other central banks to keep liquidity flowing.  Our Fed had arrangements in place with the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank among others.  This type of coordination was considered essential to tackle the problems at hand. 

All of the pieces I see in front of me make me wonder if the Fed is talking with other central banks about a new round of global coordination to address the problems we collectively face.  It’s easy to see the temptation involved with a plan that combines coordinated international fiscal and monetary actions to address the various issues that are restraining the global recovery.  I’m not saying it’s a good idea, and I’m not convinced that they’ll do it…but it’s starting to smell like coordination is in the air.

If you  have any questions or if there is anything I can be doing for you just let me know.

Steve Scaramastro, SVP

800-311-0707