There is still an air of economic uncertainty in the US, but there is hope. Hope that this year will mark the start of a recovery. The struggle to reach that point places an emphasis on the string of economic indicators and the reality behind them. We know that the Fed is keeping a close watch and is considering its options should the economy show signs of strength later this year.
March FOMC Minutes
The latest minutes were released early to several high ranking officials and the joke goes that if they can't get an email right, what makes us so sure that they can get the timing of a QE exit correct. Nevertheless, the minutes for March were released to the public during the morning hours EST instead of the usual afternoon time. It showed the evident discourse among FOMC members about when the phase out of the controversial and much extended QE program (reaching a record $3.22 trillion) will occur. We get a feeling that the consensus is for later this year when some economists expect a pick-up in the US economy.
Even still, members said that if labor market conditions improved as anticipated, it would probably be appropriate to slow purchases later in the year and eventually stop by year-end. There is still the possibility of returning to QE-lite because uncertainty still lingers, and the Fed might feel the need for continued support.
The debate over when to put a nail in the QE coffin is nothing new. The past few minutes have brought to light the concerning nature about balance sheet risk and the economy's ability to continue growth without the artificial push. The first mention of this was back in Q4 of 2012 which sparked an immediate stock market sell-off. Now, investors are aware of the ageing QE program, to the point where recent attention shifted to negative news from Cyprus which then caused a plunge in treasury yields.
We can't ignore the healthy rise in equities. Some wonder if it is inspired by QE or just last minute bids on a general fear of missing out on some good gains. The fact is that QE has shifted asset allocation away from the usual safe-havens and stimulated a risk-on investment environment. But we have to take a step back and remember the fundamentals behind the recent low from early this year in which equities used as support for a rally. Stock market gains are not matching earnings and economic data, which suggests that a mix of sentiment and the quest for yield is the driving force. The stock market was bogged down with debt ceiling and fiscal cliff bickering at the start of 2013 which created a good buying opportunity. Technicals looked right and investors took advantage of the dip.
A deeper look into the economic fundamentals display some evidence of a transition to recovery. We see wealth gains mainly in the form of equities and a pick-up in housing construction and building activity. Consumers are still deleveraging which allows for spending. For example, refinancing could mean that savings are free to be allocated to more productive areas such as home improvement. A deeper look into the data gives us an understanding of how consumers are economizing during the economic transition.
Consumer debt has dropped to more comfortable levels, and credit can pick-up to reflect some confidence in the consumer's ability to borrow. However, the employment picture looks bleak. With a significant decline in labor force participation and a stagnant low-wage environment, there is little evidence to support a healthy labor market. Most of the activity is coming from the capital side of the growth equation. The fact is that most are under-employed and we are seeing households stick together - income sharing to phase out the negative in anticipation of a return to normalcy in which every member of the household is fully employed and self sufficient. Until we get there, a lot of the data might reflect only a half-truth.
We also have a demographic battle in which economic activity is missing the matriculation of first time buyers and the fresh labor pool of earners and spenders. The stark reality is that student debt is holding back the younger population resulting in higher defaults and the lack of entry level opportunity that is commensurate to the cost of study. Close attention to the Northeast housing and consumer market will be an important indicator to track this, as a great share of college graduates populate that region.
China marches back, but the West still looks ill
Good China trade and industrial data caught investors by surprise. There is a renewed sense of optimism in emerging markets overall. But some concerns over China's local debt problems and demographics keep the longer term outlook on a tightrope. The hope is that the new government will be quick to address these issues.
We will need full strength of the West for a clear sign of a global pick-up. Europe still looks weak with new sprouts of headline cases like Cyprus still in the mix.
The uncertainty is still there - look at the peso's fall against the greenback on Thursday as a signal that there is some concern about the ability of the US to boost the global economy. The Americas need the demand from the US, and LatAm markets can be an important indicator for foreseeable strength in terms of trade.
Long term view relies on current policy action
At some point, we will see sustained growth. Whether it starts later this year or rolls into 2014, there is evidence of transition and signs of hope. But the real question is how will we be able to keep the economic engine going.
Take a close look at the coming budget negotiations. Approach the issue with a clear mind and hear out both sides. Compromise on a long awaited budget will pave the way. We desperately need a framework to guide us through a recovery, or else we will get more of the same out of control spending and borrowing. There is doubt that whatever deal is reached, it will not be enough to address the serious fiscal deficit issue and economic folly that is inherently structural.
Immigration should be an important focus to keep the US as the most reasonable place to innovate. Innovation is part of the global market, and we must remain competitive. Higher education is taken up by more foreign students who will be at the helm of the growth. Look at Canada's latest plan for guidance.
Lastly, there is belief in the states. Despite underfunded pensions and liability short-falls, states have been busy strengthening their fiscal position. Most states are in a good cash position and the supply of municipal debt has declined. Investors are starting to see less risk, and the latest Census data shows an increase in state tax revenues. The revenue plans are highly strategic and take advantage of areas of productivity such as drilling out West. Some regions of the US are doing far better than most, and perhaps there's a good model out there for solid growth.
Thursday, April 11, 2013
Thursday, February 21, 2013
The political turmoil began in the summer of 2010 when then Deputy PM Julia Gillard was elected unopposed as Prime Minister after the former PM Kevin Rudd lost the support of his party and resigned. Despite weathering the global economic storm of 2008 by avoiding a negative hit to GDP, Rudd's controversial policies regarding climate change and a mining tax were largely opposed by both opposition and members of his own Labor party. At this point, it was assumed that Gillard's administration was better able to correct those unpopular moves and get the job done. In the words of her right hand man Treasury Secretary Wayne Swan: returning to a budget surplus will be done "come hell or high water."
The Labor party is riddled with failed promises after implementing a complex mining tax and a continuous budget deficit. Much of this has been blamed on the high value of the Aussie dollar and external pressures on commodity prices which weighs on mining activity. Tax revenue is on the decline, but there has been little effort to get a handle on spending. PM Gillard has called an election for September 14th in order to allow more time for a healthy political debate. In what will mark the longest campaign session in Australian history, this leads many to believe that the real reason is for the Gillard administration to show economic proof in hopes of a better turnaround. While no one expects a budget surplus in time for the election, there are some hopes for a pick-up in economic activity abroad during the latter part of this year which can have a positive effect on Australian output. So far, voters are not buying it.
As the Labor party looks more unstable, polls are showing a greater preference for the current opposition leader Tony Abbott. The polls are a blow to Gillard and shows that there is a growing mistrust for the Labor party on key issues such as the mining tax, immigration policy, and the economy. Rudd is more popular than Gillard, and there is some speculation that he might be drafted to lead the party despite his expressed lack of interest to do so. Throughout all of this political turmoil, the market response has been largely muted; guidance has been provided from a mix of risk appetite and the slump in commodity prices. However, the market is not quick to lay its hand off the economic pulse.
It's clear that Labor hasn't held up to its promise. The Australian economy is largely held up thanks to the limited downside during the 2008 crisis under Rudd's leadership. Housing prices are still high and haven't seen a significant correction yet. Structural issues are evident and unemployment is still elevated for the nation.
The more pressing issue that will likely stem out for a long time is the looming budget crisis. Treasury Secretary Swan revealed a collapse in tax revenues of nearly $4bn mainly due to a slowdown in mining activity. Swan stated that the government will need to raise revenue and cut expenses, but spending cuts are essentially part of an austerity agenda. "Delivering another deficit is driven by Gillard government's core values about jobs or working Australians" said Swan. The RBA has already taken measures to offset future austerity measures by cutting its official cash rate.
Hopes for a pick-up in mining activity are complicated. The latest mega-project Origin Energy's Australia Pacific LNG project amounts to a whopping $2bn development budget while also freeing up expenses by slashing 850 jobs. The fact of the matter is that costs are building up and there is a capital strike. Similar to the US, Australian shareholders are demanding dividend income. Shell's plans are on hold for its Gorgon LNG project in hopes of getting a hold on higher capex expectations. A Dec FT article warns:
"If these issues are not addressed then new investment in Australia’s LNG industry could dry up in 2017, warn industry executives and analysts, and new suppliers based in Canada, east Africa and the US will move to capture a lucrative prize: 90m tonnes of annual uncontracted Asian LNG demand.
Tony Abbott has a plan to boost productivity by way of a major infrastructure-spending boom if elected in September. This is not the way to go as the government will just break even with a return through tax revenue. It will just swell the deficit to another low level with no long term objective of fostering sustainable business activity. But Gillard has no star plan of her own and will likely keep some form of the mining tax with no efforts to offset lower revenue with spending cuts. Australia cannot continue to rely on the sways of its offshore trading partners to dictate economic conditions at home.Australia is poised to overtake Qatar as the world’s biggest LNG exporter as seven colossal projects reach full capacity over the next five years. But the industry is also facing serious headwinds as a consequence of its rapid growth. A second wave of developments and project extensions, worth an estimated A$150bn, is at risk from rising labour costs, infrastructure bottlenecks and the strong Australian dollar."
The economy is still relatively stable despite these looming fiscal troubles. The recent lift in consumer sentiment could indicate more breathing room for the RBA. The rise in share prices is also welcomed. However, lower commodity prices and concern that risk taking has gotten too far could stall significant growth. Consumers are still cautious about taking on more debt despite the pick-up in household wealth. Consumer spending and unemployment expectations have leveled out. Australian households are cautious about job prospects which is keeping the consumer on the sidelines - and businesses are taking note as well by holding onto cash.
More room for an Aussie decline, but expect a bumpy road
AUD/USD is trading along a declining channel, with a recent slump attributed to a Reuters report on chatter in global markets that a hedge fund had been liquidating positions in commodities. RBA members have also expressed concern about the effects of a high AUD. These concerns were actually brought up at the start of this year when AUD/USD traded around 1.0590, and has since declined off those levels. Concerns about an overvalued currency are also seen in New Zealand where RBNZ Gov Wheeler stated that the NZD is still too high and that the RBNZ is ready to intervene if necessary despite some signs of a stronger than expected economic rebound.
The recent decline in AUD/USD is also correlated to lower risk appetite following the latest FOMC Minutes which suggests some unease among Fed members about a scale-back in asset purchases.
Moments ago, AUD/USD was given a boost after RBA Gov Stevens expressed confidence in the current level of interest rates. He went on to state that the high AUD/USD was weighing on the economy which inspired the previous rate cuts. However, Stevens did reiterate that rate cuts are more likely than increases. The recent lift in AUD/USD might be the result of over reaction from the markets given the lower outlook by the RBA. The central bank lowered its growth and inflation forecasts and pointed to concerns that mining investment could reach a crest this year. Lower hiring demand from resource companies could also lead to a softer labor market. Additionally, the strength of the Aussie is being watched for indications of higher inflation.
The lengthy political debate and fiscal issues deserve great attention. Investors should keep an eye on Australia especially given the recent evidence of declining money flows. FT Alphaville published an insightful article which cites data from the Japanese Ministry of Finance showing that Japanese investors were selling Aussie assets at an increasing rate. Japan holds about 20% of Australia's national sovereign debt, according to FT.
Monday, January 14, 2013
I cringe every time I read a headline from Japan. Rounds of stimulus borrowing and spending is a big gamble for an economy that's not structurally sound, and the well orchestrated softening of the Yen is overstretched and looks ripe for some good profit taking. This means that aggressive measures by the BoJ and a staunch tone by newly elected PM Abe must continue to maintain the pressure on the Yen. But is the recent rally enough? Japan's Economy Minister stated on Monday that "the Yen has come to a good level....if it falls to a three-digit level it would boost import prices, weighing on the everyday life of the nation."
The market needs progress, not just rhetoric in order to play its part; and this could continue to play on with the coming BoJ meeting in about two weeks. PM Shinzo Abe is building up the pressure, and he has a history of speaking out about the Japanese economy, but has done little to actually show for it. Abe was elected as the 90th PM of Japan by a special session in 2006, but only served for less than a year. Perhaps now is his time to shine as he stood on a strong platform of pressuring the BoJ to tackle deflation by means of inflation with aggressive monetary stimulus and greater cooperation with the newly elected government. The monetary-fiscal cooperation interferes with the Bank's legal independence, but talks still continue amid the threat of a constitutional change to the BoJ's independence so long as the Bank abides by Abe's recommended 2% inflation target.
So called 'Abeconomics' has a direct market effect, causing a bounce off 2012 September lows in USD/JPY to extend to its current rally. The market's reaction is welcomed as a softer Yen helps boost Japanese exports and paves the way for inflation. But will this inflation come with growth? Abe's latest $117bn stimulus is projected to boost GDP by about 2% while creating 600,000 jobs. Nomura estimates that the the stimulus will help deliver real annualized GDP growth of 3.5%; and with ongoing disaster recovery from the 2011 tsunami, we could see more government-led growth. Of course, the way to do this is through private sector growth accompanied by a sound economic structure. More supply growth by way of stimulus could face the consequence of left out demand which would do little to boost prices. Economists worry that this is a big gamble for a sustained recovery. Nikkei Business Daily cites the growing probability of large spending in rural regions and the government's ability to prioritize projects. This is why there is so much pressure on the monetary side.
In comes Shirakawa, the current BoJ Governor. Shirakawa announced an additional $128bn as part of the Bank's monetary easing programs in the fall. Japan's total spent on asset-buying programs has now past the $1tn mark, which is quite excessive. Meanwhile, the Japanese economy is stuck in its fourth recession since 2000. Much of this downfall is due to a strong Yen which halts export growth, the sluggish global economy, and the struggle to recoup from the 2011 tsunami disaster. Even still, the Japanese economy has continued its constant debt buildup and fiscal woes for about 20 years now. At some point, this cannot be sustained.
The market implications are tricky. USD/JPY has soared enough, but not yet touching that 90 mark. Abe would like to see more JPY weakness to aid in his aggressive growth strategy. However, with USD/JPY shorts back in the game, we could see some profit taking. Over the past two weeks, the USD/JPY breather has extended for longer time-frames, but has always returned with a rise to continue the the upward trend. This could indicate some positioning as traders decrease exposure to the pair ahead of a correction or just pure uncertainty. Further Yen weakness could continue so long as the BoJ abides by Abe's commands in its coming meeting. The market needs to see progress on Abe's strategy in order for the Yen to weaken by theory. Remember that Shirakawa's term as BoJ Gov is up in April, so there is the possibility for this to continue, albeit at a softer tone (assuming no sharp correction). The USD/JPY shorts could pave the way for the April appointment of the next BoJ Gov, creating another profit opportunity in the pair. So far, Abe is meeting this week with monetary policy experts to begin the discussion on who will be the next BoJ Gov. Abe stated that he is looking for a "bold leader...someone who shares our views."
US following in Japan's footsteps? Further reading:
Thursday, December 20, 2012
Some form of the fiscal cliff is inevitable. The fiscal framework of our nation is designed with limits to be amended as we go to ensure that we are somewhat responsible to continue running the country on a balanced footing. This is why Congress has the power of the purse, but constant partisanship never gets us to that ideal point of leadership. In this case, we see extreme political strategy that surprisingly hasn't seen the kind of backlash that Europe has. The fact of the matter is that each proposal includes spending cuts that target many entitlements that we have grown accustom to but are clearly unsustainable. Our complex tax code deprives us of key revenue while the spending outlook will continue to dig us deeper into deficit. Whatever is agreed upon will still decrease our potential to accelerate economic growth.
We must address the political strategy, because this will determine whether or not we will ever get it right. The White House has cleverly used this 'balance' myth by shying away from real reform and spending cuts. If you really dig into the budget, many of those line items are highly sensitive because so many people rely on entitlements especially during these times. No one is willing to take bold action, and would rather gradually scale down the effects of costly programs that truly have a demographic mishap such as social security and medicare. When Republicans pressure spending cuts and reform, the White House has blamed lack of revenue as the reason for imbalance and then automatically factor in tax hikes and cuts on the middle class to show the 'only' way to balance the books. This type of thinking is a far step-back from reality.
Elsewhere in the developed world, governments have realized the problem and are cutting their forecasts. Canada, which relies on a US comeback in order to fully push on with full potential, has pushed its expectations back by one year to around 2015 when the country should return to surplus. The country also decreased its revenue projections over five years, and will essentially rely on decreased government spending in order to balance the books. In the UK, the Autumn Statement called for a decrease in welfare entitlement spending which caused quite a stir among its dependents. The ECB decreased its growth forecasts for the eurozone, and Germany is set to feel a pinch with declining industrial production. Lastly, Australia's Finance Minister Swan admitted during an unscheduled press conference on Thursday that the country is unlikely to achieve a budget surplus this year, breaking the major platform in the Labor Party's election pledge. Meanwhile, Australia's Prime Minister Gillard is on vacation; once again shying away from addressing fundamental issues.
Greece is a special case. Yes, we all know this. But it has essentially become the hallmark of austerity, and could set precedent on how its done (whether the country is proceeding in the right or wrong direction is a separate discussion). The fact is that Prime Minister Samaras is quick to work on structural reforms and grow the economy as part of the strict terms of its long awaited aid tranche of short term rescue loans. Closing in on its sixth year of recession and +20% unemployment, Greece's real problem is demographic. Greek youth are fleeing the country, choosing school over work, or are busy protesting austerity in the streets of Athens. The country is one of the worst in the world for setting up a businesses given the impending legal costs, and the businesses that do come to fruition are short lived. Most of the people are employed by the government; and working for a broke employer disrupts the dependent system to begin with. Austerity at its finest. Or maybe just pure socialism.
Central Banks Prepared?
Central banks are ahead of the game, but it still won't provide a full cover-up of the underlying fiscal set-back. The Fed removed its 2015 guidance and agreed on additional asset purchases which suggests that the US economy is still under performing. The RBA cut rates and hinted at a mining peak which should help prepare for some fiscal tightening down the road for Australia to eventually reach a budget surplus.
The bottom line is that fiscal tightening is ahead, and this will force us to struggle along the recovery stage, performing below our full potential. Banks may have access to easy capital thanks to the easing mechanisms of central banks, but that money will remain stashed on the balance sheet until the political storm passes. Businesses will not invest unless there is some certainty on corporate taxes and the consumer's ability to be productive. We will all be a bit shaken with a change in the status-quo.
Check out: Rising stars of the fiscal cliff - Maya MacGuineas of Fix the Debt
Wednesday, November 7, 2012
This past election was about who will be in charge of the nation's long road to recovery from the 2008 downfall. In the month leading up to election day, the US reported encouraging figures which at first glance seemed to indicate that we are on a path to a sustained recovery. The disappearance of housing inventory and a low rate environment inspired some support for a sector that was at the heart of the recession. Unemployment continued its decline to 7.9%, but still the overall trend remains weak with a lot of Americans simply settling for lower wages to make ends meet. Let's not forget about the long term unemployed facing declining skill levels and personal discouragement. It's clear that a recovery is in sight, but many challenges are ahead that will disrupt the progression.
Despite the debatable policies of the last four years and failed attempts to try to get the economy going (ie QE and fiscal stimulus), the private sector surely has struggled, but it carried along to continue doing business. Individuals and businesses don't rely on government wholeheartedly to keep moving; it is in our nature to keep the economy going. Surely, the pace at which we do this can be fine tuned by government forces. We know that businesses have high amounts of cash, but are cautious to invest and hire because of the high level of uncertainty. The private sector needs proof of a sustained recovery in order to take that risk to naturally stimulate a return through growth. So far, the government has discounted many of these potential decisions, and the political dithering is causing the economy to under perform.
Two examples that support this claim are seen in the recent earnings season and our domestic energy sector. Earnings came out relatively good at face value, but the slew of negative profit outlooks is very troubling. The fact of the matter is that consumers are spending because the cost of living is higher. This does not necessarily mean the price of goods are higher; lower wages decreases our purchasing power and uncertainty about what's to come forces us to spend rather than save. This fuels revenue growth in key sectors such as consumer cyclical. Companies that deal with trade and logistics such as UPS and FedEx have expressed some concern about future demand despite having the capabilities to continue running smoothly.
In energy, we have a clear distribution problem that cuts directly into the business of drilling. Despite the opening of some federal lands during the last four years, the pipeline network to actually fuel demand is severely lacking and the decision to block Keystone until after the election only adds to the problem. Drillers know the economics don't work just by having access to a glut of supply; a concrete energy plan is needed and will get us on a solid track to recovery. This could truly be America's new innovation moment, but again it has been discounted. A lame duck session is unlikely to get this rolling.
Furthermore, the market has responded to the electorate decision, and it clearly supports my stance. Despite an immediate rise in equity futures following the election results, equities came to terms and reversed direction to the downside. Treasuries saw a significant rise as yields declined. Gold and silver soared with gains at 1.91% and 2.76% respectfully. This indicates a level of risk-aversion due to both the near term uncertainty and the longer term assurance of monetary easing.
The fiscal cliff poses a large threat to the economy, and House Speaker Boehner said it best - we have to build a house on rock instead of a house on sand. No doubt there will be some bickering, but this is our chance (once again) to reverse years of economic folly that is already deeply rooted in the US. The spending limit is a mandate that has been abused year after year to continue along an unsustainable path. Recoveries come and go, but we need to make sure that we have a country that has its books in order to limit the downfall. Boehner is calling for a new growth/reform model that is open to greater revenue, but it will require lots of work. That's what these next four years should be about. We must continue the fight outside of the ballot box and vote with our dollars. Trust in ourselves to make it through, and be prepared for any outcome. Four years should not be the end all. Make it a legacy.