Friday, April 6, 2012

Weekend links

1--Profits Are at a Near Record Share of Income, CEPR

Excerpt: That would have been worth mentioning in a piece that reported that profit growth is expected to slow in the first quarter of 2012 and may stagnate for the year as a whole. With profits already near post-war highs as a share of income, they can't grow any more rapidly than GDP unless the profit share goes still higher. Since it unreasonable to expect the share of GDP going to profits to continue to rise indefinitely, a slowdown in profit growth was virtually inevitable. (See chart)

2--Fed Watch: Labor Market Softens in March, economist's view

Excerpt: Labor Market Softens in March, by Tim Duy: If the employment report falls on a holiday weekend, does it make a sound? Yes it does, at least when it comes in far below expectations, with 120k nonfarm payroll gain compared to a consensus of 205k. Treasury yields collapsed on the news, and are now once again hovering around 2 percent on the ten-year bond. In my opinion, this is yet another data point that confirms what has become my baseline view of this recovery - neither an optimist nor a pessimist should one be. The economy is grinding away at rate close to its potential growth rate, perhaps a little above. Certainly not a disaster in terms of expecting another recession, but also certainly also not a success story....

As far as other views, a couple caught my eye this morning. The first was from spencer at Angry Bear:

The index of hours worked has been raising a red flag about the numerous other signs of stronger employment and an acceleration of economic growth. They are not showing the recent improvement that other employment data have been reporting Recently, unit labor cost has been rising faster than prices, implying margin pressure and very weak profits. To sustain profits growth, firms have to reestablish stronger productivity growth. The weakness in March employment is a strong indicator that business is trying to rebuild productivity growth and profits growth....

The data is sufficiently disappointing as to not alter the view of the doves, and notably Federal Reserve Chairman Ben Bernanke, that there is no need to tighten policy in the near future, leaving the 2014 timing intact. Thinking about the trends as noted above, there is no reason on the basis of this report to believe that a significant deterioration in the outlook has or is about to occur, and thus no reason to expect this will nudge the FOMC toward another round of QE. This I find unfortunate because, as I noted earlier, the longer the Fed continues to operate policy along the post-recession growth trend the more likely it is that this will indeed become the new trend for potential output.

Bottom Line: A disappointing jobs report for those who expected the US economy was about to rocket forward, but one consistent with the slow and steady trend into which the US economy appears to have settled. And no reason to change the basic outlook for monetary policy - the Fed is on hold until the data breaks cleanly one direction or the other.

3--ECB Rates Policy is Clogged in Key Periphery Markets, The Wilder Report

Excerpt: How the Euro area (EA) will grow, according to Mario Draghi:

The outlook for economic activity should be supported by foreign demand, the very low short-term interest rates in the euro area, and all the measures taken to foster the proper functioning of the euro area economy.

In this post, I address Draghi’s point that the ECB 1% refi rate will support economic activity through the lens of the mortgage market. Specifically, I find that the interest rate channel is clogged in the economies that are in most desperate need of lower rates: Spain, Portugal, and Italy.

Regarding ‘very low short-term interest rates’, what Draghi means is that the standard interest rate channel of monetary policy will stimulate domestic demand via increased spending by consumers and firms. If ECB policy is indeed passing through to retail credit (households and firms that borrow from banks to buy goods and services), then we should see evidence of this as falling interest rates to retail credit sectors, like those for consumer goods, home mortgage lending, loans for businesses, or even corporate credit rates to finance business investment.

In mortgage markets, the Euro area average borrowing rates are indeed falling....But a closer look across mortgage markets shows a worrying trend for key periphery economies. The pass-through from ECB rate setting policy to mortgage borrowing costs is clogged in Spain, Portugal, and Italy, where mortgage rates have risen since the ECB cut the refi rate to 1%. Indeed, these are the economies that ‘need’ the stimulus to offset the fiscal consolidation.

Sure, mortgage rates are arguably low – but they’re not lower....

Core mortgage rates are falling, and this could create a positive stimulus for Spain, Portugal, and Italy down the road. But for now, the transmission mechanism, dropping the ECB refi rate to 1%, is not easing housing and mortgage financial conditions in those economies hit hardest by fiscal austerity.

4--Unemployment rising too fast, then falling too fast … going forward, it should (unfortunately) be just right, EPI

Excerpt: ...So, what to make of all this?

First, going forward, the best predictor of what will happen to unemployment remains the Okun-based estimates based on GDP growth. Given that most estimates of GDP growth in the next couple of years do not see it beating growth in potential output by much, there is little reason to expect that the recent rapid declines in unemployment rates will continue.

Second, rising average hours might explain a lot of the too-rapid rise in unemployment in 2009 and 2010.

Lastly, given this large rise in hours, an aggressive program to promote work-sharing instituted during the recession could have been a big help in not allowing rising hours to soak up so much of the extra labor demand, and would’ve allowed the economic activity spurred by the American Recovery and Reinvestment Act to translate more directly into higher head counts and lower unemployment. The Center for Economic and Policy Research’s Dean Baker had a good real-time proposal that would have been a real help. It’s not totally too late either – work-sharing pilot programs were included in the recent extension of payroll tax cuts.

5--The Fable of the Century, Robert Reich's blog

Excerpt: Imagine a country in which the very richest people get all the economic gains. They eventually accumulate so much of the nation’s total income and wealth that the middle class no longer has the purchasing power to keep the economy going full speed. Most of the middle class’s wages keep falling and their major asset – their home – keeps shrinking in value.

Imagine that the richest people in this country use some of their vast wealth to routinely bribe politicians. They get the politicians to cut their taxes so low there’s no money to finance important public investments that the middle class depends on – such as schools and roads, or safety nets such as health care for the elderly and poor.

Imagine further that among the richest of these rich are financiers. These financiers have so much power over the rest of the economy they get average taxpayers to bail them out when their bets in the casino called the stock market go bad. They have so much power they even shred regulations intended to limit their power.

These financiers have so much power they force businesses to lay off millions of workers and to reduce the wages and benefits of millions of others, in order to maximize profits and raise share prices – all of which make the financiers even richer, because they own so many of shares of stock and run the casino.

Now, imagine that among the richest of these financiers are people called private-equity managers who buy up companies in order to squeeze even more money out of them by loading them up with debt and firing even more of their employees, and then selling the companies for a fat profit.

Although these private-equity managers don’t even risk their own money – they round up investors to buy the target companies – they nonetheless pocket 20 percent of those fat profits.

And because of a loophole in the tax laws, which they created with their political bribes, these private equity managers are allowed to treat their whopping earnings as capital gains, taxed at only 15 percent – even though they themselves made no investment and didn’t risk a dime.

Finally, imagine there is a presidential election. One party, called the Republican Party, nominates as its candidate a private-equity manager who has raked in more than $20 million a year and paid only 13.9 percent in taxes – a lower tax rate than many in the middle class.

Yes, I know it sounds far-fetched. But bear with me because the fable gets even wilder. Imagine this candidate and his party come up with a plan to cut the taxes of the rich even more – so millionaires save another $150,000 a year. And their plan cuts everything else the middle class and the poor depend on – Medicare, Medicaid, education, job-training, food stamps, Pell grants, child nutrition, even law enforcement.

What happens next?

There are two endings to this fable. You have to decide which it’s to be.

In one ending the private-equity manager candidate gets all his friends and everyone in the Wall Street casino and everyone in every executive suite of big corporations to contribute the largest wad of campaign money ever assembled – beyond your imagination.

The candidate uses the money to run continuous advertisements telling the same big lies over and over, such as “don’t tax the wealthy because they create the jobs” and “don’t tax corporations or they’ll go abroad” and “government is your enemy” and “the other party wants to turn America into a socialist state.”

And because big lies told repeatedly start sounding like the truth, the citizens of the country begin to believe them, and they elect the private equity manager president. Then he and his friends turn the country into a plutocracy (which it was starting to become anyway).

But there’s another ending. In this one, the candidacy of the private equity manager (and all the money he and his friends use to try to sell their lies) has the opposite effect. It awakens the citizens of the country to what is happening to their economy and their democracy. It ignites a movement among the citizens to take it all back.

The citizens repudiate the private equity manager and everything he stands for, and the party that nominated him. And they begin to recreate an economy that works for everyone and a democracy that’s responsive to everyone.

Just a fable, of course. But the ending is up to you.

6--The rise of the machine: Does high-frequency trading alter commodity prices?, VOX

Excerpt: Trade in commodity derivatives – such as oil futures – has grown tremendously over the last few decades. Some believe that the "financialisation" of commodity markets has made them more efficient. Others worry that financialisation has resulted in greater price distortions and volatility. This column presents high-frequency trading data suggesting that the sceptics may have a point.

Why does it matter?
In our view, this finding adds to the growing empirical evidence supporting the idea that the financialisation of commodity markets has an impact on the price determination process. Indeed, the recent price movements of commodities are hardly justified on the basis of changes of their own supply and demand. In fact, the strong correlations between different commodities and the S&P 500 at very high frequency are really unlikely to reflect economic fundamentals since these indicators do not vary at such speed. Moreover, given the large selection of commodities we analyse, we would expect to have different behaviours due to their seasonality, fundamentals, and specific physical market dynamics. Yet, we do not observe these differences at any frequency. In addition, the fact that these correlations at high frequencies started during the 2008 financial shock provides additional support for the idea that there are financial-based factors behind this structural change. Therefore, the very existence of cross-market correlations at high frequencies favours the presence of automated trading strategies operated by robots on multiple assets. Our analysis suggests that commodity markets are more and more prone to events in global financial markets and more likely to deviate from their fundamentals.

This result is important for at least two reasons. First, it questions the diversification strategy and portfolio allocation in commodities pursued by financial investors. Second, it shows that, as commodity markets become financialised, they are more prone to external destabilising effects. In addition, their tendency to deviate from their fundamentals exposes them to sudden and sharp corrections.

7--Kasriel’s Parting Thoughts – Has the Fed Boosted the Stock Market?, Northern Trust

Excerpt: You bet. And aggregate demand for goods and services, too. If the Fed had not expanded its balance sheet in the past few years, the weakest U.S. economic recovery in the post-WWII era would have been even weaker and U.S. stock prices would have suffered. Chart 1 shows the year-over-year percent changes in monetary financial institution (MFI) credit. Private MFI credit is made up of the sum of loans and securities of commercial banks, savings & loan associations and credit unions. Total MFI credit is private MFI credit plus assets on the books of the Federal Reserve, i.e., Fed credit. The median year-over-year change in private MFI credit from Q1:1953 through Q4:2011 was 7.5%. In 2009, private MFI credit began what turned out to be its most severe contraction since the early 1930s. Although private MFI credit resumed growth in the second half of 2010, the rate of growth has been far below its long-run median rate of 7.5%. Even with the Fed’s second round of quantitative easing QE) from November 2010 through June 2011, total MFI credit, private plus Fed, has been growing well below the long-run median rate for private MFI credit. But without QE2, credit creation for the U.S. economy would have been even weaker.

So, yes, the Federal Reserve’s actions have benefited the stock market as well as aggregate demand for goods and services in the U.S. economy. You got a problem with that?

8-- Market loses Fed crutch, IFR

Excerpt: The second issue is how well equity markets will be able to get along in the absence of Fed support? What happens if we simply inch along, suffering low growth while households and governments slowly repair their balance sheets?

In the absence of further Federal Reserve easing you have to ask yourself: do I want to buy equities at an all-time peak of earnings as a share of GDP? Really a similar question can be asked of all riskier corporate assets. It is unclear how earnings will be sustained given poor wage growth and the need to save. Data last week showed that U.S. consumer spending rose a better-than-expected 0.8 percent in February even as earnings only increased by 0.2 percent. Consumers found the money by cutting back on a luxury: savings, which fell to 3.7 percent, the lowest level in 30 months. If your milk cow is producing more in milk than she consumes in nutrition you have a sustainability problem, although one which seems pleasant as long as it lasts.

Market reliance on the promise of accommodative policy is both a measure of the success of the Fed’s policy and an illustration of its inherent, and central, weakness. The Fed has helped the economy by floating asset prices higher on a sea of liquidity. That’s made people feel better and spend more. It has also transferred some money from savers, who lose out on interest, to borrowers, who are probably more likely to circulate the extra cash then are their lenders.

The weakness, sadly, is that the accommodation so often produces more of the kinds of mal-investment that makes the booms almost equally as destructive, on a long-term view, as the busts. If the Fed didn’t ease after the Long-term Capital Management debacle the dotcom bubble wouldn’t have been as bad, and if it hadn’t eased as much after the dotcom bust then the housing bubble wouldn’t have grown so distended.

And, as just the removal of the promise of more Fed aid has walloped the market, imagine what might happen if they actually began to liquidate their portfolio? The market and the Fed may have cornered each other, leaving neither party an obvious route of escape.

9--No antidote to outbreak of contagion, IFR

Excerpt: A cruddy day in the markets like Wednesday can get one thinking. Just when it felt safe to be cautious without being too bearish, what General Arthur Wellesley, First Duke of Wellington would probably also have dubbed “The Spanish Ulcer” took hold and it all went to hell in a handcart. No need to list the numbers, but it was scary.

The scary bit wasn’t the way in which Spanish asset prices got slaughtered after the failed five-year bond auction to which simply not enough people turned up – we have even seen German Bund auctions meet with a simple lack of investor enthusiasm – but the way in which the bonds of all the usual periphery suspects got flattened at the same time.

There was no notable reason to knock a point and a half off the Italian 10-year or to trash the Greek secondaries. No, what we saw was a spontaneous outbreak of contagion, a phenomenon which the grand EFSF/ESM upgrade of Copenhagen was supposed to have found the antidote to. Are we back to “Everybody into the pool; everybody out of the pool”?

Away from the obvious though, there is something very spooky going on.

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