Daily Clueless Musings 2/28

We are heading into a data heavy week. ADP, Humphrey Hawkins and nonfarm payroll are all expected this week. The January reading of Personal Income is better than expected, up 1%. While spending rose less than expected. So are US consumers finally saving? The reality should be read as government largesse boosted personal income but failed to stimulate consumption. Reduced employee contributions for government social insurance, which reflected provisions of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, boosted personal income in January by reducing the employee social security contribution rates. Excluding these two special factors, disposable income only increased 0.1 percent in January. Chicago ISM jumped to its highest reading since 1988. Cost inflation continues. Energy, steel and cotton are all on the rise. Interest rate came in and yield curve flattened before Humphrey Hawkins. The text of Bernanke's remarks may have nothing new from last FOMC (slightly better economy, weak job market and low inflation), though at least the Q&A may be a little more interesting.I think Ben will be asked tough questions regarding rising commodity prices and Fed’s playbook of dealing with it. Market is expecting a rather dovish Fed. Dollar also lost its ground against other major currencies, even when newly elected Irish government is trying to renegotiate the "bailout". Volatility is relatively firm before the Humphrey Hawkins and Nonfarm payroll and vol path generally under performed the skew.

Daily Clueless Musings 2/25

Fourth quarter GDP real growth was revised down from 3.2%saar to 2.8% in the BEA’s second estimate of the 4Q10 data. The major reason for the downward revision is government consumption, which was from -0.6% to -1.5%. Lower spending level were mostly on state and local government level. It is just a pre-show for a fiscal drag in 2011. The slower fiscal spending is coming. The coming budget crisis in many states will pressure the spending at lower level governments. On the federal level, Obama is likely to make concessions to the republican proposed budget cut. Oil price stabilized as Saudi raised oil output as Libyan exports disrupted. Market took a break from the panic mode. "Buy the dip" spirit is still live and strong for equity traders. Yield curve did not move too much from yesterday's settlement even as GDP number is a disappointment. Consumer confidence is still strong. The final February reading of consumer sentiment from the U of Michigan was better than expected up more than two points from the preliminary report to 77.5, the highest mark since January 2008. It is interesting that the record high consumer confidence does not translate into the sales number for big retailers like Wal-mart, Target, Kohl's and the likes. As long as the job market remains soft, the spending of less wealthy consumers will be depressed. The inflated asset prices only stimulates the impulsive spending of the wealthy. Those spending is going to disappears as soon as stock market corrects. As Fed is pouring liquidity into the punch bowl, market acts like any drunk person, whose perception of risk is often detached from the real world. Both consumer and fiscal might become a drag to the expected recovery in 2011.

Daily Clueless Musings 2/24

Economic data were mixed today. The weekly report on Initial Jobless Claims is back to the cycle low. Job number continue to show unpredictable fluctuations, given the severe weather conditions in the recent weeks. The January reading of New Home Sales was well under the forecast at 284k units annualized, as the California’s (home buyer tax credit) party ends. The January reading of Durable Goods Orders is in line with expectation, but Orders ex-transportation are -3.6%, much lower than the 0.5% expected. Rail traffic continue to show strong gains year over year, which bodes well the new round of inventory building. Across the pond, Euro area Jan inflation printed 2.4% gain year over year. Expectation for rate hikes rose and Euro gained against US dollar. News from middle east over shadow the economic news. Oil, S&P and Eurodollar back futures traded with a very high correlation. As rumors about Qaddafi is either dead or flee to Zimbabwe circulates the market, oil broke 2 bucks and yield curve steepened. Spot volatility seems to be very cheap, especially given the expectations for BoE and ECB rate hike this year are high.

Daily Clueless Musings 2/19

HP blamed weak US consumer for its terrible earning. Both home depot and Lowe’s guided lower than streets expectation. It seems that the mass retailers did not do as well as the high end ones in the last quarter. The former is more correlated with labor market, while the later draw their pay check from stock market. Good job, Ben! On the bright side, January reading of Existing Home Sales was higher than expected. Outside the states, the unrest in middle east shows no signs of easing. There is rumor about anti-manarchy protests being planned for tomorrow in Saudi Arabia. Oil traded higher and skew flipped to the call skew aggressively. The potential disruption of oil supply and higher oil prices led to higher demand for hedging and speculative buying.Fixed income traded well even after a slightly disappointing 5 year treasury auction. But the back end of the yield curve steepened as soon as stock bounce back from its lows. Vols were sold off before the back contracts traded lower. While gold and silver are trading close to their all time highs and the real hedgers bid up call options on oil futures, stocks and yield curve continue refusing to price in geo-political risk.

Daily Clueless Musings

The tension in middle east is rising. There are also small protests in several major cities in China. Although the development is not surprising at all to people who follow the situation, the market has been, as we discussed before, underpriced the potential risk on US economy. After gold and silver made their highs for the last several days, US stock market finally broke and red-green futures finally flattened on the rally. Time will tell if the market is going to turn a blind eye to the situation and buy on the dip again, as they did after the protest in Egypt broke out. But for now, market still does not fully price the potential risk. Stocks are still sitting comfortably above the lows it made after the Egypt protest. Volatility in oil futures actually traded lower on the day. And the steepness of the Eurodollar curve is still sitting in the back reds and front greens. Market seems to be discounting the fact that $100 oil is going to be a tax on discretionary consumption of the majority of the consumers. Wal-Mart reported a terrible earning today, which painted a dark picture of the low end consumer. Gallup's consumer daily spending number also shows a strong pay check cycle. Ironically the February reading of Consumer Confidence is 70.4, 5 points higher than expectation. Maybe only people with a sizable stock portfolio are doing those surveys. The recent pickup in economic activity is largely led by better than expected consumption in 4th quarter of 2010. A weaker US consumer will certainly push the recover further. If oil stays at the current level, the steepest part of the yield curve should be pushed further out toward the backend.

Random thoughts on QE

The second round of Quantitative easing, a fancy name for Fed buying treasuries, is half way through. From the last FOMC minutes, Fed seems to be "satisfied" with the result of QEII so far. It is hard to understand how Fed could be happy with QE II. After 167 billion freshly minted dollars and 69 billion from principal payments on agency debt and MBS are invested in treasuries, yield curve is at its steepest since the great recession started. US economy is not generating anywhere close to the 110k-125k nonfarm jobs that are needed to just keep up with the population growth. Inflation is already showing up at producer level. Inflation is seen in those areas that Fed does not want to see. Cost of living is higher on higher food and energy cost. While disinlfation is seen in the areas which Fed is trying to inflation, such as housing and labor cost. Owner's equivalent rent has been one of the major components that has kept CPI lower. But it has no impact on consumer's cash flow. Fed insisted the low resource utilization rate and sluggish labor market should keep CPI at depressed level, as 70% of the cost of goods are labors. That seems to be right. But it is hard for me to understand how buying US treasuries can turn this vicious cycle around. Company won't hire more people, when there are ample capacity sitting around and they can not pass on higher raw material cost to consumers. Fed maybe is turning a deaf ear to many major US companies last quater's earning. Kraft, Pepsi, P&G and the likes are all reporting lower margin and higher raw material cost. Fed's money printing is going to squeeze the margin of US corporations. Fed can ignore higher PPI and headline CPI for as long as they want, but do they really believe companies will hire more people when they are not able to pass on higher cost?

The only major accomplishment by the QEII is higher equity prices. Fed is trying to cure the hangover by giving the drunk more drinks. Fed cheered that consumer was very strong in the last holiday season. Ironically, it coincided with the first expansion of consumer credit card balance first time after the recession started. Maybe people is borrowing against their paper profit in stock market. It is funny that we got into this recession because inflated housing price cause by the Fed's ultra easy monetary policy, which is used by Fed to pull the economy out of tech bubble, which was again caused by artificially low Fed fund rates help US to recover from the housing bubble in 90s. It seems like the only cure fed has for this alcoholic (or low-rateholic) economy is to have more drinks, so it can pass out and don't have to worry anything before wake up in hangover again. No wonder the Fed fund rate since Paul Volker has been making lower lows during every economic downturn. It was only a matter of time that Fed funds would hit the mighty zero boundary. Now there are QE I and QEII and possibly QEIII, which are designed to mimic a negative interest rate, so savers are punished and spending and leveraging are rewarded.

I don't know how it will end. The bull/bear cycle of interest rate often lasts generation long. People often missed the turn of market and only recognized it long after it happened, as the market tend to anchor its expectation for a "reasonable" range of treasury yield to the recent history. There is only strong meaning reverting mentality among the fix income investors. Market was chasing 2% treasury yield in the 40s after world war II, while 12% in early 80s found no takers. The current bull market for bond has lasted for almost 30 years. Maybe this is going to a starting point of a new bear market for treasuries.