Fed statement hits all the dove buttons

The Fed's December 2011 and Jan 2012 statements have some notable differences...

Fed January 2012

 http://www.federalreserve.gov/newsevents/press/monetary/20120125a.htm

Fed December 2011

 http://www.federalreserve.gov/newsevents/press/monetary/20111213a.htm

The main change between these two reports is that the Fed has shifted the period of the ultra-low funds rate end to late 2014 from mid-2013.

Also in the new statement Jeffrey Lacker has dissented:

"Voting against the action was Jeffrey M. Lacker, who preferred to omit the description of the time period over which economic conditions are likely to warrant exceptionally low levels of the federal funds rate.”

The Fed dropped one of its key statements about inflation vigilance compared to December. One thing we noted in this month’s inflation report is that core–services sector inflation has continued to creep up. The Fed seems to be ready to put up with this inflation up-creep aside for a while. 

 

 

A portion of the Fed’s December statement is below. The portion in red is now gone.

The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.

The Fed also seems to have linked changes in its securities purchase program more directly to changing views on the economy (see below). Does that mean that it is going to make shifts more quickly in the future based on a changing economic view?

The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.

Previous the Fed had said vaguely that it was prepared to use its tools…

The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools to promote a stronger economic recovery in a context of price stability.

Summary:

The Fed is for some reason setting aside the pick-up in growth we have seen over the past few months. There is little way to understand the Fed’s shift to push out longer into the future the period for which it thinks rates will remain ultra-low. To me this is a confidence-killing statement.

Moreover, the shift toward less inflation concern suggests a Keynesian view has taken hold and the monetarist view has been set aside along with the observed up-shift in the highly trend dominate core services inflation rate. Is it true that inflation cannot rise if there is economic slack or a large GDP gap? Is that the belief that is behind this shift? Given that the data are going the other direction right now, this conflict between Monetarists and Keynesians bears a lot of watching

We do not know if the Fed made these changes in language because it is pessimistic on the economy’s rebound or if it is worried about Europe or the global economy. It seems to be a policy move that goes in a direction opposite that of the recent economic data and weights weakness and risk in Europe relatively more heavily.

We may find out more about this later today.

More weather-aided housing strength

If April showers bring May flowers what does a winter warming trend bring? Answer: distorted data. And that continues to be the story as existing home sales continue the winning streak of recent housing reports with upside surprises. 

Existing home sales jumped by 5% in December as all four regions saw sales rise. Prices fell by only 2.5% Yr/yr about half the drop of one month ago. 

It is the highest sales pace for existing home sales since January 

We are cautioning about the housing data because of the unusually warm weather.

Note that the largest gains this month were in the normally cold weather regions of the NE and Mid-west. In the NE sales rose by 10.7%; in the Mid-west they rose by 8.3% despite still poor economic conditions. In the South and West sales rose by less than 3% in the month (still a good performance). Winter weather is less a factor in the South except for wetness while the West is a mixed weather region.

Housing has probably been distorted upward this winter.  All the reports have showed strength recently and they are not usually in lock-step.  

Now that winter has come and with a vengeance in some places we can look for the housing data to beat a retreat. We are not negative on housing, just wary of the degree of ebullience. 

Economic reports point to better times ahead

Claims plummet

It was another day of positive data in which people have tried to find bad news. How many of you do this when you open your Christmas presents? Do you look at the thing and try to figure why it isn’t as good a present as is seems?

The day’s jobless claims data are unequivocally goods news even we cannot evaluate them fully. Claims shot up by 27K the week before and now they have plunged by 50K. This is huge volatility even by the standards of jobless claims. Last week we pondered if all the progress was slipping though our fingers; this week it looks like progress has re-accelerated. Well, maybe not, but at least we know that last week’s signal was false and now, once again, we wait for next week’s report to give us a clue where claims are going to settle in.

The 350K mark is quite good and is as close to normal as we have seen for some time. Claims rarely get down below the 300K level.

Since 1974 the median value for claims has been 367K. Also since 1974 claims have been below the 300K level only 109 times in 1,985 weeks or only 5.5% of the time. Claims fall below the 350K level and stay above the 300K level 38% of the time. But claims are above the 370K mark 47% of the time. Thus claims are elevated in recession and stay that way in recovery periods. Even though recessionary periods are relatively short, they ratchet claims up and it takes them a good part of the recovery to get back below the 350K mark. They take some time before they work down into the ‘normal zone’ leaving the level of claims high (above 370K) much more than they are moderate (350-300K).. Indeed, the high claims Zone is all too normal occurring as it does 47% of the time.

But apart from claims falling to 352K in the week of Jan 13 for the previous week when claims spiked, the insured rate of unemployment rate fell to 2.7% its lowest level in this cycle. It was last at 2.7% in Sept of 2008.

Thus there is quite a lot of evidence that the labor market is improving.

Housing Starts

Housing starts is one of those reports you know is not going to be too good. It’s like unwrapping a Christmas present from your stingiest aunt. Don’t get your expectations up. Still there can be unexpected positive surprises. While the housing headline was not one of those surprises the continuing rise of single family starts was as single family starts continue their string of increases.  But housing still has issues. We do not like to put too much emphasis on the winter housing reports because they are so much about the weather rand the weather has been mild this year and it could example the improved tend over the last few months. Also the lift for single family starts is still quite shallow and only the largest of the multi-unit categories has any real lift to it. The housing report had some good news but it was not completely believable.

The Philly Fed MFG Survey -January

 The Philadelphia Fed’s January MFG survey ‘disappointed’ because its lift was low and it so was its level. The level for December was revised down giving January a lower base to spring from. That accounted for some of the disappointment. And then the January gain itself was not large. Many of the January categories were weaker notably orders and shipments but the separately surveyed barometer did rise month to month. The Philadelphia outlook index also advanced strongly. Despite having some irregularities Philadelphia posted a strong outlook and showed continued employment and a strong work week gain.  

The CPI

The CPI and CPI trends remain in good shape.  Headline inflation is on the strong side year over year at 3% but over six month that is a 0.4% annual rate decline. So the energy induced bulge is dissipating. Core inflation is decelerating from 2.2% to 2% to 1.8% from 12-months to 6-Mos to 3-mos.  Inflation seems to be on the run and yet is not running too fast to worry the Fed.  

Yet, interestingly, the trend for service inflation is up. The services sector, a lower productivity and more inflation-prone sector and the center of job creation is showing a persisting rise in inflation. That should be enough to keep the Fed from worrying that deflation is setting in. It might also be the harbinger of less tight times for services and evidence that the sector is warming and will take the lid off job growth.  And that may be the most tantalizing element of the CPI report.

PPI, IP and NAHB different wrinkles on the outlook

Three reports… like three blind men feeling the elephant...

·         The PPI shows inflation trends to be tempered but it show some inflation is percolating. The Fed is not focuses on this so this is not analysis for Fed policy but could be something to watch.

·         Industrial output has stopped accelerating. It is growing nicely in Q4 and there are some hints of slowing down. We know we lose momentum from exports. The thrust for IP will be determined by the consumer here at home.

·         As for the housing sector the NAHB index jumped but we think weather distortions were behind it. Beware the effects of weather in the winter months

Is the PPI Percolating?

The PPI head lines is at -0.1% leaving the Yr/Yr still strong at +4.8% But inflation is declining if we look at sequential growth rate to 2% over six months and to -0.6% over three months (all at annual rates).

But for the part of this report that feeds into what the Fed will most care about, the CPI, the trend are worse. Finished consumer goods at the PPI level show their core trends to be more stubborn. this month the Core Fin Goods PPI rose by 0.4% in December. Over three months the annual rate is 2.5%, compared to 3.3% over six months and 3.6% over twelve months.

Still the higher inflation might reflect just a bit more consistent demand. If those two things go together, the Fed will have some choices to make in 2012.

The economy is too weak for the Fed to worry much about that right now- right or wrong that is the Fed's bent. Some are worried that the Fed is letting inflation and inflation fodder flourish longer than it should. Perhaps that will be the unexpected transition in 2012? Will inflation begin to emerge faster than what people think?

The core PPI suggests that even after all the trouble of last year core prices for finished consumer goods in the PPI showed some pressure, rising 3.6% on the year. If growth picks up in 2012 why should that figure be lower? And when with that sort of pressure when will it stick in the CPI itself?  

Industrial output rises

After dropping by 0.2% in November industrial output rose by 0.4% in December 2011 to end the year on a better note.

Still sequential growth rates are unclear as the growth trends shows 2.9% over 12-months, moving up to to 4.7% over six-months and back down to 3% over three-months.

Momentum has had its wings clipped, but not deeply severed.

Overall output rose at a 1.6% annualized rate in Q4 compared to 1.9% for MFG. 

The MFG slow down may also be seen as a failed speed up as growth is at 3.7% over 12-Mo then 5.7% over 6-Mo and 3.9% over three mo. The 3.9% over 3-Mo is slowing compared to six months but not to 12-months. and 3.9% is not a bad rate of growth at all.

Consumer output has slowed. Overall it is to 0.4% over three months from roughly 2% over six-months and 1% over 12-months.  For durables the slowing is to 4% over three months from over 8% over 6- and 12-months. Nondurables output slowed as well but the output there is energy goods: non-energy durables picked up over three-months to a 1.3% pace while output of energy goods plunged at a 4.9% pace. 

Excluding tech and transportation business spending has been very stable at around a10% pace. but spending on Vehicles has slowed steadily and sharply while spending on computers and office equipment plunged to zero in Q4. Materials output continues at a barely reduced pace in the quarter.

On balance there is substantial evidence of slowing of output in Q4. But the slowing is not dramatic; its a moderation. Inventories are lean and the outlook surely will depend on the consumer. US exports are starting to sputter and that portion of output that gets exported should start to slow. 

NAHB

The January NAHB index jumped to level of 25 (from 21 in Dec) its highest level since June of 2007, a 55-month high 

The single family sales index rose to 25 in Jan from 22 in Dec.

The six month outlook index rose to 29 in Jan from 26 in Dec.

 The January Traffic index rose to 21 in Jan from 18 in Dec.

By region the NE made the biggest jump to 23 from 14. The West index spurted to 21 from 16. In the South the index advanced from 25 to 27. In the Mid West the index edged higher to 24 from 23.

The regional data under score that this index has huge elements of weather in it. In the South where the weather is generally more temperate the index did not move up by much in the period of abnormally warm weather. In the NE where weather is a huge winter factor the the index made a giant leap. The West is a combination of cold/warm regions and the index saw a moderate advance. The Midwest is largely cold but there was little special impact there as the local index made a small rise.

Weather seems to be importantly behind the rise in this index. the good weather helped to get people out as the traffic index made the greatest percentage gain- but each survey component rose by 3-points.

Can MFG be led to greener pastures by the service-sector state, New York?

Out of the woods?

 Empire State Index jumps

 

The NY MFG survey turned in an impressive set of readings to start the New Year. The index reading jumped to 13.48 from 8.14, a large gain. The index now sits squarely in the 48^th percentile of its queue nearly at its median. More impressive is its outlook index at a level of +54.87 which sits high in its queue of values as the fifth highest outlook reading in the last 91 months.

 

New orders rose sharply in the month to the 75^th percentile of their range and the 58^th percentile of their queue. The shipments index a real-time evaluation of activity advanced to 21.69 from 20.06 and stands in the 73^rd percentile of its range and the 69^th percentile of its historic queue. Both are impressive readings. Unfilled orders, however, continue to be negative. They rank near the bottom one-third of their historic queue.  Unfilled orders and order backlogs tend to correlate with job growth but the jobs metric made a very strong push to 12.09 in January from 2.33 in December; jobs are now in the top 20% of their high/low range and stand at the 71^st percentile of their historic queue of values (the queue reading at 71 means that the jobs index has been higher than this only 29% of the time historically). Average hours worked also have jumped in the month to 6.59 from -2.33.

Overall it is an impressive performance from New York. Will the service sector state prove to be a bellwether for the nation’s manufacturing sector?  

Eternal existential ratings questions

Or playing the downgrade game…

What is a rating? Is it a statement about the credit quality of a country or security RIGHT NOW, or is it about what it will become?

What does it mean to give a rating and put the country or security on downgrade alert?

Does a negative outlook mean you did not have the guts to take the rating down to where it belongs, to a level that would make it stable? I think so. Fourteen EMU counties now have negative outlooks. So why would any investor buy any of these sovereign debt securities priced at their current rating level, perched on the verge of another downgrade? Is this a fool’s game?

Think of this as you might a baseball player’s contract. Albert Pujols is a good example. He has been a great player. But in snatching him away from the Cardinals, the Angels are going to pay him a very hefty fare. As players get old their statistics deteriorate- you can take that to the bank. Pujols is no Spring Chicken. That is very clear, yet Albert now has a 10-year deal worth $254mln. So evaluating someone or something at its past performance is not simply a problem that resides with credit rating agencies. It is hard to see how the Pujols deal will make sense as it ages. How would you rate this deal as far and money spent? Could you help your team more by spending $245mln a different way?  

So too with the ratings in EMU… Italy has just been cut by two notches and is put on a negative outlook – overnight! What happened? Bad pasta? Food poisoning?

Is that action of a TWO-NOTCH cut and a NEGATIVE OUTLOOK S&Ps way of saying, hey, we blew it, we should have downgraded them a long time ago but now it would be too embarrassing to take them down by THREE notches in one fell swoop?

Is there something systemic about downgrading all these EMU countries together (but then in not downgrading all of them… and not downgrading all of them equally…)? There is something to that but in the Zone, indeed one of its fallings, is that there are still so many individual responsibilities and so little to centralization other than currency- and monetary policy- sharing.

To settle this once and for all, I think ratings should not be allowed to have an outlook bias. If investors are going to buy sovereign debt instrument they need to know how you view it now and for ‘the foreseeable future.’ If the current rating does not seem to be sustainable then it should be downgraded now, it is the wrong rating.

I want to see ratings constructed in such a way that the probably of upgrade is equal to the probability of downgrade. Then I will admit to ratings being fair. But as long as credit rating agencies are waiting for huge downgrades and giving a downgrade with a bias I don’t see the ratings as having any veracity.

In the case of EMU the rating game is more difficult since ratings depend on what the e-Zone will agree to and it is not agreeing to do much of anything. But as long as this is reality it seems that a harsher near term down grade makes all the more sense! It just might be the stuff to get reluctant countries to the bargaining table to make the tough choices they are refusing to make now.

One intrinsic problem with setting current ratings levels, and this is true with all financial variables in fact, is that they are nothing more than the present value of a discounted stream of expectations. Still, it would be wrong to think that ratings are anything more special or different than the securities that they rate, since securities prices (stocks, bonds, etc.) have that same property.  If a rating agency cannot handily compress a vector into a scalar-rating maybe it should seek a new profession?

For now the ratings game is muddled. The agencies seem to be quite unsure how to proceed. I would make it easy. Anytime a true question arises about whether a rating is justified, it isn’t. Any serious question about a security or a country keeping its rating in the near future means it longer owns its current status; it is borrowing it from its past reputation, like an over-the-hill sports hero.

This approach would also lead to quicker decisions on downgrades and more downgrades and presumably more upgrades too. Right now the system is too rigid, too-ossified. Ratings agencies are too worried about making changes and they procrastinate, thereby putting themselves behind the eight-ball when changes are needed. What has just happened to Italy is somewhere between a farce and joke- but it is no shock. It’s no wonder that the Europeans want to move away from using any of the findings of the credit rating agencies.

I can understand a sports team overpaying for a baseball player as the Angels have done for Pujols. In baseball there is emotion and an assessment that involves the human factor. Some players will underperform on the field and yet may be worth more than their mere numbers suggest at the box office - fan loyalty and infatuation. But the ratings game in markets is a numbers and letters game and we need for those who play it, to play it fairly, squarely and with a sharp pencil. I don’t suggest an algorithm to be used without any personal judgment since ratings do require some judgment.

I would suggest rating contracts to trade on the CBOT or some other exchange. That would put speculators at an equal risk of upgrade or downgrade risk and would assure that ratings changes are not delayed. I do not refer to betting on any agency’s rating but on a separate set of market determined ratings where investors could go long for short the contract and where financial gain or loss would accrue to a change in the markets assessment of the rating.  There might still be events that would precipitate two-notch changes, but far fewer of them. There might also be a greater danger of overshooting as we see in times of financial crisis.

Of course someone might note that CDSs are already sort of like this…except they are part of the game not separate from it. Greece (so far) has been able to engineer a default without triggering CDS payments. That’s a nice thing if you are writing them, not so nice if you have purchased them. Moreover, CDSs are about an event called ‘default’ whereas ratings are a broader concept. Maybe markets should step in and do something where the ratings agencies seem to be failing. Dollars to doughnuts Italy would have been seeing the pain much sooner had this practice been in play. We can blame the ratings agencies for their abruptness but we cannot be too critical of where they have currently set most of their markers. But then there is that issue of negative outlooks…