Cue The Panic

By: Michael Ashton | Thu, Aug 19, 2010
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Well, the economists kept their streak going; they have now under-forecasted claims for 18 of the past 21 weeks (including revisions). That is impressive. For comparison, the odds against flipping 18 or more "heads" on a coin in 21 flips are approximately 1341-1 against. So economists can take solace in that their recent consensus forecasts have been statistically different from a coin flip. Worse, as it turns out, but at least different.

That being said, I wouldn't have had the timing right either if I was forecasting the weekly number. On the other hand, I probably wouldn't have been consistently low, either.

The count of initial unemployment claims looks as if it has started to climb again (see Chart). As an aside, the current level of 500k exceeds the level seen in every week of the last recession save for one, the week of 9/28/01. I would have some sympathy for the view that this recent upturn may have something to do with the end of Census employment, with a delay - perhaps the Census was employing some folks who would otherwise have been joining the unemployment rolls, and they're now drifting back - except that other signals are starting to look worse as well. Case in point: today's Philly Fed index.

US Initial Jobless Claims
If I believed in technical analysis on economic indicators I'd be long here.

The Philadelphia Fed composite Business Activity index, expected to come in at +7, instead came in at -7.7 (see Chart). The subindex for Number of Employees was the lowest since late last year; the Workweek index was the lowest since last summer. There is not much ambiguity here when you combine this with the Claims number. It isn't looking great (see Chart).

Philadelphia Fed Business Outlook Survey
It's a volatile index, sure, but this is too deep a dip to dismiss.

Now, note that the Philly Fed index is pretty volatile. So this is a good time to think in terms of rejectable hypotheses. Last month, I would have said the dip is concerning, but at the limit of what might be acceptable volatility for an economy still expanding. This dip, however, is sufficiently large that I believe we can dismiss the hypothesis that the economy is still growing as strongly as it was in Q1 and Q2 (when the government was stimulating the economy, that is). At -7.7, given the volatility of the series, we can't be sure the economy is actually contracting, but at least in the Philadelphia region it is probably pretty close to zero.

Markets didn't take this news well.

The 10y note declined to 2.58% (actually, not a very strong showing all things considered) and stocks fell 1.7%. The minor melt-up on Tuesday has been fully erased. Volumes remain weak, but they did expand today compared to that seen during the up days. The VIX reached the highest level since early July. Inflation swaps and TIPS breakevens declined, although that was partly because the Treasury announced a $7bln reopening of 30y TIPS for next Monday's auction, and that was towards the upper end of dealer estimates. The current yield of bond TIPS is 1.75%, which while low is a heck of a lot higher than the 0.11% of the 5y TIPS. The issue will pull demand from investors who would rather take some bond price risk than guarantee a negative real return - long-lived accounts, like pensions, endowments, and non-US pensions. Will it be enough to place that much duration? I think it will be, but we'll see. The dealers will be timid and cheapen the issue up before the auction, and it is August.

On Friday, there is no data due but that doesn't mean the panicky government reactions cannot begin. Today President Obama said that the week's jobless claims data showed that Congress should act on a new jobs bill. You know, the last one worked so well. How about working to reduce costs on business and reduce the barriers to hiring? Just a thought, but as that would imply smaller government it isn't likely to get much of a hearing. I expect to hear more great plans over the weekend, and I expect the stock market won't much care for it. Frankly, I doubt the bond market will like it very much either.

There is nothing to say that the panic in the government and the central bank needs to lead to a market panic, but I would not be very surprised if things started heading that way.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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