The Least-Ugly Sister

By: Michael Ashton | Thu, Mar 24, 2011
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It's good to be the least-ugly sister.

American markets powered ahead again today, despite ongoing tensions in Europe and very bad economic data. Stocks rallied 0.9% on volume that is again slipping into the "sleepy" zone (the last three days' volume is the lowest 3-day volume since the holiday season), but the indices seem dead-set on skittering to new highs over the next couple of weeks. Bonds sold off once again, pulling the 10-year yield up to 3.41%. TIPS, however, did marvelously after a terrific 10y auction that cleared well through the screens, 0.92%, on a 2.97:1 bid-to-cover ratio. Demand for inflation protection is plenty strong enough to sustain a market with no net issuance.

Initial Claims was on-target, but the Durable Goods report was awful. The headline printed -0.9% versus +1.2% expected. Ex-transportation, a more-relevant number, was -0.6% versus expectations for +2.0%. With last month's -3.0%, that marks the first back-to-back negative monthly numbers in core Durables since March and April 2009 (and in that case, April 2009 was only -0.1%). It appears that orders may have gotten a bit ahead of themselves. Remember that these are February orders, so not affected by the Japanese earthquake. Shipments of capital goods ex-aircraft, a number useful in projecting GDP, was +0.8% (Bloomberg had no forecast for this number, which fell a revised -2.3% in January). Q1 GDP might be closer to zero than people were thinking a few weeks ago, but remarkably equity futures barely twitched when this bad news hit the tape.

Perhaps our markets just look better than other markets even with the caveat that equities might have discounted too much good news already. After all, in Europe (where the ECB is threatening to tighten, remember) we saw the resignation of Portuguese Prime Minister Jose Socrates today after he lost a parliamentary vote on austerity measures. German Chancellor Merkel praised him for having sought those austerity measures, and this illustrates the problem. The people - of Portugal, Ireland, Greece, and other countries seeking to implement austerity measures - feel cheated because they were told for years that they could have their cake and eat it too, and besides someone else would provide the cake. Today, they are being told that not only is there no more cake, but they are also being billed for the cake they have already eaten. And the people are being asked to vote on approving the bill for the cake. Predictably, most of them are refusing.

This creates a problem, of course, because without those austerity measures any bailout package is just a stopgap. A $100bln (€70bln) stopgap, but a stopgap nonetheless. It's analogous to trying to lose weight versus dieting and exercise, compared to having liposuction. These countries (and I include the U.S. in the category) need to change their lifestyles and live within their means, or they'll be back under the knife before you know it. But it isn't fun having someone else tell you that you need to diet and exercise.

I still don't see how the ECB raising interest rates would help rather than hurt the overall situation. Raising rates is a declaration that the central bank places greater importance on defending the ability of the core countries to access capital at low rates than on using the inflation-default option to help periphery countries. In my mind, it is all but a declaration of war on the periphery countries - "you can't default, because we won't let you, and you can't inflate your way out, because we won't help you. Here's some money. Now beat it, you ne'er do wells." Well, we'll see if the ECB follows through on its threats. If I were one of these struggling countries, I know how I would respond.

One way that the ECB is nuts is that they have press briefings after monetary policy meetings. There is just no upside at all to telling the world what the central bank believes. If it turns out to be correct, there is no credibility gain, but if it turns out to be wrong - as it has, repeatedly, in every test of the proposition - then there is a credibility loss. Moreover, having crystal clear signals is an invitation to over-lever, since it removes the question of monetary policy as a source of uncertainty. With the central bank promising to let investors know months in advance before they undertake any action, and furthermore promising to act in ways that are designed to support the market by lowering volatility, there is one less thing to worry about. Except for one little detail, and that is that the central bank doesn't control the keys to the black swan pen. When the black swan hits, the central bank will respond suddenly, and over-levered investors will get steamrolled. If it stops there, then who cares because those investors made a bad bet and over-levered. But we all know who picks up the tab when the investor or trader is "systemically significant."

So, of course, the Fed looked at the ECB with jealousy since those guys were getting all of the TV time. Why, Chairman Bernanke hasn't been on a major program since 60 Minutes, and that's despite doing his level best to make dramatic television by declaring his perfection, his "100% certainty" that the Fed can engineer the preferred outcome. That cannot stand, and thus today the Fed announced that the Chairman would now have a press briefing four times a year after policy meetings. Great idea. Terrific idea. This ought to give Ron Paul more ammunition in his crusade to do away with the Fed, that's for sure! Just when you think that central bank process can't get any worse, they find a way to make it worse. (By the way, the NY Fed recently added a blog, joining the fairly high-quality Atlanta Fed macroblog as places that central bankers can spout off both their good and their bad theories).

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There was an interesting article on Bloomberg today by columnist/economist Caroline Baum. She pointed out that the Japanese disaster is a supply shock, not a demand shock; the implication is that it is inflationary and contractionary, instead of being disinflationary and contractionary. Therefore, a central bank (actually, all central banks) should be thinking about tightening, rather than easing, in order to avoid accommodating the inflation caused by the supply shock (think easing in reaction to the 1970s oil embargo as the wrong response).

This is textbook theory, and in a 2-good, frictionless world with perfect demand and supply curves that might be the right answer. In the real world, I suspect that it is not. We don't know the knock-on consumption effects that follow from the initial supply-side impact. In fact, I could argue that the global supply shock is probably overestimated since most industries are multinational and other countries can pick up the slack for any lost Japanese production. But the important point is that all outcomes are less certain, the distribution of outcomes is more diffuse, and therefore the Fed (and all central banks) ought to move more cautiously, not less cautiously as Baum suggests.

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Tomorrow's data basically boils down to the final revision of Q4 GDP, expected to be nudged up to +3.0% from +2.8%, and a revision to the Michigan confidence figure. There are also a lot of Fed speakers scheduled - Kocherlakota, Fisher, Evans, Lockhart, and Plosser. Hey, they can't let Ben hog all the limelight, right?

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My oddball observation of the day - aside from whatever qualifies in the remarks above: yesterday night I was watching the Saturday Night Live episode from two Saturdays ago (God Bless TIVO) and saw a performance by a musician I'd not seen before. This is not surprising, since I am not an audiophile and there are almost no acts on SNL that I have seen before. But while the artist (named Jessie J) was okay the lyrics of the song, entitled "Price Tag," really intrigued me. Help me out, readers. We're 11 years into a flat market with two bubble-bursting recessions. As I said, I am not an audiophile but this is the first song I can remember hearing in a long time that was anti-consumption. I have probably just missed the trend, but I'm curious to hear if readers can name other anti-consumption lyrics from authors written in the last few years?

 


 

Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA
E-Piphany

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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