Food Fight!

By: Michael Ashton | Thu, May 19, 2011
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The maxim goes that victory has a thousand fathers, but defeat is an orphan. The solidarity in official Europe that accompanied the original Greek bailout is fraying, and rapidly. EU finance ministers have been working furiously to put together some sort of package that would "re-rescue" Greece while giving some hope that the package would actually meet approval from the various constituent nations of the EU. They have had another constraint as well, which Citigroup thinks is throwing a wrench into plans to 'soft-restructure' or 'reprofile' Greek debt. According to a Bloomberg story,

"Officials struggling to stem the crisis want to avoid triggering swaps out of concern for stigma, contagion and rewarding speculators, whom they blame for worsening the region's crisis, Hampden-Turner said."

This seems to me to be a bad time to throw a hissy fit. Stop me if I am wrong, but weren't the speculators who said the first bailout wasn't going to work...correct? Can you seriously make the case that Greece, plunging output and all, would have been just fine if nasty speculators hadn't bet the 'under'? For goodness' sake, let it go. Maybe next time, the ministers ought to look at the market signals and talk to some of those folks who suggested last year's band-aid wasn't going to change anything but the timing of the ultimate resolution of the crisis. Actually, perhaps now might be a good time to talk to those people!

Meanwhile, the EU ministers have a bigger fight on their hands anyway. Their flank has been exposed by the ECB of all institutions. Today the ECB warned the EU that if Greece restructured its debt at all - haircuts, maturity extensions, whatever 'reprofiling' it wants to do - then the ECB would cut off the bottomless credit line that it extends to Irish and Greek banks. Specifically, it would stop accepting non-investment grade paper...such as, for example, Greek sovereign collateral for these loans. Apparently the fiction they have grumblingly accepted, that sovereign bonds are always worth par, is harder to put over when the bonds have actually defaulted.

Well, isn't this a fine kettle of fish? Hang together, Ben Franklin said, or assuredly we shall all hang separately. They're warming up the gallows right now, and while half of the policymakers are preparing to tilt at another windmill the other half are preparing their alibis. I suspect this makes the tilt more difficult.

What would really help these various crises is for a nice, robust recovery to take hold. But this looks like a distant dream. Today's Initial Claims data were better than expected, at 409k, but Existing Home Sales were disappointing (5.05mm versus 5.20mm, with a large rise in the inventory of new homes as shown below).

US New Privately Owned Housing Units
You can still have your pick of existing homes. Inventory remains very high.

This just isn't getting better very quickly; a year ago the inventory of existing homes stood at 4.029mm; today it is at 3.870mm. We might hypothesize that the steady inventory might still represent improvement as the 'shadow inventory' of foreclosed and nearly-foreclosed homes is gradually making it into actual inventory - we will look at some charts a little later that call that idea into some question.

The reallydisappointing number was Philly Fed, which showed 3.9 versus 20.0 on the headline figure. The table below shows the various subindices (which are independent from the headline question), along with last month's number and December's for comparison.

Philly Fed components

The fact that "Number of Employees" held up, and actually increased, while "New Orders," "Average workweek," and most other subindices dropped is moderately cheering, since it suggests the possibility that businesses are seeing the current slowdown as a temporary ripple of the Japanese supply-chain disruption. In that case, while New Orders might drop and people might not be working as hard, you wouldn't necessarily want to be shrinking your workforce. I wouldn't read too much into one month's worth of the Philly Fed, but this is one interpretation that might soften the impact of the headline figure (who says I can't be optimistic sometimes?).

Now, let's step a bit further back and look at some other charts, which are from the New York Fed's Quarterly Report on Household Debt and Credit. We read a lot about how credit trends are improving, and that's surely true. Given how bad the economy was in the aftermath of the Lehman et. al. collapses, almost anything represents an improvement. This is why we can get excited about 400k Initial Claims, which ordinarily would be something less than thrilling. Back to credit, though. The following three charts are (a) the proportion of total consumer credit balances by state of delinquency, (b) the dollar value of new serious

delinquent balances, and (c) the quarterly transition rates for 30-60 day late mortgage accounts.

Total Balance by Delinquency Status
New Seriously Delinquent Balances by Loan Type

Transition Rates

There is no denying that all three of these charts are better than they were just a year or two ago. But there's also no denying that each of these trends is still worse than it was at the depths of the last recession. Less than 90% of consumer loans are current, and around 4% are seriously 'derogatory' (somewhat more than 120-days late) The 120-day-late loans have either been curing or transitioning to the 'derogatory' category as fast as others are written off. The second chart suggests that mortgages are still going bad at very high rates. Think back to the 'shadow inventory is draining' hypothesis, which was a sunny way to look at the inventory of existing homes. The second chart above tells us that the shadow inventory continues to fill, albeit at a lower pace than it was filling last year. And finally, the last chart tells us explicitly how many of the 30-60 day late mortgages are getting current, versus getting more delinquent. In the good old days (when you could easily refinance yourself temporarily out of a bad situation and kick the can down the road, rather like Greece come to think of it), roughly four mortgages cured for every one that transitioned to 90+-days delinquent. Now, those numbers are even. Better than at the depths of the crisis, sure. But good? I wouldn't say that.

The implication of this is that while the next hurricane isn't hitting at high tide, it isn't hitting at low tide either. The U.S. economy (and by extension, most of the global economy) is not healed, and not in a position to take another serious body blow such as might be associated with, say, a Greek default. Or an Irish default. Or a Portuguese default. Or a Spanish default. Or the Fed selling a couple trillion bonds.

I believe the Federal Reserve is serious about eventually withdrawing QE2, and steadfastly against QE3 (although the FOMC minutes left that door open wider than I had expected). But suppose that Greece can't be saved without restructuring, and the ECB crosses its arms petulantly (they just tightened, after all), and various banks shudder and threaten to topple? Will the much more-dovish Federal Reserve ride to the rescue?

Do you want to bet they won't?

Maybe this is why the TIPS auction went passably well today. The market had backed up 5bps, but investors were still being asked to buy a 10y TIPS issue with a real yield around 0.88%. The possibility that Bernanke might ride again - and we're just now starting to experience the negative effects of his first ride - might be enough to persuade investors to hold small-upside paper in order to avoid the possible big downside if the food fight gets messy.



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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