Disowned

By: Michael Ashton | Wed, Feb 1, 2012
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The data today were weaker-than-expected, but I can't characterize them as weak. ADP missed expectations by 45k when revisions are included, but if we can blame the spike last month and the plunge this month on poor seasonal adjustment, the average was still 231k and that would ordinarily be considered quite acceptable for an expansion (if not for the early stages of an expansion). The average for 2004, 2005, and 2006 was 165k, so this isn't too shabby in the grand scheme of things.

Similarly, although ISM Manufacturing fell short of expectations at 54.1, as I pointed out yesterday that's not really falling short of where the actual expectations were. And it represents a jump from 53.1 last month. Again, 54.1 is in the 'expansion' zone. It's below where it was last spring, and in the spring of 2010, but manufacturing isn't falling apart, at least yet.

Not to be overlooked is that domestic vehicle sales for January were at a seasonally-adjusted 14.13mm units, above expectations and at the highest level (excluding the cash-for-clunkers spike) since May 2008 (see Chart, source Bloomberg).

US Auto Sales

Considered another way, sales almost reached levels that were typical of mature expansions such as those in the late 1990s and the late 1980s. They are not at levels, and probably won't reach levels, at the 0%-financing-induced plateau of the early 2000s. It is incredible, when you think about it, that car companies were floundering through the 2000s despite record sales. This is a great example of how excessive private debt can dampen inflation: margins were tight and, rather than push up prices and margins but lose cash flow, heavily-indebted car companies had to spread their interest costs over as many cars as they could in order to make any profit at all. Now, of course, Government Motors has dramatically less debt (in 2008, the old GM had $102bln in long-term liabilities; now it has $55bln) and wiped out $50bln of a $60bln post-retirement medical care liability out when they turned it over to the UAW to run. With essentially $100bln less in debt, GM doesn't need to sell a trillion cars to make money. (More cynically, the profit motive is somewhat less operative now as well, considering that the overlords have other metrics they are shooting for).

So, while the data are disappointing to those economists and investors who were reaching for the stars but only got the moon, it's not that bad. I need to add the caveat 'yet,' because I think the economy isn't going to be expanding all year, but we're still chugging along.

Equities therefore had another swell day, rising 0.9%. Commodities rose, and inflation swaps jumped about 4bps as bond yields rose. Portuguese yields fell sharply as it was able to easily sell its Treasury bills, as I suggested on Monday would happen. By these bill sales Portugal thereby kicks at least some of its funding problem all the way to May and July. Whee! The country is not out of the woods yet, folks.

While we enjoy some good data here, the biggest dangers for investors remain European growth, and global inflation. Regarding the latter, a strongly-worded speech by Bundesbank president Jens Weidmann suggested that the ECB's provision of liquidity is "too generous" and raises "higher risks for banks and thus also risks to price stability." The old wisdom held that the ECB had "Bundesbank DNA," but it sounds to me like it is on the verge of being disowned by Daddy.

Another back-page story to keep an eye on as it is a prime candidate for the 2012 "unintended consequences award" was the recommendation, contained in the report released yesterday from the Treasury Borrowing Advisory Committee (TBAC), that the Treasury start to allow T-Bill auctions to clear at negative yields. What happens now is that in periods of crisis, T-bills have been trading with negative yields; however, since the Treasury can't mechanically auction them at negative yields, the auctions will be extremely well bid at a zero yield (that is, the T-Bill is issued at par and matures at par, with no interest) and then immediately trade at a negative yield in the secondary market. It's free money to the banks who participate, and the TBAC suggests seemingly-cleverly that the auctions should be allowed to clear at negative yields so that the Treasury isn't just throwing away money.

The problem is akin to the problem a football team faces when it sells tickets at $80 and watches them immediately be scalped for $150 to fans clamoring for tickets to the sold-out game. Why doesn't the team just charge the going rate of $150 and cut the scalpers out, taking all the surplus to themselves? There are lots of reasons, most of which boil down to wanting to make sure they keep fans happy,[1] but one reason is that the team wants to make sure the game sells out all the time. If the game isn't sold out, it can't be shown in local markets. And if it can't be shown in local markets, it means the TV revenue is lower. So by sacrificing a few bucks, the team makes sure the game is sold out.

I would suggest the Treasury ought to consider this analogy. A failure to "sell out" a T-Bill auction - for the record, this week the Treasury sold $93billion in 4-week, 3-month, and 6-month bills - would be worth far more in a negative direction than the pennies the Treasury gives up to the "scalpers."

From a trading perspective, this creates a singular risk every time there is an auction that may clear at negative yields. Maybe everyone will show up and bid 0%, so the auction will just tail back to zero. And, maybe not. It's a small chance, but it's one more random thing to have to keep an eye on.

Thursday before Employment would ordinarily be a sedate trading session but we are again on Greek PSI watch. Today a headline ran (on Dow Jones, I think) predicting there would be agreement within 24 hours. Obviously, there will be a knee-jerk positive response when there is a deal announced, even though the details may not be announced right away and we certainly won't know whether anyone will participate. Greece is not only not out of the woods, it's tied to the tree.

Initial Claims (Consensus: 371k from 377k) is due tomorrow. Claims the day before Employment doesn't usually deserve much attention, but in this case it's worth watching with one eye because the seasonal volatility is diminishing and so the error bars are narrowing as well.

Be aware that both Chicago Fed President Evans (he of the 'Evans Rule' suggesting that rates be declared to be immobile until Unemployment falls below some stated threshold) and Chairman Bernanke are speaking tomorrow morning.

 


[1] By letting fans pay a floating price to a scalper, the scalper can extract the consumer surplus while the football team charges a price that most fans could pay. So a fan who can't get into the game because the scalper is charging $150 isn't mad at the team because the team charged $80. He's mad at the scalper. But I digress.

 


 

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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