Let’s begin by describing where we are in the economic Long Wave.
The week ending September 18, 2015 is analogous in my work to the week ending March 1, 1928.
If you remember our previous discussions, the Fed has the same problem now that it faced back then: Money was sitting on the sidelines (mainly in bonds) and was not out chasing higher return potentials in the secular economy.
To counter this, the Fed raised interest rates (reported here as the discount rate) several times leading up to the ultimate blow-off top September 3 of 1929.
As you can see, the 1920s Fed began with a hike in August of 1927, and since we are in the analog to March of 1928, we note that the Fed increase is way overdue.
However, the Fed was not as subject to public scrutiny back then. Communications was mainly in long boring tables of data published in back sections of big city newspapers. In today’s world, reactions will be faster.
The good news about reactions being faster, though, is that the speed of trading can reduce the evolution of “information asymmetry” within the complex global financial system.
We have seen recently, for example, how the Shanghai market has managed to decline from a 52-week of of 5166.35 down to as low as 2,289.87 without the world falling apart. I believe it is significant that a market can lose more than 50% of its value without imploding the world. It proves something but we can’t be certain what.
I like to think that when the Fed talks its next move a year in advance that everyone except a few wild-eyed traders can see what’s coming.
What the Fed should do, as I see it, is a 10 basis point increase. This would be proportionate to a “normal” 25 BPS increase at higher interest rates. It would signal to the bond market that the Fed thinking is that things really are improving, yet at the same time, it would avoid potential bloodshed if a larger increase was enacted.
Even so, a 25-basis point hike would not be the end of the world. You see that “velocity of money at M2” chart? That gives you an idea of the “inventory turns” of money. In a fractional reserve system, such as ours, the turn-over rate is critical.
During the ramp up to the Internet bubble peak (1997) the turnover of money was around 2.2 times per year. Here recently, the turnover rate has been much lower: 1.497 times and 1.5 times per year in the most recent two quarters.
The job of the Fed right now (which would be in keeping with their dual mandate) is to provide stable prices and good employment. The road to both will involve, as I see it, some increase in the turnover of money.
Raising the interest rate is a prickly problem to understand. But it goes something like this:
If you have a bond with $100 of face value, paying 1%, the price of the bond will be discounted to maturity some amount based on prevailing inflation expectations.
Thus, in a world where there is zero inflation, the 1% bond will have some value we’ll call X.
Now, however, let’s increase the inflation rate to 10% to illustrate a point. The NPV (net present value of the bond will drop – very significantly) in order to compensate for the higher inflation rate.
Frankly, I can almost hear the backroom discussions at the Fed. It might go something like this:
“Yeah…if we raise interest a big, where would the money go? Normally, we should create jobs with infrastructure projects like highways and housing, but in this economy of Apps and stupid things like a $100 pencil for a tablet, where will be bond money go?”
“I think maybe into consumer goods. But if prices go up a bit there, it won’t hurt us too badly….”
“Well, if we do that, it will be price-driven inflation, not wage driven. Shouldn’t we see some of that first?”
“Yeah, but the prevailing inflation rate is really much higher…what’s masking the real increase is the massive declines in oil prices. You filled up your car lately?”
“Yeah, but I thought our plan was to press energy down so government could up taxes more so we could get more tax revenue for infrastructure, before we raise interest rates…let state and local take some heat…”
“Yeah, but states are in trouble because of defined benefits and their retirement funds will grab anything that comes in so I say raise now…”
That’s all hypothetical, but you can see how the dance goes. Round and round. At some point in this dance someone is going to get their foot stepped on.
The argument could be made that the bondies have done massively well as the rest of the country suffered through real estate equity evaporation. So it’s their turn at the wheel. If the bondies take a hit, well so be it.
The bondies will scream like it’s rape, but it’s really just rates.
Besides, there are two aspects to any long-term bond investment: rent on money and risk of default. The bondies need a lesson or two that they’ve managed to dodge so far.
Should that money chase $100 laptop pencils? No. But there’s this new field called photobiomodulation I’ve been telling subscribers about…
Futures were about flat going into the morning’s first numbers…
Data: Save By Auto Sales, Redux
Hot off the press release:
The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for August, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $447.7 billion, an increase of 0.2 percent (±0.5%)* from the previous month, and 2.2 percent (±0.7%) above August 2014. Total sales for the June 2015 through August 2015 period were up 2.2 percent (±0.5%) from the same period a year ago.
The June 2015 to July 2015 percent change was revised from +0.6 percent (±0.5%) to +0.7 percent (±0.1%). Retail trade sales were up 0.1 percent (±0.5%)* from July 2015, and 1.4 percent (±0.7%) above last year. Food services and drinking places were up 8.2 percent (±3.3%) from August 2014 and nonstore retailers were up 6.9 percent (±1.4%) from last year.
No surprise around here, Auto Sales Saved America:
Just one question: Who’s buying all the damn cars? Take out car sales and the economy sucks because why?
Data 2: Empire State Data
Manufacturing data just out, too:
“The September 2015 Empire State Manufacturing Survey indicates that business activity declined for a second consecutive month for New York manufacturers. The headline general business conditions index remained well below zero at -14.7. As in August, declines were reported for both orders and shipments, with the new orders index coming in at -12.9 and the shipments index registering -8.0. The inventories index slipped a point to -18.5, indicating a continuing drop in inventory levels. Price indexes pointed to a small increase in input prices and a small decline in selling prices. Labor market indicators suggested that both employment levels and hours worked contracted. Indexes for the six-month outlook were generally lower than last month, suggesting that optimism about future conditions waned.
Our bottom line:
Although there is some case to be made for a 10 BPS rate increase at the Fed meeting tomorrow, the latest data here don’t support even that. The only thing that would light up a rate hike would be a blip in Consumer Prices tomorrow morning, but with falling gasoline prices, don’t hold your breath.
Drop by Thursday morning for the post mortem as we find out if the Fed plans work, or not.
IF the Fed was SMART, they would pass on a hike tomorrow but hint the “fine tuning” of 10 BPS instead of traditional 25 BPS moves may be used. Then I would expect a 10 BPS hike at the October meeting which would spur the market to retest the S&P 1,850 down to 1,812 level, previously expected in the present timeframe.
E.G. we expect that market low in early November now, and Schmitatans will have to toss out that nonsense when the market rallies *(if it does) later this week. The 10 BPS approach would slowly let the air out of the bond market and would preserve order and set up the final wave 5 rally.
Gallup Economic Confidence Model is still at –14…
Which gets us to thinking that the potential long-term benefits of supporting Syria (potential for oil and gas in the region, destabilization of Europe) is sure a fine payback for the US intervention in Ukraine which upset a delicate long-term balance.
Just Like Old Times
What’s the old saying? Like father, like son? Nuts – both of ‘em.
The Iran nuclear deal just keeps looking worse and worse. We see how China is going buddy-buddy with Iran now. Oil for nuclear development tools sets up a nuclear arms race in the Middle East…
Sadly, regardless of how things go in Washington, I wo9uld encourage you to read the Washington Post’s Fact Checker Column: Obama’s claim that the Iran deal has ‘strong support’ from lawmakers and citizens.
They politely don’t call Obama a liar…but since I’m not on the press release handout and suck-up list, I will simply note that to me “strong support” means more than 50% and that is NOT the case.