Morning Report – The Week Ahead 1/5/15

Markets are lower this morning as oil and the euro continue to slide. Bonds and MBS are up.

The NY ISM came in at 70.8, a very strong number. We are also getting December vehicle sales this morning, and the generally look strong.

This promises to be an eventful week, with the FOMC minutes on Wednesday and the jobs report on Friday. It will be interesting to see how the Fed viewed 3Q GDP at 5% – is this a temporary blip, or the beginning of a more robust recovery. Note the Fed did not change its 2015 GDP estimate, which is still in the range of 2.6% to 3.0%. I would be interested to see their internal forecast for the price of oil, but that won’t be released.

The other focus will be on the Fed’s MBS portfolio: If I were the Fed, I would be very reluctant to continue to purchase MBS at these levels. While QE is officially done, the Fed is still re-investing funds from maturing MBS back into the market. With prepayment speeds picking up, it seems like the Fed has a golden opportunity to shrink its balance sheet with a minimum of disruption to the capital markets.

Chart: Federal Reserve Bank Total Assets 2006 – Present:

While the drop in oil is a good thing for the US, it does pose some risks to the financial system, as emerging market distressed debt continues to get smoked. The banking system is much better capitalized now than it was in 2008 or even the late 90s, when the Asian Tiger crisis threw the markets for a loop. This is already pushing down interest rates worldwide (the flight to quality), so keep in mind the push-pull dynamic happening with US rates – in an economic vacuum, US rates would be much higher due to the recovery, but international worries and relative value trades are pulling them lower. One possible dark cloud – during the Asian Tiger Crisis, the Fed cut rates help ease the pain in the financial system. They don’t have that option this time.

21 Responses

  1. Good David Frum piece:

    “Does Immigration Harm Working Americans?
    Many economists say no—but they may be too glib.
    David Frum Jan 5 2015, 7:30 AM ET ”


  2. Can acountryysustain economic growth without population growth?


    • Can a country sustain economic growth without population growth?

      Theoretically, yes. In practice, I doubt it. In practice, permitting skilled immigration [not “family reunification”] should increase productivity.

      Theoretically, productivity could increase fast enough through technological breakthroughs to make increasing the population non-critical. That happens, but not reliably or smoothly, by any stretch.


    • McWing:

      Can acountryysustain economic growth without population growth?

      Certainly not in the context of a substantial and growing welfare state.


  3. When protesters are self defeating.

    “#BlackBrunchNYC protests disrupt ‘white’ N.Y. breakfast spots
    By Justin Moyer and Nick Kirkpatrick
    January 5 at 2:31 AM”


  4. Wow!

    This is all the result of the regents’ irresponsible oversight. In 1990, UCRP had 137 percent of the assets it needed to meet its obligations, so regents suspended employer and employee contributions to the pension fund. State legislators also stopped allocating money to UCRP. This “pension contribution holiday” lasted 20 years. To top it off, during this period, university officials boosted pension benefits a half-dozen times. By 2012, more than 2,100 UC retirees were each collecting six-figure pensions for life.
    The contribution holiday and benefit increases devastated the pension fund, with funding levels plummeting from 137 percent to only 75 percent. A September 2010 UC report admitted the catastrophic mismanagement: “Had contributions been made to UCRP during each of the prior 20 years at the normal cost level, UCRP would be approximately 120 percent funded today.”

    Five years later, UC officials are denying their mismanagement. Gary Schlimgen, an executive director with the retirement system, said recently: “The contribution holiday is neither here nor there. . . . We feel we’ve been responsible stewards of the system. Pension plans cost a lot of money to keep going. They just cost money.” In reality, what costs more money is not making sufficient contributions and losing decades of compounded earnings.


  5. Heh.


  6. This is great.

    “Health Care Fixes Backed by Harvard’s Experts Now Roil Its Faculty

    JAN. 5, 2015”


  7. Choking. On. It. is for the little people I guess.


  8. @ScottC: “But here’s a crazy fact: those 46 Democrats got more votes than the 54 Republicans across the 2010, 2012, and 2014 elections.”

    Vox should read the constitution, or some history. That’s the whole frickin’ point of the senate. It’s why we have one, and representation of those lower population states being even of the higher population states is the whole reason we had 13 colonies, and eventually 50 states, in the first place.

    Interesting such awareness of this electoral “unfairness” only gets noticed with the GOP wins.

    “The problem isn’t that the deck is stacked in favor of Republicans. The problem is that the deck is stacked in favor of small states”



    • Kevin:


      Perhaps the author was educated overseas and never actually attended an elementary school American history lesson.


  9. “The Senate is a profoundly anti-democratic body and should be abolished.”

    You’d think we lived in a representative republic or something! Who’da thunk it?


  10. From the Atlantic:

    And the main effort of military leaders through the past decade, under the Republican leadership of the Bush administration and the Democratic leadership of Obama, has been to get rid of the A-10 so as to free up money for a more expensive, less reliable, technically failing airplane that has little going for it except insider dealing, and the fact that the general public doesn’t care.

    The weapon in whose name the A-10 is being phased out is its opposite in almost every way. In automotive terms, it would be a Lamborghini rather than a pickup truck (or a flying tank). In air-travel terms, the first-class sleeper compartment on Singapore Airlines rather than advance-purchase Economy Plus (or even business class) on United. These comparisons seem ridiculous, but they are fair. That is, a Lamborghini is demonstrably “better” than a pickup truck in certain ways—speed, handling, comfort—but only in very special circumstances is it a better overall choice. Same for the first-class sleeper, which would be anyone’s choice if someone else were footing the bill but is simply not worth the trade-off for most people most of the time.

    Each new generation of weapons tends to be “better” in much the way a Lamborghini is, and “worth it” in the same sense as a first-class airline seat. The A-10 shows the pattern. According to figures from the aircraft analyst Richard L. Aboulafia, of the Teal Group, the “unit recurring flyaway” costs in 2014 dollars—the fairest apples-to-apples comparison—stack up like this. Each Warthog now costs about $19 million, less than any other manned combat aircraft. A Predator drone costs about two-thirds as much. Other fighter, bomber, and multipurpose planes cost much more: about $72 million for the V-22 Osprey, about $144 million for the F-22 fighter, about $810 million for the B-2 bomber, and about $101 million (or five A‑10s) for the F-35. There’s a similar difference in operating costs. The operating expenses are low for the A-10 and much higher for the others largely because the A-10’s design is simpler, with fewer things that could go wrong. The simplicity of design allows it to spend more of its time flying instead of being in the shop.

    In clear contrast to the A-10, the F-35 is an ill-starred undertaking that would have been on the front pages as often as other botched federal projects, from the Obamacare rollout to the FEMA response after Hurricane Katrina, if, like those others, it either seemed to affect a broad class of people or could easily be shown on TV—or if so many politicians didn’t have a stake in protecting it. One measure of the gap in coverage: Total taxpayer losses in the failed Solyndra solar-energy program might come, at their most dire estimate, to some $800 million. Total cost overruns, losses through fraud, and other damage to the taxpayer from the F-35 project are perhaps 100 times that great, yet the “Solyndra scandal” is known to probably 100 times as many people as the travails of the F-35. Here’s another yardstick: the all-in costs of this airplane are now estimated to be as much as $1.5 trillion, or a low-end estimate of the entire Iraq War.

    The condensed version of this plane’s tragedy is that a project meant to correct some of the Pentagon’s deepest problems in designing and paying for weapons has in fact worsened and come to exemplify them. An aircraft that was intended to be inexpensive, adaptable, and reliable has become the most expensive in history, and among the hardest to keep out of the shop. The federal official who made the project a symbol of a new, transparent, rigorously data-dependent approach to awarding contracts ended up serving time in federal prison for corruption involving projects with Boeing. (Boeing’s chief financial officer also did time in prison.) For the record, the Pentagon and the lead contractors stoutly defend the plane and say that its teething problems will be over soon—and that anyway, it is the plane of the future, and the A-10 is an aging relic of the past. (We have posted reports here on the A-10, pro and con, so you can see whether you are convinced.)

    In theory, the F-35 would show common purpose among the military services, since the Air Force, the Navy, and the Marine Corps would all get their own custom-tailored versions of the plane. In fact, a plane designed to do many contradictory things—to be strong enough to survive Navy aircraft-carrier landings, yet light and maneuverable enough to excel as an Air Force dogfighter, and meanwhile able to take off and land straight up and down, like a helicopter, to reach marines in tight combat circumstances—has unsurprisingly done none of them as well as promised. In theory, the F-35 was meant to knit U.S. allies together, since other countries would buy it as their mainstay airplane and in turn would get part of the contracting business. In fact, the delays, cost overruns, and mechanical problems of the airplane have made it a contentious political issue in customer countries from Canada and Holland to Italy and Australia.


    • A man who worked for decades overseeing Pentagon contracts told me this past summer, “The system is based on lies and self-interest, purely toward the end of keeping money moving.” What kept the system running, he said, was that “the services get their budgets, the contractors get their deals, the congressmen get jobs in their districts, and no one who’s not part of the deal bothers to find out what is going on.”


  11. Is it shocking there is corruption in the Pentagon? Its the 2nd most corrupt entity in government.


  12. I’m tempted to say it’s a tie between the Executive branch, the Legislative branch and the Judicial Branch but instead I’ll say Medicare. It should be eliminated completely.


  13. What’s the first?

    I vote for DHS.


    • DHS would be my guess, too. Although several of the individual agencies were really good before they were forced into the mix. Perhaps it is a coincidence that the larger the bureaucracy the less transparency it has.


      • Mark/Mich:

        DHS would be my guess, too.

        The DHS budget is relatively tiny. Under the theory that, in order to find corruption, follow the money, I’d say that health and human services is where most of the corruption lies.


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