Morning Report: Bond Market Bubble talk 6/12/15

Stocks are lower as both the EU and Greece dig in their heels over a rescue package. Bonds and MBS are up small.

Inflation remains muted at the wholesale level. The Producer Price Index rose 0.5% in May, however that is energy driven. Ex food and energy, it was up 0.1%, or 0.6% year-over-year. The PPI is not that critical of an inflation index – the Fed uses the PCE deflator – but it shows that inflationary pressures remain contained. IMO we won’t see any sort of inflation until we see wage gains, and we are only just starting to see that.

Higher energy prices are not denting consumer sentiment according to the University of Michigan. June Consumer sentiment rose to 94.6 from 90.7 in May.

A couple Fed researchers have crunched the numbers and believe that the natural rate of unemployment is about 4.3%, versus the 5.2% number the Fed currently uses. They focus on labor’s share of income, which has fallen from 72.2% in 2001 to 62.9% now. If correct, that means the Fed has room to let the economy run. The bigger question is why the number has fallen so much. Is it weak bargaining power? Is it the fact that the emerging companies in the US need less employees? (For example, GE has a market cap of $276B and has 305,000 employees. Facebook has a market cap of $228B and has only 10,000 employees). IMO, it will come down to the labor force participation rate. Are the people who have involuntarily exited the labor force coming back?

Cash sales make up 35% of all home sales, according to CoreLogic. That is down from the peak of 46.5% in Jan of 2011, but still well above the pre-crisis level of 25%. So for originators, this means more “gettable” business even if existing home sales don’t improve all that much. I guess you can use cash sales as a proxy for distressed sales, and the places with the biggest foreclosure inventory and lowest price appreciation have the highest cash sales percent.

The raging debate in bond circles is whether we are in a bond bubble. Certainly sovereign debt yields are telling you that inflation is never, ever, ever coming back. However the bigger issue is corporate debt, which is being issued at a record pace as companies lock in low borrowing costs. If they were using that cash to build out capacity and invest in the business then there would be less concern. However, they are levering up to fund buybacks and M&A activity. That is a bigger issue. The biggest issue is that the holdings of corporate debt are now very, very concentrated in bond mutual funds, foreign investors and insurance companies. When there are bond fund redemptions, they have to sell. And new regulations regarding proprietary trading and bank capital mean that trading desks at the big investment banks are not going to absorb all that selling pressure. In addition, hedge funds are getting fewer and bigger as well. Corporate debt could get slammed hard if everyone heads for the exit all at once. Right now, the stock market is anticipating no problems when the Fed starts raising rates. That may end up being a bad bet.

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