Stocks are up this morning as we await the big day Thursday. Bonds and MBS are down.
Retail Sales rose 0.2% in August, just missing the 0.3% Street estimate. The control group (which excludes volatile and price-sensitive goods like autos, gasoline and building supplies) rose 0.4%, which was better than the 0.3% Street estimate. August is the back-to-school month, so overall decent numbers, which bodes well for the holiday shopping season. Big retailers like Amazon.com and Wal Mart are up pre-open.
Industrial Production fell in August by 0.4%, which was lower than the -0.2% estimate. Capacity Utilization fell to 77.6% from 77.8%. Separately, the Empire Manufacturing Survey (which measures manufacturing activity in New York State) was highly negative at -14.7. The strong dollar is taking a bite out of manufacturing activity.
Business inventories and sales rose 0.1%. The inventory-to-sales ratio held steady at 1.36x. The inventory / sales ratio has been ticking up recently, which is a worrisome sign, at least for a cyclical recession. During recessions, it is not uncommon to see a big spike in this ratio. Historically, it has been much higher. You can see on the graph below the latest increase, and also the secular decline in the ratio that began in the mid-80s as manufacturing implemented just in time inventory management.
Tim Duy, an influential Fed-watcher makes the case for not moving this week. His argument: With rates at the zero bound and market turmoil, the Fed has no margin for error since it is more or less out of ammo. Better to wait until the waters are calmer to make a move. FWIW, I tend to agree with those arguments, and I think the Fed is very wary of a 1937 scenario. Inflation is nowhere to be found and while there is a bubble in credit markets, widening credit spreads are acting as a tightening all by themselves (the Larry Summers argument).
The argument for raising rates: – we have bubbles in the credit markets, and certainly in the pre-IPO market. Uber, which earns nothing, and has a market cap similar to Dow Chemical, is indicative of a craziness we haven’t seen since the skyrocketing IPOs of eToys and Pets.com in the late 90s. Stocks are up 200% from the lows in 2009. His point is that we DO have inflation – but it is “too much money chasing too few assets,” not “too much money chasing too few goods.” Imagine if the Fed had raised rates in 2003 and the real estate bubble had popped in 2004. We still would have had a recession, but I seriously doubt the banking system would have collapsed the way it did in 2008. And the recession would have certainly been shorter and less severe than 2008 – 2009. His point: it is time to end the addiction to low interest rates. The economy is strong enough to take a Fed Funds rate of 50 basis points. This argument is highly, highly unpopular in policy circles, so it won’t get any traction. The consensus in Washington (at least on the left, which runs things at the moment) was that policy had absolutely nothing to do with the bubble – it was 100% Wall Street Sharpies that did it, and “smart regulation” will prevent another one from happening.
Note that the one advocating for standing pat is a professor, and the one advocating moving is a trader. So they will look at the issue from two entirely different points of view.
As credit spreads have widened, we have seen some jumbo securitizations pile up at the banks. This probably signals less aggressive jumbo pricing ahead. LOs – something to tell your borrowers, especially if they are thinking of floating right now. Even if the 10 year bond goes nowhere, jumbo rates could be heading up.
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