Morning Report: Trade war tensions pushing rates lower 3/5/18

Vital Statistics:

Last Change
S&P Futures 2681.3 -9.0
Eurostoxx Index 369.2 2.2
Oil (WTI) 61.4 0.1
US dollar index 83.8 0.1
10 Year Govt Bond Yield 2.84%
Current Coupon Fannie Mae TBA 103.591
Current Coupon Ginnie Mae TBA 103.688
30 Year Fixed Rate Mortgage 4.4

Stocks are lower this morning the trade cold war between the US and the world escalated. Bonds and MBS are up.

Those hoping that Donald Trump would re-think his position on trade over the weekend were disappointed. He is now threatening EU automakers and demanding a re-negotiation of NAFTA to ease steel and aluminum restrictions with Mexico and Canada. Exiting and / or renegotiating NAFTA will probably not be as easy as he thinks it will be. The US has always had the leadership position globally in encouraging free trade. There is no doubt it that has accepted some protectionism from other countries as a cost of doing business, and in the spirit of moving the ball on free trade in general. In other words, the US has accepted a disadvantaged position, and these “free trade” agreements were in reality a negotiation over how many points the US would spot other countries.

Rates this week will be primarily determined by the fluid state of trade announcements. We will get  some important market-moving data this week with the jobs report on Friday, and productivity on Wednesday. There will also be Fed-Speak all week.

Big picture, trade tensions are causing a flight to quality, which is pushing down interest rates. This is probably going to be only a temporary phenomenon so I would encourage LOs to push their customers to lock. Despite rising rates, we are not seeing an influx of foreign money into Treasuries, and we are seeing European investors and Japanese investors investing in Bunds and JGBs despite the lower yields. Why would investors accept 62 basis points in Germany or 5 basis points in Japan when they could get 2.8% in the US? Currency hedging costs wipe out the differential.

Trade battles are generally bad for everyone involved, except for domestic producers in the industries being protected. Note that Secretary of Commerce Wilbur Ross is an ex-steel guy himself and is not an idealistic free-trader. I suspect that is where Trump is getting his advice, although the media claims it was a petulant decision out of the blue as a result of negative headlines.

Tariffs on steel and aluminum will be bad for the construction industry, especially multi-fam. Don’t forget, the housing business is already dealing with a 20% tariff on Canadian soft lumber. Building Material prices are already at record highs.

The services economy continues to expand, with the ISM Non-Manufacturing index hitting 59.5 in February. This was lower than the exceptionally strong January reading of 59.9. The internals of the report were good, with the New Orders and Employment indices coming in over 60. Some of the comments from business below:

  • “Lumber-related costs continue to increase as supply is also starting to become a problem. The market volatility of construction materials and the short supply of construction labor have added difficulty to long-term planning.” (Construction)
  • “Slight increase in activity; beginning to see some higher cost for goods and services.” (Finance & Insurance)

Strong growth and inflation is the takeaway.

Amazon is in talks with JP Morgan to start providing checking account services. Amazon mortgages can’t be far behind. Has Bezos ever looked at banking P/E ratios? They aren’t triple digit.

European Contagion

There is quite a lot in the news about the Euro crisis. I’m skeptical of claims that a Euro implosion would be disastrous for the U.S. economy. First off, Greece being ejected from the Euro doesn’t mean the end of the Euro. Just that Greece was brought in with an overvalued currency and with the full knowledge that the books were cooked. The U.K. was ejected from the Euro’s predecessor 20 years ago. That event propelled a dramatic economic recovery from disastrous interventions to stabilize its currency. It’s also the primary reason Labor was in government from 1997 to 2011. Even with larger knock on effects, the Euro zone is not a significant growth market for U.S. exports and an economic slow down might have a knock-on effect for materials prices. The U.S. performance this year tracked fairly well with oil. I’m likely wrong about this, but I don’t see this as our greatest challenge.

The most interesting piece that I read was a graphic in today’s Post illustrating U.S. exports to Europe. As I expected, exports to the southern tier countries aren’t that great. I expected the bigger EU countries (U.K., France, Germany) to make up the lion’s share. The shocker to me is that the largest market for us is Benelux (Belgium, Netherlands, Luxembourg), accounting for roughly $55B of U.S. exports per year, well ahead of the U.K. at $42B. One might quibble with me combining the three countries, but our Benelux exports rival those to Germany and France combined ($58B). For the record, here’s the top 10.

Country Imports Exports
Canada $237B $210B
Mexico $196B $146B
China $292B $74B
Japan $92B $49B
United Kingdom $38B $42B
Germany $72B $36B
Korea, South $43B $33B
Netherlands $18B $32B
Brazil $22B $32B
Hong Kong $3B $27B

Incidentally, there is only one country that shows zero imports or exports to the U.S.–Yemen. Unless you included postal bombs.


It’s Demand & Income Inequality (Wed. Open Thread)

One of my favorite conservatives, Bruce Bartlett, confirms what I’ve been saying for the last year. We’ve seen the economy worsen, from the small business perspective, and slow to a crawl. We talk to between 30 and 40 business owners a day, and don’t forget 78% of small businesses have less than 20 employees, and they all tell us they don’t really give a diddly squat about regulations or taxes right now. They care about the lack of customers. I understand my evidence is anecdotal, and there’s not necessarily a reason to believe me, but now the Bureau of Labor Statistics has verification. I also get it that Republicans and some large businesses care about regulations, especially the energy and health care industries, but could we stop pretending it’s true for small businesses or all large businesses?

On Aug. 29, the House majority leader, Eric Cantor of Virginia, sent a memorandum to members of the House Republican Conference, telling them to make the repeal of job-destroying regulations the key point in the Republican jobs agenda.
“By pursuing a steady repeal of job-destroying regulations, we can help lift the cloud of uncertainty hanging over small and large employers alike, empowering them to hire more workers,” Mr. Cantor said.
Evidence supporting Mr. Cantor’s contention that deregulation would increase unemployment is very weak. For some years, the Bureau of Labor Statistics has had a program that tracks mass layoffs. In 2007, the program was expanded, and businesses were asked their reasons for laying off workers. Among the reasons offered was “government regulations/intervention.” There is only partial data for 2007, but we have data since then through the second quarter of this year.
The table below presents the bureau’s data. As one can see, the number of layoffs nationwide caused by government regulation is minuscule and shows no evidence of getting worse during the Obama administration. Lack of demand for business products and services is vastly more important.


I also came across this interesting study yesterday. We’ve looked at so many statistics on income inequality, but I’m not sure anyone really understands why it’s important. I think this study gets to part of it at least. I also believe the “Occupy Wall Street” protests reflect the helplessness people, especially young people, feel in being able to combat it. Oh I know, they’re just a bunch of kids and unemployed people who don’t understand the global economy, but they know what’s happened to them over the last three years and it feels wrong. They’re calling themselves the 99% and that’s for both being unemployed and without benefits and also in the bottom 99%.

For example, the bailouts and stimulus pulled the US economy out of recession but haven’t been enough to fuel a steady recovery. Berg’s research suggests that sky-high income inequality in the United States could be partly to blame. So how important is equality? According to the study, making an economy’s income distribution 10 percent more equitable prolongs its typical growth spell by 50 percent.

Berg and Ostry aren’t the first economists to suggest that income inequality can torpedo the economy. Marriner Eccles, the Depression-era chairman of the Federal Reserve (and an architect of the New Deal), blamed the Great Crash on the nation’s wealth gap. “A giant suction pump had by 1929-1930 drawn into a few hands an increasing portion of currently produced wealth,” Eccles recalled in his memoirs. “In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When the credit ran out, the game stopped.”

Many economists believe a similar process has unfolded over the past decade. Median wages grew too little over the past 30 years to drive the kind of spending necessary to sustain the consumer economy. Instead, increasingly exotic forms of credit filled the gap, as the wealthy offered the middle class alluring credit card deals and variable-interest subprime loans. This allowed rich investors to keep making money and everyone else to feel like they were keeping up—until the whole system imploded.
There is a link to the study here which is in the current issue of Finance & Development, the quarterly magazine of the International Monetary Fund.


And last, but not least, it’s the trade deficit stupid. This piece in The Nation is an important one I think. Essentially, we need to get the wealthy investors to quit investing in financial instruments and steer them into long term “making stuff for export and consumption” stuff. There are ways to do that but they probably won’t like it too much because it’s much easier to do what they’re doing now.

But what’s behind it all is the fact that the United States cannot pay its way in the world. And while a smaller country would have expired long ago, we keep stumbling along, getting sicker, losing industrial weight, because the rest of the world has an interest in continuing to hold us upright. 

For Keynes that would be the challenge—not just to bring down but to eliminate it: the whole thing. The failure to do so has real implications for other parts of Keynes’s theory. The answer to our crisis is not to “hire and rewire,” or to have a lot of public works. Let me add, by the way: I’m a labor lawyer; I want the government to spend. I love public works. I’d love a new O’Hare Airport. I’d love a repaving of Lake Shore Drive. And certainly Keynes loved public works. He saw people starving; he had a heart. We have to do something. We can’t wait for the trade deficit to come down. But that’s not the answer—it’s urgent, to be sure, but it’s just a first step. The answer is to get rich people to put their money into real “investments” and not “loans.” It’s to induce the rich in this country to invest “by employing labor on the construction of durable assets.” Call them widgets; call them iPads. Call them anything we can wrap, ship and sell to somebody abroad.“Oh, but he wouldn’t put that ahead of the stimulus.” 

No—but he’d put them together.

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