All Things in Moderation

Vital Statistics:

Markets are flat after a mixed bag of economic data.  Retail sales increased .3% in November vs an expectation of .5%.  Initial Jobless claims fell to 343k and were well below the 369k expectation. The Producer Price Index showed inflation running lower than anticipated. The Bloomberg Consumer Comfort Index fell.  Bonds are down a few ticks and MBS are flat. 

As expected, the Fed announced a Treasury buying program in its FOMC statement. $45 billion per month, until unemployment drops below 6.5% and inflation stays below 2.5%.  Bernake was careful not to characterize the 6.5% unemployment rate as NAIRU – or the non- accelerating inflation rate of unemployment. They took down their GDP projections from September, with their 2013 GDP forecast falling to a range of 2.3 – 3.0 from a range of 2.5 – 3.0.  They also took down unemployment as well, to a range of 7.3% to 7.7% from a range of 7.6% – 7.9%.  Inflation forecasts were lowered as well. Here is a video of the press conference.  Bonds reacted negatively to the announcement.  Biggest takeaway – the Fed has the pedal to the metal and they are writing the book as they go along. 

Looks like no progress so far on the fiscal cliff. A recent poll shows overwhelming support for increasing taxes on the rich.  Business execs have been lobbying for a deal. Liberals are fighting spending cuts. Bernake mentioned in his press conference that the Fed does not have the ability to offset the negative effects to the economy if we go over. 

A delay in BofA’s jumbo deal shows just how hard it is to bring private capital back into the mortgage market. Private Label Securitizations were $3.5 billion this year, versus $1 trillion in 2006. Blame Dodd-Frank’s proposed “skin in the game” rules, which combined with accounting and other requirements would require banks to hold capital against all of the underlying loans. 

Transunion is forecasting mortgage delinquency rates to fall to 5.06% at the end of 2013 from 5.32% today. RealtyTrac reported foreclosure starts are at a 71 month low.

From the Department of Irony:  it turns out that the government’s exit from GM hinges on the success of its newly-unveiled full size Silverado pickup.  I could have sworn I heard many in Washington claim that the reason GM hit the wall was because they were making these huge vehicles that “nobody wants.” 

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Markets are up slightly this morning ahead of the FOMC statement this afternoon. Mortgage Applications were up 6.2% last week. Right to Work was passed in Michigan. Bonds and MBS are flat.

The FOMC statement is due out at 12:30, and at 2:15, the Bernank begins his press conference. Things to look for:  New Treasury purchase plan to replace Operation Twist, 2013 GDP forecast, any comments on its outlook for housing. The WaPo speculates that the Fed will shift more buying to Treasuries than mortgages, and it looks like Bill Gross concurs, as he is lightening up his MBS position.

Looks like FHFA Acting Director will be out of a job soon. This will undoubtedly pave the way for a mass principal forgiveness / underwater refis on Fannie and Freddie loans. Mortgage-Backed securities will be vulnerable to news of more interventionist policies out of FHFA, so beware as you could have Treasury pricing and MBS pricing diverge.

While individual tax rates are going up as part of the fiscal cliff, corporate tax rates may be going down. Obama earlier this year proposed lowering the corporate tax rate to 28% from its current 35%.  The lower rates would be offset by eliminating some deductions and the net revenue would be the same. I would argue that we are at the point on the Laffer Curve where lowering rates would actually raise revenues as it would eliminate some of the transfer-pricing games companies play to declare as much income as possible overseas. The poster child of these transfer pricing games is GE, which paid no US income taxes in 2010. Or Google, which shifted $9.8 billion in revenues to a Bermuda shell company, which allowed it to avoid paying roughly $2 billion in taxes.

Dodd-Frank implementation could stall for a while after Mary Schapiro steps down as Chairman of the SEC, leaving the commission deadlocked with 2 democrats and 2 republicans.  Politically divisive issues like prop trading and restrictions on executive pay will have to wait until a fifth commissioner is nominated and confirmed.  Fun fact:  The SEC has finalized just 32 of the 95 rules that the 2010 law required.

The Fed has been quietly telling the big banks:  No more mergers. Banks that hold 10% of US deposits are already capped in size, but now it looks like the biggest banks just below that threshold are now prohibited from growing by acquisition. Fed Governor Dan Tarullo gave a speech which discusses the TBTF problem and examines various alternatives (re-instate Glass Steagall, capping non-deposit liabilities, etc.)

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Markets are higher this morning on optimism for a deal on the fiscal cliff and a better-than-expected report on German investor confidence. The US government exited its AIG position. UBS will begin charging clients for deposits in swiss francs. Bonds and MBS are down.

The NFIB Small Business Survey fell off a cliff in November to 87.5. The survey blames the election, not Sandy. If people though uncertainty over the election was the cause of the nascent slowdown, this survey shows that it wasn’t.  Of course there is a correlation and causation effect happening here:  Does uncertainty cause a lousy economy, or does a lousy economy increase the risk that politicians will do something stupid? 

Chart:  NFIB Small Business Optimism:

Part of the reason for falling optimism is falling profits.  One claim constantly thrown out is “Profits are at record levels, why aren’t people hiring?”  Maybe it is because they are not, at least not in the small business arena.  This is even more profound when you consider that taxes are going up.  Small business should be pushing as many expenses as possible to next year in order to minimize their 2013 tax bite, which means that profits should be increasing now as their expenses are deferred.  Which means that underlying business profitability may in fact be lower.  

Chart:  NFIB Small Business Earnings:

Note that Bill Dunkelberg is a free-market sort of guy, so the language of his survey will reflect his political leanings.  That said, the numbers are what the numbers are. 

Ezra Klein of WaPo sums up where things really stand in the fiscal cliff negotiations.  The White House needs (a) an increase in tax rates for the rich, (b) a long-term solution to the debt ceiling, and (c) an extension of unemployment insurance. Republicans need something on the entitlement front – either an increase in the medicare eligibility age or a change in inflation calculations for Social Security. 

The change in inflation calculation involves a going to a “chained CPI.” One of the historical criticisms of the Consumer Price Index is that it fails to take into account the substitution effect, which means that as relative prices increase, consumers substitute cheaper goods for higher priced goods.  In other words, if the price of beef rises, consumers substitute chicken for beef. Since the CPI is based on a static basket of goods, it fails to take into account the fact that the basket of goods changes as relative prices change, which means that it overstates inflation.  The chained CPI is an attempt to correct for this. 

Today begins the two-day meeting of the FOMC. The Street is expecting that the Fed will announce an open-ended Treasury Purchase program, which could push its balance sheet to almost $4 trillion. The estimate is that the latest round of QE will add $500B in Treasuries to $620B in mortgage backed securities.  It will be interesting to see if the Fed notes its frustration that consumer borrowing rates are not falling in lockstep with mortgage backed securities.  It would be even more interesting if there was some acknowledgement of G-fee increases, which explain the reason why. 

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Markets are mixed this morning as optimism on the fiscal cliff is overshadowed by European events.  Mario Monti is resigning, creating an opening for Silvio Berlusconi to return.  Italian bond yields are up 31 basis points to 4.83%.  Japan is officially in a recession again (its third in the last four years) as 3Q GDP shrank at a 3.5% annualized rate. Bonds and MBS are up small.

Generally, we have a data-light week coming up, with inflation numbers dominating.  The FOMC rate decision is Dec 12.

The details of a deal on the cliff are taking shape.  On the revenue side, either a “split the difference” between the current top rate and 39.6%, or a redefinition of what is considered “rich,” to 375k – 500k. Entitlement cuts will be part of the package.  Ezra Klein reported Friday that the deal will probably be an increase in the top rate to 37% and an increase of the Medicare eligibility age to 67. Both sides seem to be inching closer together, and we’ll see if Boehner can pull his caucus together when they meet on Wed. 

Ever since the financial crisis began, “uncertainty” has become the buzzword thrown out to explain why the economy continues to limp along. Two professors from Chicago and Stanford tested the hypothesis that uncertainty is driving the economy by regressing economic variables against the number of times the word “uncertainty” was mentioned in the press.  They found a statistical relationship between the two, and estimate that the upturn in uncertainty caused a 16% drop in private investment and 2.3 million jobs. Of course there is a big risk of confusing correlation and causation.  Does uncertainty cause a bad economy, or does a bad economy increase the risk that government will do something (either good or bad) in an attempt to fix the economy?

New lawsuits continue to be filed against the banks for the sins of the subprime crisis. Some in the banking industry fear the cost could reach $300 billion. Investors are now suing the trust banks for failing to police issuers.  This is a new front, as the trust banks merely hold the securities and collect / disburse payments for a nominal fee.  Servicers, are you next?

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Markets are higher after a better-than expected jobs report.  Nonfarm payrolls increased by 146k in November vs an expectation of 85k.  October was revised down from 171k to 138k.  The unemployment rate dropped from 7.9% to 7.7%, but this was driven by a drop in the labor force participation rate from 63.8% to 63.6%. Surprisingly, Sandy didn’t appear to have much of an impact on the numbers. Still the headline numbers look good, and that is driving the index futures higher.  Feels like the Street was leaning short going into the numbers.  Bonds are down a point and MBS are down 7 ticks.

Small Business Hiring Plans hit post-recession low. Hiring plans are as low as they were in late 2008.  Resolution of the election “uncertainty” doesn’t seem to be having an effect, at least not yet.  We’ll see if resolving the fiscal cliff changes anything; my guess is that it won’t. 

The National Association of Homebuilders added 76 MSAs to their Improving Markets Index. The recent housing strength is spreading across the country. They note that “overly tight mortgage lending standards” are the one thing that is holding back progress.

HUD Secretary Shaun Donovan told the Senate Banking Committee that FHA is committed to selling at least 10,000 distressed loans per quarter over the next year, and it will raise the annual insurance premium paid by borrowers by 10 basis points. 

If the Fed adds another Treasury-buying program to compensate for the end of Operation Twist, they will almost certainly have to re-write their exit plan.  The sheer size of the numbers (estimates are that the Fed will have to sell $2 – $3 trillion worth of assets over several years.  If the Fed attempts to dump mortgage backed securities en-masse, it will exacerbate the increase in borrowing rates that will already be taking place.  

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