Category: Market Action

Fed policy? Here’s the dovish view:

Federal Reserve Governor Lael Brainard counseled continued prudence in tightening monetary policy, even as she said the economy is making gradual progress toward achieving the central bank’s goals.

“The case to tighten policy preemptively is less compelling” in an environment where declining unemployment has been slow to spur faster inflation, Brainard said Monday, according to the text of her prepared remarks in Chicago. She made no reference to a specific meeting of the policy-setting Federal Open Market Committee.
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In Monday’s speech, Brainard highlighted five major reasons for caution: inflation is less responsive to labor-market improvement than in the past, labor-market slack seems to persist, financial transmission from foreign markets is strong and poses a risk, and the interest rate where policy moves from easy to tight is lower than in the past — and is likely to stay there for some time. Her final point is that monetary policy is less able to respond to negative shocks than to a quick pickup in demand.

Despite that cautious view, Brainard also pointed to recent developments that show the economy is moving toward achieving the Fed’s goals of maximum employment and 2 percent inflation. She said the job market is making progress and getting closer to full employment and the Fed has “seen signs of progress on our inflation mandate.”

And a hawkish view:

Federal Reserve Bank of Atlanta President Dennis Lockhart repeated his call for a “serious discussion” about raising interest rates at the U.S. central bank’s meeting later this month, even after some recent disappointing economic indicators.

“Notwithstanding a few recent weak monthly reports — from the Institute for Supply Management, for example — I am satisfied at this point that conditions warrant that serious discussion,” Lockhart said Monday in Atlanta.
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“After relatively weak growth over the first half of the year, I expect a stronger second half,” Lockhart said to the National Association for Business Economics, citing the bank’s estimate. Third-quarter growth was tracking at 3.3 percent on Friday, according to the Atlanta Fed’s tracking estimate.

The economy is “making progress” toward full employment, Lockhart said, though progress in moving inflation toward the 2 percent goal may have stalled.

“The inflation data overall have not been suggesting disinflation or deflation, but the flat trend line is enough below target that, in my opinion, the shortfall cannot be considered immaterial,” he said. “I find this to be an awkward state of affairs.”

And a market view:

U.S. stocks rebounded after the biggest rout since June wiped about $500 billion from the value of equities, the dollar fell and Treasuries erased losses as the Federal Reserve’s Lael Brainard remained dovish in her approach to tighter monetary policy. Emerging-market assets slumped.

The S&P 500 Index jumped the most in two months after sinking 2.5 percent Friday, holding gains after Brainard urged “prudence” in removing accommodation. The dollar fell for the first time in four sessions as the odds for a rate hike next week slid to 22 percent. Ten-year Treasuries remained little changed, with yields near 1.68 percent. Shares in Europe and Asia, which were closed Friday when the selloff began, dropped Monday. Emerging-market equities tumbled 2 percent, while oil rebounded past $46 a barrel.

In a sign of the times, rent control may be coming to the San Francisco bay area:

The concept of rent control, once found mostly in large cities, is spreading to the Bay Area’s suburbs, even though virtually every economist thinks it’s a bad idea.

Six Bay Area cities have measures on the November ballot that would protect existing tenants from the stratospheric rent increases that are a result of job growth far outstripping housing creation.
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A 2012 survey by the University of Chicago’s Booth School of Business asked respected economists if they agreed that rent-control ordinances in cities such as New York and San Francisco have improved the quantity and quality of affordable rental housing over the past three decades. Eighty-one percent disagreed, 2 percent agreed and 9 percent were uncertain or had no opinion.

In 2013, Peter Tatian of the Urban Institute reviewed academic research on rent control and found “very little evidence that rent control is a good policy.” The strongest finding of one comprehensive survey was that “tenants in noncontrolled units pay higher rents than they would without the presence of rent control; one reason being that landlords need to make up the difference for lower rents in controlled units.”
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In a report issued in February, California’s Legislative Analyst’s Office warned that rent control could encourage property owners to cut back on maintenance and repairs. “Over time, this can result in a decline in the overall quality of a community’s housing stock,” it said.

There’s a certain amount of agitation in Vancouver for more rent control:

Since 2002, British Columbia has had a two-tiered system where fixed-term renters get no protection, while those who rent month-to-month do. The legislation restricts landlords with monthly renters to a set annual increase. This year, the cap is 2.5 per cent.

Yet landlords who have the benefit of long-term tenants get the added bonus of being able to set whatever price they want when the term is up. It can lead to gouging, particularly now when the vacancy rate in Vancouver is virtually zero.

It means that renters are left with a lousy choice: Take a short-term rental and risk being asked to leave with only 30 days’ notice or sign a lease and risk having the rent skyrocket at the end of the term.

In Toronto, of course, rent control was introduced in the ’80s by Bill Davis (under election pressure from the NDP) and construction of rental apartment buildings basically halted. There have been a few buildings lately, but it’s my understanding that these developments only make sense if you can get a package of land from the city on sweetheart terms.

Common equity took a hit today:

After two months in which even a 50-point move in the Dow Jones Industrial Average was reason for excitement, investors were shaken out of their slumber as central bankers signaled reluctance to extend stimulus and sent U.S. stocks to their worst week since February.

Damage was worst in the final session, when Boston Federal Reserve President Eric Rosengren warned against waiting too long to raise interest rates. Selling built after European Central Bank President Mario Draghi downplayed the need for more measures to boost growth a day earlier. When it was over, the S&P 500 Index was down 2.3 percent to 2,127.81 on the week, with Friday’s plunge wiping out a slight gain over the first three days.

Bonds did not escape the carnage:

Draghi’s reticence accelerated a selloff in bonds that extended from Europe to the U.S. and Japan, with longer-dated securities, which have been outperforming in recent months, being the hardest hit. While yields are still low compared with historical averages, they are quickly rising from records reached earlier this year, recalling the bond rout of 2015, which saw German 10-year yields climb more than a percentage point in less than two months.

The yield on German 30-year bonds climbed 10 basis points to 0.60 percent, adding to a nine-basis-point jump the previous day. The rate on similar-maturity U.S. securities rose seven basis points to 2.38 percent.

Chances of the Fed raising rates at the September meeting climbed to 38 percent, up 16 percentage points from Wednesday, according to fed funds futures.

The U.K. and Japan, two markets which have help drive the global bond rally this year, also saw losses. The yield on 10-year gilts rose to a one-month high of 0.84 percent and the Japanese 10-year yield, which has been below zero since March, climbed to minus 0.02 percent.

Quantitative Investing is now a strategy that over-promises:

Banks and investment funds are hiring quants — people with training in physics or higher mathematics — as market intervention by central banks make it difficult to post robust profits. Money managers including UBS, Credit Suisse Group AG and GAM Holding AG are betting that the strategies widely used by the hedge-fund industry will help convince clients spooked by market volatility to invest their money instead of keeping it in cash.

The bank decided to diversify and increase the number of offerings to clients because of low interest rates, Haefele said. As part of the strategy, it raised $471 million for an oncology fund earlier this year and hired a team led by Vinay Pande from hedge fund Brevan Howard Asset Management to focus on short-term investment strategies earlier this year.

UBS manages more than $1.5 billion through quant analysis, Andreas Kessler, a spokesman for the bank, said in an e-mail. The wealth management unit started its first directly quant-based offering last year, he said.

Clients who hand over investment decisions to Haefele and his team have on average earned more on their portfolio than those who make decisions themselves, he said. That’s because they may find themselves exposed to a market downturn and fail to reinvest when things improve, he said. The bank does not disclose client returns.

Investment returns are a chaotic system; you cannot predict future absolute returns. Relative returns can be predicted a little bit, provided the two comparators are closely related. But, since UBS does not disclose client returns they’ll be able to get away with any claims they want for a long time.

There is great news from the world of drones:

In what’s sure to be a college student’s dream come true, drones will soon be delivering burritos on the campus of Virginia Tech.

The experimental service, to begin this month and last just a few weeks, is a test by Project Wing, a unit of Google’s parent company Alphabet Inc. Chipotle Mexican Grill Inc. and the Blacksburg, Virginia, university have agreed to participate.
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Project Wing will use self-guided hybrids that can fly like a plane or hover like a helicopter. They will make deliveries from a Chipotle food truck to assess the accuracy of navigation systems and how people respond.

The devices will hover overhead and lower the Chipotle edibles with a winch.

Part of the experiment will be to see how well the packaging protects the chow and keeps it warm. Food was selected as the demonstration cargo because it’s a challenge. The company is already at work on a more sophisticated second version of the aircraft that won’t be used in the tests, Vos said.

Negative interest rates have a silver lining for some firms!

It’s a sign the world is getting used to negative interest rates when what once seemed bizarre starts looking like the norm.

Consider Switzerland, where more and more companies are taking out insurance policies to protect their cash hoards from theft or damage.

“Because of the low interest rate level, we note increasing demand for insurance solutions for the storage of cash,” said Philipp Surholt at Zurich Insurance Group AG, among underwriters reporting a surge in such requests. “We’re seeing demand for coverage for sums ranging from 100 million to 500 million francs.”
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Helvetia Holding AG said it charges about 1,000 francs ($1,020) a year to insure 1 million francs, a fraction of the 7,500 francs a company would pay to park the same amount in a bank for a year — assuming the lender passes on the full charge. But that amount doesn’t include the cost of logistics such as transport or security features like reinforced walls, guards and alarm systems.

Companies need to save a lot on bank fees for cash storage to be economical because, in addition to insurance, they have to assume the costs of managing the money, said Roberto Brunazzi, a spokesman for Baloise Holding AG. He said the company has long offered such coverage “but there has been a noticeable increase and now it’s becoming more commonplace.”

Switzerland’s continued use of high-denomination banknotes adds to the appeal of self-storage: About 1 million francs worth of 1,000-franc bills can fit in a small box.

PerpetualDiscounts now yield 5.12%, equivalent to 6.66% interest at the standard equivalency factor of 1.3x. Long corporates yield a hair over 3.60%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 305bp, a slight (and perhaps spurious) widening from the 300bp reported August 31.

Jobs, jobs, jobs!

Good. But not too good.

That is the verdict from economists after the Labor Department reported on Friday that in August employers added 151,000 jobs, the unemployment rate was unchanged at 4.9 percent, and wage gains were modest. It was a solid performance that keeps the economy on track, but not strong enough to push the Federal Reserve to raise its benchmark interest rate when policy makers meet this month.
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The jobless rate, based on a separate survey of households, stayed at 4.9 percent, roughly half of what it was seven years ago, and consumer spending remains healthy. But a broader measure of unemployment that includes discouraged and underemployed workers is nearly twice that figure.

Wages have only recently begun to climb. The 12-month increase was a modest 2.4 percent in August, slower than in the previous month but a pace that keeps most workers ahead of inflation.

Bloomberg adds:

Traders are pricing in a 32 percent chance the central bank will raise borrowing costs at its September meeting, down from 34 percent before the jobs data, though the probability earlier slipped as low as 20 percent. The first month with better-than-even odds of a hike is December.

Those wagers have influenced trading with stocks, bonds and the dollar amid a spate of mixed economic data and comments from central bank officials. Financial markets were taken aback on Thursday by weak manufacturing numbers, after other reports pointed to a recovery on the heels of still-robust consumer spending. While Fed Chair Janet Yellen said last week that the case for an increase in borrowing costs has strengthened, wagers on a hike receded even before the jobs figures.

Richmond Fed President Jeffrey Lacker said Friday the message he took from the August data was that “labor markets are continuing to tighten.” He called the report “reasonably strong.”

In a sign of the times, McDonald’s is becoming more corporate:

McDonald’s has long been famous for its small-owner-focused franchise system, in which entrepreneurs with only a store or two would sweat the details of their restaurants, yielding better customer service. Lately, however, the fast-food giant has begun shedding mom and pop owners in favor of bigger operators. Since 2014 the number of U.S. McDonald’s franchise owners has dropped 2.6 percent, while the number of franchised locations has grown 1.2 percent, according to data compiled by researcher FranchiseGrade.com. The chain’s biggest franchisees are getting larger, while those who own five locations or fewer are on the wane.

Getting rid of smaller franchisees allows McDonald’s to speed renovations and the implementation of new technology, such as the self-ordering touchscreens being tested in about 250 locations. Such gear can be expensive, and smaller franchisees often don’t have the capital to pay up—making them less willing to embrace the company’s plans.
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There are about 1,842 domestic McDonald’s franchisees who own five restaurants or fewer, compared with 1,930 in 2014, a 4.6 percent drop, the FranchiseGrade.com data show. There’s been about a 12 percent jump, however, in the number of those operating more than 10 stores: 245 now, vs. 218 in 2014. McDonald’s spokeswoman Becca Hary says that stores often end up in the hands of larger operators when smaller ones sell out, but both big and small operators are among its best franchises.

Capital requirements are pretty steep – it’s not a middle-class business environment any more!

Click for Big

At month-end, PerpetualDiscounts yield 5.11%, equivalent to 6.64% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 3.65%, so the pre-tax interest-equivalent spread (in this context, the Seniority Spread) is now about 300bp, a widening from the 290bp reported July 27.

Remember how I said on August 26 that:

But eventually (probably after the Fed Rate has struggled carefully and cautiously to 1% and above) there will be a series of hikes, bang, bang, bang, bang, that will result in a very nasty environment for bonds.

Well, here’s a different view:

Some at the U.S. central bank may still be too optimistic about how high interest rates can rise in the longer run, based on new Federal Reserve Bank of San Francisco research.

San Francisco Fed economist Kevin Lansing started with a simple premise: estimates of the inflation-adjusted neutral interest rate — the one that neither stokes nor slows growth — track pretty well with the U.S. Congressional Budget Office’s four-quarter growth rate of potential GDP estimates. Looking at the CBO’s projections for the next decade, he predicts “a very gradual rise” in the neutral rate, referred to as r-star in standard economic models, from near-zero in 2016 to about 1 percent in 2026.

“If the long-run value of r-star is indeed only around 1 percent or less, then the process of normalizing the federal funds rate may end up being more gradual than the midpoint paths implied,” Lansing wrote. He notes that excluding high and low outliers, officials at the middle of the Fed’s June projection see a longer-run real rate of 1.15 percent.

But don’t be too quick to write of growth! There’s a new growth industry in Germany:

German savers are leaving the security of savings banks for what many now consider an even safer place to park their cash: home safes.

For years, Germans kept socking money away in savings accounts despite plunging interest rates. Savers deemed the accounts secure, and they still offered easy cash access. But recently, many have lost faith.

“It doesn’t pay to keep money in the bank, and on top of that you’re being taxed on it,” said Uwe Wiese, an 82-year-old pensioner who recently bought a home safe to stash roughly €53,000 ($59,344), including part of his company pension that he took as a payout.

Interest rates’ plunge into negative territory is now accelerating demand for impregnable metal boxes.

Burg-Waechter KG, Germany’s biggest safe manufacturer, posted a 25% jump in sales of home safes in the first half of this year compared with the year earlier, said sales chief Dietmar Schake, citing “significantly higher demand for safes by private individuals, mainly in Germany.”

And don’t forget drones!

Before some cutting-edge online retailer can use a drone to drop granola bars on your doorstep, a railroad born when Abe Lincoln was in Congress will first have to iron out the kinks.

BNSF Railway Co. is flying drones as far as 150 miles (240 kilometers) along the New Mexico desert to inspect tracks, helping the Federal Aviation Administration develop rules for operating unmanned aircraft beyond the pilot’s line of sight. That’s an essential step for expanding use to such commercial endeavors as deliveries by Amazon.com Inc. and other companies.
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BNSF, owned by Buffett’s Berkshire Hathaway Inc., is particularly suited for the task. The railroad operates 32,500 miles of track crisscrossing sparsely populated areas along a well-defined right of way, which eases planning. Communications towers that are part of a safety system for trains can be used to help guide drones.

The railroad also has a compelling business case. The Latitude HQ-40 drone that Graetz supervises has a six-foot wingspan and is equipped with cameras that when paired with special software can potentially detect track anomalies more quickly, possibly preventing derailments. The flights, from just outside of Playas, New Mexico, lay the groundwork for drone inspections of other fixed infrastructure, such as pipelines and power lines.

The British aren’t satisfied with the calibre of their secret policemen:

Once again, the British government has decided that US technology companies should shoulder more responsibility for preventing terrorism.

Facebook, Twitter and YouTube are ‘the lifeblood of Daesh’ and are ‘consciously failing’ to prevent the spread of terrorist material, a panel of lawmakers said today, adding that they are ‘hiding behind their supranational legal status’.

In its report, parliament’s home affairs committee accuses the companies of passing the buck when it comes to cracking down on propaganda online.

“They must accept that the hundreds of millions in revenues generated from billions of people using their products needs to be accompanied by a greater sense of responsibility and ownership for the impact that extremist material on their sites is having,” it reads.

The MPs are calling for the web firms to move far more quickly to close down infringing accounts – or give a good reason why not. It also wants them to second staff to work within the Metropolitan Police’s counter-terrorism internet referral unit (CITRU).

But the American Secret Police are very active:

Lorne Wald thought he had run into a technical glitch on a Friday night in early August when PayPal halted his attempts to purchase two books. The 60-year-old retired IT worker in Mount Royal, Que., has had a PayPal Inc. account since the online payment platform came to Canada in late 1990s and has never had any trouble buying things online.

But Mr. Wald’s transaction hit a roadblock when an error message warned that he had violated PayPal’s “terms of use” when he tried to buy The New Persian Kitchen, a cookbook by Louisa Shafia, and The House of God, a satirical novel about Beth Israel hospital in Boston – from Canadian online bookseller BookOutlet.ca.

When he contacted the company’s customer service, he was informed by a representative that “the payment was pending clearance by OFAC [the U.S. Office of Foreign Asset Control].” He asked if he could simply cancel the purchase, and was told no, it would have to be adjudicated by PayPal’s compliance team. “It sort of creeped me out,” Mr. Wald says. “If they are going to try to crack down on crime that’s all very noble, but then it’s in your face; and this is a $20 transaction.”