Month: April 2017

Earlier we showed that when looking at asset returns in the first quarter, there were hardly any underperformers while positive returns were generous across virtuall all asset classes. What drove this outsized performance, which once again left most hedge funds and asset managers seeking to generate alpha in the dust? The answer: a continuation of the capital reallocation euphoria launched with the Trump election in November, which continued for the second consecutive quarter. And while stocks were by far the biggest beneficiaries of the fund flows, with US equity ETFs alone taking in $62 billion in Q1, as TrimTabs’ David Santschi points out, the bond inflow was perhaps the most noteworthy, which saw $34 billion in inflows even as Bond ETFs rose just 1.0% last quarter, yet money kept pouring in all quarter.

Here is the summary of how retail investors allocated funds to the market, courtesy of the TrimTabs:

All Stock and Bond Funds Get $162 Billion in Q1 2017, Biggest Quarterly Inflow in Four Years. Insider Selling Hits Six- Year High in February and March. Real Wages and Salaries Keep Rising at Brisk Pace, although TrimTabs Macroeconomic Index Levels Off, and Credit Indicators Not Signaling Big Pickup in Growth

And the Demand (Fund Flows) details

Fund investors went on a buying spree last quarter, snapping up $162 billion worth of stock and bond funds, the most since the inflow of $193 billion in Q1 2013. U.S. equity ETFs alone took in $62 billion in Q1 2017 following the record inflow of $109 billion in Q4 2016.

 

Our U.S. demand indicators generally improved last week, turning mildly bullish for the short term (one to two weeks) and more firmly bullish for the intermediate term (one to two months). 

 

Demand for U.S. equity ETFs decreased in recent weeks, which is encouraging from a contrarian perspective. Inflows into these funds totaled just $2.2 billion (0.1% of assets) in the past week, and the trailing one-month inflow has plunged to a seven-week low of $11.5 billion (0.7% of assets).

 

The TrimTabs U.S. Equity ETF Index (TTEI), which uses ETF flows for short-term market timing, rose to 62.9 on March 30, up from 52.2 a week earlier. Since the TTEI is between 50 and 75, the TTEI Model Portfolio is 75% long the S&P 500.

 

 

 

Leveraged ETFs are not sending such positive signals, but recent flows have been light. Leveraged short ETFs redeemed 1.6% of assets for a second consecutive week, while leveraged long ETFs added 0.9% of assets.

 

Sentiment measures continue to send more negative short-term signals than flows. Major sentiment surveys show optimism has pulled back a bit but remains historically high, the equity put/call ratio has not cracked 0.8 for two months, and the VIX fell to 12.4 last week.

Yet while retail investors, whether due to latent “Trumpforia”, or other reasons, were allocating cash to risk assets, others were selling, most notably corporate insiders, who according to TrumTabs unloaded $10 billion ($500 million) in stock in the first quarter, the highest volume since February 2011, even as corporate buybacks continued to decline to the lowest level since November 2013. Some more details:

U.S. companies have been committing less money to shrink the float ever since the election. In March through Thursday, March 30, announced corporate buying (new cash takeovers + new stock buybacks) of $44.5 billion was only 1.5 times the $29.5 billion in new offerings. This buy/sell ratio is the lowest since November 2013. Since the start of November 2016, the buy/sell ratio has been 2.7-to-1, below the average of 4.3-to-1 in all of 2016.

 

As companies have been less willing to use cash to support share prices, corporate insiders have been selling at the fastest pace in six years. Insiders unloaded $9.9 billion ($500 million daily) in February and $9.7 billion ($450 million daily) in March, the highest monthly volumes since February 2011.

Do buying mom and pop investors know something selling corporate insiders do not? Normally, some would smile at this assumption, alas in this day and age when retail investors are increasingly becoming the “smartest” money (with hedge funds almost terminally relegated to “dumb money” status), this time may just be different. For the definitive answer check back this time next quarter.

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Earlier we showed that when looking at asset returns in the first quarter, there were hardly any underperformers while positive returns were generous across virtuall all asset classes. What drove this outsized performance, which once again left most hedge funds and asset managers seeking to generate alpha in the dust? The answer: a continuation of the capital reallocation euphoria launched with the Trump election in November, which continued for the second consecutive quarter. And while stocks were by far the biggest beneficiaries of the fund flows, with US equity ETFs alone taking in $62 billion in Q1, as TrimTabs’ David Santschi points out, the bond inflow was perhaps the most noteworthy, which saw $34 billion in inflows even as Bond ETFs rose just 1.0% last quarter, yet money kept pouring in all quarter.

Here is the summary of how retail investors allocated funds to the market, courtesy of the TrimTabs:

All Stock and Bond Funds Get $162 Billion in Q1 2017, Biggest Quarterly Inflow in Four Years. Insider Selling Hits Six- Year High in February and March. Real Wages and Salaries Keep Rising at Brisk Pace, although TrimTabs Macroeconomic Index Levels Off, and Credit Indicators Not Signaling Big Pickup in Growth

And the Demand (Fund Flows) details

Fund investors went on a buying spree last quarter, snapping up $162 billion worth of stock and bond funds, the most since the inflow of $193 billion in Q1 2013. U.S. equity ETFs alone took in $62 billion in Q1 2017 following the record inflow of $109 billion in Q4 2016.

 

Our U.S. demand indicators generally improved last week, turning mildly bullish for the short term (one to two weeks) and more firmly bullish for the intermediate term (one to two months). 

 

Demand for U.S. equity ETFs decreased in recent weeks, which is encouraging from a contrarian perspective. Inflows into these funds totaled just $2.2 billion (0.1% of assets) in the past week, and the trailing one-month inflow has plunged to a seven-week low of $11.5 billion (0.7% of assets).

 

The TrimTabs U.S. Equity ETF Index (TTEI), which uses ETF flows for short-term market timing, rose to 62.9 on March 30, up from 52.2 a week earlier. Since the TTEI is between 50 and 75, the TTEI Model Portfolio is 75% long the S&P 500.

 

 

 

Leveraged ETFs are not sending such positive signals, but recent flows have been light. Leveraged short ETFs redeemed 1.6% of assets for a second consecutive week, while leveraged long ETFs added 0.9% of assets.

 

Sentiment measures continue to send more negative short-term signals than flows. Major sentiment surveys show optimism has pulled back a bit but remains historically high, the equity put/call ratio has not cracked 0.8 for two months, and the VIX fell to 12.4 last week.

Yet while retail investors, whether due to latent “Trumpforia”, or other reasons, were allocating cash to risk assets, others were selling, most notably corporate insiders, who according to TrumTabs unloaded $10 billion ($500 million) in stock in the first quarter, the highest volume since February 2011, even as corporate buybacks continued to decline to the lowest level since November 2013. Some more details:

U.S. companies have been committing less money to shrink the float ever since the election. In March through Thursday, March 30, announced corporate buying (new cash takeovers + new stock buybacks) of $44.5 billion was only 1.5 times the $29.5 billion in new offerings. This buy/sell ratio is the lowest since November 2013. Since the start of November 2016, the buy/sell ratio has been 2.7-to-1, below the average of 4.3-to-1 in all of 2016.

 

As companies have been less willing to use cash to support share prices, corporate insiders have been selling at the fastest pace in six years. Insiders unloaded $9.9 billion ($500 million daily) in February and $9.7 billion ($450 million daily) in March, the highest monthly volumes since February 2011.

Do buying mom and pop investors know something selling corporate insiders do not? Normally, some would smile at this assumption, alas in this day and age when retail investors are increasingly becoming the “smartest” money (with hedge funds almost terminally relegated to “dumb money” status), this time may just be different. For the definitive answer check back this time next quarter.

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With the S&P having traded as high as 2,400 last month, which is also JPM’s year end price target, and having dipped a modest 3% since then peak to trought, some traders were worried if this is finally the start of the inevitable correction that has evaded stocks for so long. Not according to JPM, though. Recall that several weeks ago, JPM’s Marko Kolanovic called for an imminent bounce in volatility following the March quad-witching. In retrospect, it appears that this was it, and in a note released overnight, JPM’s chief equity stratetgist Dubravko Lakos-Bujas has a new recommendation to clients: “buy the dip” because “the market is likely to remain resilient and supported by the Trump and Fed “puts” as well as the continued improvement in the fundamental backdrop both domestically and abroad. On balance, we continue to maintain a broadly constructive view. If anything, we see a confluence of conditions potentially coming together in the months ahead and setting the stage for the market to reach new highs.“

Here are the details from JPM

After S&P 500 touched our price target of 2,400 in March, we argued that the market could face higher volatility and some weakness in the short-term at a time when both fundamental and systematic investor positioning was stretched. While the broader market fell by ~3% from the peak, there has been more pronounced weakness in trades tied to reflation and Trump’s agenda (see Figure 1).

Uncertainty around the upcoming French election and lack of clarity on timing of the US tax reform could continue to weigh on the market in the near term. However, we see limited risk of a larger pullback and recommend buying the dip(s).

The market is likely to remain resilient and supported by the Trump and Fed “puts” as well as the continued improvement in the fundamental backdrop both domestically and abroad. On balance, we continue to maintain a broadly constructive view. If anything, we see a confluence of conditions potentially coming together in the months ahead and setting the stage for the market to reach new highs.

Policy remains a source of upside risk for equities. As detailed in our 2017 Outlook, a key source of upside risk to our price target is the passage of corporate tax reform. The failed AHCA bill last week has led investors to question the administration’s legislative efficacy. In our view, the lack of sufficient GOP support to replace ACA is not necessarily a negative for equities. Instead, the failed vote could potentially pull forward the timeline for the tax reform, which has broader and more bipartisan support than the healthcare bill. Currently, the market does not seem to be pricing in much upside from pro-growth policy reforms. Equities tied to Trump’s agenda have unwound most of their post election gains: deregulation (JPAMDREG -14% from peak relative to S&P 500), corporate tax reform (JPAMTAXP -6%), and infrastructure spending (JPAMINFR -12%), see Figure 1. We recommend investors to opportunistically add exposure to these themes.

Even if the Tax Reform Blueprint pivots to a less ambitious plan, we still see upside for earnings and equity values. For instance, implementing a tax rate of 27.5% (midpoint between current 35% and original GOP 20% rate) and excluding the highly controversial BAT, we estimate should add $8 to S&P500 EPS, see Figure 2.

In an even more conservative scenario where the tax rate is cut by only 4% (similar to the last Reagan tax cut in 1986), EPS should still increase by $4. While the reduction in statutory tax rate should accrue mostly to domestic companies, a move to a territorial system including cash repatriation should benefit US multinationals. If multinationals were to onshore ~$1 trillion of foreign cash, we estimate this would lift S&P 500 EPS by an additional ~$1.30. At the current 18.5x P/E multiple, the total EPS boost of ~$5 is worth an incremental ~100 points for S&P 500. With the market trading near our policy-neutral YE 2017 price target of 2,400, we see little of Washington’s agenda priced into the market currently. Also, if infrastructure spending is included in some form with the tax plan, there could be further upside to our EPS estimate. While there is still much ambiguity around this plan, the Trump administration could gradually release details ahead of the more comprehensive budget proposal in May.

Downside risks of higher rates and stronger USD contained for now. On the whole, Fed’s stance remains relatively balanced, while global growth continues to improve and USD reverses from peak levels. With the unemployment at the natural rate of 4.7% (the job market is neither too hot nor too cold) and core inflation still running below 2% target, the Fed sees near-term risks to the economic outlook roughly balanced (i.e. “goldilocks” economy) and continues to reiterate that the path of future hikes will be data dependent. Furthermore, it is not unreasonable to expect that President Trump (as is often the case with incumbent presidents) might appoint more dovish members to the Federal Reserve Board. There are two vacancies already and perhaps two more likely to open in the next one year on the seven-member board. The year to date weakening USD trend could also be further reinforced especially if ECB and/or BOJ signal(s) gradual reversal in monetary policy, allowing interest rate differentials to narrow. Further weakening in USD would likely result in positive earnings revisions given that the consensus view in FX markets is still mostly biased towards stronger dollar. We estimate that for every ~2% decrease in the USD TWI, S&P500 EPS should be revised up by ~1%.

Earnings recovery is resilient and we remain confident in our policy neutral EPS of $128 for 2017. After S&P 500 companies delivered a record-high EPS of $31.28 in 4Q16 (+6.0% y/y), we are expecting growth to accelerate further to >10% in 1Q, highest growth rate since 2011. Additionally, company guidance activity has been encouraging YTD, which reflects strengthening global growth, healthy labor market as well as strong business survey data and consumer confidence (at 16yr high). To reflect this improvement, the Street’s revisions have been much more benign so far YTD compared to recent years. This supports our view for a high-single-digit EPS growth this year driven by mid-single-digit organic sales growth, minor margin expansion (due to improving operating leverage and expense rationalization) and continued share repurchases.

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As Nasdaq reaches ever record-er, record highs, it seems the ability to create a "Hello World" app is no longer enough to warrant an H1-B visa according to new guidelines from the Trump administration.

As The Hill reports, the new policy guidance that would make it harder for companies to use the H-1B visa program to bring foreign computer programmers into the U.S. A policy memo from the U.S. Citizenship and Immigration Services changes the way the agency will process visa applications for computer programming positions, making companies jump through extra hoops to fill those jobs with foreign workers…

The memorandum also does not properly explain or distinguish an entry-level position from one that is, for example, more senior, complex, specialized, or unique.

 

Furthermore, the memorandum also did not accurately portray essential information from the Handbook that recognized that some computer programmers qualify for these jobs with only “2-year degrees.” While the memorandum did mention beneficiaries with “2-year” degrees, it incorrectly described them as “strictly involving the entering or review of code for an employer whose business is not computer related.”

 

…

 

Based on the current version of the Handbook, the fact that a person may be employed as a computer programmer and may use information technology skills and knowledge to help an enterprise achieve its goals in the course of his or her job is not sufficient to establish the position as a specialty occupation. Thus, a petitioner may not rely solely on the Handbook to meet its burden when seeking to sponsor a beneficiary for a computer programmer position. Instead, a petitioner must provide other evidence to establish that the particular position is one in a specialty occupation…

Companies use the H-1B program to import workers for highly skilled positions that are difficult to fill. The Trump administration, however, has alleged that tech companies and IT outsourcing firms have abused the program to the detriment of American workers.

The lottery for companies to apply for 2018 visas opened on Monday. Interestngly, as livemint reports, a feature film about the difficulties facing an Indian temporary work-visa holder waiting for permanent residency will be screened in 25 US cinemas on Friday, with backing from Silicon Valley investors, fuelling an already heated immigration debate.

Advocates of immigration often cite H1B success stories like Sundar Pichai of Google and Satya Nadella of Microsoft. But the work visas are controversial and critics say companies that use them the most — information technology services companies with the bulk of their operations in India — are hurting American workers by undercutting salaries and taking away jobs.

Workers who want to gain permanent residence are treated like indentured labor, said Vivek Wadhwa, Distinguished Fellow at Carnegie Mellon University’s College of Engineering. If they change jobs or take a promotion, they lose their turn in line, so they end up doing menial jobs during the most productive years of their lives, he said.

“I call this one of Silicon Valley’s darkest secrets,” said Wadhwa, who is also a director of research at Duke University’s Pratt School of Engineering.
 

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It appears a number of sell-side shops are catching on to just how unprecedentedly low VIX was in Q1, as we noted first here.

Despite a quarter characterized by elevated policy uncertainty and an intense focus on tax reform, infrastructure spending and deregulation, U.S. equities had one of their lowest volatility quarters on record.

As Goldman notes, the average VIX level in Q1 was 11.69, the lowest first quarter in VIX history. Low volatility levels were persistent, with the VIX trading in a tight band between 10.6 and 13.1 over the first quarter.If we include all calendar quarters, Q1 2017 was the second lowest quarterly average VIX level back to 1990; only ranking behind Q4 2006, when VIX averaged 11.03.

Estimating the VIX based upon payrolls, ISM levels and economic policy uncertainty, Goldman suggests an average VIX level of 13.7, two points higher than the Q1 average.

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After a stellar quarter for US equities, stocks have unexpectedly slumped on the first day of Q2 despite “whispers” of pent upmutual fund reallocation into risk assets that would take place today.

So why are stocks lower,  besides “more sellers than buyers” and “money going back to the sidelines” of course? For a comprehensive assessment of what is going on below the surface, here is RBC’s Charlie McElligott (who as a reminder warned on Friday about the Double Whammy in the April Effect) looking today’s rates reversal, the shift to “anti-beta” leadership and the “momentum factor” reversal, all of which explain the bad start to the second quarter.

RATES REVERSAL, ‘ANTI-BETA’ LEADERSHIP AND ‘MOMENTUM FACTOR’ REVERSAL WITHIN EQUITIES NOT GOOD START TO Q2

Summary

• Kind of the start to Q2 that I was exactly highlighting in Friday’s note, i.e. rates reversing fueled by softening ‘soft’ data vs ‘prices paid’ overshoot, helping to ‘kick off’ a reversal within equities ‘momentum’ longs as ‘growth’ names fading,’defensives’ lead and ‘reflation’ is again hammered.
• Early focus on the big ‘Prices Paid’ beat in today’s ISM (highest absolute # since ’11), with S&P futures at lows on the session following the release indicating ‘bad inflation’ concerns when weighed against signs of ‘slowing growth’ (Street Q1 GDP downgrades, Atlanta Fed GDPNow downticking, Markit comments on Q2 post Manu PMI release) and weakening ‘soft data.’  This harkens back to the post Dec Fed concerns around ‘stagflation’ potentials and / or ‘hiking faster than we’re growing’ fears…i.e. Fed “policy error.”
• Firmer USD (“policy divergence” and start of new Japan fiscal year highlighted below) is meagerly attempting to keep US rates from breaking dangerously lower (recent move lower fueled by the leveraged fund short-squeeze in USTs turning now to interest in establishing LONGS), but this week’s heavy econ calendar will also have fundamental impacts. 
• Today’s US data update is showing us that the much-focused-upon ‘hard vs soft’ data dynamic is showing signs of a ‘true-up,’ with the scale of ‘soft’ data survey beats reverting modestly lower (also see the ‘forward looking’ quote below from Markit’s Chief Business Economist—“…the loss of momentum seen in February and March bodes ill for the second quarter”).
• As per Friday’s note, on watch for signs of April’s ‘momentum reversal’ in equities, which would have large negative impact on buy-side performance as per the heavy overweight in ‘growth’ and the factor crowding in ‘market’—i.e. long books are very ‘high beta’ right now.  RIGHT NOW, WE SEE ‘MOMENTUM’ MARKET-NEUTRAL DRAGGING LOWER.
• Current glimpse at session-performance shows us leadership from ‘defensives’ / ‘low volatility’ / ‘anti-beta’ which certainly isn’t helpful for the buy-side majority.  Initially the ‘new safe haven’ of ‘growth’ held, although as Tech slips further back on the S&P sector performance tables, we see ‘momentum’ fading as well.  Bringing up the rear we see ‘cyclicals’ / ‘value’ getting properly hammered as the aforementioned ‘duration sensitive’ sectors rally, as ‘reflation’ takes another hit.
• To see ‘anti-beta’ outperform against a buy-side universe so ‘long beta’ (‘market’) isn’t a ‘feel good’ indicator for the start of Q2…especially with ‘reflation’ / ‘value’ dragging lower as well and most-notably performance bell-weather ‘momentum’ fading too.

Details

– Historically, this first week of April has been a positive one for risk-assets / higher USD and higher US rates.  Why?  It might have something to do with the start of the Japanese fiscal new year.  Into year-end, yen repatriation flows drive higher yen / weaker Nikkei, lower USD and US rates.  In theory, the commencement of the new fiscal year in Japan reverses that flow, and thus, the pivot to weaker yen / higher USD / higher Nikkei and higher US rates.

So, we now have this additional short-term driver contributing to USD strength, which is proving to ‘hurt’ those who had recently flipped-short per what had been the nascent ‘policy convergence’ narrative.  The issue of course was that last week (as we predicted the day post-Fed) FOMC members–especially doves–rolled out ‘hawkish’….while late last week, a number of ECB speakers (Nowotny, Praet and Knot) were seemingly forced to walk the ‘dovish’ plank.  So, just as Euro longs were being built by tactical funds and shorts slashed / covered (CFTC speculative positioning least net short since May 2014), we saw the EURUSD drop from 1.0906 highs last week to its current 1.0665 level….OUCH. 

– So for now, the near-term narrative has shifted back to the “central bank policy divergence” story as the ‘chief USD-driver.’  That said, this week’s very heavy US econ data calendar will have a role to play too with USD and with US rates as well, especially with the profoundly ‘cleaner’ rates positioning of late, following the enormous leveraged-fund UST short-cover spree of the past few weeks against the ‘lumpy’ asset-manager long selling seen in 5y and 10y.

Where we are NOT seeing less-extreme positioning is the front-end, as the spec net positioning in 3m Eurodollars goes even deeper to another new record net short:

The above positioning seemingly speaks to confidence on more hikes coming down the pipe from the leveraged fund universe.  However, as my colleague Mark Orsley points out this a.m., there have to be some hedgies sweating their ED$ shorts a bit following 1) Fed’s Dudley dovish interview with Bloomberg over weekend…while at the same time, we’re 2) seemingly catching-hints of the long-awaited “true up” between HARD VS SOFT data divergence as expressed by indicators such as the Atlanta Fed GDPNow GDP Forecast (hard-data focused) turn MARKEDLY LOWER, while numerous Street economists reduced Q1 GDP numbers (RBC from 2.5% to 2.0%); Mark also speaks to 3) strong ED$ April seasonality as well and 4) bullish ‘inverse head and shoulders’ in EDZ8 and a bear-flattening ‘head and shoulder’ in EDZ7 / EDZ8 curve.

– The Markit US Manu PMI released earlier touches on this “SOFT VERSUS HARD” data dynamic—here are the comments from Chief Business Economist at HIS Markit Chris Williamson speaking to the thought I’ve been pushing on the likelihood of the ‘soft’ survey beats likely to ‘mean-revert’ down to hard data:

“The post-election resurgence of the manufacturing sector seen late last year is showing signs of losing steam. Output growth slowed to a six-month low in March, optimism about the outlook has waned and hiring has slowed accordingly.

 

While the survey data suggest that the goods producing sector enjoyed a relatively good first quarter on the whole, the loss of momentum seen in February and March bodes ill for the second quarter.”

‘SOFT’ BEATS Z-SCORE SEES DOWNTICK FOLLOWING THIS MORNING’S U.S. DATA DUMP:

US stocks today all about watching for sub-index level signs of ‘April Effect’ commencement (as per Friday afternoon’s “Big Picture” note).  There will be certain buy-side ‘performance pain’ IF the market was to see a perpetuation of the ‘recent’ April ‘momentum-unwind’ phenomenon, largely on account of 1) ‘crowded longs’ (and thus with significant ‘momentum’ attributes) being so heavily ‘growth’-weighted (tech, biotech, cons disc) and 2) significant ‘market’ factor crowding risk in long portfolios, i.e. longs are exceedingly ‘high beta’ right now (‘High Growth’ basket raw beta to SPX = 1.25, adjusted beta 1.16; ‘S&P Info Tech’ sector raw beta to SPX = 1.20, adjusted beta to SPX = 1.14; ‘High Hedge Fund Concentration’ basket raw beta to SPX = 1.19, adjusted beta to SPX = 1.13).

Today as noted in the summary above sees ‘duration sensitive’ sectors like ‘defensives’ / ‘low vol’ / ‘anti-beta’ as the clear outperformers, with the ‘new’ safe-haven of ‘secular growers’ like Tech holding modestly well initially, but fading currently.

Also from a risk sentiment perspective, it’s notable that the bounce seen last week in ‘reflation’ plays i.e. ‘cyclical beta’ and ‘value,’ which in light of seeing GDP #’s taken lower around the Street currently likely shows further pain to come with rates rallying. 

So, ‘growth’ poster-child ‘tech’ is now slipping lower, and as such, so too are ‘momentum longs’ fading.  In conjunction ‘anti-beta’ outperform against a buy-side universe so ‘long beta’ (‘market’) isn’t a great indicator for the start of Q2, ESPECIALLY with ‘reflation’ / ‘value’ being hit.

MODEL EQUITY L/S PORTFOLIO SUCKING WIND HERE WITH ‘WRONG LEADERSHIP’ FROM ‘DEFENSIVES’ AGAINST ‘GROWTH’ LONGS—AND THUS, ‘MOMENTUM’–FADING:

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Authored by Mike Shedlock via MishTalk.com,

If Central Banks wanted to make a positive impact on the global economy, they would abolish themselves and let the free market set rates.

Instead, and after pursuing a 2% inflation target for decades, central bankers now ponder the need for even higher rates of inflation.

Rethinking Made Worse

Please consider Rethinking the Widely Held 2% Inflation Target.

Inflation has finally returned to the Federal Reserve’s 2% goal after undershooting it for nearly five years. Now, just as the central bank has inflation where it wants it, economists and central bankers are starting to think the goal, and how it has been implemented in many places, was a mistake.

 

Spooked by inflation spikes during the 1970s and early 1980s, central bankers had come to view targets as a core tenet of sound monetary policy. In the 1990s and 2000s, many picked a 2% target, seeing it as not so high that it would disrupt business decisions and wage negotiations, and not so low that it would make interest rates unmanageable.

 

Today, after a long period of exceptionally low inflation and interest rates, central banks are talking about alternatives to rigid 2% targets. Many of these alternatives involve the option of letting inflation rise above 2% either permanently or for a time.

 

“This is one of those ideas that has moved from a crazy idea that no one would discuss to an idea that is being seriously discussed by important policy makers,” said Emi Nakamura, an economist at Columbia University.

 

The financial crisis and its aftermath shifted the consensus. Instead of high inflation, today’s central banks are confronted with aging populations, lower long-term growth and higher saving rates. Those all hold down the real natural interest rate—the equilibrium interest rate, adjusted for inflation, that keeps borrowing, lending and the broader economy in balance.

 

A very low natural rate is a problem for central bankers, who manipulate short-term interest rates to manage their economies. When the economy heats up, they push rates higher to slow it down. When the economy slows down, they cut rates to speed it up.

 

When the natural rate is very low, central banks risk running rates into zero when they’re trying to cut, effectively running out of room to stimulate the economy in a downturn. New research by Fed economists Michael Kiley and John Roberts suggests Fed officials may now confront near-zero interest rates 40% of the time or more because of the low natural rate.

 

Olivier Blanchard, an economist at Peterson Institute for International Economics, kicked off the debate over higher inflation in 2010 when he suggested a 4% target while serving as the International Monetary Fund’s chief economist. The idea was that a steady rate of higher inflation would mean that nominal interest rates could be higher too, leaving central banks more room to cut in a downturn to boost output.

Preposterous Nonsense

The blatant nonsense inherent in the above article is apparent in one second flat, just by looking at the chart.

The natural interest rates can never be negative. Here’s why: A negative rate implies things like one would rather have 90 cents tomorrow than a dollar today.

That’s illogical. Rather than accept negative rates, one could simply sit on money.

Don’t confuse negative natural rates with storage charges for safe keeping. Storage charges are a service fee, not a natural interest rate.

Also, the idea the Fed or anyone else can divine the natural rate is in and of itself preposterous. The free market could, not a collective bunch of self-appointed economic wizards.

Finally, these self-appointed wizards not only think they can determine the natural rate, they arrogantly believe they know when to override that rate.

Economic Challenge to Keynesians

Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.

I have commented on this many times and have been vindicated not only by sound economic theory but also by actual historical examples.

My article Deflation Bonanza! (And the Fool’s Mission to Stop It) has a good synopsis.

And my Challenge to Keynesians “Prove Rising Prices Provide an Overall Economic Benefit” has gone unanswered.

There is no answer because history and logic both show that concerns over consumer price deflation are seriously misplaced.

The BIS did a study and found routine deflation was not any problem at all.

“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the BIS study.

It’s asset bubble deflation that is damaging.

And in central banks’ seriously misguided attempts to fight routine consumer price deflation, central bankers create very destructive asset bubbles that eventually collapse.

When those bubble burst, and they will, it will trigger debt deflation, which is what central banks ought to fear.

For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?

Meanwhile, economically illiterate writers bemoan deflation, as do most economists and central banks. The final irony in this ridiculous mix is central bank policies stimulate massive wealth inequality fueled by soaring stock prices.

Challenge to John Williams

I challenge John Williams to a debate on interest rate policy. All proceeds will go to charity. Of course, Williams would never agree to debate me.

Confused About Safekeeping?

For a discussion of the difference between safekeeping charges and negative interest rates, please see Confusion Over Negative Interest Rates; What About Safekeeping Fees?

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As we previewed last Friday when Senator Clair McCaskill’s “No” decision was seen by many “whip counts” as the decisive “final” vote, moments ago Senate Democrats clinched enough support to block Neil Gorsuch’s nomination to the Supreme Court, in the process setting up what now appears an inevitable “nuclear” showdown over Senate rules later this week.

The threshold was passed when Sen. Chris Coons  announced on Monday that he will oppose President Trump’s pick on a procedural vote where he will need the support of eight Democrats to cross a 60-vote threshold. Coons became the 41st Democrat to back the filibuster.

“Throughout this process, I have kept an open mind … I have decided that I will not support Judge Gorsuch’s nomination,” Coons said quoted by The Hill. “I am not ready to end debate on this issue. So I will be voting against cloture,” Coons said, absent a deal to avoid the nuclear option.

After Coons’ decision, unless one of the 41 Democrats change their vote, the filibuster of Gorsuch will be sustained in a vote later this week.

More details from The Hill:

Gorsuch’s path to overcoming a filibuster closed on Monday after Democratic Sens. Dianne Feinstein (Calif.), Patrick Leahy (Vt.) and Mark Warner (Va.) each announced they would oppose Gorsuch’s nomination. Only four Democratic senators have said they will support President Trump’s pick on the initial vote: Sens. Heidi Heitkamp (N.D.), Joe Donnelly (Ind.), Joe Manchin (W.Va.) and Sen. Michael Bennet (Colo.). 

 

Heitkamp, Donnelly and Manchin are each up for reelection in states carried by Trump in the 2016 election. Bennet — who won reelection last year — has been under a microscope because of Gorsuch’s ties to Colorado, and didn’t specify that he would vote for the nominee during a final vote.

Having been “under a mountain of pressure” from liberal outside groups to block Gorsuch’s nomination, Democrats predictably caved. “Progressives argue that voting for his nomination — even on a procedural vote — helps enable President Trump and is out of line with what the base of the party wants. With Democrats now able to block Gorsuch’s nomination, Republicans are expected to change the rules to circumvent the filibuster.”

The most likely next step is the Republican use of the nuclear option (previewed earlier), and although GOP leadership hasn’t specifically said they will use the “nuclear option,”  GOP senators appear resigned to lowering the threshold for Supreme Court nominations. Republicans have been quick to note that Democrats, then led by Majority Leader Harry Reid (D-Nev.), used the nuclear option in 2013  to lower the confirmation threshold for lower court judges and executive nominees.

“If we have to, we will change the rules, and it looks like we’re going to have to,” Sen. Lindsey Graham (R-S.C.) said during the Senate Judiciary Committee’s meeting on Gorsuch’s nomination. “I hate that. I really, really do.” 

Sen. John Cornyn (R-Texas), the No. 2 Senate Republican and a member of the committee, added that Gorsuch will be confirmed by the end of the week.  “If they’re going to oppose Neil Gorsuch to the Supreme Court of the United States, they will never vote and never support a nominee of this President,” he said. 

 

With the Judiciary Committee expected to clear Gorsuch’s nomination on Monday, a full Senate vote is expected by the end of the week.

 

Graham compared Democratic complaints to “arsonist complaining about the fire.”

For a longer take of how the GOP’s use of the nuclear option could transform the Senate, please read the following preview.

via http://ift.tt/2oC1CBv Tyler Durden