Falling Discount, Gold and Silver Get Powelled, Report 29 Oct 2017

Warren Buffet famously proposed the analogy of a machine that produces one dollar per year in perpetuity. He asks how much would you pay for this machine? Clearly it is worth something more than $1.00. And it’s equally clear that it’s not worth $1,000. The value is somewhere in between. But where?

This leads to the concept of discount (which we mentioned in Falling Productivity of Debt two weeks ago). A dollar to be paid next year is worth less than a dollar in the hand today. One reason is that we are mortal beings. In order to be alive next year, we must remain alive every single day between now and then. There are natural reasons for time preference—the desire to have a good today, and not postpone it. We are also not omniscient. Something may come up, such as an illness, which forces us to consume what we did not plan to consume.

Another reason is, of course, risk. Unlike the magic machine in our example, a business enterprise may cease to make money for any number reasons including a new competitor or changing customer preferences.

For many reasons, a dollar to be paid next year is not worth a dollar today. A dollar to be paid in ten years is worth even less. Future payments must be discounted. The discount is related to the interest rate, and it shares many of the same causes.

It can be quoted as a yield, if you look at earnings divided by share price. We aren’t going to go through the formula to discount future earnings into perpetuity here. However, the math works out. The current P/E ratio of S&P 500 stocks is 25.74. This is the same as saying the E/P ratio is 3.89%. If you discount a dollar of earnings every year into perpetuity, at 3.89%, you get 25.74. So we use discount rate and earnings yield equivalently, depending on context and the point we want to make.

The higher the price of the share, the lower the yield. With each halving of discount rate and hence earnings yield, the share price doubles. A nifty trick to create free money, eh? Just somehow lower rates and yields across the economy…

It should not be surprising that discount has been falling along with the interest rate. Let’s look at earnings yield again (ignoring dividend yield which is under the control of corporations, who have broad discretion to set the dividend, and hence not as clear a signal).

This chart is showing three things. First and most obvious, the earnings yield on stocks falls with the interest rate (as does marginal productivity of debt as we showed last week). And it makes sense, the more the Fed pushes down interest, then equities become more attractive. At least until their yields are pulled down closer to Treasury yields.

Second, yield purchasing power is falling. This is not how many groceries you could buy if you liquidate your stocks (as the mainstream view would have you think). It is how many groceries you can buy with the earnings of the businesses you own. Stocks are partial ownership of businesses, and as a shareholder you have a portion of the earnings. As yield purchasing power falls, it takes more and more capital to generate enough income to buy food. At the current level of 3.89%, if you need $50,000 a year to live, you need about $1.3 million worth of S&P shares.

And it’s actually worse than that. Corporations do not pay 100% of their profits to shareholders. At present, they pay out a bit under half of their profits. To live on the dividends, you would need about $2.7 million worth of shares. But as we noted above, equities incur significant risk that the business will become less profitable. Debt must be paid. Dividends are optional.

Third, and you probably saw this coming, discount is falling. The market price of that dollar of earnings way out in the futures, years away, is rising. It is saying that a dollar to be earned by the corporation in a decade, is worth over 67 cents today. And a dividend to be paid out in a decade is worth 83 cents.

I hardly think we would be alarmists or perma-bears to say that at such a low discount, investors have a razor thin margin of safety. This is without getting into the rising debt level to maintain even this profit. Nor the problem of borrowing to pay dividends.

We want to underscore one final point here. When the Fed pushes down interest rates, it manipulates discount and hence measurement of both time and risk. It is toying with powerful forces, which should not be toyed with. All the king’s horses and all the king’s men know little about the damage they wreak. They focus only on the rate at which consumer prices are rising, or perhaps GDP. Meanwhile, investors are forced to pretend that a bird 10 bushes away is worth almost as much as a bird in the hand.

We can only shake our heads again, and refer to the impotence of governments to repeal natural law with legislative law. We can only point to the example of King Canute. The tide did not roll back for his command, nor does time preference and discount bend to the will of King Fed.

We love to hate the expression “it’s not a problem until it’s a problem,” but it seems so apropos to the unsustainable trends of falling discount, rising corporate debt, and falling marginal productivity of debt.

The above, by the way, describes a process of consumption of capital. Of eating the seed corn (two processes, if you count corporate borrowing to pay dividends). With each new speculator buying shares at ever-higher prices, there is a transfer of wealth from the buyer to the seller. The seller receives it as income, and spends some of it. The sellers are consuming some of the buyers’ wealth. These buyers fork over their wealth in the expectation that new buyers will come along soon, and give them even more wealth.

This is also known as the wealth effect, without any apparent irony. The people it harms most, the owners of capital, seem to like it. The way a junkie seems to like heroin. It may be destroying him, but the euphoria blots out other considerations.

We will close with two separate thoughts about gold. These thoughts should be kept separate, as far too often proponents of buying gold (e.g. dealers) mix up monetary economics with the driver to buy the metal.

One, in a free market for money (aka gold standard), no one has the power to manipulate interest rates, hence asset prices, yield purchasing power, and discount rates. The time preference of the savers has real teeth. This is the principle virtue of the gold standard (not static consumer prices, aka inflation, which is neither possible nor desirable).

Two, the falling marginal productivity of debt and falling discount is pathological. If one wants to avoid (well, minimize) one’s exposure, then one buys gold. Not out of hopes of a higher price (and the same seed-corn eating process of speculation described above). But simply as the alternative to equities with too little discount, and bonds with too little interest.


The prices of the metals dropped a bit more this week, -$7 and -$0.16.

We all know the dollar is going down, that it is the stated policy of the Federal Reserve to make it go down. We all know that gold has been valued for thousands of years. So why do we measure the timeless metal in terms of paper currency? It should be the other way around. We therefore encourage people to think of the price of the dollar measured in gold, rather than the price of gold measured in dollars.

This week, the dollar was up to 24.43 milligrams of gold.

On Friday, we had a curious thing. A report came out that Jerome Powell, who is on the Board of Governors of the Federal Reserve, is now the leading candidate to replace Janet Yellen as Chairman. This was deemed by the market to be good for gold and especially silver. Powell is not only an establishment guy, he has been part of the decision making body which has brought you the monetary policy which has caused/coincided with the drop in the price of gold from $1,558 when he took office.

Presumably the reason why he is a candidate, and the reason why the gold market bid up the price of gold, is that he will continue the current central plan. This plan could be charitably dubbed “monetary largesse”. Notwithstanding the theory held by both the mainstream Fed apologists and alternative Fed critics, this policy has not resulted in skyrocketing prices of either consumer goods or gold. But no matter, the likely appointment of the mainstream insider (as opposed to the other leading candidate, John Taylor, who is an academic and not a Fed official) is good news. For gold. For now.

Despite that this same policy over the last 6 years has caused /coincided with falling and more recently sideways or weakly rising gold price action, Powell is deemed good for gold. Speaking of more recent weak rising price action, we know technical traders who see the small size of this move as proof of another down leg to come in the price.

In the short term, of course, the price will bang about due to such Kremlinology. In the long term, equally of course, the price will change due to the fundamentals. That is what this Report is all about. We have invested in many years of research and development (and a license to a tick history database that contains every bid and offer with sub-millisecond resolution, going back to 1996). The output of our data science work are graphs showing the internal structure of the market, with unprecedented accuracy and clarity.

Below, we will discuss both the long-term big picture supply and demand fundamentals, and the intraday action around the Powell news. But first, here are the charts of the prices of gold and silver, and the gold-silver ratio.

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. The ratio rose.

In this graph, we show both bid and offer prices for the gold-silver ratio. If you were to sell gold on the bid and buy silver at the ask, that is the lower bid price. Conversely, if you sold silver on the bid and bought gold at the offer, that is the higher offer price.

For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph showing gold basis and cobasis with the price of the dollar in gold terms.

We see a rising cobasis (our measure of scarcity) along with a rising price of the dollar (i.e. falling price of gold, in dollar terms). This is not surprising; it is the typical pattern nowadays.

Our calculated Monetary Metals gold fundamental price fell $10 to $1,347.

Now let’s look at silver.

We also see a rising cobasis along with rising price of the dollar in silver terms (i.e. falling price of silver in dollar terms). Much of this rise is the mechanics of the contract roll, as traders start to sell the contract before expiry and buy the next month.

Our calculated Monetary Metals silver fundamental price fell $0.05 to $17.03.

Now, on to Friday’s “Powell Spike”. Somebody thought Powell would be good for gold. The price rallied four bucks in a minute, and then another three bucks within 8 minutes. But who? Was it stackers loading up on coins, prepping for inflatiocalypse? Or was it speculators loading up on leverage, betting on futures?

In Part II of this article, we answer this question by analyzing intraday graphs of the gold and silver basis.

 

© 2017 Monetary Metals

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Mueller Indicts Manafort, Trump Hits Personal Low Approval Rating, Obama Gets Jury Duty: A.M. Links

  • The Robert Mueller investigation into alleged Russian meddling in the 2016 elections has yielded its first indictment, that of Paul Manafort.
  • President Trump hits a new personal low on his approval rating, 38 percent in the latest NBC News/WSJ poll.
  • The governor of Puerto Rico says the territory’s power contract with Whitefish, which has earned media scrutiny for its generous terms and the company’s perceived connection to Interior Secretary Ryan Zinke,ought to be canceled.
  • “White Lives Matter” activists canceled a rally in Tennessee after more counter-protesters showed up.
  • Iran President Hassan Rouhani insists his country will keep building missiles.
  • At least 23 people were killed in a hotel siege in Mogadishu for which Al-Shabaab claimed responsibility.
  • Life goes on as Spain enforces direct rule in Catalonia.
  • The president of Iraqi Kurdistan announced he would resign after the region’s failed independence bid.
  • Barack Obama gets called for jury duty.

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Spain Files Charges Against Catalan Government For Rebellion; Puigdemont Runs To Brussels

Spain’s Director of Public Prosecutions, Jose Manuel Maza, made a short statement this morning as he filed a suit against former Catalonian leader, Carles Puigdemont and his colleagues, accusing them of “rebellion, sedition and misuse of public funds”. In total, charges have been made against 20 people, 14 of them former members of the Catalan and six of them members of the Speaker’s Committee in the Catalan Parliament (which facilitated the declaration of independence). 

Below is the front page of the document which details the charges, courtesy of the twitter account of The Spain Report.

The Spain Report published a summary of the charges.

  1. Accusations to be rebellion, sedition and misuse of public funds. All very serious crimes under Spanish Criminal Code 1995.
  2. Charges to be against all members of former Catalan government and members of Catalan Parliament Speaker's Committee.
  3. So Puigdemont, Junqueras, Romeva, Turull, etc. (regional got) and Forcadell (Speaker, parliament).
  4. Accusations against Puigdemont, Junqueras, etc. going to National High Court. Having been sacked, they no longer enjoy special privilege.
  5. Accusations against Forcadell and Speaker's Committee going to Supreme Court. They still enjoy special privilege until new elections.
  6. No word on remand petition yet. Prosecutor will wait until first court appearances to decide.

If found guilty, the charges of rebellion, sedition and misuse of public funds carry prison terms of up to 30, 15 and 6 years, respectively, under Spanish law.

Prior to the Public Prosecutor’s move, events in Catalonia had got off to a subdued start on the first day of the new working week. Only one Catalonian government official, Josep Rull, turned up for work, posting a photo of himself online via his Twitter account.

Rull, who is responsible for territory and sustainability, tweeted that he was in his office… “exercising responsibilities entrusted by Catalan people”.

According to La Vanguardia, two members of the Catalan police force visited Rull and informed him that he could be arrested. Spain’s Interior Minister, Juan Ignacio Zoido, urged Rull not to lead Catalonian officials “to the cliff edge.”

He subsequently departed. The newspaper also reported that accused Catalan Parliament Speaker, Carme Forcadell, cancelled a meeting of the group which organizes the Catalan Parliament’s daily agenda. The meeting had been scheduled for 10a.m. tomorrow.

Meanwhile, AP reports that one of the Catalan separatist parties is already drawing up plans for the upcoming regional elections.

A spokesman for a Catalan separatist party ousted from the regional government for pushing ahead with an independence bid has confirmed plans for the party to run in an upcoming regional election. Lawmakers of the Catalan Republic Left, or ERC, party, and their ruling coalition partners, passed a unilateral declaration of independence from Spain on Friday with the support of other separatist legislators. Making use of extraordinary powers, the Spanish government has fired the Catalan government, dissolved the regional parliament and called an election for Dec. 21. ERC party spokesman Sergi Sabria told reporters after a meeting of the party leadership that “we will find the way to participate on Dec. 21. Dec. 21 can be one more opportunity to consolidate the republic.”

As the news of the prosecutions was breaking, The Spain Report noted on its Twitter account that El Periodico de Catalunya, a Barcelona daily newspaper, reports that Carles Puigdemont is in Brussels.

Yesterday, The Brussels Times reported that Puigdemont could seek asylum in Belgium.

Carles Puigdemont, the former Catalonian President, could seek asylum in Belgium, the State Secretary for Asylum and Immigration Theo Francken has told VTM Nieuws. “No request has been submitted yet, but things change quickly. We’ll see what happens in the next few hours or days”, the State Secretary told VRT. The Spanish government has threatened to charge Mr Puigdemont because the regional Parliament voted for a unilateral independence resolution on Friday. A few days ago, Carles Puigdemont implied that it was possible he would seek asylum in a European country via an embassy. Belgium would be his preference.  

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Key Events In The Coming Very Busy Week

With a full slate of central bank meetings, data (including payrolls Friday) and earnings next week there’s a little bit for everyone. On Thursday, according to Politico, we will also know who the next Fed Chair is as well as get a first look at a version of the House tax bill in the US, perhaps on Wednesday.

In terms of the scheduled events, front and center we’ve got the Bank of Japan (Tuesday), Fed (Wednesday) and Bank of England (Thursday) policy meetings all due in a three day window. Only the BoE is expected to change policy though with a 25bp hike to 0.5% the consensus on the street.

In terms of the Fed, while there is no Yellen press conference scheduled we may get clues in the statement as to whether the Fed is on track to raise rates in December.

Over at the BoJ, Governor Kuroda will make a scheduled press conference post the meeting so keep an eye on that.

With regards to the economic data next week, Monday’s just reported September PCE report in the US was closely watched with a modest +0.1% mom core reading expected (it printed at 0.1%, in line with expectations), while attention will also fall on Germany’s flash CPI report for October. We’ll get the wider Euro area report on Tuesday where the consensus is for no change in the +1.1% yoy core reading. In the US we also get ADP, ISM, and trade balance. We also have FOMC rate decision and Fed speakers in the schedule. 

In the Eurozone, we wait for unemployment, GDP, CPI, PMI and ECB speakers. In the UK, main focus is on BoE rate decision but we also have PMIs

Scattered throughout the week will be the final October PMIs, while we end the week with a bit of a bang on Friday with the October employment report in the US and that ever important nonfarm payrolls print. Current market expectations is for a bounceback 310k reading following that -33k slide in September. A +0.2% mom average hourly earnings reading is also expected.

Earnings wise next week we’ve got 136 S&P 500 companies scheduled including Apple on Thursday while 58 Stoxx 600 companies are due.

The full breakdown charted below, courtesy of BofA

DB’s Jim Reid has a day by day summary of key events:

  • Monday: A big day for inflation readings with the September PCE and personal spending reports in the US and flash October CPI report in Germany being the highlights. October confidence indicators for the Euro area and September money and credit aggregates data in the UK will also be worth watching, while the October Dallas Fed manufacturing activity reading in the US will also be out this afternoon. Late tonight we get industrial production and jobless rate data in Japan. Politics wise, Germany Chancellor Angela Merkel is due to meet leaders of the Free Democrats and Greens in the latest round of exploratory talks on forming a government.
  • Tuesday: The most significant overnight event is the BoJ monetary policy meeting along with the release of the Bank’s quarterly outlook report. Governor Kuroda’s press conference is due to follow shortly after. Meanwhile notable data includes the October PMIs in China, the flash October CPI print for the Euro area and France, advance Q3 GDP report for the Euro area and consumer confidence for the UK for October. In the US the Q3 employment cost index, October Chicago PMI, October consumer confidence and August S&P/Case-Shiller house price index is amongst the data due. The ECB’s Visco and Padoan are also due to speak while UK Brexit Secretary David Davis is questioned by the House of Lords EU Committee about the state of Brexit talks. BP and BNP Paribas are amongst the companies reporting results.
  • Wednesday: Front and centre on Wednesday evening will be the FOMC meeting although it’s worth noting that there is no scheduled Yellen press conference after. Along with the meeting we’ll also get some important data releases in the US including the ADP employment change report for October, ISM manufacturing print for October and October vehicle sales. Prior to this, in Asia the Caixin manufacturing PMI in China and Nikkei manufacturing PMI in Japan are due, while in the UK October house price data and the manufacturing PMI for October will be out. Away from that, UK Trade Secretary Liam Fox testifies before a parliamentary panel on plans for post-Brexit trade while BoJ Deputy Governor Nakaso is due to speak. In the US, the initial version of the tax plans should be released for further debates. Facebook and Tesla are amongst the notable earnings reports.
  • Thursday: Another central bank meeting should hog the spotlight with the BoE meeting outcome due around lunchtime. BoE Governor Carney will follow while the Bank’s latest inflation report will also be released alongside. Datawise we’ll receive the final October PMI revisions in Europe along with the October unemployment print in Germany and initial jobless claims and Q3 nonfarm productivity and until labour costs in the US. The Fed’s Bostic is also due to speak along with the IMF’s Lagarde. Apple and Credit Suisse are amongst the notable corporate reporters.
  • Friday: A busy end to the week for data. The highlight will likely be this afternoon with the October employment report in the US including the latest monthly nonfarm payrolls print. China’s remaining Caixin PMIs for October, the UK’s remaining October PMIs and the ISM non-manufacturing, final durable and capital goods orders for September, factory orders for September and the final PMIs in the US round out the data. The Fed’s Kashkari will also speak in the afternoon and the ECB’s Coeure in the evening. President Trump is also due to depart on his 11-day trip to Asia.

Finally, looking at just the US, here are the key events together with consensus expectations…

… and a full breakdown from Goldman:

The key economic releases this week are the personal income and spending report on Monday, ISM manufacturing on Wednesday, and the employment report on Friday. The statement from the October/November FOMC meeting will be released on Wednesday, and there are a few speaking engagements by Fed officials later this week.

Monday, October 30

  • 8:30 AM Personal income, September (GS +0.4%, consensus +0.4%, last +0.2%); Personal spending, September (GS +1.1%, consensus +0.9%, last +0.1%); PCE price index, September (GS +0.39%, consensus +0.4%, last +0.2%); Core PCE price index, September (GS +0.14%, consensus +0.1%, last +0.1%); PCE price index (yoy), September (GS +1.65%, consensus +1.6%, last +1.4%); Core PCE price index (yoy), September (GS +1.34%, consensus +1.3%, last +1.3%): We estimate a 1.1% increase in September personal spending (nominal, mom sa), reflecting a post-hurricane rebound in retail spending and auto sales, as well as a boost from higher gas prices. Based on details in the GDP, PPI, and CPI reports, we estimate that the core PCE price index increased 0.14% month-over-month in September, or +1.34% from a year earlier. Additionally, we expect that the headline PCE price index rose 0.39% in September, or +1.65% from a year earlier. We estimate a 0.4% increase in personal income.
  • 10:30 AM Dallas Fed manufacturing survey, October (consensus 21.3, last 21.3)

Tuesday, October 31

  • 08:30 AM Employment cost index, Q3 (GS +0.7%, consensus +0.7%, last +0.5%): We estimate that growth in the employment cost index (ECI) accelerated to 0.7% in Q3, with the year-over-year pace rising a tenth to +2.5%. Our forecast reflects diminished labor market slack and a boost from expected mean-reversion in the pace of growth in incentive-paid industries, particularly sales and related occupations. Wage growth also firmed in the third quarter, and our wage tracker—which distills signals from several wage measures—rose to 2.8% year-on-year in Q3 from 2.6% in Q2.
  • 09:00 AM S&P/Case-Shiller 20-city home price index, August (GS +0.4%, consensus +0.4%, last +0.3%): We expect the S&P/Case-Shiller 20-city home price index to increase further by 0.4% in August, following a 0.3% increase in the prior month. The measure still appears to be influenced by seasonal adjustment challenges, and we place more weight on the year-over-year increase, which was 5.9% in July.
  • 09:45 AM Chicago PMI, October (GS 62.5, consensus 60.0, last 65.2): We expect the Chicago PMI to moderate 2.7pt to 62.5 following a 6.3pt gain in the prior month. The index is likely to remain at levels consistent with expansion in business activity.
  • 10:00 AM Conference Board consumer confidence, September (GS 119.5, consensus 120.0, last 122.9): We estimate that the Conference Board consumer confidence index pulled back 3.4pt in September following a 5.6pt increase over the previous two months. Our forecast reflects sequential deterioration in higher frequency consumer surveys as well as scope for hurricane related weakness.

Wednesday, November 1

  • 08:15 AM ADP employment report, October (GS +135k, consensus +200k, last +135k): We expect a 135k increase in ADP payroll employment in October, reflecting a large drag from the September nonfarm payroll decline that is an input into ADP’s model. The report is likely to be difficult to interpret as a result, particularly because it could also be affected by the net strength in other financial and economic indicators used in the model.
  • 09:45 AM Markit US Manufacturing PMI, October (consensus 53.1, last 54.5)
  • 10:00 AM Construction spending, September (GS flat, consensus -0.2%, last +0.5%): We expect construction spending to be flat in September following a 0.5% gain in the August report, likely reflecting the impact of recent hurricanes on construction activity.
  • 10:00 AM ISM manufacturing index, October (GS 60.0, consensus 59.6, last 60.8): Regional manufacturing surveys have strengthened on net in October, while other measures of business confidence were more mixed. Overall, our manufacturing survey tracker moved up 0.9pt to 60.5 in October. We expect the ISM manufacturing index to decline 0.8pt to 60.0, following a 4.5pt gain over the last two months, but it will likely remain at levels consistent with a firm pace of expansion in business activity.
  • 02:00 PM FOMC statement, Oct 31-Nov 1 meeting: We expect the FOMC to keep policy unchanged next week and see few substantive changes to the statement. We expect a slightly more upbeat tone on growth that acknowledges the disruptions from the hurricanes but characterizes them as temporary or in the past tense, as we think Fed officials will view the data released over the inter-meeting period as broadly encouraging. Despite the disappointing September CPI report, we do not expect a downgrade of the inflation assessment or outlook, reflecting broadly stable year-over-year inflation and the further decline in the unemployment rate. We also expect the committee will continue to describe the risks to the outlook as “roughly balanced,” but there is a possibility that the statement upgrades the assessment of growth risks to “balanced” and leaves the inflation language unchanged (“closely monitoring”).
  • 5:00 PM Total vehicle sales, October (GS 17.7mn, consensus 17.5mn, last 18.5mn): Domestic vehicle sales, October (GS 13.7mn, consensus 13.7mn, last 14.3mn)

Thursday, November 2

  • 08:30 AM Nonfarm productivity (qoq saar), Q3 preliminary (GS +3.2%, consensus +2.5%, last +1.5%); Unit labor costs, Q3 preliminary (GS +0.6%, consensus +0.4%, last +0.2%): We estimate non-farm productivity increased 3.2% in Q3 (qoq ar), well above the 0.75% average achieved during this expansion. We expect unit labor costs – compensation per hour divided by output per hour – to increase 0.6% (qoq saar).
  • 08:30 AM Initial jobless claims, week ended October 28 (GS 230k, consensus 235k, last 233k): Continuing jobless claims, week ended October 21 (consensus 1,897k, last 1,893k): We estimate initial jobless claims fell 3k to 230k in the week ended October 28. Our forecast reflects additional post-hurricane normalization in Florida filings, which have retraced most of their earlier increases. Continuing claims – the number of persons receiving benefits through standard programs – have resumed their downtrend, falling to a new year-to-date low in the week ended October 21.

    08:30 AM Fed Governor Powell (FOMC voter) speaks: Federal Reserve Governor Powell will deliver introductory remarks at the Alternative Reference Rates Committee’s roundtable event in New York. No Q&A is expected.

  • 12:20 PM New York Fed President Dudley (FOMC voter) speaks: New York Fed President William Dudley will give closing remarks at the Alternative Reference Rates Committee’s roundtable event in New York. No Q&A is expected.
  • 06:15 PM Atlanta Fed President Bostic (FOMC non-voter) speaks: Atlanta Federal Reserve President Raphael Bostic will take part in a panel on “The Vital Role of Government Statistics” at the Association for Public Policy Analysis and Management’s 39th Annual Fall Research Conference in Chicago. Audience Q&A is expected.

Friday, November 3

  • 08:30 AM Nonfarm payroll employment, October (GS +325k, consensus +310k, last -33k); Private payroll employment, October (GS +310k, consensus +300k, last -40k); Average hourly earnings (mom), October (GS +0.2%, consensus +0.2%, last +0.5%); Average hourly earnings (yoy), October (GS +2.7%, consensus +2.7%, last +2.9%); Unemployment rate, October (GS 4.2%, consensus 4.2%, last 4.2%): We estimate nonfarm payrolls rebounded 325k in October, following a 33k decline in September and compared to three- and six-month moving averages of 185k and 160k, respectively. Our forecast reflects a 150k boost from workers returning to their jobs after Hurricanes Harvey and Irma, which weighed heavily on September payrolls based on the state-level breakdown. Relatedly, we note that electricity usage in Florida and Texas had returned to normal levels by mid-September, several weeks before the October survey period. We also believe the underlying pace of job growth remains firm, as jobless claims fell to a 44-year low in the survey week and our service-sector employment tracker rose to a 2-year high in October. We estimate the unemployment rate was unchanged at 4.2%, as the two-tenths drop last month was not driven by unusual declines in hurricane-affected areas. Finally, we expect average hourly earnings to increase 0.2% month over month and 2.7% year over year, reflecting neutral calendar effects.
  • 08:30 AM Trade balance, September (GS -$43.5bn, consensus -$43.3bn, last -$42.4bn): We estimate the trade deficit widened by $1.1bn in September. The Advance Economic Indicators report last week showed a wider goods trade deficit, and we also expect a pickup in services imports following lackluster growth in recent months.
  • 09:45 AM Markit US Services PMI, October (consensus 55.3, last 55.9)
  • 10:00 AM ISM non-manufacturing index, October (GS 59.0, consensus 58.5, last 59.8): We expect the ISM non-manufacturing index to move down 0.8pt to 59.0 in the October report, following a 4.5pt gain in September. A post-hurricane rebound in construction, mining, and retail is likely to offset some moderation following a big September boost. Overall, our non-manufacturing survey tracker decreased by 0.3pt to 56.7 in October.
  • 10:00 AM Factory orders, September (GS +1.4%, consensus +1.2%, last +1.2%); Durable goods orders, September final (last +2.2%); Durable goods orders ex transportation, September final (last +0.7%); Core capital goods orders, September final (last +1.3%); Core capital goods shipments, September final (last +0.7%): We estimate factory orders increased 1.4% in September following a 1.2% gain in August. Core measures in the September durable goods report were strong, with solid growth in core capital goods orders and shipments.
  • 12:15 PM Minneapolis Fed President Kashkari (FOMC voter) speaks: Minneapolis Fed President Neel Kashkari will participate in a moderated Q&A session with Women in Housing and Finance in Washington. Audience Q&A is expected.

Source: BofA. DB, Goldman

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US Savings Rate Crashes To 10 Year Lows As Spending Surges Most Since ‘Cash For Clunkers’

While incomes grew at an expected 0.4% MoM, US consumers spent at an exuberant 1.0% MoM clip – the biggest monthly rise since Aug 2009 (cash for clunkers). To cover this spending surge, the savings rate tumbled.

 

The last time – Aug 09 – that spending surged like this was when the government unleashed 'cash for clunkers', it plummeted the following month…

Spending on durable goods rose 3.5 percent after adjusting for inflation after a 1.4 percent decline in August.

Outlays on services rose 0.3 percent, while spending on non- durable goods also advanced 0.3 percent.

Under the hood, the PCE Deflator printed as expected +1.6% YoY.

Private workers wage growth continues to outstrip government workers' wage growth YoY and upticked in September…

And while outgoings surged with relatively flat incomes, the savings rate plunged to its lowest since Dec 2007 to enable the spending…which just happens to be when the last recession started.

As Bloomberg warns, the jump in September outlays was driven by purchases of durable goods including the replacement of motor vehicles lost in recent flooding from hurricanes. That means the latest surge probably overstates the strength of consumer spending.

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Trump To Make Fed Chair Announcement On Thursday: Politico

Far more important than any corporate earnings or central bank announcements this week, will be Trump’s widely telegraphed and trial ballooned choice who will replace Janet Yellen, and as Politico writes, that announcement is likely to come on Thursday. As Politico reports, citing sources, “look for an announcement on Thursday, though plans are not totally set yet.” The reports adds that Jerome Powell is still the most likely pick, but Trump could surprise, Politico says and adds that if Trump changes his mind, “Kevin Warsh is more likely than John Taylor.”

More details on Warsh’s unexpected rise in the ranks:

The reason for this is that senior administration officials argued (evidently successfully) to Trump that while Taylor is a rock star economist and monetary policy expert, he might not be the steady hand you’d want at the helm during a potential crisis. Powell may not be the world’s most exiting chair but he is viewed as the safest pick outside of Janet Yellen. That’s where Warsh comes in.

 

If Trump decides at the last second that he wants a splashier pick that would satisfy more conservatives, Warsh could be the guy. And he worked at the Fed during the financial crisis, so presumably could be counted on if for whatever reason we hit the skids hard again.

 

Still, as of this writing, Powell remains the very likely pick. He wouldn’t be able to take part in any announcement early in the week, given the FOMC meets Tuesday and Wednesday. That would push the announcement to Thursday.

Meanwhile, over the weekend, the NYT reported that Trump is unlikely to simultaneously tap a vice chairman at the same time, Treasury Secretary Steven Mnuchin said on Saturday, eliminating one potential twist in a selection process being closely watched on Wall Street.

Finally, as far as the market is concerned, the only surprise at this point is if Powell is not picked as next Fed chair.

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Can The Cautious Capitalist Invest in Cryptocurrency?

 

 

The currency market is hot and many investors are attracted, but “What we’re looking at is a new technology that people are still trying to understand,” says Mathew Gertler of Digital Asset Research and compares it to the Internet in 1994. Warren Buffet has been quoted as saying. “Never invest in a business you cannot understand.” Joe Kinahan of TD Ameritrade illustrates the bitcoin transaction problem: “Say you agree to buy a car [in bitcoin] and the price on Saturday is $32,000 and because of a bitcoin move, on Monday it’s $41,000—people just can’t live their lives like that.”

 

Opening the bitcoin market to average investors is a problem of securitization. Goldman Sachs is considering bitcoin operations. J. P. Morgan is working on its own block-chain technology even though its chairman calls bitcoin a “fraud.” Shares of an exchange-traded fund (ETF) called Global X FinTech (FINX) are up 43% for the year. LedgerX LLC has received permission to trade bitcoin futures and options from the Commodities Futures Trading Commission (CFTC). ProShares has filed an application for an ETF dependent upon receipt by the Chicago Board Options Exchange (CBOE) of approval for trading of long and short options on bitcoin. Wall Street sees the demand and wants a piece of the supply.

 

In October of 2008, Satoshi Nakamoto wrote, “The steady addition of a constant amount of new coins is analogous to gold miners expending resources to add gold to circulation. In our case, it is CPU time and electricity that is expended.” Over 16 million bitcoins have been “mined” by computers running the open-source software Mr. Nakamoto released in 2009. As gold miners are less rewarded for their effort expended as they dig deeper into the earth, so over time, will bitcoin miners be paid less for their work. The reward for each “block” added to the “blockchain” is halved every 210,000 transactions or every four years at a rate of one transaction every ten minutes. Like gold, bitcoin has the “law of diminishing returns” included in its programming. The deeper a gold miner digs, the more it costs to produce an ounce of gold.

 

Since 2009, the reward for verifying and storing newly broadcast bitcoin transactions has been reduced by half, and then halved again. The halving will continue until the miner is paid nearly zero in about one hundred years. There is a finite amount of gold, which can be removed from the planet before the product is worth less than the effort expended to produce it. Rather than ever-larger steel monsters eating the Earth’s crust, bitcoin miners use ever more powerful central processing units (CPU’s) to keep up with their competition for the next bitcoins to be “hashed.” Rewards for mining bitcoins have an endpoint similar to that of gold. By halving the reward every four years, the miner will eventually be paid next to nothing for effort expended.

 

Shekel is a term still used to refer to coined money in some cultures today. Croesus, King of Lydia in the 6th century BC, may have been the first to issue coins called shekels. Originally a weight measure for barley, it became a monetary value when it was used to measure gold. One shekel equaled about one-third of an ounce of gold. Today, one of those shekels would be worth about four hundred dollars. Coins stamped out of metal with universally recognized value expedited transactions of goods and services. Instead of having to trade a load of barley directly for food, shelter, and clothing at the time of delivery, a barley producer could take the value of his barley in tokens that could be carried in a pocket or purse. With convenient conveyance and storage also came increased risk of sudden loss to thieves, so security of savings became more important as people's collection of shekels increased.

 

The most popular shekel today is bitcoin. Bitcoin introduces the certain value of hard currency in a form that is portable, transmittable and secure. One bitcoin today represents the value of fifteen shekels or about five ounces of gold, but 10,000 bitcoins can be carried on a memory stick. For an equivalent value of shekels, one would need at least a couple of pickup trucks. Bitcoin, with the click of a mouse, can be used as a buy-in for an online poker game, to order a new television, or purchase a tropical island. Shekels, where accepted, require delivery and delivery is a problem when carrying such weight and wealth in a pocket, purse, or pickup truck. Bitcoin is secured by the ever-decreasing possibility of hacking the source code, which gets longer with a new iteration every ten minutes. For their efforts, honest mining would better reward hackers than digital theft. Shekels can wear holes in pockets, be left in purses at the blackjack table, or be outright burgled.

 

But bitcoin today is not the only cryptocurrency available as shekels were not the only coined precious metal. Coins of other realms stamped with other royal faces came to compete with the shekel accompanied by the problem of comparative valuation between currencies. How many drachmas per shekel? What is the value of 1000 obols in staters? Today the questions include: How many Litecoin per Bitcoin? What is the value of 1000 Peercoin in Ethereum? What are a million Euros worth in IOTA?

Enter Legolas. Not the Sindarin Elf of the Woodland Realm in The Hobbit, but “a demonstrably fair, premium centralized exchange using decentralized blockchain technology.” As Forex is the market in which currencies are traded, so Legolas intends to be the market for cryptocurrencies. Developed by Frederic Montagnon, co-founder of French ad tech company Teads, Legolas intends to bring security and transparency to the infant market for “cross-chain” transactions. Legolas, like bitcoin, will publish all its transactions in a public blockchain to prevent theft by hacking. In so doing, they will create a monetary digital token, called LGO, compatible on the Ethereum blockchain. One side of every transaction on the Legolas Exchange will be denominated in LGO.

As important as security is Legolas’ proposed ability to make large, immediate and anonymous transactions between bitcoin, other cryptocurrencies, and fiat money. For this purpose, the Legolas business model requires inclusion of an established banking institution. Their associated bank, PayQix, is a next generation bank with accounts in both fiat and cryptocurrencies, which can process large transactions.

 

There is pent-up demand for investment vehicles that will allow conservative investors to dip a toe into the cryptocurrency market. Fundamental to opening this market to average investors are immediate, transparent and secure intra-chain (Ethereum/bitcoin), cross-chain (Litecoin/Ethereum), and fiat/crypto (Euro/bitcoin) transactions. Legolas intends to cover 100% of this market and become “the largest fair exchange in the world”, and be able to answer the question, “How many shekels for one bitcoin?”

 

 

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Frontrunning: October 30

  • Paul Manafort, Who Once Ran Trump Campaign, Told to Surrender (NYT)
  • Russia Probe Puts Focus on Washington Research Firm (WSJ)
  • Trump tax overhaul under intensifying fire as Congress readies bill (Reuters)
  • House Tax Writer Gives Ground on a State and Local Tax Break (BBG)
  • Work resumes normally in Catalonia as Spain enforces direct rule (Reuters)
  • Russia Wields Oil Diplomacy, Pushing In on U.S. Interests (NYT)
  • The Man Behind Moviepass’ 1,151% Rally Has Had 99% Wipeouts in the Past (BBG)
  • China Bond Selloff Spreads to Stocks (BBG)
  • John Boehner Unchained (Politico)
  • U.S. regulator wants to loosen leash on Wells Fargo: sources (Reuters)
  • Why Are Markets Rising? Investors Buy Every Dip (WSJ)
  • Long-time Ally of Offshore Drillers Oversees Safety Agency (WSJ)
  • Black lists matter: the betrayal of democratic liberalism (Medium)
  • The Biggest Stock Collapse in History Has No End in Sight (BBG)
  • Puerto Rico moves to cancel Whitefish power contract after uproar (Reuters)
  • Spacey Apologizes Over Past Harassment (Reuters)
  • Why Is the Government Giving Money to Dying Malls? (BBG)
  • A Missing Piece of the Global Growth Jigsaw Starts to Fall Into Place (BBG)
  • Iran fulfilling nuclear deal commitments: IAEA chief (Reuters)

Overnight Media Digest

WSJ

– The first defendants in a criminal investigation of Russia’s meddling in the 2016 presidential campaign could be taken into custody as soon as Monday, people familiar with the matter said, though the nature and target of the charges couldn’t be determined over the weekend. on.wsj.com/2yWFg3o

– Puerto Rico’s governor said Sunday he would cancel a $300 million reconstruction contract with a little-known Montana energy firm after the Federal Emergency Management Agency said it had “significant concerns” about the deal. on.wsj.com/2yWcjV4

– Strayer Education Inc is nearing a deal to merge with Capella Education Co, according to people familiar with the matter, a move that would create a for-profit education company valued at nearly $2 billion. on.wsj.com/2yVYc20

– General Electric Co executives didn’t notify the company’s board until this month about its regular flying of a spare business jet for its CEO, and it didn’t tell directors that GE had received an internal complaint about the practice several years ago, according to people familiar with the matter. on.wsj.com/2z3amIw

 

FT

Ahead of the autumn budget, Finance Minister Philip Hammond faces the prospect of either abandoning his fiscal targets or ignoring growing demands for more public spending, according to think-tank Institute for Fiscal Studies.

Law firm Stewarts Law is seeking to launch a legal challenge against HSBC Holdings Plc on behalf of small companies that allege they have lost money as a result of being unable to conduct business because their accounts were frozen by HSBC in attempts to crack down on anti-money laundering.

The UK government will hold back the 1 billion pounds ($1.31 billion) promised by Prime Minister Theresa May to the Democratic Unionist Party (DUP) ahead of imposing a budget on Northern Ireland where talks for a deal between the DUP and Sinn Fein to restore the region’s government are yet to materialise.

 

Canada

THE GLOBE AND MAIL

Canada Jetlines Ltd will begin operations with four planes next year instead of six as originally planned and has scaled back plans to start flying out of two airports in Southern Ontario. tgam.ca/2xxRg9L

Hunter Harrison, owner of CSX Corp, says there’s no truth to market speculation that his ill health is behind the arrival of a new operating chief and the departure of three executives. tgam.ca/2xymbTH

One of Vancouver’s tech entrepreneurs, Jeff Booth, abruptly resigned from BuildDirect.com Technologies Inc, the e-commerce company he co-founded 18 years ago and hoped would become the Amazon of heavy-duty home-improvement supplies. tgam.ca/2xyNP2C

 

Britain

The Times

British Treasury ministers were left in the dark about plans to alter UK listings rules in an effort to attract the potential 1 trillion-pounds-plus listing of Saudi Aramco to London amid intense competition to win the float, according to emails disclosed to the Times. bit.ly/2z30K0z

Pay for British-based partners at one of the world’s biggest accountancy firms, Ernst & Young, has swelled to nearly 680,000 pounds ($892,704.00) as the professional services industry enjoyed bumper revenues in spite of Brexit and political upheaval around the world. bit.ly/2z1xszb

The Guardian

The Bank of England is poised to raise interest rates this Thursday for the first time in more than a decade, raising the cost of borrowing for British households already hurt by an earnings squeeze. bit.ly/2z1k9Pr

Britain is on track for a budget deficit – the gap between government spending and tax receipts – to reach 36 billion pounds by 2021-22, more than twice the initial official forecast of 17 billion, according to the Institute for Fiscal Studies. bit.ly/2z3bhJ5

The Telegraph

Ontario Graphite, a Canadian graphite producer, is drawing up plans to capitalise on the electric car boom and raise 40 million pounds by listing in London later this week. bit.ly/2yVWkGN

The government’s triennial review of the UK’s betting industry is expected to act over fixed-odds betting terminals, known as the “crack cocaine” of gambling because they allow punters to stake as much as 100 pounds in a single 20-second flutter. bit.ly/2z310g3

Sky News

The former owner of Monarch Airlines has pledged to use part of any profit it makes from the collapsed airline to compensate taxpayers saddled with a 60-million-pound bill for flying holidaymakers back to UK. bit.ly/2z1koKl

The Independent

A rising number of British restaurants are at risk of going bust due to Brexit, according to new research from accountancy firm Moore Stephens that says 20 percent of restaurants, or 14,800 outlets, are threatened with closure

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Paul Manafort Told To Surrender To FBI

Surprise, surprise. The New York Times is reporting that the first indictment in Special Counsel Robert Mueller's probe into possible collusion between the Trump campaign and Russia has been unsealed. And the target is none other than Paul Manafort, who briefly served as chief executive of the Trump campaign last summer before reports about his work for Ukraine's former leader Viktor Yanukovich forced him out. Manafor has reportedly been asked to surrender by the FBI, sparing him an embarassing perp walk.

Manafort and his former deputy Rick Gates have both been asked to surrender. The charges against the pair weren't immediately clear. But they do represent an escalation in the probe that has loomed over President Trump's first year in office.

Gates is a longtime protege and junior partner at Manafort's firm. His involvment in the probe was revealed in the spring. His name appeared in documents linked to a Cypriot firm Manafort set up to receive payments from Eastern European politicians like Yanukovich, who purportedly paid Manafort with money looted from the Ukraine state.

Manafort had been udner ivnestigaiton for violations of federal tax law, money laundering and whether he failed to properly disclose his foreign lobbying.

As we've noted, since these charges mostly stem from Manafort's work before he became involved with the campaign, they leave ample room for Trump to declare victory. Now, we watch for the administration's response.

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It’s Time to Privatize the V.A.: New at Reason

National Building Museum exterior frieze. There’s a building in Washington, D.C., that’s mostly empty space. The Pension Building, as it was known when it was commissioned by Congress in 1881, fills an entire city block. Like an M.C. Escher fever dream, columns of every size rise in stacked colonnades around a stupendously massive atrium.

By the time the last of the 15 million red bricks had been stacked six years later, there were enough offices ringing the edges of the building to house 1,500 clerks serving 324,968 pensioners, mostly Civil War veterans. The building was grand by design, a memorial to the fallen as well as a place of honor for surviving Union soldiers, their widows, and their orphans. Service pensions were a big deal in Washington in the 1880s; they made up almost one-third of the federal budget. Forty percent of the legislation introduced in the House in the 49th Congress and 55 percent in the Senate consisted of special pension acts.

These days, meeting obligations to veterans is less of a priority. Sure, there’s still grandstanding about how “only the best is good enough for our troops.” But in 2014, news leaked out that the Veterans Health Administration (VHA)—which currently consumes 38 percent of the Department of Veterans Affairs’ $182 billion budget, and which was previously celebrated by Democrats as an exemplary experiment in single-payer health care—was falsifying patient records in an effort to cover up long and occasionally fatal wait times for appointments.

President Barack Obama’s administration responded to the crisis quickly—and ineffectively. In October of last year, then–Veterans Affairs (V.A.) Secretary Bob McDonald could be found bragging that two-thirds of the system’s medical centers had new directors. But in fact, those fixes were little more than an enormous game of musical chairs, writes Katherine Mangu-Ward.

View this article.

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