Month: December 2017

Authored by 720Global's Michael Lebowitz via RealInvestmentAdvice.com,

The Federal Reserve raised the Federal Funds rate on December 13, 2017, marking the fifth increase over the last two years.  Even with interest rates remaining at historically low levels, the Fed’s actions are resulting in greater interest expense for short-term and floating rate borrowers. The effect of this was evident in last week’s Producer Price Inflation (PPI) report from the Bureau of Labor Statistics (BLS). Within the report was the following commentary:

“About half of the November rise in the index for final demand services can be traced to prices for loan services (partial), which increased 3.1 percent.”

While there are many ways in which higher interest rates affect economic activity, the focus of this article is the effect on the consumer.  With personal consumption representing about 70% of economic activity, higher interest rates can be a cost or a benefit depending on whether you are a borrower or a saver. For borrowers, as the interest expense of new and existing loans rises, some consumption is typically sacrificed as a higher percentage of budgets are allocated to meeting interest expense.  On the flip side, for those with savings, higher interest rates generate more wealth and thus provide a marginal boost to consumption as they have more money to spend.

This article focuses on borrowers and savers to show how the current interest rate cycle is squeezing consumers. Said differently, the rising cost of borrowing is dwarfing the benefit of saving.

Borrowers

As mentioned but worth repeating, personal consumption accounts for the bulk of economic activity. To gauge how higher interest rates might affect individuals’ spending, we classify personal debt into the following five categories: mortgages, home equity lines, auto loans, student loans and credit card debt. The following table shows the amount of debt outstanding in each category and estimates the percentage of each loan type that has fixed interest rates and floating interest rates.

Distinguishing between fixed and floating interest rates is important, as borrowers using fixed-rate loans are largely unaffected by higher interest rates. Accordingly, we focus this analysis on floating rate debt as those borrowers and consumers will see immediate increases in their interest expenses every time the Fed raises rates.

Based on the table, approximately $2.8 trillion of consumer loans outstanding are floating rate. We calculate that every 25 basis point (0.25%) interest rate hike by the Fed will increase interest expense higher by $7 billion annually for these consumers.  Since December 2015, when the Fed began to hike interest rates, the Fed Funds rate and other interest rates to which consumer debt is frequently indexed are about 125 basis points higher. Thus on an annual basis, the additional cost of borrowing is approximately $35 billion. Looking forward, if the Fed raises rates three times in 2018 as they currently forecast, the annual interest expense will increase by another $21 billion to bring the total to $56 billion per year.

The graph below charts Fed Funds, 3-month LIBOR, and average credit card rates to show the nearly perfect correlation between Fed actions and short-term borrowing rates. 3-month LIBOR is the index most frequently used to determine floating rate interest rates.

Data Courtesy: St. Louis Federal Reserve (FRED)

Savers

To do a complete analysis of the effect of higher rates on consumption, we must look beyond the increased interest costs, as quantified above, and also consider the benefits of higher interest rates to savers. According to the Fed, personal savings equals $471 billion. The increase in interest rates should reward savers, which will help offset the economic burden related to the increase in interest expense.

Interestingly, what should happen and what has happened are two different stories. The truth of the situation is that individual savers have barely benefited from higher rates as banks and financial intermediaries are not passing on higher rates to savers. The chart below provided by WalletHub and Wolfstreet.com compares the change in the Fed funds rates and credit card interest rates to instruments of savings. Please note the table does not include the most recent increase in rates on December 13, 2017.

To confirm the data in the chart, we searched for other sources of savings rate data. Data from the FDIC reports that bank savings rates, 3-month CD’s, money market accounts and interest checking rates have increased by 0, 3, 1, and 0 basis points respectively since the Fed began raising rates two years ago.

Based on the graph and the data above, it is fair to say that borrowers have benefited by less than ten basis points (0.10%) on average despite 125 basis points (1.25%) of interest rate increases. Based on total savings of $471 billion, we can approximate the benefit to borrowers is a mere $600 million.

Summary

Consumers are being squeezed. Debt linked to short-term interest rates is rising lockstep with the Federal Funds rate while savings rates remain stubbornly low. While the dollar amounts are not massive, the transmission mechanism of the Fed’s rate hikes is acting like a tightening vice that will result in less consumption and slower economic growth.

One of the key takeaways from the Fed’s action during and following the financial crisis of 2008 has been a prolonged and intentional effort aimed at crushing savers. Near zero percent savings rates is part of the Fed’s strategy to incentive savers to move out of the security of cash and invest in riskier assets and/or consume. Even today, despite the rise in interest rates, banks accept the benefits of higher rates imposed on borrowers while refusing to adjust rates for savers. As one of the primary regulators of the financial system, the Fed could encourage a change in that behavior, but to date, no such influence has even been mentioned. Interestingly, the savings rates that banks earn on deposits at the Fed has increased lockstep with Fed Funds.

After nearly a decade of imposing its unique brand of price controls over the cost of money, the Fed admittedly is not willing to do that which is in the best interest of the general public and continues to adhere to policies that favor their primary constituents, the big banks and major corporations.

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Former President Barack Obama is America’s “most admired man” for the 10th consecutive year, according to new survey data from Gallup, and perhaps even more surprising, Hillary Clinton was named the most admired woman for the 16th year in a row.

As Gallup notes, the pair retain their titles this year, although by much narrower margins than in the past. Obama edges out Donald Trump, 17% to 14%, while Clinton edges out Michelle Obama, 9% to 7%.

Source: Gallup

Trump is one of few incumbent presidents who have not been named the most admired among all Americans.

Gallup has asked the most admired man question 71 times since 1946 — all but in 1976. The incumbent president has won 58 of those times.

Previous incumbent presidents who did not finish first include Harry Truman in 1946-1947 and 1950-1952, Lyndon Johnson in 1967-1968, Richard Nixon in 1973, Gerald Ford in 1974-1975, Jimmy Carter in 1980, and George W. Bush in 2008. All but Truman in 1947 and Ford in 1974 had job approval ratings well below 50%, like Trump.

As would be expected for a Republican president, Trump wins handily among Republicans — 35% name him as the man they admire most, with only 1% naming Obama. In contrast, Obama leads among Democrats, with 39% mentioning him and 3% Trump. Independents are slightly more likely to name Obama (12%) than Trump (9%).

The former secretary of State and presidential candidate has been named most admired more than any other man or woman in polling history, according to Gallup, who notes in a release that her polling numbers this year (at just 9%) were the lowest in the past 15 years, making it unlikely for her to hold the top title for much longer.

“She managed to win this year because she remains arguably more prominent than other contenders,” Gallup said.

 

“However, retaining that stature may be more challenging in coming years with her political career likely over.”

Perhaps more reflective of the state of society, a quarter of respondents could not name a man or woman they admired most, according to Gallup, and about a tenth named a relative or friend.

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Authored by Nick Cunningham via OilPrice.com,

The Trump administration is hoping to slash regulations on offshore oil drilling that were implemented after the 2010 Deepwater Horizon disaster that killed nearly a dozen people and led to an oil leak that spewed for months.

According to the Wall Street Journal, the Bureau of Safety and Environmental Enforcement (BSEE), which is the agency housed in the Interior Department that regulates offshore oil drilling, is proposing a rollback of a series of changes made after the 2010 disaster.

BSEE says that the cuts will save the oil industry $900 million over ten years. The proposal has not been made public, but the WSJ reports that some of the changes include easing rules that require the streaming of real-time data of oil production operations to facilities onshore, which allows regulators to see what is going on. Another rule that would be removed requires third-party inspectors of equipment, such as the blowout preventer, to receive certification by BSEE.

Another example includes alterations to the “well-control rule,” one of the signature regulations that was implemented by the Obama administration after years of review following BP’s oil spill. The well-control rule required the use of certain safety equipment and operations intended to reduce the risk of another disaster.

But the Trump administration, in a nod to the oil industry, has proposed deleting the word “safe” from a section of the rule, the WSJ reports, which would restrict BSEE’s ability to withhold permits. “Based on BSEE experience during the implementation of the original [well control rule], BSEE has concluded that the term ‘safe’ creates ambiguity in that it could be read to suggest that additional unspecified standards, beyond those expressly stated, may be imposed in the approval of proposed drilling margins,” BSEE wrote in a justification of the rule change, according to the WSJ.

The upshot is a weaker regulatory regime over offshore oil and gas drilling and it comes at a time that Trump’s Interior Department is also moving to expand drilling not just in the Gulf of Mexico, but eventually in the Atlantic and Arctic Oceans.

The current head of BSEE said earlier this year that the Obama administration overstepped when it put in place regulations on drilling. “It was obvious to me that back then there was a conclusion that it was a systemic problem, and yet I don’t believe there was evidence at the time that it was a systemic problem,” Scott Angelle, the director of BSEE, said in June.

BSEE now argues that the oil industry has learned from its mistakes, and has incorporated changes since the 2010 incident, and thus, does not need heavy government oversight.

Meanwhile, BSEE also sent a stop-work order on a study that would evaluate how the agency inspects offshore oil and gas operations. The study, to be conducted by the National Academies of Sciences Engineering, and Medicine, was initiated last year and was intended to figure out ways to improve inspections.

Environmental groups are crying foul.

“The Department of the Interior, whose job it is to make sure offshore drilling is safe, should welcome a serious investigation into the best way to carry out that job, especially as the administration pushes to expand drilling even further in the Atlantic and the Arctic,” Andrew Rosenberg, director of the Center for Science and Democracy at the Union of Concerned Scientists, said in a statement.

 

“Instead, they’re blocking research into the risks. What is Secretary Zinke afraid of?”

Interior is lining up a massive auction of offshore acreage, scheduled for March. The auction is expected to serve up 77 million acres for drilling, the largest offering ever held. The auction will include "all available un-leased areas on the Gulf's Outer Continental Shelf," the agency said in a statement a few months ago.

It is unclear how much interest there will be in offshore drilling, but the sector is looking to rebound several years after the market downturn. The EIA expects the U.S. Gulf of Mexico to add 344,000 bpd of new supply in 2018 from seven different projects, although many of those were planned years ago.

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Remember the post-tax-reform, pre-Christmas spike in yields and the yield curve? Yeah, that's all over now!!!!

Treasury yields are down 4 days in a row with a major collapse occurring today as the long-end plunges over 8bps – the most in 3 months. The 2s30s yield curve is down over 8bps – the biggest-single-day flattening since Brexit (June 2016)…

This is the biggest 4-day drop in 30Y yields since February.

Notably 10Y yields dropped back below 2.4% (YTD unch)…

The yield curve is crashing…

The biggest 1 day flattenig since Brexit…

All of which is fascinating given that net spec positioning is near record long the long-end…

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2017 has been a banner year for the world’s richest individuals.

Pumped by a tidal wave of central-bank driven liquidity and corporate buybacks, equity indexes around the world climbed to all-time highs this year – a phenomenon that has disproportionately benefited the world’s wealthiest, particularly the 500 individuals included in Bloomberg’s billionaires index.

By the end of trading Tuesday, Dec. 26, the 500 billionaires controlled an aggregate $5.3 trillion, a $1.1 trillion increase from their holdings on Dec. 27 2016.

Unsurprisingly, the biggest beneficiary of this Federal Reserve inspired rally was Amazon.com Inc. founder Jeff Bezos, who added a staggering $34.2 billion to his net worth in 2017 as Amazon shares soared above $1,000.

After announcing in October that his family office had given $18 billion to his Open Society Foundations over the past several years (Masking an elaborate tax dodge under the guise of altruism), Soros slipped to No. 195 on Bloomberg’s ranking, with a net worth of $8 billion.

Bezos notably knocked Microsoft Corp. co-founder Bill Gates out of his spot as the world’s richest person in October – a position that Gates had held since May 2013. Notably, Gates has been donating much of his fortune to charity, including a $4.6 billion pledge he made the Bill & Melinda Gates Foundation in August. Bezos, whose net worth topped $100 billion at the end of November, currently has a net worth of $99.6 billion compared with $91.3 billion for Gates.

While China topped the US in terms of the number of billionaires last year, the tax bill that Trump signed into law last week will certainly go a long way toward helping the US reclaim the top spot.

As the chart below shows, the wealthiest Americans will receive an overwhelming share of the benefits from the Trump tax cut plan.

Meanwhile, corporations, which received a massive tax cut, will have even more money to continue buying back their shares, driving benchmark indexes ever higher and minting even more billionaires and millionaires in the process. 

It's also worth noting that, while the rich are getting richer, the average life expectancy in the US declined in 2016 for the second straight year, largely a result of a spike in drug overdose deaths even as the overall rate of deaths declined.

And while it's entirely possible that the flood of free corporate cash flow unleashed by the tax cuts could buoy stocks for years to come (JP Morgan's Jamie Dimon fittingly compared the cuts to the Federal Reserve's QE program), such sharp declines in life expectancy have historically been an ominous indicator for equity returns.

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Over the past week we have shown on several occasions that there once again appears to be a sharp, sudden dollar-funding liquidity strain in global markets, manifesting itself in a dramatic widening in FX basis swaps, which – in this particular case – has flowed through in the forward discount for USDJPY spiking from around 0.04 yen to around 0.23 yen overnight. As Bloomberg speculated, this discount for buying yen at future dates widened sharply as non-U.S. banks, which typically buy dollars now with sell-back contract at a future date, scrambled to procure greenbacks for the year-end.

However, as Deutsche Bank’s Masao Muraki explains, this particular dollar funding shortage is more than just the traditional year-end window dressing. Instead, the DB strategist observes that the USD funding costs for Japanese insurers and banks to invest in US Treasuries – which have surged reaching a post-financial-crisis high of 2.35% on 15 Dec – are determined by three things, namely (1) the difference in US and Japanese risk-free rates (OIS), (2) the difference in US and Japanese interbank risk premiums (Libor-OIS), and (3) basis swaps, which illustrate the imbalance in currency-hedged US and Japanese investments. In this particular case, widening of (1) as a result of Fed rate hikes and tightening of dollar funding conditions inside the US (2) and outside the US (3) have occurred simultaneously. This is shown in the chart below.

What is causing this? Unlike on previous occasions when dollar funding costs blew out due to concerns over the credit and viability of the Japanese and European banks, this time the Fed’s rate hikes could be spurring outflows from the US, European, and Japanese banks’ deposits inside the US. Absent indicators to the contrary, this appears to be the correct explanation since it’s not just Yen funding costs that are soaring. In fact, at present EUR/USD basis swaps are widening more than USD/JPY basis swaps.

According to Deutsche, it is possible that an increase in hedged US investments by Europeans could be indirectly affecting Japan, and that market participants could also be conscious of the risk that the repatriation tax system could spur a massive flow-back into the US, of funds held overseas by US companies

In fact, one can draw one particularly troubling conclusion: the sharp basis swap moves appear to have been catalyzed by the recently passed Trump tax reform.

• Corporate tax reform in the US

The United States House of Representatives and Senate recently passed a tax reform bill that lowers the corporate tax rate from 35% to 21% starting 2018. Lowering corporate taxes would likely accelerate the pace of Fed rate hikes, which could trigger a shift from dollar deposits to Government MMFs. Revisions to interest tax deductions would encourage companies to repay corporate bonds and could spur a decrease in dollar deposits (however, demand to bank loan could also weaken).

• Repatriation tax system

The tax bill also includes the abolishment of taxation (currently 35%) on dividend payments from overseas subsidiaries. However, overseas subsidiaries’ retained earnings would be subject to a one-time tax. It is expected that this repatriation tax system would result in reserves held overseas by US companies (we estimate 90% are USD-denominated) flowing back into the US. This could create tighter conditions for USD financing outside the US.

Which leads to a surreal outcome, that while the GOP tax reform may benefit corporate America, it appears set to punish America itself as buyers of US Treasurys suddenly require far greater yields to offset the surge in funding costs!

* * *

Whatever the cause behind these sharp funding shortages, one thing is clear – dollar funding costs (FX hedging costs) for both Japanese and European insurers and banks to invest in US Treasuries are surging (with Japanese buyers and reached a post-financial-crisis high of 2.35% on 15 Dec. And in terms of practical implications for the treasury market this means that, all else equal, marginal demand for US paper is about to plunge for one simple reason: the FX-hedged yields on US Treasurys have plunged to (negative) levels never seen before (unless of course foreign investors buy US Treasurys unhedged).

To demonstrate this point, the chart below from Deutsche Bank shows the yields on currency-hedged US Treasuries from the perspective of Japanese investors. Japanese financial institutions tend to use 3-month FX forwards when they invest in hedged foreign bonds. Annualized hedge costs have recently risen to 2.33%, which means that investments in 10y US Treasuries result in virtually no yield. Furthermore, yields from investment in shorter than 10y US Treasuries would be less than JGBs and result in negative spreads. This means that unless funding costs slide, Japanese buyers will simple pick JGBs over TSYs, eliminating one of the biggest sources of Treasury demand in receng years.

There is another consideration: as Deutsche Bank notes, whenever it is time to roll over a hedge, financial institutions need to decide whether to (A) sell US Treasuries or (B) hold them as unhedged foreign bonds. Engaging in (B) on a large scale would be difficult unless the institution’s outlook calls for yen depreciation. After implementing (A), institutions should then choose to invest in high-yielding US MBS (high interest rate risk), medium- to low-rated corporate bonds (high credit risk), European and other sovereign bonds, or to reinvest in JGBs.

Moving away from Japan, and looking at Europe one finds an even more dramatic slide in hedged TSY yields, which net of hedge costs have plunged to -0.6%, by far the lowest – and most negative – on record, something we highlighted yesterday in “There’s Never Been A Worse Time For A European Investor To Buy US Treasuries” .

The conclusion is that as a result of the recent surge in funding costs, seemingly in response to the nuances of Trump tax reform as explained above, suddenly buying US Treasurys is no longer an economic option for virtually all foreign buyers! Needless to say, something will need to change because if funding costs stay where they are, yields across the curve will have to jump for US Treasurys to once again be an attractive purchase for foreign buyers, which as a reminder comprise the majority of TSY buyers in recent years.

What is the outlook? Some parting thoughts from Deutsche, which writes that according to the chart below, fundings costs will likely continue widening as the Fed raises interest rates.

DB then also warns that the repatriation tax system that was just passed into law, coupled with ongoing Fed rate hikes, will indirectly result in the widening of dollar funding conditions in and outside of the US. And the punchline: if these indeed continue to widen, and US long-term interest rates stay at a low level, “this would restrict investments in US Treasuries by Japanese financial institutions relying on short-term dollar funding.” This could then lead to a sharp move higher in US yields – and rates- as the US finds it needs an aggressive increase in foreign demand to finance the widest US budget deficit in years. 

In other words, by pounding the table on – and recently passing – tax reform, Donald Trump appears to have sown the seeds of the equity market’s own destruction, because remember that the one thing that can bring the house of manipulated cards down faster than you can say covfefe, not to mention burst the equity bubble, is a sharp move higher in long-term yields, rates, and ultimately – inflation.

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As Israeli police conclude their corruption investigation of Prime Minister Benjamin Netanyahu, former advisor to the force, Lior Chorev, says the indictments to follow will be "earth-shattering" and will result in early elections – possibly as soon as May 2018, which would end the political career of the longest-serving Israeli leader since founding father David Ben-Gurion. 

Israeli Prime Minister Benjamin Netanyahu (photo credit: AMIR COHEN/REUTERS)

Chorev, who resigned last month under pressure from Netanyahu's allies, told The Jerusalem Post “When they [the recommendations] will be announced, they will have information such as the specific charges and a complete list of the people involved,” he said, adding “Netanyahu is not running a campaign for his innocence but a campaign to keep the coalition intact. It is a political campaign, not a legal one, and so far he is succeeding. He is keeping his coalition in one piece despite very complicated investigations.”

The indictment recommendations will bear "a lot of information that we didn't know – and it will cause an earthquake here." 

While police recommendations in Israel aren't binding, and prosecutors can choose to proceed with indictments, an official recommendation to indict would turn Israel's political landscape on its head. Netanyahu has been questioned seven times by investigators in connection with two corruption cases.

Israel police claims that Chorev, as an external investigator, wouldn't have access to information on the Netanyahu investigation: 

“In these sensitive subjects, the Israel Police is providing information to the public via official statements that are released in accordance with the attorney-general and the state’s attorney,” the police said. “We are asking the public to focus only on official statement… Not once was the police blamed for leaking information by ‘different entities,’ but what they said was completely false.”

In response to the police wrap-up, Netanyahu's allies in parliament are pushing through a bill that would forbid police from submitting written recommendations to the state prosecutor's office on whether to indict a suspect – in what critics are calling a tool to silence investigators and interfere with police work.

Relations between Netanyahu and police have grown sour throughout the investigations, nearly a year after they became public knowledge. As Bloomberg reports, the prime minister and his supporters have accused police of deliberately leaking information about the investigations to Israeli media, claiming he’s the target of an organized campaign by the press and left-wing opponents to unseat him. Thousands of Israelis have taken to the streets in recent weekends, rallying against government corruption and calling on Netanyahu to step down.

Sara Netanyahu

In a third case, 24 year old Shira Raban claims that Netanyahu incessantly insulted her while she worked for a cleaner at their residence for one month. Raban is seeking $64,000 for "verbal abuse and unreasonable requests" by Sara Netanyahu, and says she feared for her safety. Netanyahu allegedly forbade Raban from eating, drinking or resting, and required that she change her clothes dozens of times per day. Raban claims she was also required to wash her hands about 100 times a day with hot water, drying them on a separate towel from the Netanyahu family. 

Several other former employees have claimed mistreatment by Sara Netanyahu, with one caretaker receiving an award of around $43,000 last year for mistreatment. 

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