Advant Guard

Lending Trend - December Update

2012-01-17T19:53:00.001-05:00

Updating the graph of all loans and leases at all commercial banks, we see that the five year growth rate continued to fall, although total loans grew in December over the previous month. Commercial and Industrial loans and consumer loans rose. The current level of loans was first exceeded in March of 2008 and we are still below the April 2010 level.

As the graph shows, even with lending beginning to grow, it is falling far short of the increase from five years ago. The twelve month increase in loans was 11.81% in December 2006 and 2.06% in December 2011.

Unwinding

2012-01-15T14:06:00.000-05:00

This is totally premature but I am thinking about the process that the Federal Reserve begins to normalize monetary policy. I actually expect the problems in Europe to get worse before they get better, so we may see addition Fed action this year. But interest rates will not be zero forever.

I suspect that the indicator to watch is the unemployment rate. Once the unemployment rate reaches the 7.5%-8.0% range, the Federal Reserve will begin preparing for increasing interest rates. Additional statistics to watch are bank lending and personal income. I expect that there will be a process to prepare the markets before the first interest rate move, so it will not be a surprise.

Now the last time the discussion of exiting emergency measures happened, they FOMC discussed whether sales of assets would have to come first or whether interest rates could be raised before liquidity level were reduced. The committee decided that asset sales could occur after interest rate were increased. I think this is completely wrong given that so many of the assets are bonds, which lose value as interest rates rise. Asset sales are more effective at tightening policy when interest rates are low. The danger the Federal Reserve must be aware of is that the asset sales will be more effective than the committee expects, resulting in another downturn.

This highlights another important point: the unwind will be a slow and long process. Interest rates will take a decade or more to return to "normal" levels. Japan shows it could be even longer than that.

Recession Triggers

2012-01-07T19:03:00.002-05:00

The Employment report yesterday gave further proof that the American economy continues to improve, although very slowly. If we can continue for six more months, we will reach the mark of 36 months of non-recession(recovery is too strong a word to describe the economy.) But, at some point, there will be another recession. The traditional trigger for a recession is a rise in inflation followed by higher interest rates. Given the slow recovery in personal income, inflation does not seem to be an immediate danger.

Another way that a recession can start is for sales to suddenly drop, leading to a build up of inventory and an exaggerated fall off in production as producers overshoot the inventory correction. But that generally occurs due to optimism about growth prospects. Most signs are that inventories are being kept lean and producers are cautious about production plans.

The third, and possibly most likely scenario, is a disruption of oil supplies. However, the U.S. is no longer the swing consumer for oil. Gasoline sales have still not recovered from the price rises of 2008 and 2011. China is much more economically sensitive to the price of oil than the U.S. Any disruption in oil supplies may result in developing countries being priced out of the market before the U.S. economy is affected to any material degree.

I do not put much stock in the idea that a financial crisis in Europe could tip the U.S. into recession. The problems in Europe are too well advertised and the Federal Reserve is likely to extinguish any contagion to the U.S. banking system.

It is possible that a sudden strengthening of the Dollar could reverse the recent upsurge in exports, but the corresponding drop in commodity prices should cushion the economy somewhat.

Inflation thoughts

2011-12-31T12:12:00.001-05:00

Calculated Risk gives his thoughts on inflation for the coming year. The two indicators to look at to forecast inflation are money supply and nominal GDP. Money supply tends to dominate in the short term but nominal GDP (which is by identity nominal income) is a better long term predictor.

The chart shows 4 qtr nominal GDP growth since 1948. As is visible, the growth rate for nominal GDP is very volatile. The second line is the average growth rate for the post war period. Reversion to mean would suggest that we are due for some catch up growth. But then there is the third line, created by dividing the data into four period: 1948-1965, 1966-1982, 1983-2088, 2009-2011. The average for each of these periods(6.28%, 9.65%, 5.81% and 1.71%, respectively) is plotted.

The growth rate for the current period is clearly much lower than previous experience. Given even modest improvements in productivity, there is a lot of deflationary pressures as nominal GDP undershoots expectations (meaning that debt was more expensive than people expected it to be.) There will be some time before society restructures to accommodate the new, higher cost of debt.

November Personal Income

2011-12-25T08:28:00.000-05:00

The Bureau of Economic Analysis estimates that personal income for November rose 0.1% over the previous month. While there have been some signs of improvement in the labor market, with small but consistent increases in payrolls, so far that improvement hasn't flowed to increases in income. Much of the improvement in personal consumption has come at the expense of the savings rate.

Transfer payments have been stable this year. We should see a bump up in January as the Cost of Living Adjustment is applied. But after that we should see a slow decline as people roll off the unemployment roles.

Dictator Watch

2011-12-20T21:14:00.001-05:00

Robert Mugabe, aged 87, is President of Zimbabwe. He is currently racking up the points in the most genocidal dictator of the 21st century. He acts as if he will be President forever. Most analyst consider this unlikely.

Bashar al-Assad, aged 46, is President of Syria, but facing stiff internal protests and sanctions from the Arab League.

Muhammad Hosni Sayyid Mubarak, aged 83, in prison while facing charges.

Kim Jung Il, Dead.

Muammar Gaddafi, Dead.

Saddam Hussein, Dead.

Federal Reserve Balance Sheet

2011-12-18T17:47:00.001-05:00

Updating our chart of the Federal Reserve balance sheet, we see that things have been mostly quiet. The little uptick in the last week is the first result of the change in currency swap rules. But other than that, the "Operation Twist" has had little visible effect on the balance sheet. There remains the possibility of additional purchases but either the situation in Europe must get worse or we would need to see more of a drop off in inflation.

The item I am watching is China. FDI is no longer offsetting the 'hot capital flows' out of the Yuan. Friday, the central bank intervened. How long will China spend down its currency reserve to support its currency? Once they stop, then we may see a marked move downward in inflation.

Lending Trend - November Update

2011-12-10T19:55:00.001-05:00

Updating the graph of all loans and leases at all commercial banks, we see that the five year growth rate continued to fall, although total loans grew in November over the previous month. All categories of loans increased, even real estate loans. The current level of loans was first exceeded in March of 2008 and we are still below the April 2010 level.

As the graph shows, even with lending beginning to grow, it is falling far short of the increase from five years ago. The twelve month increase in loans was 12.07% in November 2006 and 2.26% in November 2011.

Lending Trend:October Update

2011-11-12T15:14:00.001-05:00

Updating the graph of all loans and leases at all commercial banks, we see that the five year growth rate continued to fall, although total loans grew in October over the previous month. All categories of loans increased, even real estate loans. The current level of loans was first exceeded in February of 2008 and we are still below the May 2010 level.

As the graph shows, even with lending beginning to grow, it is falling far short of the increase from five years ago. The twelve month increase in loans was 12.01% in October 2006 and 1.17% in October 2011.

Federal Reserve Balance Sheet Update

2011-11-10T20:30:00.001-05:00

Six weeks into "Operation Twist", we update our look at the Fed's balance sheet. If it isn't apparent to you that the Fed is doing anything, that's because the changes are small and to date they have been overwhelmed by the shrinkage in emergency lending programs (such as TALF.) I still expect the FOMC to start another round of long term asset purchases (QE3), this time with more focus on GSE MBS. But we are probably going to have to wait to see a slow down in money supply growth, so January or March are the likely dates for them to announce a program.

U.S. 3rd Quarter GDP

2011-10-29T23:22:00.003-04:00

The Bureau of Economic Analysis announced that it's advance estimate of 3rd Quarter GDP was 2.5% above the previous quarter (at an annualized rate.) The GDP estimate is above the previous peak in the fourth quarter of 2007, perhaps this time this milestone won't be revised away.

The reports was very slightly below my estimate. The biggest surprise is the size of the draw down in inventories. This should be supportive of production in the future. Right now my forecast for the fourth quarter is in the 2.5- 3% range, with the preponderance of risk to the upside. Christmas sales should be decent though not especially robust, but retailers will have stock conservatively so I don't expect more discounting than usual.

Blaming the Canary

2011-10-16T11:29:00.000-04:00

Greece is Europe’s canary in a coal mine. The point of this practice is that dangerous but odorless gasses build up in coal mines. Canaries are very sensitive to the level of oxygen, so the effects of the invisible gasses would be visible first in the canary before the miners were affected by it.

In Europe’s case, the oxygen is risk capital invested in sovereign debt. As the appetite for even low levels of risk in sovereign bonds has ebbed, this has been visible in the prices of Greek, Irish, Portuguese and now, Spanish and Italian debt. Part of the cause has been low levels of capital in European banks, which has made them unwilling to the risk that growth would not be robust enough to allow payment of the interest and principal.

Instead of dealing with the real problem, European politicians have blamed the canary for being so dependent on oxygen. Some proposals are the equivalent of fitting the canary with a tiny oxygen mask. It may keep the canary alive but it allows the real problem to get worse; putting stress on the next weakest link. Eurobonds don’t address the problem either. If there is not enough money, you can’t redistribute it to make everyone happy.

Current proposals to raise required capital levels for banks are likely to make them even more reluctant to lend, leading to slower growth and higher budget deficits. So while another plan to address the problem may emerge next week, I expect the crisis to continue as the doctors apply their treatments to the wrong patient.

Canary in a Coal Mine.

Lending Trend: September Update

2011-10-15T12:39:00.000-04:00

Updating the graph of all loans and leases at all commercial banks, we see that the five year growth rate continued to fall, although total loans fell very slightly in September over the previous month. Commercial and Industrial loans and other loans and leases were higher than the previous month while real estate and consumer loan were flat. The current level of loans was first exceeded in January of 2008 and we are still below the August 2010 level.

Bank lending is still showing some progress but the pace is slower than even my anemic expectations. These numbers show a big divergence from the money supply number which were growing strongly during the last three months. If there is a "resolution" to the banking crisis in Europe, we may see banks begin to deploy some of the cash they are sitting on into the economy. But, for now, we play the waiting for Godot game.

August Personal Income

2011-10-01T17:50:00.001-04:00

The Bureau of Economic Analysis reported its estimate of Personal Income for August fell by 0.1% over the previous month. As shown on the chart, transfer payments have been declining and other personal income has not risen enough to compensate. A continued fall in personal income less transfers would be one indicator supporting a recession call by the NBER. The Economic Cycle Research Institute is now calling for a recession based on falling values of their leading indicators.

I am still predicting no recession in the U.S. though I think parts of Europe are already in recession. Interest rates in the U.S. are still accomodative, inventories are not building and there are no obvious catalysts for a slowdown, though growth will certainly be below trend and unemployment may rise.

Federal Reserve Balance Sheet

2011-09-24T19:12:00.000-04:00

Given that the Federal Reserve is beginning a new operation next month, dubbed by the press as "Operation Twist", it is worthwhile updating the chart of the Federal Reserve Balance sheet.

Today's chart limits the period and breaks out the term of the the Treasury holdings. As you can see the biggest part of the holdings are less than five years (about 45% of total Treasury holdings.) The five to ten portion is slightly smaller and the greater than ten year portion is a little less than 12% of total Treasury holdings.

The end of QE2 is quite visible on the chart with the level of bank reserve credit being flat to slightly declining. Operation Twist shouldn't change that, but we should see the different elements of Treasuries change relative proportion.

Will Operation Twist have any effect? I don't think anyone knows. The direct effects are probably small but at this point the placebo effect i probably the dominant factor. QE2 'worked' because people believed it would increase inflation, traders bid up the prices of commodities and other risky assets. So far the response to this sterilized in place bond rotation has been skeptical. The market prefer a simple story they can understand, and Operation Twist is not to their taste.

Lending Trend: August Update

2011-09-10T20:27:00.003-04:00

Updating the graph of all loans and leases at all commercial banks, we see that the five year growth rate continued to fall, although total loans rose very slightly in August over the previous month. Commercial and Industrial loans and other loans and leases were higher than the previous month while real estate and consumer loan were flat. The current level of loans was first exceeded in January of 2008 and we are still below the December 2010 level.

So long as de-leveraging continues the Federal Reserve will not be able to normalize monetary policy. Now that QE2 has ended, the growth of the money supply will depend on increases in lending. Right now the pace of increases is very slow, though there is hope that lending will accelerate. The current pace is disinflationary.

Outlook Cloudy

2011-09-03T20:15:00.000-04:00

The surprising report yesterday, that employment in August showed no change from the previous month, certainly dents talk of an acceleration of economic growth during the second half of the year. There is talk of additional easing at the next Federal Reserve Open Market Committee, but it is not clear what action the Fed can take while inflation is still running hot due to the surge in oil prices earlier in the year. I am still standing by my forecast for the current quarter of growth near 2 percent annualized.

Fundamentally, financial conditions are supportive of the real economy, though Wall Street has more than priced in the effects of policy. I expect a period of time where the economy does better than the stock market as liquidity comes out of commodities and financial assets. The big uncertainty is how policy makers in Europe deal with the coming restructuring of Greek debt and assistance to Spain and Italy. China policy also seems to be on hold right now.

Japanese 2nd Qtr GDP

2011-08-14T21:12:00.000-04:00

Japanese 2nd quarter GDP fell less than expected, 0.3% q/q. Given the earthquake, tsunami and the nuclear plant melt down, this initial estimate of GDP is an indication that the damage remains localized. However as shown on the chart, Japan is once again the weakest of the large economy since the beginning of the U.S. recession in fourth quarter of 2007.

There are still large uncertainties for Japan, including a very strong currencies, a large government debt, continued deflation and a paralyzed political system. Many expect an improvement in the economy in the third quarter but the headwinds that global growth is facing may delay renewed growth in Japan.

Lending Trend: July Update

2011-08-13T14:06:00.000-04:00

Updating the graph of all loans and leases at all commercial banks, we see that the five year growth rate continued to fall, although total loans rose very slightly in July over the previous month. All components other than real estate loans were higher than the previous month. The current level of loans was first exceeded in January of 2008 and we are still below the December 2010 level. So long as de-leveraging continues the Federal Reserve will not be able to normalize monetary policy.

Now that QE2 has ended, the growth of the money supply will depend on increases in lending. Right now the pace of increases is very slow. This will be disinflationary.

Italy at crossroads

2011-08-06T13:17:00.000-04:00

Italy, faced with rising interest rates on it bonds, brought forward spending cuts to reduce its budget deficit. While the announcement will slow the panic gathering in the market, additional measures may be required. Many analysts are looking for bond purchases by the ECB, in particular. But opposition to buying any bonds, much less Italian bonds without an agreed policy program, makes significant action unlikely.

Italian goods tend to be more price sensitive than other European exports and so Italy has suffered more from the strong Euro. Now that growth in the Eurozone core is slowing, we may see a shift to lower rates at the ECB, which will weaken the Euro and make credit more available to all governments. However, it is harder getting back confidence in Italian debt than it is to lose it.

U.S. 2nd Quarter GDP

2011-07-29T14:40:00.000-04:00

The Bureau of Economic Analysis released their advance estimate of Second Quarter GDP. They also made large revision to GDP statistics going back several years. The 1.3% growth rate for the second quarter was lower than my expectations and much lower than the consensus estimate of 1.8%. But the real surprise was the revision of the first quarter growth from 1.8% to 0.4%. As a result, GDP has not returned to the peak level before the recession.

The chart shows that the U.S. has clearly fallen behind Germany in growth since the beginning of the recession. Japan has entered a new recession due to the earthquake and the Eurozone as a whole may fall back into recession due to the combination of sovereign debt issues and higher interest rates. The asymmetric trade patterns in Europe are causing deflation in the periphery while causing inflation in the core. The ECB is choosing to address the latter instead of the former and hoping that intergovernmental transfers can address the former.

Final Act

2011-07-26T18:05:00.000-04:00

We are finally reaching the end of the drama about the U.S. debt ceiling. Everything before this week was just a preamble, noisy but not significant. As Ezra Klein has pointed out there is no much difference in the spending between the two plans. So we pretty much know what is going to be cut, the difference is that one plan raises the entire amount, while the other plan requires a second vote later this year.

The Boehner bill is already running into resistance within his caucus. It seems clear to most political observers that a bill to raise the debt ceiling will require substantial votes from Democrats, given the number of Tea Party votes who are opposed to any increase. But the process must go forward to its logical end.

I expect the debt ceiling to be raised before the U.S. defaults. The ratings agencies may downgrade the U.S. government credit rating but that will have little effect. But we may see another showdown when it comes time to appropriate funding for 2012.

Nominal GDP Trend

2011-07-18T11:22:00.000-04:00

Today, I'd like to talk about Nominal GDP. This is less discussed than Real GDP (which removes the affect of inflation) but it has a certain importance because most debt in denominated in nominal dollars. The hurdle rate for making investment decision is effectively a forecast of growth in Nominal GDP. If velocity of money was stable, the growth of Nominal GDP could be controlled by managing the growth of the money supply (the monetarist view.)

The first chart shows the value of nominal GDP since it was reported in 1947. The scale is logarithmic to make clearer the growth trend. I have added a line to indicate the trend in growth over this period: 6.76%. As you can see, there was a period where Nominal GDP was below trend in the late 50's and 60's and then inflation in the 70's and 80's lead to Nominal GDP growing above trend, and then it has returned to the overall trend line due to slower growth in the last two decades. I have added trend lines to show how the post 1974 growth was at a higher rate (7.24%) and another to show the substantial slowdown in Nominal GDP growth since 2004 (4.04%).

The second chart is expands the last part of the previous charts, showing the period from 1999 to present. Here we can see the actual value of Nominal GDP fall from above the 1974 trend line to below the overall trend line.

The reason I wanted to highlight these trends is that if Nominal GDP is going to continue to grow at the recent lower rate, then incorrect investment decisions will result in the misallocation of capital. Opportunities with a lower return rate will not be funded while opportunities that appear to have high returns will be overpriced (resulting in lower actual returns.) Inflation will be much lower than people are used to as well.

Lending Trend: June Update

2011-07-16T11:45:00.000-04:00

Updating the graph of all loans and leases at all commercial banks, we see that the five year growth rate continued to fall, although total loans rose very slightly in June over the previous month. All components other than real estate loans were higher than the previous month. The current level of loans was first exceeded in December of 2007 and we are still below the January 2011 level. So long as de-leveraging continues the Federal Reserve will not be able to normalize monetary policy.

Now that QE2 has ended, the growth of the money supply will depend on increases in lending. Right now the pace of increases is very slow. This will be disinflationary.

Post QE2 look at Fed Balance Sheet

2011-07-07T17:30:00.000-04:00

Now that the Federal Reserve has completed its Long Term Asset Program (popularly known as QE2), we update our graph of the balance sheet. The steady rise of the balance sheet during QE2 stands out, though smaller and slower than the emergency lending during the financial crisis.

We should expect continued growth in the level of Treasuries but at a slower pace as principal returned by the MBS is reinvested in Treasuries. The total balance sheet will be level at least until the next FOMC meeting, though expect it will be several months before the FOMC decides the next direction in policy. I expect another, smaller, round of asset purchases (QE3) possibly starting next year in order to boost money supply growth to desired levels.

For now attention turns to bank lending which will have the predominant effect on money supply in the absence of new purchases.