FINANCIAL REVIEW

Fans of Gridlock

Sinclair Noe — November 21, 2014

Podcast: Play in new window | Download (Duration: 13:17 — 6.1MB)

DOW + 91 = 17,810
SPX + 10 = 2063
NAS + 11 = 4712
10 YR YLD – .02 = 2.32%
OIL + .77 = 76.62
GOLD + 5.80 = 1201.30
SILV + .15 = 16.50

Record highs for the Dow and the S&P.

China has cut interest rates for the first time in more than 2 years. The first thought is that China is trying to stimulate growth for a slowing economy. However, in making the announcement, the People’s Bank of China tried to emphasize that the economy is growing within a reasonable range, and the rate cut was not about spurring growth. Instead, they emphasized the need to reduce corporate financing costs to help struggling companies. So, you might think that lower rates would only encourage more borrowing in a country that already has too much debt. What the Chinese central bank appears to be doing is making it feasible to refinance the existing debt at lower rates, which would allow Chinese companies to lessen their debt burdens. So, in this way, lower rates is a way to deleverage.

And this is not the first attempt at reducing borrowing costs. Since September the People’s Bank of China has provided more than $130 billion in medium term loans to banks on the condition they lower borrowing rates for small businesses; trying to channel to certain industries, including small and rural businesses as well as government-financed low-income housing projects, without adding excess capacity to other industries, such as steel and real estate. The problem is that this did not work; most of China’s piecemeal efforts to make lending more affordable have not worked, and so the next step was to cut rates. And despite the official story, China is concerned about growth. China’s economy, the world’s second-largest after the US, grew by 7.3% year-over-year in the third quarter, its slowest pace in more than five years, and short of their 7.5% growth target.

Meanwhile, a lack of real demand for loans, rather than a shortage of credit, is holding the Chinese economy back; and whatever the justification, the People’s Bank of China is loosening monetary policy, and this is probably not the last rate cut. China joins the European Central Bank and the Bank of Japan in stimulative monetary policy, which raises the question of whether we are in a new round of currency wars or economic battles due to slow growth. Probably not, but this does add extra cash into the global financial system, and the global markets love free money.

Today, Mario Draghi, the chief of the European Central Bank said that inflation must be brought back to target “without delay”, paving the way for full-blown quantitative easing. Draghi says low growth and a lack of inflation must be reversed. Draghi stressed that while there had been improvements in the financial sphere, these had “not transferred fully into the economic sphere”, where the situation “remains difficult”. I wonder if he has heard of “pushing on a string?” Most markets moved higher today, including Europe and the US, which started the day with triple digit gains on the Dow.

Last night President Obama delivered a speech on immigration; I’m sure you heard about it – or maybe not; it was a prime time address, except it wasn’t covered by the major networks, which instead decided to air The Biggest Loser, The Big Bang Theory, and Grey’s Anatomy. Today, Obama was signing memorandums that will defer deportation for up to 5 million people who came to the US as children and for parents of children who are citizens or legal permanent resident, provided they meet certain requirements. The administration says the changes won’t provide an easier path to citizenship. Separately the administration will streamline the visa process for foreign workers and their employers and provide more options for foreign entrepreneurs. The plan also calls for tightening border security. The executive order potentially shields as many as 5 million undocumented immigrants from the threat of deportation for up to 3 years.

The White House’s Council of Economic Advisers said the plan by 2024 would raise gross domestic product by at least 0.4%, expand the size of the labor force by between 147,000 and 297,000 workers, and raise average wages for US-born workers by 0.3%. There are widely different views about the economic impact of immigration changes, with some economists arguing that if you increase the supply of labor, you will put downward pressure on wages; the counter argument is that you aren’t really increasing the pool of labor, just bringing it out of the shadows, and that should boost wages, at least in the near term.

The executive action is temporary, and to that end Obama issued a challenge to Congress to pass legislation.

The president’s decision to act unilaterally infuriated Republicans, and already there are threats of lawsuits and cutting off funding for specific agencies that would be tasked with the immigration orders, and maybe also shutting down the entire government. Government funding expires Dec. 11, and lawmakers must make new appropriations or risk a shutdown. No decisions are expected until after the Thanksgiving holiday.

Although today, the Republicans sued Obama; not on immigration; they finally filed a lawsuit against the president over implantation of the Affordable Care Act. Actually, the president was not named as a respondent; the suit names the secretary of health and human services and the Treasury secretary.

The suit claims that the administration’s actions, including the delay of the employer mandate and cost-sharing for insurance companies, were beyond the normal discretion the executive branch has to carry out laws. The first issue that will have to be addressed is “standing.” To get into court, the House would have to prove that it was damaged by the way the administration carried out the ACA, and courts have consistently rejected that idea.

Anyway, if you are a fan of gridlock, you’ll love the next 2 years in Washington DC.

Meanwhile, amnesty is alive and well. I’m not talking about immigration, rather on the other end of the food chain where the non-enforcement of the law protects the elite bankers. Today, a Senate banking subcommittee is digging into the cozy culture between Wall Street bankers and the New York Fed, which is one of the top entities that polices Wall Street, following reports from ProPublica which released 46 hours of recordings of meetings between regulators at Goldman Sachs and the regulators’ bosses at the New York Fed. At the hearings, NY Fed president William Dudley at one point rejected his role as a banking regulator, saying “Our orientation is the safety and soundness of the firms we supervise.” Dudley went on to describe his role as more of “a fire warden, not a cop on the beat.” One thing is certain, Dudley is not a bank regulator. In what looks like a defensive move, the Federal Reserve announced it would review crucial aspects of its bank supervision.

Meanwhile, this is Day 2 of another Senate Committee hearing into how banks have cornered physical commodity markets and how they’ve been rigging prices, specifically Goldman Sachs in the aluminum market. Meanwhile, in what looks like a defensive move, the Federal Reserve announced it is considering putting several new limits on Wall Street’s involvement in the commodities market. The Fed has been examining the need for new rules since 2010.

Much of the shale oil boom can be traced back to Wall Street, where years of low interest rates encouraged energy companies to fuel their growth by tapping eager investors in the bond and loan markets. Now, the price of oil has dropped 25% in 3 months. Many energy companies built their business based on prices around $90 a barrel and a drop to $60 a barrel could cause energy companies to default on their debt, which could start a cascading effect that pushes the whole US energy sector into distress. Energy bonds now account for about 16% of the $1.3 trillion junk bond market, up from about 4% a decade ago; it is the largest sector in the high-yield market.

Not much in the way of economic reports today. The Labor Department released state by state unemployment numbers; nonfarm payroll employment increased in 38 states and decreased in 12 states. North Dakota has the lowest rate of unemployment at 2.8%, and Georgia had the highest rate of unemployment at 7.7%. Arizona remains in the bottom 10 at 6.8% unemployment.

Next week’s economic calendar includes the Tuesday release of the S&P/Case-Shiller report on home prices. Wednesday brings a report on durable goods orders which might give us some indication of capital spending. Also, Wednesday a revision to the third quarter GDP numbers, likely going down from the initial estimate of 3.5% growth. Friday is a half day for the markets. Why not just take the day off? Well the markets are never supposed to be closed for more than 3 consecutive sessions.