Generally Quite High
DOW – 86 = 17,841
SPX – 9 = 2080
NAS – 19 = 4919
10 YR YLD + .07 = 2.24%
OIL + .30 = 60.70
GOLD – 1.80 = 1192.20
SILV – .02 = 16.59
A worldwide sell-off in government bonds deepened today. Benchmark 10-year Bunds now trade at 0.53%, having hit a record low of 0.05% last month, when many expected them to turn negative. For German bund investors that represents a 12% loss over the past 2 weeks, or roughly 25 years of yield just went down the drain. In the past month, the yield on French 10 year debt is up 42 basis points, on 10-year Italian bonds the yield is up 62 basis points, Australia up 62 basis points, Hong Kong up 29 basis points. And here in the US, the 10 year Treasury yield has jumped from 1.9% a month ago, to 2.24% today. Around the world yields have been rising and bond prices have been falling.
Meanwhile, oil prices have been rising. Crude prices hit fresh 2015 highs; earlier in the session prices topped $62 a barrel before sliding back. This follow a 22% gain in April. A couple of reports show oil supplies dropping for the first time this year. U.S. oil inventories fell 3.9 million barrels last week, the first weekly decline since Dec. 26, according to data provided by the U.S. Department of Energy. Late yesterday, the American Petroleum Institute reported stockpiles fell by 1.5 million barrels. The data showed a sharp drop in imports for the week, likely just a blip in the reporting. Meanwhile, domestic oil production remains strong at more than 9.3 million barrels a day, declining by just 4,000 in the weekly data, and crude inventories remain near record highs, at 487 million barrels. So, the price of oil rallied well before any recovery in supply-demand balances.
Still, the price of oil is what it is, and compared to 2 months ago, it has now recovered enough to provide inflationary pressure. Fuel prices are a key ingredient to a basket of goods that are measured to determine inflation. And the price of oil affects much more than just the price at the pump; it affects manufactured goods or anything that requires energy or transportation. We don’t know if the recovery in oil prices will continue or not, but the recovery has been strong enough to have an inflationary impact. When oil prices rise because of increased demand that indicates the economy is strong and we need more oil to transport all the products being made and services being sold; however, when oil prices rise due to a reduction in supply that indicates the economy is shrinking not growing; when we have a recovery in inflation without a recovery in growth, the result is stagflation, which is still a form of inflation, even if it turns out to be temporary.
And the bond market hates inflation because it erodes the real, inflation adjusted return on bonds. An uptick in inflation could also give the Fed leeway to raise short-term interest rates in order to reduce the demand for credit and help prevent the economy from overheating. So this might go a long way to explaining the meltdown in bonds in the past few weeks.
There are other explanations to consider as well. The increase in oil prices might be due, in large part to speculative traders, first betting on lower oil prices, and as prices moved a little higher, they were caught in a short squeeze. Tens of millions of barrels are struggling to find buyers in Europe with traders of West African and North Sea crude blaming poor demand. The deep disconnect between the oil futures and physical markets looks similar to the events of June 2014 when the physical market weakness became a precursor for a futures price crash. Traders said around 80 million barrels of Nigerian and Angolan crude oil are on the market with at least a dozen May-loading cargoes still available. Futures prices do not match the physical market.
Still, higher oil prices have an inflationary impact that is being felt in the bond market, kind of, sort of. The bond market is not oblivious to higher oil prices, but there might be another reason for falling bond prices. Maybe central banks have decided to ease up on bond purchases. The Federal Reserve stopped large scale asset purchases a few months ago, but the European Central Bank stepped in with their own quantitative easing program, buying about $66 billion worth of bonds a month, which would push bond prices higher, unless there was a pause in their purchase plan. Maybe that has something to do with the bond meltdown, maybe not. These are complex markets, and they can be moved for any number of reasons, but we do know that whatever is happening is reflected in price, and the price has been moving lower. And as bond prices move lower, stock prices have also been moving lower.
This morning, Federal Reserve Chairwoman Janet Yellen warned of the risks in the stock and bond markets in the environment of low interest rates. Yellen said that equity market valuations are “generally quite high” and “there are potential dangers there.” Yellen was speaking at a forum on finance in Washington, and she added: “Now, they’re not so high when you compare the returns on equities to the returns on safe assets like bonds, which are also very low, but there are potential dangers there.”
Using a valuation technique sometimes referred to as the Fed model, U.S. equities remain cheap compared with government bonds. The S&P 500’s earnings yield, or profit as a percentage of price, stands at about 5.5 percent, more than twice the 2.2 percent rate on 10-year Treasuries. Still, Yellen said the Fed is aware of the possibility that there could be a sharp jump in long-term rates when the Fed raises interest rates. The announcement from Yellen sounded like so much jawboning; the Fed may have some concerns about inflation but right now the economy is not showing signs of strength, not enough to warrant a rate hike.
Productivity in the U.S. fell in the first quarter; the largest back-to-back decline in more than two decades. The measure of employee output per hour decreased at a 1.9% annualized rate, following a 2.1% drop in the fourth quarter. Part of the blame may be attributed to the harsh weather, port-related delays, the stronger dollar and a drop in oil costs that brought the economy to a near-halt in the first quarter and hurt efficiency and profits. The lack of business investment in new technology may also mean productivity will continue to stall. As worker costs are pushed up, it also means corporate profits will be challenged.
ADP, the payroll processing firm, reports the economy added just 169,000 private sector jobs last month; the first time in two years that new jobs created has dipped below 200,000 for two months straight. ADP says job creation has slowed for five months in a row. Mark Zandi, chief economist of Moody’s Analytics issued a report saying: “Fallout from the collapse of oil prices and the surging value of the dollar are weighing on job creation. However, this should prove temporary and job growth will reaccelerate this summer.” The ADP report is sometimes considered an indicator, or maybe an omen, of the Labor Department’s monthly jobs report, which will be reported Friday.
Greece has made a €200 million-euro interest payment to the IMF, although concerns over its future continued to rattle European markets. Athens faces another €750 million-euro debt repayment due on May 12 and it isn’t clear where the money is going to come from. The cash-strapped country still remains in a deadlock with creditors over its next tranche of bailout funding. Meanwhile, the possibility of a Greek default is another factor weighing heavily on the European bond market. It is estimated that past week’s losses on German bonds erased $410 billion in valuation – more than enough to pay for the Greek debt. I’m just saying.
The 2010 “flash crash” that sent the Dow plunging almost 1,000 points was five years ago today. But since then, there have been changes made in the hope of reducing the chances that it could happen again. The British trader fighting extradition to the U.S. on charges of having contributed to the 2010 “flash crash” told a London court today that he’d done nothing wrong.
In today’s edition of “Banks Behaving Badly”: According to its latest quarterly filing, JPMorgan is in “advanced stages” of settlement talks with the DOJ and Federal Reserve over previously disclosed foreign exchange investigations. The bank said the amount it may need to pay – in excess of legal reserves – could be as much as $5.5 billion. Meanwhile, JPMorgan has been placed under formal investigation in France as part of a probe into alleged tax evasion by senior managers at investment firm Wendel, part of a wider investigation in which as many as 14 Wendel executives face charges including tax evasion and insider trading over transactions conducted in 2004-2007. The bank is suspected of acting as an accessory to tax evasion.
The City of Los Angeles has filed a civil lawsuit against Wells Fargo alleging the bank has been looking the other way as its sales people opened up accounts and issued credit cards to customers without their knowledge or permission. Wells Fargo has pushed to get every customer to carry at least 8 different Wells Fargo accounts. Wells Fargo employees said that the company had a systematic, high-pressure quota system for employees that ultimately left them with the choice of engaging in fraud, or being disciplined or fired. Employees were expected to constantly get customers to open new accounts and purchase new banking products, or else. To reach the quota, sales people just started inventing accounts. Some employees went so far as to raid client accounts for money to open additional accounts.
In addition to charging fees on unwanted accounts, San Francisco-based Wells Fargo harmed customers by placing them into collections based on unauthorized withdrawals and reported damaging information on their credit reports when unwarranted fees went unpaid. The lawsuit seeks a court order shutting down the alleged wrongdoing, along with penalties of up to $2,500 for every violation and restitution for customers who were harmed. Wells Fargo denies the allegations.