Morning in Arizona

Morning in Arizona
Rainbows over Canyonlands - Dave Stoker

The Headline Animator

Thursday, June 04, 2015


Financial Review


DOW – 170 = 17,905
SPX – 18 = 2095
NAS – 40 = 5059
10 YR YLD – .06 = 2.31%
OIL – 1.66 = 57.98
GOLD – 8.60 = 1177.40
SILV – .40 = 16.18

The sun will come out tomorrow, beyond that we don’t have much certainty. Tomorrow could be a very interesting day in the markets. Greece is scheduled to make a debt payment to the IMF; that will not happen. OPEC meets tomorrow in Vienna; they are expected to leave the current production ceiling of 30 million barrels per day unchanged. And in the US, we have a Jobs Report Friday; the Labor Department is expected to report the economy added about 225,000 new jobs in May and the unemployment rate is forecast to remain unchanged at 5.4%. Any one of these three events could result in major market moves. So buckle your seat belts.

This morning the Labor Department reported the number of people seeking unemployment benefits at the end of May remained near a 15-year low. Some 276,000 Americans filed initial jobless claims in the period running from May 24 to May 30, a week that included the Memorial Day holiday. That was down 8,000 from the prior week.

In addition to the headline numbers in the Jobs Report, we will be looking to see if wages are actually increasing; plus, we’ll look to the U-6 number to see how much slack remains in the labor market (hint: quite a bit; the U-6 stands at 10.8%, and in a tighter labor market, it should be closer to 8.5%); and then we’ll look at the industries where jobs are being created; if manufacturing and construction look weak, it might indicate the economy hasn’t pulled out of the first quarter funk.

Also tomorrow, Greece was supposed to pay a little over $300 million to the IMF, part of several payments due in June totaling more than $1.6 billion. It’s not gonna happen. The Greeks are now saying they will defer the payment. The Greeks offered a proposal to their creditors earlier in the week; the creditors responded with their own take-it-or-leave-it ultimatum. Greece rejected the latest proposal from Greece’s international creditors, with the Finance Ministry saying the plan “can’t solve the riddle” and an agreement requires “immediate convergence of the institutions to more realistic” proposals.

The creditors are demanding Greece make spending cuts and slash public programs to try and generate a zero to 3% surplus in its budget; but the problem is that the Greek debt to GDP ratio is now around 180%, and the more they cut spending, the more the GDP shrinks, which in turn makes the debt to GDP ratio higher. And even if they did cut spending and increase taxes and it miraculously didn’t shrink the economy, it would still take about 50 years of austerity for the Greek public sector debt to fall to a level of sustainability.

So, these negotiations are about the IMF and ECB releasing enough emergency cash to keep Greece afloat. It is a dispute about whether the Eurozone’s creditors (at this point, mainly the IMF and the ECB) will release funds so that they can pay themselves and avoid having to call Greece in default. There is a problem when the creditors have to lend money to the borrower just to make interest payments on the debt; and that in turn, means the fiscal targets in future years are just insane.

There is a temptation for lenders to allow Greece to default and then kick them from the Euro Union. Which would probably be a very, very bad idea. State authority has suffered a bloody collapse in the Middle East and North Africa, and it already poses a serious threat to Turkey. To lose Greece in these circumstances would constitute a major defeat, even though it might be good for the Greek economy, or not – nobody really knows. There has only been one hard study on the macro-economics of a Grexit and it shows a 50% devaluation of the Greek currency would not result in rampant inflation, and would likely restore trade competitiveness. Sure there would be some chaos, but then investors would flood the country to buy on the cheap.

For the ECB and the IMF, the fear is that leniency or even debt forgiveness would encourage Spain, Portugal, Italy, and Ireland to default on debt. For Greek Prime Minister Alexis Tsipras there may be more to lose by betraying his core election pledges than by holding firm in negotiations with creditors, even if it does result in a Greek exit. Tsipras will address the Greek parliament tomorrow.

The IMF sent out an emailed statement that says: “Under an Executive Board decision adopted in the late 1970s, country members can ask to bundle together multiple principal payments falling due in a calendar month. The Greek authorities have informed the fund today that they plan to bundle the country’s four June payments into one, which is now due on June 30.”

So, technically this is not a default, it is a delay; they are kicking the can, but there is little chance they can bundle together $1.6 billion by the end of the month. The Greeks did not roll over and take the take-it-or-leave-it ultimatum from the IMF. Tsipras issued a statement saying: “The proposal of the Greek government is the only realistic one on the table.” Greece’s decision to withhold the payment carries political and financial-market implications that are hard to predict. You might want to buckle your seat belt because it looks like we’re in for a bumpy ride tomorrow.

This morning the yield on the 10 year German bund moved up to 0.93%; that’s a gain of 48 basis points in the past month. The global bond market selloff has erased all of this year’s gains. And maybe we are starting to see some capitulation after that wild spike; time will tell; it might just be people moving to the sidelines ahead of the jobs report and reaction to the Greek debt delay tomorrow.

Oil prices are 40% below year ago levels. OPEC meets tomorrow in Vienna to determine production levels as world-wide crude output continues to exceed consumption. OPEC, which opted not to cut production at its last meeting despite plunging oil prices, is widely expected to stick to that strategy when it meets Friday. The group’s output level already exceeds its quota of 30 million barrels a day.

European oil majors are openly declaring interest in returning to Iran, with leaders of Royal Dutch Shell, BP and Total all saying they are ready to return as soon as international sanctions are lifted. U.S. oil companies remain somewhat more cautious on Iran, at least for now – give them time.

According to the AP: “One of the biggest hits to the economy last quarter came from cuts in drilling activity by energy companies — fallout from the sharp drop in oil prices over the past year. The government said investment in the category that covers energy exploration plunged at an annual rate of 48.6 percent, the steepest drop since 2009.” There had been hope that consumers would spend savings from lower gasoline prices and give a shot in the arm to the economy, but what has happened is the savings have gone to necessities such as rent and groceries, not discretionary consumer spending. Cheaper prices at the pump are not compensating for a raise in the paychecks; and we all have a sinking feeling that lower gas prices are just temporary anyway.

The International Monetary Fund says the Federal Reserve should delay raising rates until next year given the risks that moving too soon could stall the economy. IMF Director Christine LaGarde said the Fed should wait for “more tangible signs” of wage or price inflation than are currently evident. Starting too early to raise interest rates raises the risk of having to retreat back to zero. Overall, the IMF said that the fundamentals for continued growth and job creation remain in place for the U.S. economy, but momentum has been sapped in recent months by a series of negative shocks. The first Fed rate hike could still rattle markets and lead to instability. The IMF calculates that inflation won’t hit 2% until sometime in 2017. The IMF assessment of the US economy said growth had been slower than it expected, and it cut its 2015 forecast to 2.5 percent, from 3.1 percent.

The report from the fund says: “A later lift-off could imply a faster pace of rate increases following lift-off and may create a modest overshooting of inflation above the Fed’s medium-term goal (perhaps up toward 2.5 percent). However, deferring rate increases would provide valuable insurance against the risk of disinflation, policy reversal, and ending back at zero policy rates.”

Earlier this week, Fed governor Lael Brainard said that “foreign headwinds” were causing problems that could lead the Fed to delay interest rate increases.  She said the Fed should adopt a stance of “watchful waiting” and offered the cautious assessment that “liftoff could come before the end of the year.” Only a few Fed officials, however, have suggested that the Fed should wait until next year.

One of the big problems is the strength of the dollar, and if the Fed raised rates it would likely strengthen the dollar even more, especially in light of weakness in the rest of the developed world. As you know, first quarter GDP was revised lower, to show the economy shrinking by 0.7%; and while the contraction was blamed on temporary factors such as bad weather and the West Coast port closures, you can’t overlook the fact that the trade gap widened and trade has been hard-hit by the strong dollar, which makes US exports expensive compared with those from other countries.

I do not know what will happen in the markets tomorrow, but it should be wild. Stay tuned.

No comments: