Financial Review

Endless Possibilities

Sinclair Noe — July 15, 2015

Podcast: Play in new window | Download (Duration: 13:15 — 6.1MB)

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DOW – 3 = 18,050
SPX – 1 = 2107
NAS – 5 = 5098
10 YR YLD – .05 = 2.35%
OIL – 1.43 = 51.61
GOLD – 5.90 = 1149.90
SILV –  .28 = 15.19

I think the markets couldn’t quite figure out what to make of today.

In the late 1970s Sen. Hubert Humphrey and Rep. Augustus Hawkins sponsored legislation known as the Full Employment and Balanced Growth Act of 1978. The idea was to set monetary policy to try to achieve the goals of full employment, growth in production, price stability, and balance of trade and the budget. The Act also required the Federal Open Market Committee to report to Congress twice a year, in February and July; we used to call it the Humphrey-Hawkins testimony.

Testimony coincides with the publication of the Fed’s Beige Book, which was released today. The Beige Book cited improving consumer spending, mixed activity for transportation, positive reports on real estate, increasing lending activity, and “modest” wage pressures. The report did reveal trouble spots, such as the strengthening dollar, which led to soft growth around border areas, and the decline in oil and natural gas drilling.

The Humphrey-Hawkins Act expired about 10 years ago; perhaps because the goals of full employment, balanced budgets and balanced trade seem like Utopian pipedreams, but the Fed chair still heads to Congress twice a year to update politicians. Today, Fed Chair Janet Yellen delivered her testimony to the House Financial Services Committee. Tomorrow she will head over to the Senate and deliver the same prepared remarks.  After the speech, the Fed head opens it up from questions from the politicians, which allows them to grandstand, bloviate, and generally demonstrate their ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge.

In prepared remarks, Yellen said she expects the economy to strengthen over the rest of 2015 and put the central bank on a path to raise interest rates “at some point this year.” She didn’t give an exact date, however she gave us a hint, saying: :If the Fed waits much longer to raise rates – as some institutions like the IMF want it to do – it might be forced to move aggressively once it starts. However, if it moves sooner, that could allow it to proceed gradually and observe how the economy and markets respond. An advantage to beginning a little bit earlier is that we might have a more-gradual path of rate increases.” A gradual path, she added, is a “prudent approach to take.” It may be prudent but it isn’t really data dependent, now is it?

Yellen pointed to cheaper gasoline prices, higher consumer confidence and a pickup in consumer spending, particularly new cars and trucks. And Yellen said the economy is still creating enough jobs to reduce the unemployment rate over time. She said the situation in Greece remains difficult and China could pose some risk to the US economy, but overall she was sticking with the optimistic tone and unwavering determination to hike rates.

During the Q&A session Yellen responded to questions about the government investigation into a Fed leak of information back in 2012; she also tried to explain that the GDP numbers are not fabricated from whole cloth; higher interest rates will make it harder to balance the budget; the Fed has no authority over the Puerto Rican debt problem; the Fed can’t do a bailout in the same way as they did in 2008; and there might have been an actual question about monetary policy in there somewhere, maybe. Generally the Q&A session is a sad indictment of our elected officials and today’s performance did not disappoint on that count.

Meanwhile, several new figures from the White House budget office’s “Mid-Session Review” are casting a shadow over projections made at the beginning of the year. The new estimates display U.S. GDP rising by just 2% this year before rebounding to 2.9% in 2016 – down from an earlier forecast of 3% growth for both years. Short-term estimates for inflation were also trimmed. The consumer-price index is now expected to post an annual average increase of just 0.2% this year, down from an earlier forecast of a 1.4% gain.

Meanwhile, San Francisco Federal Reserve Bank President John Williams delivered a speech in Phoenix to the Greater Phoenix Economic Council. Williams echoed Yellen’s views on the economy, citing improvement in the labor market and concerns about potential inflation as motivating factors to raise interest rates. Williams also provided familiar, yet largely ignored advice for Arizona by suggesting we could create a more durable economy by investing more in education.

Wholesale prices in the U.S. climbed more than forecast in June as the cost of fuel picked up. The 0.4 percent increase in the producer-price index followed a 0.5 percent gain in May. A broad pickup in prices would help strengthen the case for Federal Reserve policy makers to start raising interest rates this year. A shortage of eggs after an outbreak of bird flu continues to pressure food prices. Wholesale egg prices soared a record 84.5 percent last month after surging 56.4 percent in May.

U.S. factory production failed to advance for a second straight month in June. The Fed said manufacturing output was unchanged both last month and in May. Despite the soft manufacturing reading, overall industrial output climbed 0.3 percent after a 0.2 percent decline in May. Mining output jumped 1.0 percent and utilities production gained 1.5 percent.

It’s again crunch time in Greece as lawmakers gathered for a crucial vote on austerity and reform measures that will determine if the country will be eligible for a much-needed third bailout. Protesters threw Molotov cocktails at police in front of parliament ahead the vote on a bailout deal, and police responded with tear gas in some of the most serious violence in over two years. Meanwhile the IMF has issued an analysis of the deal saying Greece needs debt relief “far beyond” what European creditors have been willing to consider, including possibly deep “haircuts” on the value of Greek debt.

Prior to the vote, Prime Minister Alexis Tsipras tried to sell the deal saying that when he negotiated the agreement earlier this week, “it was the most difficult moment of my life. It was a decision which will be a burden for me for the rest of my life. I don’t know if we did the right thing. But I know we did something to which there was no alternative.”

So, he admits the bill will hurt the economy; that might be a first for a politician, at least the admission part. Tsipras just gave a sadly defiant speech, one of the saddest defiant speeches in the history of sadly defiant speeches. Last weekend the Greek finance minister resigned; today the deputy finance minister resigned. There is widespread revolt in the Syriza ruling party.

The vote just finished and the deal has passed. Eurozone finance ministers will hold a conference call tomorrow.

China’s economic growth proved resilient in the second quarter as policy makers stepped up support and a stock market boom – since soured – spurred services. GDP rose 7% in the three months through June. Despite the upbeat economic data, Chinese shares extended their slump. Shanghai -3%; Shenzhen -4.7%.

Elsewhere in Asia, the Bank of Japan kept monetary policy unchanged and largely maintained its upbeat inflation forecasts, even as it cut its growth outlook on soft exports and household spending.

It is earnings reporting season. Bank of America reported its quarterly profit more than doubled as legal expenses declined and mortgages increased. Don’t break the law as much and therefore don’t pay massive multi-billion dollar fines; instead make more mortgage loans – this is a truly innovative business model for financial institutions.

Netflix reported it added more subscribers in the second quarter than originally projected. Net subscriber additions rose about 94 percent year-over-year to about 3.3 million in the second quarter, beating the company’s forecast of 2.5 million. Revenue jumped 22.7 percent to $1.64 billion in the second quarter ended June 30, from $1.34 billion a year earlier. Net income fell to $26.3 million, or 6 cents per share, from $71 million, or 16 cents per share a year earlier.

Intel reported better-than-expected quarterly profit and revenue on Wednesday as growth in its data centers and Internet-of-Things businesses helped offset weak demand for personal computers that use the company’s chips.

Today is Christmas in July. If that sounds like a made-up, commercialized holiday…, well it is. Amazon decided to celebrate its 20^th anniversary by having a big, one-day sale (today); they call it “Prime Day”, with big discounts for Amazon Prime customers. Walmart responded quickly with a plan to reduce its minimum order for free shipping and deeply discounted online deals. Meanwhile, Best Buy is promoting its “Black Friday in July” sales event. Target recently completed its own sale.

Honda’s U.S. financing division has agreed to pay $25 million to settle allegations the company overcharged minority buyers with higher interest rates on vehicle loans. According to the complaint, the company charged thousands of African-American, Hispanic and Asian/Pacific Island auto loan borrowers higher interest rates solely because of their race. Honda said it disagreed with how regulators determined discrimination but the company shares “a fundamental agreement in the importance of fair lending.”

The New Horizons spacecraft has done a fly-by of Pluto.  After a nine-year, 3 billion-mile journey, the piano sized spacecraft just passed within 7,750 miles of Pluto’s frozen surface, snapping pictures and taking readings all the way. The images and the data took 4.5 hours to reach Earth even moving at light speed. Just the mere fact that New Horizons is right on target is amazing. NASA says it’s the equivalent of a commercial airliner landing within a tennis ball’s width of its target.

The New Horizons spacecraft carried a small canister with a few of the ashes of Clyde Tombaugh, the Nobel Prize winning astronomer who discovered Pluto at Lowell Observatory in Flagstaff back in 1930.

Some people wonder why we explore space, why we spend money and energy. Exploration is not necessarily a human trait; some cultures are xenophobic and shrink into isolation. Exploration has always been a part of the American culture. We have always been ready and willing to find new frontiers, even at great cost. We have been rewarded with the uniquely American characteristics of innovation, inquisitiveness and individualism that derive from the existence of a frontier.  Exploration requires a sense of discovery, a hope for something beyond ourselves, a faith in something greater than ourselves. And each new discover expands our understanding and our minds. Each new discovery strikes a blow against isolation and decay, and strikes a victory for civilization and progress.

We are just now getting pictures back from Pluto. Nine years ago we didn’t know if the New Horizons spacecraft would reach its target and what we might find. And we don’t know what the next mission might discover, but the possibilities are endless.

Markets Were Full Of Sound And Fury, Signifying ... Not Much?

Financial Review

Sound and Fury

Sinclair Noe — July 10, 2015

Podcast: Play in new window | Download (Duration: 13:15 — 6.1MB)

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DOW + 211 = 17,760
SPX + 25 = 2076
NAS + 75 = 4997
10 YR YLD + .11 = 2.41%
OIL + .04 = 52.82
GOLD + 3.50 = 1163.80
SILV + .23 = 15.72

For the week, the Dow rose 0.17 percent while the S&P fell 0.01 percent and the Nasdaq ended down 0.23 percent in its third straight weekly decline. The markets were full of sound and fury, signifying nothing, perhaps.

Greece faces a Sunday deadline to reach a deal with its creditors. Yesterday, Greek Prime Minister Alexis Tsipras submitted a proposal that appears to meet most creditor demands in exchange for a new €53 billion-euro bailout. The package of spending cuts, pension savings and tax increases almost mirrors that from creditors on June 26, which was rejected by Greek voters in a July 5 referendum. Eurozone decision makers are set to assess the plan during crisis meetings on Saturday and Sunday. Meanwhile, Tsipras took the proposal to the Greek parliament to see if they will stand behind the deal. Outside, anti-austerity protestors rallied against the deal; which makes sense; last week a strong majority voted against the very type of deal Tsipras is now trying to sell. The Greek blueprint for pension cuts and VAT increases is essentially copied word-for-word from the June 24 European proposal; it does not appear to include debt relief. The unsustainable Greek debt from 2 weeks ago still seems unsustainable today.

The euro and stocks surged on the prospect of a resolution to end a near-six-month standoff. We are still waiting to see if this deal will stick with the IMF, the ECB, the Greek parliament, the Greek people, and of course, the Germans. And even if a deal is struck, the bigger question is whether Greece will be able to pull itself out of economic decline. But for now, movement. We’ll have to wait and see if that movement equates to progress.

Chinese stocks rose sharply for a second day today. Chinese Regulators ordered listed companies to submit plans to stabilize their stock prices, via measures such as share buybacks and employee shareholding plans. However, it still remains to be seen whether the rally can overcome the steep declines that wiped out $3.9 trillion in value from Chinese equities over the past four weeks. The Shanghai Composite closed up 4.6% (although it’s still off 25% from its June high).

So, Greece might be nearing a deal and China bounces back with 2 days of solid gains following a month long meltdown. Everything is coming up roses. Not so fast. The Greek deal could still fall apart or if they take the deal, Greece could fall apart; for all we know, Tsipras may have just destroyed Greece and the Eurozone. Chinese markets could still stumble and crash and bring down much of Asia as they fall. Or not. Even if we get past both of these problems, it will likely take some time to work through details and mop up excesses. The global system has the ability to manage through each of these shocks, though not without some stress. It could even handle them both together, provided nothing else goes wrong. Yet success is not guaranteed. It requires much better coordinated and more comprehensive policy responses. And should such responses continue to struggle, asset prices will converge down towards the lower levels warranted by fundamentals

Federal Reserve Chair Janet Yellen deliver a speech today in Cleveland. Yellen maintained her call for an interest rate increase this year, saying: “I expect that it will be appropriate at some point later this year to take the first step to raise the federal funds rate and thus begin normalizing monetary policy.” Yellen said the job market had not fully recovered but the overall assessment of the economy was upbeat. She made no mention of China in her speech, and only a passing reference to Greece. Absent an unexpected meltdown, Yellen was prepping the markets for a rate hike.

Kansas City Fed President Esther George spoke yesterday, saying: improvement in the job market and stable inflation suggest that “modestly higher” short-term interest rates are appropriate, and “Economic trends and experience suggest…we would be wise to act modestly but act now.”

The Commerce Department reports that wholesale inventories rose 0.8% in May.  Inventories of durable goods, such as autos and machinery, increased 0.6%. Meanwhile, inventories of nondurable goods rose 1.2%. Wholesale sales rose 0.3% in May, following growth of 1.7% in April. At May’s sales pace, the inventory-to-sales ratio remained at 1.29.

The International Energy Agency has warned in its widely followed monthly report that the rebalancing of the oil market that started last year has yet to run its course and a bottom in prices “may still be ahead”, because the world remains “massively oversupplied.” In its first oil-consumption assessment for next year, the IEA, which advises industrialized nations on their energy policies, said global oil demand growth is forecast to slow to 1.2 million barrels a day in 2016. That compares with an average 1.4 million barrels a day this year.  In a bearish assessment of market conditions, the IEA said the adjustment process would “extend well into 2016″.

IDC estimates global PC shipments fell to 66.1 million in the second quarter; that follows a 6.7% drop in PC sales in the first quarter.  Gartner is offering their own analysis, estimating shipments fell 9.5% to 68.4 million. Factors blamed for the decline: Inventory reductions ahead of the Windows 10 launch (set for July 29), a strong dollar (which has led to higher overseas prices), and the end of Windows XP support.

Apple’s Mac continues to be one of the few bright spots in the PC industry. Mac shipments reached 5.1 million during the second quarter, representing 16% year-over-year growth. Apple was the only of IDC’s top six global PC makers to grow shipments last quarter. The global leader in the PC world is…Lenovo, with a 20% market share.

U.S. quarterly earnings season kicked off earlier this week, with Pepsi and Alcoa reporting better-than- expected sales. However, corporate earnings are estimated to have fallen 3.1 percent in the second quarter, according to Thomson Reuters data.

Investors poured $14.1 billion into stock funds in the past week, according to tracking firm Lipper. This marks the biggest inflows since mid-December. The inflows were the first in three weeks. Funds that specialize in U.S. shares attracted most of the new cash, at $12.6 billion, while funds that specialize in foreign shares attracted $1.6 billion to reverse the prior week’s $1.1 billion in outflows.

The NYSE shutdown this week was probably just a glitch. When trading shutdown for 3 hours, it generated all kinds of cyberterrorism, hacky kind of conspiracy theories. It happened on the same day as United Airlines suffered a glitch, and those hundreds of grounded flights are most likely a preview of things to come. As airlines switch to electronic luggage tags and more travelers swap paper tickets for boarding passes stored on smartphones, industry consultants say the impact of technology disruptions will keep growing. The airlines are just a big flying computer. It was most likely just a software glitch. The problem is that software now runs the world, and that software was built fast and cheap; and it has been patched over and over and over.

Our dominant operating systems, our way of working, and our common approach to developing, auditing and debugging software, and spending (or not) money on its maintenance, has not yet reached the requirements of the 21st century. You know we have infrastructure problems; failing bridges, dangerous railroad intersections, potholes, crumbling water pipes. Turns out, our cyber-infrastructure is also a mess. And we are on the verge of transitioning to the “internet of things”; which is kind of like building a high rise on top of a Quonset hut. The NYSE shutdown this week was probably just a glitch, which is really, really scary.

Checking in on the Libor trial in London, former UBS and Citigroup trader Tom Hayes has been testifying that he was open about his attempts to influence rates and that his managers were aware of it and that the practice was widespread in the industry. Hayes said he had been made a scapegoat to protect more senior figures, accusing UBS of “sheer hypocrisy” for disowning him when regulators got involved, even though senior managers at the bank had known all about his trading practices.
Checking in on Eric Holder, the former US Attorney General has landed on his feet; actually he landed back at his old job at Covington & Burling, a high powered law firm that regularly represents some of the biggest financial firms in the country; he even landed back in his old office, which the firm kept empty, waiting for his return. Holder will settle into a $2.5 million a year contract; not bad for a guy who could not get a single conviction in court for any crimes related to the financial crisis.

Right now a piano-sized spacecraft is barreling through space at over 36,000 mph. The target is Pluto. So far the New Horizons spacecraft has traveled nearly 3 billion miles. This week it got close, by space standards, just a few million miles away; which was close enough to snap a few good photos. The new pictures show some details we have never seen before. Pluto has distinctive contrasting dark and light colors on its surface. A large light colored region, about 1,000 miles across, is kind of shaped like an enormous heart.  NASA has carefully calibrated the spacecraft to fly within 7,600 miles of Pluto on Tuesday. The spacecraft should be able to tell if there are impact craters on Pluto’s moon, and close enough to take detailed pictures of something the size of a football field; just in case someone is playing football on Pluto.

Financial Review

Tomorrow

Sinclair Noe — June 4, 2015

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

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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.

Financial Review

More Than Bad Weather

Sinclair Noe — June 2, 2015

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

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DOW – 28 = 18,011
SPX – 2 = 2109
NAS – 6 = 5076
10 YR YLD + .07 = 2.27%
OIL + .84 = 61.04
GOLD + 3.90 = 1193.70
SILV + .04 = 16.85

It has been a busy day for central bankers. The Reserve Bank of India cut interest rates for the third time this year, lowering its key repo rate by 25 bps to 7.25%, even though the Indian economy has become one of the fastest-growing in the world. Meanwhile, the Reserve Bank of Australia kept rates unchanged at a record low of 2.0% today, in line with expectations. The Bank of Japan is also meeting today; the Nikkei Index snapped its 12-day record run, ending its longest winning streak since February 1988.

Federal Reserve Governor Lael Brainard says economic data does not point to a significant second quarter bounce. Brainard is a voting member of the Federal Open Market Committee and she says the slowdown is more than just bad weather in the first quarter; she cited the strong dollar. Brainard says net exports subtracted “a whopping” 1.9 percentage points from first quarter GDP. On the jobs side, the pace of gains has slowed, and wage growth remains soft. Consumers, for their part, are not inclined to spend their gas price windfalls. Brainard says she would oppose raising interest rates at the June FOMC meeting but she  expects higher rates before the end of the year.

The Federal Aviation Administration briefly halted all United Airlines flights this morning. The grounding happened around the same time as reports about bomb threats against five flights, including a United flight. Federal officials said later the threats were not credible. The total stoppage time was 39 minutes. The FAA originally cited automation issues as the cause for the halt.

Meanwhile, in an internal investigation conducted by the Department of Homeland Security, the Transportation Security Administration (TSA) failed to detect banned weapons and fake explosives smuggled in by undercover agents posing as passengers 95% of the time. The trials were conducted at the busiest U.S. airports and agents were repeatedly able to smuggle weapons through checkpoints. TSA agents failed 67 out of 70 tests.

The U.S. Senate has passed a bill reforming a government domestic spying program that swept up millions of Americans’ telephone records, sending the bill to the White House for President Obama to sign into law. Reversing U.S. security policy that had been in place since shortly after the 9/11 attacks, the bill would end a system exposed by former National Security Agency contractor Edward Snowden in 2013. The eavesdropping agency collected and searched records of phone calls looking for terrorism leads but it was not allowed to listen to the content of calls.

The passage of the USA Freedom Act would require telephone companies, such as Verizon and AT&T, to collect and store telephone “metadata” the same way that they do now for billing purposes. But instead of routinely feeding U.S. intelligence agencies such data, the companies would be required to turn it over only in response to a government request approved by the secretive Foreign Intelligence Surveillance Court. Passage of the bill is the first major legislative reform of U.S. surveillance practices since Snowden’s revelations two years ago this month.

Along with the phone records program, two other domestic surveillance programs authorized under the USA Patriot Act have been shut down since Sunday. The Senate missed the deadline to extend legal authorities for certain data collection by the NSA and the Federal Bureau of Investigation.

Orders for goods produced in U.S. factories slipped 0.4% in April, marking the eighth decline in nine months. Orders for durable goods — products meant to last at least three years — fell 1% in April. Orders for nondurable goods rose 0.2%.

The Big Three U.S. automakers all beat estimates for domestic light-vehicle sales in May. General Motors’ deliveries for the month were the best since 2007 while Fiat Chrysler’s were the highest in a decade. Fiat Chrysler said U.S. sales rose 4 percent last month.  Ford deliveries slipped 1.3 percent, a smaller decline than analysts projected, while GM’s 3 percent gain topped estimates. The annualized pace of sales, adjusted for seasonal trends, rose to 17.8 million, from 16.7 million a year earlier and topping estimates for a 17.3 million rate. It was the fastest pace since July 2005

Underwater homeowners who file for Chapter 7 bankruptcy protection are still on the hook for secondary loans tied to their properties. Under the bankruptcy code, the claims of secured creditors are typically cut into two parts: a secured claim up to the value of the collateral and an unsecured one for the rest. The question is whether this division means that a lien associated with the secured claim is cut down to the value of the collateral. For example, if a secured creditor is owed $100 and has a lien on property worth $40, does the secured creditor have a $40 lien after the bankruptcy case, or does it retain a lien for $100?

From the debtor’s perspective, it would be helpful to restart life after bankruptcy with as little property encumbered as possible. But creditors would like to hold on to the bigger lien in case the property value rises. The short answer to whether a debtor can “strip off” a lien is: It depends. In particular, it depends on which chapter of the bankruptcy code the debtor files under.  Individuals tend to file under Chapters 7 and 13. Under both of these chapters, the courts have ruled so-called lien-stripping impermissible, particularly with regard to the debtor’s home. On the other hand, corporate debtors routinely strip off liens of under-secured creditors in Chapter 11 cases.

In the case of Bank of America v. Caulkett, two borrowers each had two mortgages on their homes, with Bank of America holding the junior liens. Both borrowers were underwater and filed for Chapter 7 bankruptcy two years ago. The borrowers wanted to “strip off” the junior mortgages, shedding those debts. The Supreme Court ruled unanimously, finding that lenders still have a secured claim “regardless of whether the value of that property would be sufficient to cover the claim.”

The Supreme Court ruled 8-1 that retailer Abercrombie & Fitch may have violated workplace discrimination law when it turned down a Muslim job applicant because she wore a hijab, even though her religious beliefs never came up in the interview. Samantha Elauf applied for a sales position at an Abercrombie children’s store in Oklahoma in 2008. Despite her high marks in the interview, Elauf didn’t land the job because her headscarf ran afoul of Abercrombie’s employee “look policy,” which bars hats and promotes the retailer’s brand. Civil rights law requires that employers accommodate workers’ religious beliefs in the workplace, and forbids them from firing or not hiring someone because of those beliefs.

But Abercrombie argued that it couldn’t have known to make such an accommodation because Elauf, who was 17 at the time, never requested one. The majority of justices didn’t buy that argument, reversing an earlier appeals ruling in Abercrombie’s favor. They said that whether or not Abercrombie had firm knowledge of Elauf’s need for an accommodation was not relevant — only whether her headscarf was a “motivating factor” in their decision not to hire her. The ruling sends Elauf’s case back to the lower court for further consideration.

A day after an emergency mini-summit of Greece’s international creditors, the country submitted a proposal it hopes will secure a deal to unlock desperately needed rescue money. The Greek prime minister, Alexis Tspiras, said: “We have submitted [our own] realistic plan for Greece to exit the crisis. A realistic plan, whose acceptance by the institutions, our lenders and our partners in Europe will mark the end of the scenario of divisions in Europe.” He said it was now up to the bloc’s political leadership to decide whether it wanted “to adjust to realism”.

Euro zone officials branded the Greek text insufficient and said it was not formally on the table. They are now offering up their own proposal, as a take it or leave it offer. The Greek leader faces a backlash from his own supporters if he has to accept cuts in pensions and job protection to avert a default and keep Greece in the euro zone. Greece says it can make a €300-million-euro payment on Friday, but they would still face three more payments in June, totaling more than €1.6-billion-euro.

Sepp Blatter, the president of FIFA announced his resignation today following arrests of several FIFA officials in the past week as part of a corruption investigation. Blatter announced the decision at a hastily arranged news conference in Zurich, six days after police raided a hotel in the city and arrested several FIFA officials, and just four days after he was re-elected to a fifth term as president. Blatter said an election to choose a new president would be held as soon as possible, though a FIFA official said it would probably not take place until December at the earliest.

ABC News is reporting that Blatter is being investigated by the FBI and U.S. prosecutors. The FBI declined to comment because Blatter has not been publicly identified as a target of the investigation. The sources said the feds are conducting the FIFA probe the same way they would handle an old-school New York-style racketeering case.

M&A activity hit an all-time monthly record in May, surpassing the previous highs seen during the height of the dot-com bubble and peak of the debt boom that led to the 2008 financial crisis. The overall value of U.S.-bound deal-making amounted to $243 billion in May, compared to $226 billion during the same month in 2007 and $213 billion in January 2000, the previous biggest and second biggest months respectively. Companies have been on a borrowing binge as they lock in on cheap funding before the Fed hikes rates.

Financial Review

Lie or Be Lehman

Sinclair Noe — May 27, 2015

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DOW + 121 = 18,162
SPX + 19 = 2123
NAS + 73 = 5106
10 YR YLD – .01 = 2.13%
OIL – .38 = 57.65
GOLD + .20 = 1189.00
SILV – .07 = 16.75

Yesterday the Dow posted a triple digit loss, today a triple digit gain; not enough to cover yesterday’s losses. The Nasdaq was higher on strength in semiconductor stocks; the Nasdaq posted a new record high close, taking out the high from April 24. The dollar was slightly stronger, oil was down again.

Severe storms and devastating floods over the weekend in Texas and Oklahoma have killed at least 19 people. Another 14 people are missing in Texas, including eight members of two families whose vacation home was swept away. The flooding has also resulted in complications for business travelers. About 11 inches of rain fell in Houston on Monday while parts of Austin have been hit by as much as 7 inches. Helicopter crews in both cities rescued people who had been stranded in cars and on top of buildings. The National Weather Service issued a new flash flood warning today.

The IRS says tax return information for about 100,000 U.S. taxpayers was illegally accessed by cyber criminals over the past four months. The stolen information included tax returns and other tax information on file with the IRS. The IRS said the thieves accessed a system called “Get Transcript.” In order to access the information, the thieves cleared a security screen that required knowledge about the taxpayer, including Social Security number, date of birth, tax filing status and street address. The IRS is notifying those affected. The IRS said the breach does not involve its main computer system that handles tax filing submission, and that system remains secure…, for now.

A red card for FIFA, the Federacion Internationale de Football Association, plus 14 arrests for illegal activities that make the governing body for soccer look more like a mafia crime family. The Department of Justice indictment names 14 people on charges including racketeering, wire fraud and money laundering conspiracy. In addition to senior soccer officials, the indictment also named sports-marketing executives from the United States and South America who are accused of paying more than $150 million in bribes and kickbacks in exchange for media deals associated with major soccer tournaments. Law enforcement officials say their investigation has just begun and there will be more action taken to clean up the sport.

As leaders of FIFA gathered in Zurich for their annual meeting, more than a dozen plainclothes Swiss law enforcement officials arrived unannounced at the Baur au Lac hotel, an elegant five-star property with views of the Alps and Lake Zurich. They went to the front desk to get room numbers and then proceeded upstairs. The concierge called the guest and informed them they should open their hotel door rather than having police break it down.

Swiss police arrested seven FIFA officials who are now awaiting extradition to the United States. Swiss prosecutors said they had opened their own criminal proceedings against unidentified people on suspicion of mismanagement and money laundering related to the awarding of rights to host the 2018 World Cup in Russia and the 2022 World Cup in Qatar. The president of FIFA, Sepp Blatter, was not arrested but he might be questioned in coming weeks.

Meanwhile, the US Department of Justice alleges a “24-year scheme” for FIFA officials “to enrich themselves through the corruption of international soccer.” Why is the US leading this investigation? Well, it involves some US sports marketing people and apparently many of the bribes were paid in US dollars and funneled through US banks. Beyond that, we just really don’t like soccer.

G-7 finance ministers and central bankers are meeting in Dresden, Germany. The host country set the agenda and it did not include discussion of Greece. They might not stick to plans. US Treasury Secretary Jack Lew spoke with Greek Prime Minister Alexis Tsipras today for the second time in less than a week and told a London audience that “everyone has to double down” on reaching an accord. While the G-7 doesn’t have a mandate to decide how to deal with Greece, it brings together officials from the Eurozone’s three biggest economies, as well as the European Central Bank, The International Monetary Fund, and the European Union – the institutions backing the $262 billion aid package that expires next week.  The Greeks are reportedly drafting an accord.  Maybe they could borrow some money from FIFA.

Richmond Fed boss Jeffrey Lacker says policymakers must ensure that financial industry creditors do not expect government bailouts and must be willing to let firms fail in order to restore market discipline. Lacker also continued his assault on Dodd-Frank’s Title II and repeated his call to repeal the Fed’s emergency lending authority, arguing that less regulation, not more, is needed to make the system safer. British monarchy may appear to be nothing more than a vestigial ceremonial version of leadership, yet in that role, Queen Elizabeth delivered a speech today to mark the State Opening of Parliament and she promised an in-or-out popular vote on membership in the European Union. That has been a matter of debate and now the path towards a vote looks potentially shorter than anticipated, with some now talking of a referendum in 2016 rather than 2017.

Fed Chair Janet Yellen plans to skip the annual gathering of economists and policy makers in Jackson Hole this year, marking the second time in three years the Fed’s top official won’t be traveling to Wyoming. Yellen’s predecessor, Ben Bernanke, skipped the 2013 gathering. The topic of this year’s conference is inflation dynamics and monetary policy.

Former Federal Reserve Chairman Ben Bernanke said he does not see signs of extreme movements in the US real estate and financial markets. Bernanke also said that if the Fed lifts interest rates, it would be good news because it means the U.S. economy is strong enough.

Royal Bank of Scotland, Britain’s largest taxpayer-owned lender, could pay as much as $4.5 billion to resolve claims of misconduct in its handling of US mortgage securities. The legal action relates to $32 billion in residential mortgage-backed securities sold to Fannie and Freddie from 2005 to 2007.

Back in 2005 Deutsche Bank was selling derivatives that were supposed to be a form of insurance against a huge financial disaster. And after they had sold billions of dollars of these derivatives, they started writing guarantees to the pool, or conduit, that was writing the guarantees. Deutsche was getting its derivative based version of insurance from Deutsche Bank’s own money; essentially selling derivatives on the derivatives it was selling to itself; while taking a commission off the top, of course. And by the way, these derivatives were super-senior, so they were highly rated – that’s an important point. When things went bad in 2008, they charged more for the derivative form of insurance because it was highly rated, but they also still treated it as if it was very highly rated, even though the world of finance was melting down. Deutsche figured that there was not a reliable method to measure the risk in light of the market conditions, and so they just figured there was zero risk.

Ultimately, the realities of 2008 showed that risk was quite a bit higher than zero. The SEC thought the whole thing was a bit fishy, but Deutsche maintained that it did not suffer any losses. Which was true because the insurance/derivatives never paid off. And the reason it never paid off was because it was highly leveraged, and it might have destroyed the bank, and they were clever enough to write into the derivative contract that they might not pay if they didn’t want to, so they did not pay. And in Deutsche’s twisted logic that meant the derivatives were very high quality; so good that they sold them to clients and even bought some themselves and then held it on their books as high credit quality capital.

In 2010, three whistle blowers stepped up to say that Deutsche had mismarked billions in exposures in 2008 and 2009 to make it look healthier than it really was. And this is important because banks are required to keep a certain amount of very safe capital available in the event of a problem; this is called tier one capital; and if a bank does not have enough tier one capital on hand, then they are basically considered insolvent. For example, in 2008, Lehman Brothers did not have enough tier one capital and they collapsed. As it turns out, Deutsche Bank did not have enough tier one capital on its books in 2008, but they did have highly leveraged derivatives, which were kind of, sort of like insurance created out of thin air, and backed by other derivatives, which were backed by their own capital, which was protected by nothing more than imagination and bogus credit ratings.

If Lehman Brothers had been smart enough to create derivatives out of thin air and call them insurance, they might never have collapsed. And If Deutsche Bank had not lied about the credit quality of their derivatives, they could have ended up like Lehman. But that didn’t happen, because Deutsche Bank lied. Yesterday, the Securities and Exchange Commission said that Deutsche Bank made material misstatements about a giant derivatives portfolio, inflating its value at the height of the financial crisis; and the bank failed to account for a “material risk for potential losses estimated to be in the billions of dollars”. The bank agreed to pay a $55 million penalty, without admitting or denying wrongdoing. Nobody goes to jail. The bank is not sanctioned. Deutsche said it had cooperated with regulators throughout the investigation and said the settlement “will have no impact on previous financial reports.” Hey it was a long time ago, in the ancient past. And the moral of this story is that when a bank gets in trouble, they should lie or be Lehman.