Financial Review

School’s Out

Sinclair Noe — May 3, 2016

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DOW – 140 = 17,750
SPX – 18 = 2063
NAS – 54 = 4763
10 Y – .07 = 1.80%
OIL – 1.13 = 43.65
GOLD – 5.20 = 1286.70

Eurozone growth will be slower than previously expected with subdued inflation in 2016, the European Commission announced in its spring economic forecast, warning of high risks to the bloc’s economy. The GDP of the 19-nation area is now predicted to expand just 1.6% this year, less than the 1.7% growth of 2015, while consumer prices are seen up 0.2%, significantly below the 0.5% increase projected in February.

The Reserve Bank of Australia has cut its official cash rate by 25 basis points to a historic low of 1.75%, the first reduction since May 2015. The RBA noted that inflation was “unexpectedly low,” and it also gave a cautious outlook for the Australian economy. Following the rate cut, the yen surged against the Australian dollar, pushing the greenback below ¥106-yen for the first time in about 18 months.

Federal Reserve Bank of Atlanta President Dennis Lockhart says financial markets may be underestimating the odds of a rate increase in June. Lockhart calls it a real option. At the most recent FOMC meeting Federal Reserve officials signaled that they expect to raise interest rates twice this year, while investors see only one move. If economic theory is any guide, even the central bank’s more hawkish outlook would still leave the target for the benchmark policy rate way too low. 

Meanwhile, San Francisco Fed President John Williams laid out a “pretty optimistic” outlook, with unemployment coming down, growth rebounding and inflation picking up, allowing the Fed to raise interest rates gradually. Williams said he doesn’t agree with negative scenarios for the economy and doesn’t take a “strong signal” from the 0.5% growth rate in the first quarter. He said GDP data were distorted by seasonal factors and growth was actually closer to 2% annual rate.

Seven of the world’s biggest banks have agreed to pay $324 million to settle a private U.S. lawsuit accusing them of rigging the ISDAfix, an interest rate benchmark used in the $553 trillion derivatives market; ISDA stands for the International Swaps and Derivatives Association.

The settlement resolves antitrust and other claims against Bank of America, Barclays, Citigroup, Credit Suisse, Deutsche Bank, JPMorgan Chase and Royal Bank of Scotland. Several pension funds and municipalities accused the banks of engaging in a conspiracy to rig the “ISDAfix” benchmark from 2009 to 2012. Other bank defendants have yet to settle.

Nearly every school in Detroit was closed for the second straight day, once again causing more than 45,000 students to miss class because of a funding crisis that has put the city at odds with teachers. The Detroit Teachers Federation called for a mass sickout after the school district’s management announced over the weekend that it would not be able to pay teachers in the summer.

Union leaders met with district leadership on Monday but did not reach an agreement. Though most school districts in the US are run by local governments, the state took over the Detroit school district because of financial difficulties in 2009. A series of emergency managers have headed the district in the seven years since.

Puerto Rico’s debt crisis has moved into a more perilous phase after it missed a $422 million bond payment deadline for its Government Development Bank. Treasury Secretary Jack Lew warned in a letter to Congress that a US “taxpayer-funded bailout may become the only course available” if the proposed restructuring legislation isn’t approved. The missed payment, the largest so far by the island, is widely viewed on Wall Street as foreshadowing additional defaults this summer, when more than $2 billion in bills are due.

Mortgage buyer Freddie Mac said it has a loss of $354 million in the quarter, compared with a prior-year profit of $524 million and a fourth-quarter profit of $2.16 billion.  Ahead of the release, some had speculated that Freddie Mac might need what’s called a “draw” from the U.S. Treasury this quarter. While that didn’t occur, the company is clearly vulnerable to needing one in the future. Some shareholders of Freddie have pursued court action to invalidate the 2012 Treasury decision to sweep all of the profits of Freddie and its Fannie Mae to the government.

Freddie and Fannie own or guarantee about half of all U.S. mortgages, worth about $5 trillion. Along with other federal agencies, they back roughly 90 percent of new home loans. The two companies don’t directly make loans to borrowers. They buy mortgages from lenders, package them as bonds, guarantee them against default and sell them to investors.

According to the latest report from CoreLogic, Home prices nationwide, including distressed sales, moved higher year-over-year by 6.7% in March 2016 compared with March 2015 and increased month-over-month by 2.1% in March 2016 compared with February 2016. The highest appreciation was in the West, where prices continue to increase at double-digit rates.

Pfizer reported first-quarter results that blew past analyst estimates, boosted by sales of its new cancer and arthritis treatments and the acquisition last year of hospital products company Hospira. The largest US drug maker also raised its revenue and earnings forecast for the year, helped in part by the weakening dollar.

UBS Group reported a 64 percent decline in first quarter profit, with earnings at its wealth-management and securities unit hit hardest. UBS is planning job cuts. Commerzbank AG, Germany’s second-biggest lender, reported first-quarter profit was cut in half. HSBC Holdings reported profits that beat analyst forecasts, as cost-cutting measures started to bear fruit.

Sprint reported a wider quarterly loss and added fewer subscribers than expected, but vowed to cut more than $2 billion in costs in the current fiscal year to stop the red ink.

Halliburton said it would consider acquisitions to bolster its weaker businesses as the oilfield services company looks to move on after a deal to buy smaller rival Baker Hughes fell through. Halliburton also reported a higher-than-expected adjusted profit for the first quarter.

Detroit automakers reported another month of strong demand from US consumers for trucks and sport utility vehicles, but their shares dropped as analysts focused on signs the world’s second largest auto market has little room to grow.

Ahead of the final tally for US light vehicle sales in April, General Motors estimated the seasonally adjusted annualized selling rate will be 17.6 million vehicles. U.S. auto sales in 2015 hit a record 17.4 million vehicles. GM said sales of the Chevrolet Silverado pickup truck rose nearly 9 percent in April compared to a year earlier. However, sales of GM’s Cadillac CTS and ATS luxury sedans plummeted 23 percent and 18 percent respectively. Other luxury brands also had weak results in April, especially for cars.

Toyota’s Lexus luxury division suffered a 26 percent decline in sales of cars such as the large LS sedan, although sales of Lexus brand SUVs rose 20 percent. Still, April sales for Ford, Honda, and Nissan all beat analysts’ expectations. Ford’s sales rose 4 percent from a year earlier, Fiat Chrysler was up 5.6 percent and Toyota, No. 3 in the U.S. market, rose 3.8 percent. Honda’s sales rose 14.4 percent.

Google has agreed to buy about 100 plug-in hybrid minivans from Fiat Chrysler to expand its self-driving vehicle testing program, in the most advanced partnership to date between Silicon Valley and a car maker. The vehicles will not be offered for sale to the public. Unlike prior testing in which Google bought Toyota vehicles from dealers and retrofitted them, the search engine giant will work with Fiat Chrysler directly to equip around 100 of the Chrysler Pacifica minivans it launched in February with Google’s self-driving technology.

Philips is spinning off its lighting division, the world’s largest maker of lights, selling a stake of at least 25% in the new company during the IPO, which will take place on Euronext Amsterdam. Philips began as a lighting company in 1891. Analysts have valued the unit as being worth roughly $5.8 billion.

Bankruptcy talk… Fairway Group Holdings, which has lost money in every quarter since it went public in 2013, has filed for Chapter 11 bankruptcy in a New York court. The grocery chain operator listed assets and liabilities in the range of $100 million to $500 million, and is seeking approval for $55 million of debtor-in-possession financing. Meanwhile, Aeropostale, delisted by the NYSE just over a week ago, is said to be preparing a bankruptcy filing this week in which it would close more than 100 of its 800 stores.

Johnson & Johnson must pay $55 million to a 62-year-old South Dakota woman who blamed her ovarian cancer on the company’s talcum powder in the second such trial loss this year. In February, J&J lost a $72 million verdict in the same St. Louis courthouse to the family of a woman who died of the disease. J&J is accused in more than 1,000 lawsuits in state and federal courts of ignoring studies linking its Shower-to-Shower product and Johnson’s Baby Powder to ovarian cancer. Women contend the company knew the risk and failed to warn customers.

Solar Impulse 2 touched down in the Phoenix suburb of Goodyear, last night around 9 PM, after a 16-hour flight from northern California. The wings of the plane are equipped with 17,000 solar cells that power propellers and charge batteries. After Phoenix, the plane will make two more stops in the United States before crossing the Atlantic. It began its globe-circling journey last year, and flew from Hawaii to the Silicon Valley last week.

Financial Review

Ongoing Criminal Enterprises

Sinclair Noe — May 20, 2015

 

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DOW – 26 = 18,285
SPX – 1 = 2125
NAS + 1 = 5071
10 YR YLD – .01 = 2.25%
OIL + .77 = 58.76
GOLD + 1.80 = 1210.80
SILV un = 17.18

April 29 and 30 the Federal Reserve’s Federal Open Market Committee met to determine monetary policy; today, they published the minutes of that meeting. There were no surprises. Policymakers have no plans to increase interest rate targets in June. We all knew that. Officials in April “had increased uncertainty regarding the economic outlook,” the minutes showed. They had no good reason to explain why consumer spending was so weak.

“Most” Fed officials think the dramatic slowdown in growth in the first quarter was transitory and that a moderate rebound would resume in the second quarter. Inflation was also expected to move higher.  The international context isn’t helpful to the US economy. Fed officials deem “foreign economic and financial developments” as constituting “potential downside risks,” and they specifically mention Greece and China. Moreover, despite its recent partial retracement, the dollar’s appreciation is “likely to continue to be a factor restraining US net exports and economic growth for a time.”

This suggests that they see a rate hike coming sometime later this year. Only a “few” on the U.S. central bank questioned whether the Fed was providing enough stimulus for the economy at the present time and cautioned against any rate hike in the near future. This is an interesting point because the Fed really hasn’t provided much stimulus for the economy; they have provided stimulus to financial markets but not the broader economy in a direct fashion.

Indirectly, the Fed has provided stimulus to the broader economy through something known as the monetary transmission mechanism, which works largely through housing or other long-lived investments which are sensitive to interest rates. Interest rates don’t have strong impact on short-term investments or short-term capex. A lot of business investment is short-term; a lot of household spending is short-term. So Fed policy, by moving interest rates, normally exerts its effect mainly through housing. And interest rates do move housing. Remember the early 1980s when Paul Volker decided to tighten, interest rates jumped, and housing collapsed. And housing has come back from the lows, but not all the way back. One reason is because people who are most likely to buy houses got slammed in the downturn and couldn’t or wouldn’t jump back into that frying pan.

Today’s economic data backs up the relationship between housing and rates. Mortgage purchase applications fell 4.0 percent in the May 15 week though, year-on-year, applications are still up a very strong 11.0 percent. The ongoing run up in mortgage rates may be easing demand for mortgage applications just at the time that demand for purchase applications had been gaining steam.

And so the Fed is feeling like it has its back to the wall, and the wall is zero interest rates. If there is an economic problem the Fed can’t respond by lowering interest rates, or at least the impact of going into negative territory would be dangerous ground.

There was some debate about how to communicate any move to tighten rates. Some officials think it is important to give a warning to the markets, others worry that telegraphing intentions to hike rates will only result in a rate tantrum. The recent bond-market rout underscores that with bond yields near historical lows, even a moderate rise in yields would chip away the slim interest payments and inflict pain on bondholders. The Fed identifies this as episodes in which there were large monetary disturbances not caused by output fluctuations. Hopefully the Fed remembers the lesson from the Crash of 87; the markets respond violently to surprise rate hikes.

A mixed bag of economic releases this month has bolstered investors’ expectations that the Fed would wait until late this year to act. Fed Chairwoman Janet Yellen will make a speech on Friday that might provide further guidance.

Five global banks have agreed to pay $5.8 billion in combined penalties and will plead guilty to criminal charges related to manipulating foreign currency exchange rates, also known as Forex. Four of the banks, JPMorgan Chase, Barclays, Royal Bank of Scotland, and Citigroup, will plead guilty to conspiring to manipulate the price of US dollars and euros.

Barclays will pay $650 million, Citigroup $925, million J.P. Morgan $550 million and RBS $395 million. Barclays will pay another $1.3 billion to New York State, federal and U.K. regulators.

The fifth bank, UBS, received immunity in the antitrust case because they informed regulators about the Forex rigging as part of an earlier deal related to Libor rigging; UBS had signed a Non-Prosecution Agreement in 2012 on the Libor charges, and their misconduct in the Forex markets violated that earlier agreement even though they self-reported wrongdoing. So, they have immunity on Forex but they had to plead guilty to Libor rigging.  UBS will pay $545 million in fines to the Justice Department and Federal Reserve.

The five banks will pay a further $1.6 billion in fines to the Federal Reserve. Bank of America also faces a $205 million fine by the Fed, but no criminal charges. No bank employees have been criminally charged. The five banks will be under a three-year period of probation.

Between December 2007 and January 2013, euro-dollar traders at Citigroup, JPMorgan, Barclays, RBS and UBS gathered in an exclusive electronic chat room and used coded language to coordinate their moves in the U.S. dollar-euro market. They referred to themselves as the Cartel. By agreeing not to buy or sell at certain times, they protected each other’s trading positions. The big banks were the market makers, setting daily exchange rates, known as the fix. The fix became the price paid for billions of dollars of currency bought or sold on any given day.

And the Cartel managed to skim a little for their efforts. One Barclays trader in the chat room about adding secret mark-ups to the prices wrote: “If you ain’t cheating, you ain’t trying.” Ben Lawsky, New York’s superintendent of Financial Services explained it simply:  “They engaged in a brazen ‘heads I win, tails you lose’ scheme to rip off their clients.” Also, a side note, after the big settlement announcement Lawsky announced he will step down next month as New York’s top bank regulator after four years. To his credit, he is not going to work for JPMorgan.

I have not yet seen a figure for how much prosecutors think the Cartel stole, but the Forex market trades close to $5 trillion dollars a day, so today’s fines amount to about one/one-thousandth of daily volume. The rigging took place over more than 5 years. I’m guessing that the money they stole in rigging Forex might amount to more than the fines ordered today. And that raises another interesting question – how did they report that income? Will they now go back and amend their earnings reports?

Didn’t managers and Board of Directors sign off under Sarbanes-Oxley?

And remember that the Forex scandal follows on the heels of the Libor rigging scandal, and the ISDAfix scandal (that involved the $381 trillion market for interest-rate swaps and the $44 trillion market for options on swaps. Banks use it to set coupons paid for bonds tied to commercial real estate. And there is a mountain of evidence, and today Barclays agreed to a $115 million dollar settlement on the ISDAfix investigation. Other banks are also being investigated.)

And before that, the municipal bond rigging scandals, and scandals in commodity markets including precious metals, and tax evasion scandals, and money laundering scandals, and predatory lending scandals, and much, much, much more. Past performance is not a guarantee of future results, but based on past performance you have to figure that the banks have rigged all the financial markets.

FT has a running total of legal fines and settlements paid by banks to US regulators since 2007. According to their calculations, the tote board just touched $155 billion. In case you were wondering, over eight years that works out to $53m per day (including weekends, because client service is a 24 hour kind of business, right.)

The big news in today’s settlement was not the size of the fines, not the scale of the scandal, but that the banks actually admitted criminal guilt. UBS violated its 2012 Non-Prosecution Agreement, and we’re still just looking at a fine for a repeat offender. The banks will get to keep their charters; they can continue to conduct business; three years’ probation. They can still vote, or at least buy elections. The deal does not prevent the Department of Justice from going after individual criminal charges but for now, nobody goes to jail.

HSBC has become one of the biggest global banks to say it will begin charging clients on deposits in a basket of European currencies to prevent its profit margins from being crushed in a record low-interest rate environment. The unusual steps come after the ECB last year became the first big central bank to announce a negative deposit rate, in effect a penalty on banks parking their surplus cash.

The Japanese economy staged a comeback in first quarter, expanding at an annualized 2.4% vs. the previous quarter. Despite the positive figure, economists are still worried about Japanese growth and deflation as most of the expansion was due to a huge build-up of inventories. The Nikkei Stock Index finished the session at a 15-year high.

It is widely recognized that Greece is running out of money. The next questions are when they will run out money and what will happen when they run out of money. Nikos Filis, from the ruling Syriza party, told Greek television Greece will not be able to make a €1.5 billion repayment to the IMF that falls due on June 5 if there is no deal with its international creditors by then.