Morning Report: Will the US economy have a Wile E Coyote moment in 2019?

Vital Statistics:

Last Change
S&P futures 2765.5 -19
Eurostoxx index 385 -3.9
Oil (WTI) 65.16 0.1
10 Year Government Bond Yield 2.91%
30 Year fixed rate mortgage 4.57%

Stocks are lower this morning on trade fears. Bonds and MBS are up.

We will get a lot of housing-related data this week, but nothing should be market-moving. We will get housing starts and building permits tomorrow, existing home sales on Wednesday, and house prices on Thursday. Otherwise, should be a relatively quiet week.

The NAHB Housing Market Index (a sentiment indicator for the homebuilders) fell to 68 last month from 70. Rental markets are softening in some of the more pricy MSAs.

OMB official Kathy Kraninger is supposedly the front-runner to replace Mick Mulvaney as the permanent director of the CFPB. The confirmation process will probably take at least through the end of the year. She is not viewed as any sort of financial regulatory expert, so expect to see a lot of objections from Democrats over the nomination.

Ben Bernanke thinks the US economy will have a Wile E Coyote moment in 2019 or 2020 when the tax cut stimulus wears off. His point is that we are enacting fiscal stimulus at “exactly the wrong time” when the economy is already at full employment. Of course the statement about full employment is debatable. The unemployment numbers indicate we are, but the employment-population ratio does not. The employment-population ratio currently stands at 60.4%, and pre-crisis, we were around 63%. That 2.6% difference works out to be about 8.5 million people. We are getting some modest real wage growth (average hourly earnings are up 2.7% YOY and the core PCE index is growing at 2%) however broad-based wage growth probably isn’t going to happen until the EP ratio gets back up around 63%. Yes, there is a demographic element to this with the baby boomers retiring, but that is overplayed. Many people who are retiring in their 60s would rather work. You can see just how bad the Great Recession was. Most of the gains that started in the 60s with women entering the workforce were given back. The “retiring boomers” narrative has a kernel of truth in it, but it isn’t driving it.

employment population ratio

The FAANG stocks are now worth more than the entire UK stock market. While people talk about short Treasuries as being the most crowded trade on the Street, it doesn’t hold a candle to the FAANGs

FAANG

Goldman’s model now suggests the US economy grew at 4% in the second quarter. Friday’s Empire State Manufacturing Survey was the catalyst for the upgrade.

The government is trying to clarify the Volcker Rule, which prohibits banks from proprietary trading. So far, it seems to be clouding the issue as opposed to clarifying it. Ultimately trades held for less than 60 days are considered proprietary trades although there is a carve-out for hedging and market-making. Given the drop in commissions over the past 20 years, and sub-penny bid ask spreads, the economics of market-making are terrible to begin with, but the regulatory uncertainty probably seals the deal. The next crash is not going to be pretty.

Morning Report: The push-pull of monetary policy

Vital Statistics:

Last Change
S&P futures 2732 3.75
Eurostoxx index 391.38 -1
Oil (WTI) 70.81 0.11
10 Year Government Bond Yield 2.98%
30 Year fixed rate mortgage 4.55%

Stocks are higher this morning as trade tensions with China eased somewhat over the weekend. Bonds and MBS are down small.

The Trump Administration is pushing Congress to get a long-term funding deal done by the August recess.

There won’t be much in the way of market-moving data this week – housing starts and retail sales will be the only possibilities. We will have Fed-speak every day however.

As the yield curve flattens, it is attracting more and more attention. Chris Whalen argues that Fed manipulation of the curve is the driving force behind the flattening. By paying interest on excess reserves, the Fed has pushed up short term rates far further than demand for credit would imply – in fact he argues that if the Fed stopped paying interest on excess reserves, the Fed Funds rate would get cut in half. On the other side of the coin, fears of taking losses on its QE portfolio has caused the Fed to hold down long-term rates. Finally, he argues that the reason for the growth in nonbank lending has been due to unwritten guidance from the government to the big banks: don’t go lower than 680 on FICO scores. There is a conflict between macroprudential regulation and monetary policy, which is inhibiting credit growth despite the FOMC’s attempts to stimulate it. Whalen argues that credit growth is not high enough to really stimulate a recovery and that is due to hard caps the regulators have imposed on commercial and industrial lending, construction finance, and multifamily lending. I wonder if credit is behind the lack of housing construction despite such high demand.

As rates rise, we are seeing more and more money flow into passively-managed bond funds. One of the interesting dynamics of passively managed indices is the self-reinforcing mechanism of the investing itself. For example, look at the FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google). Their weight in the S&P 500 is based on their market caps. So, as these companies outperform the S&P 500, their weighting in the index increases, which causes passive investors to buy more in order to maintain their weighting. It becomes a self-fulfilling prophecy. Here is where it gets strange in bond-land. Companies with the most debt end up dominating the index. So in theory, as a company gets more risky (by issuing more debt), passive investors demand more of their debt. So unlike passive equity investment, which builds on strength, passive bond investing builds on weakness. This means that there should be much more room for index outperformance with actively managed bond funds than with passively managed bond funds.

Interesting chart from David Stockman:

HNW to DPI

If the ratio of net worth to income is going to revert to the mean, that means either asset prices are going to crash, or incomes are going to rise. I think the latter is what will occur.