Market Talk

Capital Economics out today with a thorough, frank and reasoned report on the US economic outlook, taking a look at a host of areas like consumption, investment, external demand, labor market, prices and monetary & fiscal policy. The upshot? Recovery is “likely to remain muted for years to come.”

Let that sink in for a minute. For years to come. Doesn’t seem as if investors have really wrapped their heads around that concept, but the firm builds a pretty compelling case, in straight-forward terms. For example, this simple point:

The fundamental obstacle preventing a return to stronger economic growth is the damage done to the balance sheets of households and financial institutions by the housing bust and
the related financial crisis.

Household deleveraging is “still in its infancy,” the firm says, noting that since the start of 2008, household debt has fallen $470 billion, but half that decline has come because of defaults, not from folks paying off their debt. “Overall, the downward pressures on real incomes and the structural problems caused by high debt and lower asset prices mean that households will not be able to spend freely for at least the next two years.” Continue reading…

In my previous post, on the Fed and deflation, I didn’t get into the nuts and bolts of where things stand on the inflation/deflation front, for brevity’s sake. Given the Fed’s almost Ahabesque determination to create inflation, there is already mounting criticism that the Fed is in fact blowing a dangerous inflationary bubble. But two notes landed in my inbox this morning that make the exact opposite argument, and illustrate again why the Fed is doing what it’s doing.

The first comes from Capital Economics. “Fears that the Fed has put the economy on the path towards rampant inflation looked even more misguided last week when it was announced that core CPI inflation fell to a record low of just 0.6% in October,” the firm writes (the note is dated Nov. 22, so the reference to last week is actually about this week.) “The real danger is that the economy is heading towards deflation.” They continue:

Although housing costs are no longer falling, the high unemployment rate means that landlords will not be able to make rent rises stick. Core services inflation is therefore unlikely to rise back. Meanwhile, core goods inflation will continue to fall, not least as auto prices drop further.

Nominal rigidities have so far prevented core inflation from falling further. But with the economy set to remain saddled with a lot of spare capacity, the downward pressure on prices will eventually become overwhelming. It might not be long before the US is flirting with deflation.

The second comes via UBS’ Art Cashin, who clips part of a speech from John Williams, director of research at the San Fran Fed. Here’s what Mr. Williams had to say about deflation, excuse me, here’s what Mr. Williams had to say on the lack of inflation:

I’d like to turn now to inflation, or, I should say, the lack of inflation.  The measure of inflation we follow most closely is the core personal consumption expenditures price index.  These prices have been rising at a 0.9 percent rate so far this year.  This is the lowest nine-month inflation rate recorded in the over 50 years that this statistic has been compiled.  Our forecast is that inflation will come in about 1 percent for the year as a whole and stay at that rate next year.  That’s about 1½ percentage points below where it was at the start of the recession and well below the level of around 2 percent that most Fed policymakers have said is consistent with stable prices.

Continue reading…

We may have gotten an insight today into the Fed’s real thought process when it come to quantitative easing, the so-called QE2 everybody’s expecting. Brian Sack, the head of the New York Fed’s markets group, was speaking today about the benefits to the economy that could come should the Fed decide to launch into a big bond-buying program.

There has been fierce debate on the subject, even within (or, more precisely, especially within) the Fed itself. But most people still think this is a fait accompli, that the Fed, in not so many words, will be cranking up the printing press. What will they accomplish by this? Well, you can imagine that interest rates will stay low, if not move lower. How’s that an accomplishment when rates are already at historic lows? Well, it isn’t, but it also isn’t really the point.

From Mike Derby’s write-up of Sack’s speech:

While asset buying is an “imperfect policy tool,” Sack said “balance sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be.”

“…by keeping asset prices higher than they otherwise would be.” Bingo! John’s the one that noticed that in the speech and jumped all over it. Because what’s he actually saying there, in typical Fed jargon, is that the central bank is looking to keep asset prices artificially high. That one of the goals of QE2 is to keep asset prices artificially high.

In less polite circles, that’s called market manipulation, and it often leads to perdition.

Continue reading…

She may just stay in port, folks.

Indecisive, choppy trading leaves stocks modestly lower in a session where the biggest influence was movement of EUR/USD.

Dollar abused again, euro parked above $1.36 and major US indexes seemed to mime every twitch and jog by EUR/USD. Materials, financials lead sector decliners, while energy and tech end in positive territory.

Lots of data coming tomorrow and Friday; comments from Fed officials today seemed to suggest bad economic data alone won’t warrant QE2 — only specter of worsening deflation will bring out the big guns. Philly Fed’s Plosser said as much, noting that beyond cutting rates (which is over and done with), the Fed can’t do much to help the labor market, and the central bank’s credibility is on the line if more asset buying fails to create the desired effect.

Weekly jobless claims, a third look at 2Q GDP and more regional manufacturing gauges all due tomorrow.

DJIA slips 22.86 to 10835.28, and Nasdaq Comp falls 3.03 to 2376.56. S&P 500 ends 2.97 lower at 1144.73.

(Photo courtesy of Wiki Commons.)

Pricey corn -- Ben Bernanke's new best friend.

Gold and Treasurys rally after FOMC yesterday signaled that they’re more concerned about deflation. “Maybe they haven’t checked the prices of commodities recently,” Terry Woo says at Minyanville.

He notes corn’s up 42% since June 1, while cotton’s up 27% and copper’s gained almost 13%, just a few examples of sharp commodities inflation lately. “So if you think this isn’t going to feed into your daily purchases at the local grocery store, then I have some oceanfront property to sell you in Arizona,” Woo quips.

“The currency debasement trade is still on and very strong and inflation beneficiaries will continue to outperform,” he says.

“Gold mining plays will shine as well as stocks with dollar-denominated liabilities and revenues coming from other countries with more stable currencies. If gold’s not your thing, look to McDonald’s (MCD), YUM Brands (YUM), and Walmart (WMT) as some potential plays.”

(Photo courtesy of Wiki Commons.)

US stocks little changed, after the Fed again dances around the question of whether it will throw yet another net under the economy. They talked real smart, and danced around the issue, but ultimately didn’t really say anything new (although they came perilously close to almost saying “deflation.” But they didn’t.)

DJIA adds 7 to 10761, but S&P 500 slips 3 to 1140, Nasdaq Comp eases 6 to 2349. Stocks did rally, but gave it back by the close. You wonder what’ll happen with stocks. Have they climbed too far? Are the heights too much? I tend to think that the bulls have this thing by the tail, to mix metaphors, and aren’t about to let go. The data are (marginally) better, the central bank’s got their back, the midterms are coming up and everybody expects the business-friendly party to come back to town. ‘Course, you never know.

Treasurys and gold stick their rallies, however, while the dollar sells off. Yield on the 10-year Treasury note fell back to 2.58%, and gold jumped to $1,287. The dollar got smacked around. With the Fed ever-so-subtly threatening to debase the currency, euro jumps to $1.3240, and the yen slides to 85.05, although there’s no overt signs the Bank of Japan stepped in to defend its line in the sand.

What’s been going on the past week or so is really something to see, though. Stocks, gold, Treasurys are all rallying. It can’t last and somebody has to be wrong, but if there is, ahem, some invisible hand behind all this, it’s doing one bang-up job right now.

Anyhow, key event today was the statement coming out of the Fed’s one-day rate-setting meeting. The bankers kept rates at zero, of course. But it’s assessment of the economy wasn’t so hot, and the Fed says it’s prepared to “provide additional accommodation” if needed. While it didn’t signal the start of any new bond-buying programs, most read this as yet another incremental step toward what’s being called QE2, another massive bond-buying program to hold things together.

But it did say, in it usual circuitous way, that inflation’s too low, and if it goes much lower, the central bank will step in. The Fed’s stance raises the issue of how other central banks will react to the notion of the world’s premier central bank bashing its own currency. As our colleague Mike Casey wrote this afternoon:

The FOMC’s latest dovish statement implying further QE to fight deflation lands at an awkward time in global currency markets. The dollar is weakening on the news, but that’s not what central banks from Brazil’s to Japan’s want to see. There’s a distinctive shift toward more intervention around the world right now. Anything the Fed does to soften the dollar raises the risk of a self-destructive round of competitive devaluations. It’s yet another sign of how global imbalances are making it harder for policymakers.

“Competitive devaluations.” Keep that phrase handy.

Language that jumps out in this latest FOMC statement comes in the final paragraph. Clever, as Bernanke & Co. know that in show business, it’s always important to have a strong close.

The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.

Translation: We’re still prepared to do whatever it takes to get this economy off the ground, and ready to do battle with deflation.

See that little trick they used? Instead of using the words “deflation” or “deflationary” or “disinflation,” the committee said it’s ready to “return inflation” to levels “consistent with its mandate” (price stability.)

Committee certainly isn’t talking about returning inflation to lower levels. Sounds like the first time the FOMC is actually, in a very indirect way, saying it’s locked & loaded for deflation.

How do you spell deflation? From Kipplinger’s, via Yahoo:

Retailers have long manipulated consumers by marking up merchandise, then promoting sales to clear inventory. Car dealers know how to play the game, too. Their marketing ploys often take the form of manufacturer’s cash rebates and low-rate financing. But car companies hate offering these incentives because relying on them to sell vehicles lowers long-term resale values across the product line.

So carmakers have introduced a fresh marketing strategy to attract your business: lower sticker prices. For the 2011 model year, several redesigned vehicles feature more amenities at prices that are the same as or less than prices for the outgoing models. This follows a trend that began with the 2010 model year.

Market uncertainty has many investors playing defense, but financial advisor Ron Carson shares an offensive move he’s using with high-net worth clients. And if deflation does hit the economy there are several ways to prepare.

Dow Jones’ Veronica Dagher reports.

- Bernanke essentially admitted the economy looks nothing like the growth he was expecting six months ago. “But he argued that 2011 will be better, because…well, it was hard to see exactly why,” Paul Krugman writes at Conscience of a Liberal. “He offered no major drivers of growth…So: I guess this speech marked a small step toward QE2 and all that. But mainly the message was that just around the corner, there’s a rainbow in the sky.”

- Big surprise from Bernanke’s speech? He said “deflation” on six separate occasions, Stephen Gandel notes at Time’s Curious Capitalist blog. “Clearly, Bernanke believes the chances of prices falling is a credible threat to the economy,” he says, although noting the Fed chairman didn’t propose any new strategies to fight deflation. “So again, Bernanke is making the case that deflation is not a problem he is worried about.”

- Intel (INTC) cutting its 3Q revenue outlook gets overshadowed by Bernanke’s speech, but don’t discount this major development, warns the Pragmatic Capitalism blogger. “We could be at a crucial turning point where the economy is slowing substantially and analysts estimates appear high,” blog says. “If Intel is any early indication…we are likely to see more warnings and a lot of analyst cuts in the coming months,” which will put pressure on markets.

- Turns out Wall Street analysts predicted Intel’s slashed outlook long before the company finally came clean. In recent weeks, Barron’s Tech Trader Daily blogger Eric Savitz notes JMP Securities, Roth Capital, Bernstein Research, BMO Capital, Barclays and Baird have all slashed estimates on Intel. Savitz ponders: “If they all could see this coming, what took Intel so long to admit there was a problem with its previous guidance?”

- Reuters blogger Felix Salmon calls sluggish 2Q GDP the “best kind of bad news,” as imports surged 32% last quarter, overshadowing 9.1% gain in exports. Relatively healthy exports and strong imports are signs that there’s still plenty of demand.

- GDP downward revision to 1.6% in 2Q, from 2.4%, is bad, but better than economists were expecting. “The revisions can be chalked up to the anticipated factors,” Ryan Avent writes at The Economist’s Free Exchange blog. “Private inventory investment and exports were lower than expected, while imports, which count as a negative to GDP, came in higher. The main bright spot in the report is a slight upward revision to personal consumption expenditures.”

- The bidding bonanza between Dell and Hewlett-Packard (HPQ) over 3Par (PAR) has many market observers wondering what’s the big deal with this previously obscure company. It’s bringing back memories of the “crazed acquisitive days of the dot-com boom,” FT’s Alphaville notes. “Who needs rationality when desperation and blind optimism conspire so well?”

- And as the bidding war between Dell and H-P stays red hot, “the rapid-fire pace could continue,” Brian Caulfield writes on a Forbes blog. “Both HP and Dell need 3Par. Dell needs to expand its presence in the corporate data centers, where it has a strong lineup of server offerings. H-P, meanwhile, already has a storage business, and is eager to grow it.”

- Corporate America couldn’t care less what Bernanke said today, Miller Tabak’s Peter Boockvar says. “They know that interest rates are already at historic lows and the average business person, whether for a big company or small knows that the cost of money at this point is not a factor in the decision of whether to expand/hire or not,” he says. “From the perspective of the consumer, they are only interested in paying down debt and saving and if anything, more ‘easing’ by the Fed just makes saving that much more difficult.”

- It’s US Open season, baby! WSJ profiles one of my favorites — New York’s own James Blake. He’s been so frustrating to watch throughout the years, but here’s to hoping the low-ranked wildcard can turn some heads at this year’s tournament.