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Event Risk
Another 12.5/32nds gain for TNotes (2.96% yield on the on-the-run 10y note), and this rally is starting to become almost ordinary with the 6th gain of the last 7 sessions. Alas, the losses on stocks are starting to grow more ordinary as well: the S&P dropped 3.1%, and this time the surge in volume wasn’t due to the Russell rebalancing. The 1.55bln shares was not a record-breaker, or as high as the volumes we saw in May…but neither was it the pedestrian total we were seeing in the first part of the year. With the exception of the March quadruple-witching, today’s equity volume exceeded that printed for any day during the first quarter of the year.
There appeared to be a catalyst in the form of a Consumer Confidence figure that was released at 52.9, down sharply from last month’s pre-revision 63.3 and about ten points below forecast. This is a surprise, with both “present situation” and “expectations” portions of the index dropping, but really all that it did was unwind last month’s surprise jump (which, many observers noted, was concentrated in the “expectations” component). See the chart below – we’re merely back in the recent range. The failure of forecasters here wasn’t because the data was awful this month, but because it was improbably strong last month. So the fault is not in the stars, but in ourselves.
Not a reason in itself for -3%.
Or, more specifically, in themselves, meaning economists, since I never believed the economy was improving sharply last month!
The important part of the number, that is the employment questions, were essentially unchanged. This is not a horrible report, and while it may have served as the reason that commentators could point to, the locus of all fears, I think the real reason for both stocks’ decline today and bonds’ rally – both of which, after all, have been moving along nicely for several days prior to this data – is deeper than that.
Banks are due to repay to the ECB tomorrow the lusty sum of 442 billion euros, about $540billion at the current exchange rate, which was lent by the ECB last year as the crisis was ebbing. The ECB is offering a three-month facility at the same time that the 12-month loans roll off. Now, this seems like a simple transaction: borrow for 3 months to pay back the 1-year loan. The problem is that the 3-month loan carries a 1% interest rate, which is substantially above the currently-clearing interbank lending rate. Thus, institutional investors who are already nervous are worried that a high “roll” into the new facility implies that the interbank funding markets aren’t really operating, or are closed to certain names. Estimates of the amount that may be rolled seem to be around 200bln to 300bln Euro although I have seen some higher guesses. The real question is the composition of the banks who are borrowing directly from the ECB – are certain banks being shut out, or borrowing this way so as not to be seen taking large quantities of deposits interbank? – but we are not likely to know important details there.
Now, the ECB is still lending almost a trillion Euro to various banks, so it isn’t like a high take-up of the 3-month facility would be unprecedented. The issue is just that this quite-large loan maturity occurs when the system is already a bit stressed and investors a bit nervous. It is just event risk.
I suspect that the ECB will announce the results of the auction and that will be it, and after the market’s initial reaction we won’t be able to slice and dice the data any further and that particular issue will fade for another three months. But that isn’t the only source of event risk, since ADP is being released and, lest we forget, both stocks and bonds made very messy technical breaks today. The speed of the return to the bottom of the stock range, and the decisiveness of the break to lower yields as well, suggests to me that these trends have significantly further to run. I am working hard to minimize my exposure to these event risks.
Air Conditioners In January
It sure would be a wonderful thing if I could start ignoring the stock market for a change. For the last couple of days, it has looked like I may be able to. Another near-unchanged day in equity-land, this time on exceedingly light volume (Friday’s spike appears related to the Russell 3k rebalancing), leaves little to talk about there as the S&P closed a mere 0.2% lower.
But bonds – that was a different story. September 10y Note futures rallied 21/32nds with the 10y yield down to 3.01%. The Dallas Fed Manufacturing Activity report was weak, but … this wasn’t about that third-tier report, I am fairly sure. A different article in the UK Telegraph, this one talking about RBS’s warning to clients that the Fed may be forced into a “monster” monetization (available here), drew attention and some chatter around the Street, but inflation markets actually softened so it seems unlikely that this was the driver.
It may, however, be part of the same general angst that is growing (at least, in the bond market) about the economy. While speculation about future monetization and (therefore) future inflation ought to be bearish at some level, it is losing mind-share to investors who are saying “we’re not sure about that, maybe later…but right now, the economy’s in bad shape and the Fed isn’t going to be letting short rates rise soon.” In other words, this might be the last little moon shot to higher bond prices before the fuel runs out in a couple of months.
It would be ironic if the Fed’s monetization engine got re-revved right about now, and inflation started moving from core-ex-housing to broader measures, because just today I closed the doors – at least figuratively – on our startup inflation-focused investment management firm. Reflecting on the fact that the recent focus has been on the exceedingly soft core inflation figures a friend commiserating about our business prospects said to me, a couple of weeks ago, “it’s hard to sell air conditioners in January.” The problem is, it isn’t January but merely an unseasonably cool June. July will come as a bit of a shock, especially when the number to the air conditioner guys isn’t answering any more. Philosophically, I can also observe that the best trades I have ever recommended have been the ones that no one liked at first, and the absolute worst ones were the ones that every client wanted to jump on. I have a funny feeling that this will be another one of those situations. As Douglas Adams once wrote, “The major difference between a thing that might go wrong and a thing that cannot possibly go wrong is that when a thing that cannot possibly go wrong goes wrong it usually turns out to be impossible to get at or repair.”
The economic releases due Tuesday and Wedenesday, in the run-up to Friday’s Main Event (the Employment report), are not insignificant. Tomorrow Consumer Confidence (Consensus: 62.5 from 63.3) will start the ramp-up. On Wednesday the Chicago Fed Manufacturing Report (Consensus: 59.0 from 59.7) will be more carefully scrutinized than was the Dallas equivalent. Prior to that release, though, the ADP number (Consensus: 60k from 55k) will definitely draw attention this month. It has been much steadier than the Employment numbers, since it is not perverted by Census workers, and last month provided early warning of the weak Jobs report. I think economists are hoping for the 60k more than really forecasting it.
Interestingly, looking ahead to Friday I notice that Bloomberg is now showing economist forecasts not just for the total Payrolls number but also for “private payrolls,” since the headline number is likely going to be negative. I don’t recall Bloomberg pointing out the weaker private payrolls number when the headline number was being pumped up by Census, but now that the Census is dragging the number down…I don’t think it’s an intentional marketing of the data; I just think that news outlets today simply don’t know how to be objective. It also makes economists’ jobs easier. Hey, if you’re having trouble hitting the target, add another target!
Tales of Tails
I am missing a piece from Friday’s puzzle.
Stocks seemed to enjoy a boring, mostly sideways day after a rough week, with the S&P closing 0.3% higher on the day. Bond yields fell slightly, but overall the market seemed quiet. The VIX fell.
Then why did volume spike like it did on equity markets? It wasn’t a triple- or quadruple-witching Friday, but aside from the quadruple-witching last December, the session posted the highest overall volume since October 2008 in the teeth of the crisis. It is approaching quarter end, but we have had lots of quarter-ends without that sort of action. Almost all of the volume was near the end of the day. I don’t have an answer for this conundrum, but it raised my eyebrows so I thought I would raise the question.
I also raised my eyebrows at an article in the UK Telegraph which declares that the Fed is considering a “fresh monetary blitz” since the recovery is faltering. I am always happy to be skeptical when an article doesn’t name names, but this seems to me to be fairly likely to be true:
“Key members of the five-man Board are quietly mulling a fresh burst of asset purchases, if necessary by pushing the Fed’s balance sheet from $2.4 trillion (£1.6 trillion) to uncharted levels of $5 trillion.”
The strategy makes sense, if you believe that the long-term effects of dramatic monetary policy movements can be evaluated over a period of a couple of quarters. I would not be surprised at all to discover that the thinking at 20th Street and Constitution Avenue is something along the lines of “hey, we did it once and didn’t cause inflation, so why not take out the paddles again? CLEAR! ZAP.” I’ve written before of the odd set of speeches we saw earlier this year describing a wondrous alchemy that the Fed seemed to believe they could accomplish: buy assets rapidly to save the economy by keeping rates low and adding liquidity. Sell the assets without completely reversing the effect by doing so slowly. Clearly, if there is real belief that the Board can pump and dump without the “dump” causing any problems, then for God’s sake why not pump?
Obviously, that’s a bunch of hooey, but I remain wary that there may be those who believe it.
The market on Friday was led (and maybe even supported) by financial stocks, because the market finally learned the form of the financial reform bill. It is bad, and will cause severe damage to bank earnings. It isn’t as bad as some people feared, but it is about as bad as was ever likely to become law. Prop trading at banks is still banned, and banks will have two years to push trading of commodities, non-investment grade bonds, and CDS that are not cleared through an exchange to separately-capitalized subsidiaries. Most derivatives will have to be cleared and traded on exchanges, which means less customization (bad for dealers, and bad for clients too). This law will be bad for turnover, bad for margins, and will cause leverage ratios to decline (probably the only reasonable part of the prescription, from my view). The Dupont model tells me those three things imply much lower ROE.
So why did bank stocks rally? This is worth a deep reflection because it explains something about markets.
Bank stocks rallied because as bad as the legislation is, the fact that we now know the form of the legislation removes the most onerous tail risks.
Bob Merton, many years ago, observed that the equity of a company can be thought of as a call option on the value of a firm: the value can only go to zero, if the firm is insolvent, but can be worth a great deal. So what do we know about options? One of the things we know is that a great deal of the value of an option comes from the expected value of unlikely, extreme outcomes. If you remove the chance at the home run, an option gets much cheaper.
This is one big reason that bear markets often end with a sharp rally off the lows (although please note that it does not follow that every sharp rally implies an end to the bear market!) – once the disaster case, the chance of an outright crash or broad economic or financial calamity, recedes in probability, the value of equities rise appreciably. A company which avoids bankruptcy by a hair will see its stock rise dramatically when the chance of losing everything goes away. Observe the behavior of many of the financials during the crisis. When TARP and other bank-supportive mechanisms began to have traction the sector leaped, not because earnings were about to be multiplied 10 times but because the fear of zeros greatly receded.
(Aside #1: Most analysts, of course, look at equity values as related linearly to earnings, and in normal circumstances they are. …a PE of 25x is rich, 15x is cheap, for example. But this is likely because behavioral biases prevent analysts from considering the value of the disaster which they think is very unlikely. In any case, a 15x multiple might be quite expensive indeed compared to a 25x multiple, if the former company is about to receive a legal judgement that could potentially destroy the firm. Indeed, one real problem with conventional investment analysis is that the 15x multiple stock might be cheap, or the multiple may in fact be a sign that tail risks are higher for this equity than for the 25x one. Buying enormous dividend yields is often unproductive because the high yield implies a market belief, often correct, that the dividend is not likely to be paid or paid in that amount.)
(Aside #2: Because so much of the value in an option comes from the tail, evaluating options using simple Black-Scholes when the underlying risk isn’t lognormal can be extremely dangerous, especially with exotic options that have path-dependent valuations and with options on underlying instruments that are known to have a high likelihood of non-linear performance – near-bankrupt equities, for example. Black-Scholes implied vols are nearly useless in such a case).
So, owning a stock or stocks generally when the tail risks are about to recede is a good recipe for making sparkling returns. But we have another name for this sort of investing strategy: “catching a knife.” You can own an AIG-like bounce, but also get run over by Lehman. On the flip side, because as an equity investor you own these negative tail events naturally, you can add a lot of value by avoiding the blow-up.
Rising volatility, then, tells you two things: first, it tells you that the market’s sense of the risk of a possible calamity is growing; second, it tells you that once these fears recede you might earn a solid return. You already knew this; it’s why the VIX is considered a contrary indicator by some.
Does it make sense to be investing more, then, when a blowup might happen, or investing less? As it turns out, the answer to this question is not entirely clear but thanks to the Kelly Criterion we can make some observations. The Kelly Criterion describes the optimal bet size, as a proportion of the bankroll, for a series of uncorrelated bets with a given edge and payoff. The simple observation (which becomes a lot less simple after they start involving the math) is that you want to bet more of your payroll if you are (a) getting good odds and (b) are very confident of the outcome. That is, your bet size should increase if you are getting good odds, and have a good edge. Kelly worked out the math to determine what the optimal bet size should be under certain conditions.
The relevance here is as follows: when a crisis hits, two things are happening to you as an equity investor. First, you are becoming more confident that the market will reward you for buying when everyone else is selling, because (as noted above) unless the world actually does end you are likely to be getting a good price. Second, though, you need to recognize that the increasing chance of debacle implies a worse payoff. In April of 2008, the chances of losing everything the next day were pretty slim. In mid-September 2008, the chances were appreciable that a bunch of your portfolio might be in trouble. So your edge (confidence in winning, if the bet was repeated a bunch of times) was growing, but your odds (payoff if you win, relative to your loss if you don’t) were worsening.
The schematic below shouldn’t be taken literally, but is meant to illustrate the basic relationships.
These lines are the pure results from the Kelly formula for the indicated inputs. Perhaps an investor might consider his/her “bankroll” in this case to be the maximum portfolio concentration in equities. Obviously, if you are extremely confident that you are going to win, then no matter what the payoff you should be making a pretty reasonable bet; therefore, the lines converge on the right. But as we move left, we get a sense of the tradeoff between the edge and the odds. When volatility is rising, the investor is moving to the left, implying a lower confidence of a payoff; if the market is trading to lower prices, it improves your odds but you can see that you would need vastly better odds to counteract the effect of increased uncertainty. I would suggest that in the range of normal investor confidence, rising volatility implies that you should tend to be taking chips off the table, even though it means you may miss a minor pop if the world doesn’t end.
We are not currently in a crisis quite like what we saw in 2008. But the elevated levels of implied volatility suggest that crisis is not so far off as we would like to see it. I think this means that we should be avoiding the possibility of the long negative tail, and taking chips off the table.
The Run To Quality Is Underway
I had planned to write yesterday, but I decided to first take a few minutes to watch a little tennis match and then…
It now appears that the bond market is going to confound most prior forecasts and rally, putting 10y yields back under 3% (and, incidentally, pressuring pension funds once again as their liabilities rise in value even as their investments shrink). Despite heavy Treasury supply, the world economic situation appears again to be deteriorating and the run to quality is underway. (Whether or not Treasuries constitute ‘quality’ any more is a philosophical diversion we can take up at another time; the point is that – as has been said in a similar sense about democracy itself – Treasuries are worst form of investment except for all the others. There will be a future selloff that may be quite ugly, but for now Treasuries are still enjoying safe-haven status. (To be sure, however, in the context of what is happening globally the rally in U.S. rates is actually pretty tame, and this might be considered worrisome another day). Today, September 10y Note futures actually declined 1/32nd despite the selloff in equities, with 10y yields at 3.12%, but as the chart below shows the rallies on Tuesday and yesterday appears to be enough to push yields through important support (and to the lows of the last year). I expect a grudging rally that could take 10y yields as low as 2.50%.
10 year yields appear to be heading back down.
The underpinnings for the rally go back to the beginnings of the Greek crisis. Despite all that the ECB has thrown at the problem, and the great amount further that it has pretended to throw at the problem, Greek CDS today went to a new record and other sovereigns weakened as well. On Tuesday (after I wrote my commentary), French banking giant BNP was downgraded a notch by Fitch to AA- from AA. These are canaries in the coal mine. And need I note that France and Italy are both out of the World Cup in the Group Stage? Europe is in bad shape economically and morale is low.
But the U.S. is hardly without its problems. Yesterday, New Home Sales shocked most observers by falling to a record low (since 1963) of 300k units. It’s a bad sign when New Home Sales is coming in consistently below Initial Claims (Claims fell today, but from a high level last week, so they’re still just floating along at a high level). The chart below (Source: Bloomberg), perhaps flippantly, shows the 4-week average of Initial Claims graphed against the seasonally-adjusted annual rate of New Home Sales. Neither is adjusted for population growth since they both ought to respond to population growth. It is interesting, I think, how the recessions of the mid-70s, the early 80s, and even the recession of the early 90s each involved the crossing of these lines. (And perhaps this illustrates how big the housing bubble already was in the early 2000s recession!)
Claims remains above New Home Sales
Now, the fact that the Federal Reserve has finally admitted that conditions are not entirely rosy at the moment is encouraging, although that is of course one reason that yields will likely fall: it is now clear to them what has been clear to most of us for a while, and that is that the European problems are not going to spontaneously heal themselves. I have previously mentioned how surprising I found it that the FOMC statement seemed to ignore the huge jump in stress that accompanied the Greek crisis; this has now been remedied as the statement yesterday mentioned the impact that “developments abroad” have had on “financial conditions” becoming “less supportive of economic growth on balance.”
Over the last couple of days, things have been playing out surprisingly like I thought they might, with bonds up and stocks down pretty sharply (-1.7% today). I don’t see any reason to think that we have seen the full depth of the equity selloff; volume was heavier today but still quite light overall, and the VIX is merely up to 30. Not that we should be expecting a selling climax with the indices in the middle of their recent ranges, but it is a little surprising how orderly the selloff has been so far.
I doubt we will be so lucky going forward.
Friday’s data is second-tier, with the final revision to Q1 GDP and the monthly revision to the Michigan Confidence number. Monday will also be boring data-wise, and we may well need to wait until Chicago PM and Unemployment next week before we get significant economic news. Meanwhile, however, the slow-motion train wreck that is the global economy will be pressing forward, with quarter-end due next week. I don’t know what good things might happen or what bad things may happen, but presently it seems there are more alternatives for the latter.
From Neutral To Decidedly Poor
The market seemed not to mind, initially, the weak print on Existing Home Sales. Contrary to expectations of an increase, Sales actually decreased despite the fact that the home buyer credit hadn’t lapsed yet during the period covered by the data. The National Association of Realtors suggested that bottlenecks associated with a surge in sales are responsible for the downside surprise, but several observers expressed skepticism…and I am one of them. Last month sales were a 5.79mm pace and this month, because of “bottlenecks” the pace of sales actually diminishes? (To be fair, I am not sure which way the seasonal adjustments run this month, so theoretically the actual sales in May might have been higher than in April and merely adjusted lower – but it wouldn’t be a huge effect like it would be if we were comparing to, say, December).
But as I said, the market surprisingly ignored this information and tread water for a few hours. Finally, gravity simply took over. Buyers have been unable to capitalize on the “double bottom” breakout on the charts from a week ago, and what doesn’t go up eventually goes down. At 2:20ET or so, the S&P passed back below the demarcation of the top of the previous range, and from that point the end was pretty clear. Stocks lost 1.6% on the day. Treasury futures gained 19.5/32nds (TYU0) with the 10y yield down again to 3.16%.
Although volumes continue to be tepid, the technical outlook for equities just went from neutral to decidedly poor. Bonds are looking quite bullish, and targets below 3% for 10-year yields are plausible. I think a rally back to the highs of late 2008 is quite unlikely, but there is a chance that the March 2009 highs will be challenged (10y yields around 2.50%). This is pretty challenging during the summer months, though, and I doubt it will be an aggressive rally. It may well be difficult to trade.
Wednesday’s main event is New Home Sales (Consensus: 410k, reversing a spike to 504k last time), which perhaps explains why the reaction to Existing Home Sales today was muted: there’s a much better chance of beating the NHS estimates, blunting some of the concern about EHS. The FOMC also releases a statement tomorrow afternoon; I don’t think this will be particularly illuminating, but it will be interesting to see if some of the upbeat language from recent statements is guarded after the recent data setbacks.
(The rest of the comment is not market-sensitive insight, but concerns an issue that is more than a back-burner issue for many localities).
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In a column in the June 22 Asheville Citizen-Times, former assistant North Carolina State Treasurer Tom Campbell points out that North Carolina’s promises to retirees from state government are unsustainable. The pension plan, once fully funded, needs $400mm currently plus higher state contributions going forward; the health care plan, like most such plans, is run on a pay-as-you-go basis despite the penalties imposed on such plans by GASB 43 and 45. In North Carolina’s case, this plan is $30bln underfunded, but this is by no means atypical.
I have done some work on the problem of hedging such plans of this type, and the answer turns out to be remarkably straightforward (which does not mean, however, that they are politically palatable answers). The problem is really two problems: first, how to hedge and defease the liability for existing retirees and employees; second, how to hedge and defease, or restructure, the plan for future hires.
The first part of that problem is often a very large one, but it is tractable. If you separate all of the existing retirees (also known as the ‘population’ of the plan) into one group, the actuarial demands are reasonably straightforward. [I abstract here from longevity risk; if all of a sudden everyone begins living much longer, then these solutions shift.] We can, using actuarial tables and the distribution of ages of the group, project the number of contracts that will likely be outstanding next year, the year after that, and so on. Obviously, this number declines over time as the population of the plan diminishes. The pension plan payments are simple and can be taken straight from plan documents. The health care part is more difficult, but with some straightforward assumptions about real consumption of medical care, we can come up with a reasonable value for the real cost of that care for the life of the plan and an approximate schedule for when these payments will be made. This is, after all, what actuaries do when they are evaluating such a plan. We can also go further and, if this is a sufficiently large plan so that actuarial uncertainties are small, mostly hedge this exposure against increases in general inflation. Let’s call the resulting portfolio the “immunizing portfolio.” It obviously involves a lot of inflation-linked bonds and/or derivatives, but it isn’t hard to do.
When we know the cost of this portfolio, we can determine how much the municipality needs to set aside in order to fund these claims. This is usually a very large number. The city, state, or other entity has two choices at this point. They can fund this immunizing portfolio, either immediately or over time, and put the problem to bed. Or, alternatively, they can take the existing assets in the plan and punt on high returns, hoping that they can outrun the problem. Over the last decade-plus, this approach has led to massive underfunding…and we’ve only considered the easy part of the plan.
So there is a solution. And, frankly, this part of the solution is tractable, although it requires a will to confront the problem. North Carolina Treasurer Janet Cowell is one of those who have actually had the guts to point out the size of the problem in dollars and cents, but many public servants simply choose to pass the problem to the next administration.
But remember, we’ve only addressed the easy part of this equation: the current retirees, which we all agree we have obligations to – but who are no longer earning benefits, and the pool of which is finite (that is, they will all eventually die and the obligation to that cohort will then be zero). The more difficult part is the claims of current employees and future employees. This problem, as it turns out, is very messy. The population is variable, in size as well as in composition (ages, etc), in contrast to the problem with current retirees where the pool is fixed. Also in contrast to the first problem, the obligations to the group of “actives” have a very long duration, meaning that the plan has exposure to far-distant medical care costs and changes in longevity, and therefore the plan is very exposed to even small changes in estimates. Moreover, this is an open-ended problem: as long as new hires are granted pension and health care benefits, the obligation grows almost without bound in nominal space. The chart below shows the pay-as-you-go costs for one particular state’s health care plan I analyzed several years ago.
It isn't the current retirees who are the problem.
I think the real challenge here is blindingly clear, and I think the solution is almost as clear. (1) Hedge the obligations for current retirees – immunize that problem, put a price tag on it, and defease it over the next 30 years. (2) Make changes in the plan for current employees that focus on cost-containment strategies. (3) Greatly reduce, or even eliminate, the plan as it applies to future hires. That is, let the nanny state stuff go.
By doing this, states such as North Carolina can at least put a fence around the problem. The more responsible states will then take steps to immunize their exposures and retire them over time; the less responsible ones will keep punting and hoping they can grow out of their problems. Personally, I think the first step to getting out of a hole is to stop digging, but bad finance theory offers hope to plan sponsors that they can get more return by taking more risk.
It may not come as a total surprise to readers that even though I have been talking to plan sponsors about solutions such as this for the last five years – states, cities, big private plans – and laying out these simple albeit stark choices in very blunt terms, I have yet to find a single one that is willing to bite the bullet and solve the problem.
Another Trip To The Shop?
The World Cup, every four years, helps to remind us that the world is still a very big place, even though electronic media have made it seem so much smaller. And yet, it seemed this morning that equity investors did not realize this lesson. Over the weekend, the Chinese central bank had declared an intent to loosen the bands in which the currency is permitted to float against the USD. Since late 2008, the CNY had essentially been fixed against the greenback after having experienced a managed float since late 2005. Over 2005-2008, the dollar had appreciated around 18%, but during the crisis the Chinese (arguably, somewhat wisely) decided to control one of the variables that were actually under their control.
Equity markets soared overnight on the theory that a weaker yuan meant better export conditions for all nations that sell stuff to the Chinese; therefore, growth will improve. It follows that stocks ought to be streaking higher, right?
Gee, the theory makes some sense, especially for the countries that sell a great deal to China. But the U.S. dollar has appreciated 25% against the Euro over the last six months, and this country does vastly more business with Europe than with China. Exports to China in 2009 were about $70bln; exports to Europe were $258bln (source: US Census Bureau, Foreign Trade Division). And somehow, the stock market hadn’t been rallying in a dizzying fashion lately, in case you’d not noticed.
The bottom line is that we don’t really know exactly what the magnitude of the impact will be, and over what time period, and frankly we don’t even know how much the Chinese will let the currency appreciate. Making an investing decision on the basis of this information is pretty optimistic. But investors, noticing the appreciating indices, figured the other guy must know what the magnitude of the impact is, and placed orders accordingly.
The capital losses will sting no less for the reason that someone else is losing money as well. Stocks ended the day with a decline, the S&P -0.4% and below Friday’s low. Volume was again light. Still, equities haven’t done anything wrong since the breakout from the “double bottom,” so we’re all still watching and waiting.
Bonds recovered from a deep overnight selloff to end up with a loss on the TYU0 of only 3.5/32nds (10y yield at 3.24%). Inflation markets did reasonably well, with breakevens up 2-3bps despite a nearly-unchanged market.
Despite the reasonably wide range, trade was relatively lethargic. With Existing Home Sales (Consensus: 6.12mm from 5.77mm) tomorrow (along with the Richmond Fed Manufacturing Index, expected to decline to 20 from 26), New Home Sales and the FOMC announcement the next day, Durables Goods, and Initial Claims ahead, investors were content to spend another day learning other lessons from the World Cup. Useful things, such as the international signs for “Oh my God, I think my leg is going to fall off, did you see that?” and “You’re crazy, I didn’t touch him, he’s faking.”
However, I want to point out one thing that was recently brought to my attention. I’ve noted recently that the question of whether we are entering a double-dip recession is clouded in my mind by the question of whether we ever got out of the first dip; when we look back at the behavior of the economy during the teeth of the crisis, we tend to relate the current level of activity to the level of activity at the nadir, and of course things look better. It’s difficult to mentally compare things to how they were before the Lehman bankruptcy, and frankly a little hard to compare current activity to activity say, six months ago.
I usually ignore the ECRI index. It was created to be an “improved Leading Indicators” index that is released weekly. Look at the chart below (Source: Bloomberg). It was astonishing to me to see the plunge it has taken recently…and I am not exactly an economy bull.
I was a little surprised to see the deep current dip in the ECRI
I included a long history for your reference, and chose a logarithmic axis so that you can get a sense for the severity of the swings. The current decline, if it had not followed so closely on the heels of the 2008-09 crisis, would be easily setting off alarm bells. The dip is comparable to the dips after the ’87 crash (which we know didn’t presage a recession), at the beginning of the recession of the early 1990s, and at the beginning of the first recession of the ‘Aughts.
We have seen a number of indicators weakening, but we have all tended to downplay the severity of these pullbacks because of the context of the really deep dip we are just coming off of. But this index suggests we should look deeper, or perhaps look wider: it suggests that we may well be soon heading into a contraction of business that, in the context of any economy other than that of the last two years, would be considered a recession.
If you’ve just recently had your car rammed by a Hummer, perhaps you don’t feel as bad when it is later smacked by a VW beetle. But you’re still taking it to the shop.
Another Reason To Not Hate CPI
Stocks launched higher near the close of trading, pushing the market back to an unchanged close after trading slightly lower for most of the day. The second consecutive day of nearly-unchanged finishes, combined with the fact of five consecutive low-volume trading days, would tend to suggest indecision and argue that a reversal lower may be imminent. However, I am a bit cautious about that technical interpretation in this case, for two reasons. First, the entirety of both ranges was above the previous range high on June 3rd; thus, these last two days may represent quiet consolidation of gains and non-rejection of these prices. Second, the market today managed the unchanged feat despite some pretty weak data. (As an aside, the Note contract gained 21/32nds and the 10y yield fell to 3.19%.)
Economists had forecast Initial claims to decline, like they forecast every week; instead, however, Claims rose to 472k. Again, much to the consternation of economists, the economy isn’t spontaneously improving and there is no evidence at this point to suggest a self-sustaining economic expansion is underway. The Initial Claims rise was underscored by a drop in the “Employment” subcomponent of the Philly Fed Index (which itself surprised by declining to 8.0) to -1.5, indicating contracting employment (albeit only marginally).
These do not indicate that the economy is collapsing anew, but they do highlight the fact that (as I just said) the scheduled improvement is not taking place. This is bad news for equities, whose valuations are predicated on the notion that they are discounting the first few years of the expansion. If the expansion isn’t expanding yet, then we’ve no business being at these levels.
So the marginally improving technical picture I alluded to above no means indicates I am bullish on stocks for the medium-term. The risk of a near-term collapse has receded, and I can imagine some modest incremental gains. More likely, we have earned some summertime chop while we wait for more data to clarify whether the possession arrow is pointed to the bulls or bears right now.
I haven’t mentioned CPI yet. That figure came in slightly above expectations. With rounding, the year/year headline fell to 2.0% (next month, it will fall to around 1% since the June ’09 jump will drop out of the calculation), and core CPI remained unchanged at 0.9%. Moreover, core CPI ex-housing stayed at 2.2%. Regular readers will know that I believe it is not only legitimate, but almost a requirement, to remove housing from the index at the moment, since that is a sector of the economy that we know to be unwinding a bubble and, therefore, is unlikely to reflect the broad pricing trends in the economy. Clearly, the pressure on rents is helping individuals; but the reason we exclude certain items is so we can get a better reading on the underlying trend and, in this unusual case, housing is both (a) behaving idiosyncratically and (b) large enough to affect the overall reading.
Even with housing included, however, core inflation almost ticked up to 1% year/year as core was just a snick higher than expected. This really doesn’t have a big econometric significance, since the difference is well within the variance of the indicator, but it does have some psychological significance to buyers of inflation-indexed securities. These folks have been under some pressure after the outright decline in core inflation in January and the near-zero performance since then. Actually, the 0.12% month/month advance in core inflation was the highest since last October! Not much to write home about, unless you tend to write home about wiggles in core CPI, but a beleaguered TIPS owner might see something bottom-like in the following chart (Source: Bloomberg):
If you look really hard, you might imagine a bottom in core inflation
(To be clear, I don’t think we have quite seen the bottom yet, but it is approaching. My models call for a slight further dip into late Q3/early Q4.)
One quick word here about CPI as a number. I don’t feel like I can ever say often enough that despite all of the conspiracy theories you will read about on the Web about the CPI, it actually is a pretty good measure of what it is supposed to measure, and does a reasonable job of measuring the rise in the general price level (to see an explanation of why it might not feel like CPI is doing its job, see my column here).
Some people, however, tell me they avoid TIPS because they are pay based on a “made up” or “manipulated” government number. I want to tell you that is a bad idea, and you don’t even have to believe that CPI is correct for it to be a bad idea. All you have to do is believe that the market is not completely fooled by the number.
If CPI wasn’t a reasonable approximation of inflation, then as I point out in that other column your standard of living over the last 20 years would have plummeted. Compounding even a small error would be devastating, never mind the huge errors that people claim CPI represents. But suppose that CPI was in fact mis-measuring inflation by, say, 3%. Suppose CPI claimed inflation was 2% when in fact it was really 5%.
If that is the case, then if markets are efficient at all TIPS will be priced to incorporate the correct level of inflation. Consider how nominal interest rates are set by the market, for starters. If I am going to lend you money for 10 years, I need to first determine what real return I need on my money in order to entice me to lend it to you rather than to consume it myself. To that, I then add an inflation premium to reflect my expectation of the decline in purchasing power over that period (and, perhaps, a risk premium). This is Fisher’s construction (1+nominal) ≡(1+real)(1+expected inflation)(1+risk premium).
TIPS replace the (1+expected inflation) part with actual realized inflation over the holding period, so their yield is simply the real return demanded on money.
But what if I, as a buyer of TIPS, believe inflation to actually be mis-stated by 3%? Then obviously, I will insist on a higher real yield of TIPS by about 3%. If my required real return is 2%, I will require that TIPS be priced to yield 5%. That way, I will actually receive 5% + fake inflation; since fake inflation=true inflation-3%, this means I will get 5% + (true inflation – 3%) = 2% + true inflation. So if the CPI is bogus, then the bonds in equilibrium should be priced to reflect the real yield that investors need if they are to actually realize the true real yield they require. In fact, in some emerging economies where the official inflation figures are indeed bogus the inflation-linked bonds linked to the official index are priced “cheap” to those that are linked to an independent index. That TIPS are not priced this way suggests that most investors believe CPI is correct, or close enough.
Now, perhaps you might retort that these are all dumb institutional investors who have money to invest and no place to put it, so they have to invest this way. But take it a bit further: if that is the case, then other issuers besides the U.S. government should be itching to issue bonds linked to inflation that look really cheap but in fact are not. If TIPS are trading at 2%, and I issue an inflation-linked bond at 3.5%, then it looks like I’m 150bps over Treasuries and if I am a quality borrower it should be snapped up by the same dumb investors…meanwhile, however, I know that I’m actually issuing debt at 3.5%-3% “fake spread” = 0.5% (true) real yield and I know I can invest this money in projects to increase the value of my firm.
Clearly, there is no such deluge of issuers; if there were then it would tend to push TIPS toward that equilibrium price that reflects the amount by which CPI is “wrong.”
So economists, inflation experts, investors, and issuers all think the CPI is pretty close to right. Conspiracy theorists and the math-challenged feel otherwise. There are plenty of ways that we can improve economic data, which are after all merely imperfect measures of the underlying reality. But I believe CPI has been very well constructed and is one of the government-produced numbers that we can actually feel reasonably comfortable with.
Sick Of Sycophants
Sometimes, it’s hard to find anything to write about. Other times, it’s hard to narrow it down.
I suppose I should take administrative note of the fact that Housing Starts (and Permits) fell much more than expected; ‘Starts are back under a 600k pace again. While one month isn’t a calamity, in this case a one-month wiggle earns more attention than usual since it correlates with the end of the tax credits for new home buyers. Because of this, we might ascribe a little more information to the wiggle than we otherwise would.
I could note the downbeat Fedex outlook and lower Nokia forecast and point out that the stock market continues to be somewhat richly-valued if analyst forecasts are correct…but if those forecasts are too high, then stocks are quite a bit rich.
It would seem the news that Bill Gates and Warren Buffett are asking billionaires to give at least half of their net worth to charity is ripe for a snide comment…but there’s no time today.
Topical, considering the European crisis, is the fact that Sweden was unable to place its entire government debt auction today, selling only 675mm kronor rather than the 1bln kronor they wished to. And this is despite the fact that Sweden is a comparatively healthy borrower.
But I know that today I absolutely must respond to the ridiculous article by Alan Blinder in today’s Wall Street Journal (link). You may recall Blinder as the idiot who presented a paper at the 2005 Fed conference at Jackson Hole, praising the Greenspan legacy and lamenting only the fact that the “secret formula” wasn’t available to other central bankers. His latest kiss-up article attempts to absolve President Obama’s economic policies. For the record, 64% of Americans think the Administration’s policies have either made things worse or had no impact. 53% still say the auto bailout was a bad idea (link). 58% still favor repeal of the health care bill (link). But according to Blinder, these people are wrong. “…to say that the president’s policies either had no effect or were harmful flies in the face of both logic and fact.”
Let’s start with two indisputable facts. First, both the financial system and the economy are in far better shape today than they were in the dark days of January or February 2009. For example, even though unemployment is higher now, it is receding rather than soaring, dropping to 9.7% in May from 9.9% in April. Second, the growth of the U.S. economy over, say, the last 12-18 months beat virtually every forecast made back then. I know, because I stuck my neck out on this page with a forecast viewed as too optimistic in July 2009, and the U.S. economy did better than I predicted.
Of course, that does not prove that the president’s policies caused the unexpected improvement. Maybe our luck just turned, and the economy would have done even better under a laissez-faire approach. (A few diehards still argue that FDR’s policies worsened the Great Depression!)
Well, since we’re talking about facts, it is worth recalling that the “diehards” who are “still arguing” that FDR’s policies worsened the Great Depression haven’t exactly been arguing that for 80 years. It is in fact only a comparatively recent development that thoughtful observers have criticized the spastic legislative agenda of FDR, and quite recent indeed that this thought has begun to move into the mainstream via books like, for example, Amity Shlaes’ The Forgotten Man: A New History of the Great Depression
But more importantly, Blinder is confused about the “fact” that the economy is showing “unexpected improvement.” About the only thing unexpected about the improvement in the GDP numbers is that it appears to be entirely due to deficit spending, and that almost no improvement in the private economy has been seen. Even the most jaded observers, who recognize that deficit spending only serves to pull future demand forward, expected to see at least some associated improvement from the private sector, and this hasn’t happened. Instead, as has been widely reported the recent improvement in Payrolls was about 95% Census workers.
Moreover, at least some of the rebound since Lehman ought to be attributed to the simple fact that the Lehman/AIG/FNM/FRE/Merrill collapse created a very easy comparison. As I have written several times, Initial Claims are now just about exactly where they were prior to Lehman (see Chart below, source Bloomberg). That is: any improvement that has been seen from the Lehman lows only looks like improvement because the initial dip was so deep. Did Administration policies save us from an implosion at that point? If so, it should not be attributed to this Administration, which wasn’t in office yet. But Blinder is arguing something stronger, that Obama policies did not merely stem the tide but have actually improved things. There is virtually zero evidence for that proposition, unless and only unless you take raw government spending as “growth.”
What improvement? We've gone nowhere since Lehman.
But the dingbat doesn’t stop there: Blinder notes that the $400bln that TARP disbursed to the banks and auto companies have been mostly paid back, with interest, so that the total costs are “only” $100bln. Well, that sounds terrific…except that he conveniently ignores the open-ended commitment to the GSEs, with some estimates (from Barclays Capital and Egan-Jones, respectively) putting a price tag of $500bln or $1trillion on that commitment.
“I come,” says Blinder, “finally, to the third major landmark:”
…the “stress tests” of 19 big financial institutions (not all of which were banks) conducted by the Federal Reserve and other banking agencies in the spring of 2009. This unheralded but ingenious policy initiative was a riverboat gamble that paid off big.
This is true. There was a huge gamble that the Administration was taking that investors would pretend to believe the results of the ridiculous “stress tests” that everyone, everyone knew were designed to be passed easily. Recall that the “worst case” stress test involved an assumption for the Unemployment Rate that not only was substantially below what was actually subsequently realized, but was also substantially below what many private forecasters were forecasting as the median case! It was a bogus show, and the gamble was that investors would pretend that it was valid.
They didn’t, but the market eventually bounced and rallied anyway because of the usual things: valuation (on the bounce), and excessive liquidity (on the overextended rally). And now, the Administration’s lackeys and those who aspire to be Administration lackeys are trying to take credit.
None of this has anything to do with good policy by the Administration. But all that means is that it creates an opportunity for Blinder’s next article: fawning, I am sure, over Ben Bernanke.
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Now that I have that off my chest, I can calmly report that the bond market (represented as usual by the September TNote contract) gained 5.5/32nds with the 10y yield down to 3.28%. Stocks chopped lethargically to a roughly unchanged close, on continued light volume.
Tomorrow, we finally get a bunch of economic data. In addition to the weekly Initial Claims data (Consensus: 450k from 456k), the BLS releases the monthly CPI figures (Consensus: -0.2% headline, +0.1% ex-food-and-energy). Last month’s negative core print was difficult psychologically for the market and led a multi-day beat-down of the TIPS curve, especially the front end (ironic, since core inflation has the least relevance for the front end). Another negative print would be devastating, but even the +0.1% anticipated on core would only serve to hold the year-on-year rise in the core rate at +0.9%. I think that’s about right, although we may have another tenth or two decline into Q3 and early Q4 before the bottom. So far, it’s playing to form and tracking the models. Recently, even core inflation ex-housing has been more well-behaved, although hardly at a level one would consider soothing. I will be especially attentive to a further ebb in that metric, which will continue to be the one to watch over the next year or so until prices in the housing market stabilize and this is transmitted to the behavior of rents. With a sizable overhang of properties on the market, housing might continue to artificially dampen inflation readings for a while, though.
Also out is the Philly Fed index (Consensus: 20.0 from 21.4), which I think has the potential for a deeper pull-back, and Leading Indicators (Consensus: +0.4% vs -0.1%) about which I care not in the slightest.
An Inquiry into the Nature and Causes of the Wealth of Bankers
Calling the current assault on the banking profession a “witch hunt” misses a crucial point. If a witch is captured and burned at the stake (or whatever you do with witches), the society does not later suffer from the dearth of witches. It is, in fact, precisely because a witch has no redeeming qualities whatsoever that it is okay to take the rather irreversible step of eliminating them.
But although some of us would like to believe otherwise, we do need bankers. Your favorite industrial concern, you may notice, once sold stock to raise capital for the enterprise, and periodically needs to float bonds, establish a line of credit, factor receivables, hedge inputs and output, and so on. You can’t do this on eBay.
I mention this because today there comes another story of an attempt to do harm to people who populate the banking industry; a Bloomberg story “Cap Bankers’ Bonuses at Half Their Salary, EU Lawmakers Say” goes on to further advocate that salaries themselves should be limited to the (large) amount of €500,000, and any bonuses should be paid out over a long period of time. Total compensation would therefore be capped at around $1mm, no matter how much money was made for the bank.
This is a destructive policy that will have a long-term crushing effect on global capital markets.
The problem isn’t that people in finance need to make a ton of money. Indeed, most people in finance do not make anything close to these limits. Nevertheless, it is important that these limits not be instituted. Why? Let’s consider what causes inequality in compensation – as explained by one of the most famous political economists who lists five reasons that pay differentials exist:
Inequalities arising from the Nature of the Employments themselves (excerpts from An Inquiry into the Nature and Causes of the Wealth of Nations, Chapter X, Part I, by Adam Smith. Full text here.)
First, the wages of labour vary with the ease or hardship, the cleanliness or dirtiness, the honourableness or dishonourableness of the employment…
Secondly, the wages of labour vary with the easiness and cheapness, or the difficulty and expense of learning the business…
Thirdly, the wages of labour in different occupations vary with the constancy or inconstancy of employment…
Fourthly, the wages of labour vary accordingly to the small or great trust which must be reposed in the workmen.
Fifthly, the wages of labour in different. employments vary according to the probability or improbability of success in them. [ed. note: focus your attention here!]
The probability that any particular person shall ever be qualified for the employment to which he is educated is very different in different occupations. In the greater part of mechanic trades, success is almost certain; but very uncertain in the liberal professions…In a perfectly fair lottery, those who draw the prizes ought to gain all that is lost by those who draw the blanks. In a profession where twenty fail for one that succeeds, that one ought to gain all that should have been gained by the unsuccessful twenty. The counsellor-at-law who, perhaps, at near forty years of age, begins to make something by his profession, ought to receive the retribution, not only of his own so tedious and expensive education, but that of more than twenty others who are never likely to make anything by it. How extravagant soever the fees of counsellors-at-law may sometimes appear, their real retribution is never equal to this…
Those professions keep their level, however, with other occupations, and, notwithstanding these discouragements, all the most generous and liberal spirits are eager to crowd into them. Two different causes contribute to recommend them. First, the desire of the reputation which attends upon superior excellence in any of them; and, secondly, the natural confidence which every man has more or less, not only in his own abilities, but in his own good fortune…
The overweening conceit which the greater part of men have of their own abilities is an ancient evil remarked by the philosophers and moralists of all ages. Their absurd presumption in their own good fortune has been less taken notice of. It is, however, if possible, still more universal. There is no man living who, when in tolerable health and spirits, has not some share of it. The chance of gain is by every man more or less overvalued, and the chance of loss is by most men undervalued, and by scarce any man, who is in tolerable health and spirits, valued more than it is worth.
That the chance of gain is naturally overvalued, we may learn from the universal success of lotteries. The world neither ever saw, nor ever will see, a perfectly fair lottery; or one in which the whole gain compensated the whole loss; because the undertaker could make nothing by it. In the state lotteries the tickets are really not worth the price which is paid by the original subscribers, and yet commonly sell in the market for twenty, thirty, and sometimes forty per cent advance. The vain hope of gaining some of the great prizes is the sole cause of this demand. [emphasis added]
So why do bankers struggle through long years of education and higher education, endure long working hours and often arduous travel schedules in a highly stressful environment, and do so for entry-level pay that is not particularly elevated? In many cases, it is because they believe that they might someday make the big bucks. As Adam Smith understood, the chance of that golden ring is enough to get much more productivity, on average, than the pay alone would be, and to attract a great many entrants that would otherwise choose more pedestrian pursuits.
Some people will remark that “perhaps it wouldn’t be a bad thing if some of these rocket scientists actually went into rocket science, rather than to Wall Street.” But before you say that, remember that the rocket scientist is able to ply his trade for Boeing because, and only because, a market exists (thanks to Wall Street) for Boeing’s debt and equity, and the planes they sell on long-term contracts to United Airlines can be financed by Wall Street, and their long-term contracts can be hedged through derivatives designed by Wall Street, and they have access to project financing from Wall Street. I wonder if Boeing would mind if their senior banker at Morgan Stanley was 30-year-old accountant who was willing to try and sell their bonds on a “best efforts” basis but couldn’t help them with hedging and who could only loan them $5mm because that is all the risk the bank, without access to credit default swaps, could take on their name?
Capital markets are raucous and chaotic, and firms need to be subject to discipline if they do not maintain a healthy enough margin of safety against economic vicissitudes. But it should be a market discipline, and not legislative discipline, that they are subject to: they ought to be permitted to fail when they mess up. Legislators are of course angry that they helped create monsters (especially Fannie and Freddie here, and lots of Euro-related problems there) that they later decided to bail out, and are of course intent on making sure that someone (not them) is punished for forcing government to bail them out. But it is a supremely bad idea to destroy the future of the global capital markets just to deflect voter ire. And if a cap is placed on the earnings of bankers, that is exactly what they will be doing.
Should We Fear A Liquidity Trap Or Not?
For the second day in a row, stocks “advanced on the outlook for global recovery.” Considering that we have been told for at least six months that we are already in a global recovery, this seems like an odd reason to rally today, and I suspect this really means that people don’t have any idea why the market went up, other than that it stopped going down.
Such a feeble reason, however, was insufficient to keep prices elevated and to pierce convincingly the recent price range in stocks. Volume was again slack, barely crossing the billion-share mark, and stocks fell back to end the day -0.2%. I am sure that all of those people who rushed to buy the morning gap, expecting apparently that they would never see lower prices again, are delighted that they got in to early.
As mysterious as the rally was, there were no specific causes for the reversal either. Moody’s cut Greece’s debt to junk, but this certainly wasn’t a surprise to anyone. Bonds rallied as stocks fell, but prices had been down so far they just couldn’t recover the close. September 10y Note futures fell 14/32nds on the day with cash 10y yields at 3.26%.
In other news, the latest price tag for the cost of saving Fannie Mae and Freddie Mac is $160bln, with a worst case (probably) of $1 trillion. So, the next time you hear about how the government’s bailouts are actually making money, you might bring this up…
The Barclays inflation conference kicked off today; this tends to produce rather lethargic trading in inflation land but breakevens rose 2-3bps with the general rise in yields.
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Speaking of inflation, or rather deflation, a friend pointed me today to an article posted on the website of the Philly Fed entitled “Monetary Policy In A Liquidity Trap.” It is interesting reading. It explains the classic problem of a liquidity trap: if inflation expectations are negative, then since nominal rates cannot go negative (n.b., in fact they not only can, they have over the last couple of years, but they cannot go deeply negative) it means the Fed is restricted in such a case to a low but positive real interest rate when a negative real interest rate may be called for. In theory, this means the central bank is hamstrung, because “with no opportunity cost for holding money, the public is willing to hold just about any amount of money the central bank supplies” (because if interest rates are zero, you earn the same amount holding cash or a fixed-income instrument).
Therefore, according to the author, there are limits to “quantitative easing.” There are conditions, in theory, under which Helicopter Ben cannot get airborne or, even airborne, dropping money does no good. Therefore, says the author, the Fed needs to credibly raise expectations of what future inflation will be, once the liquidity trap ends.
Like I said, this is an interesting piece, for several reasons. For one thing, it implies that the Fed should actually be telling everyone that they’re going to let inflation get rolling once the current period of disinflationary tendency is done, when in practice they’re doing precisely the opposite and doing everything they can to convince us that they are not going to countenance higher inflation. I believe that they will; that they won’t be able to bear the political heat from hiking rates to restrain inflation when unemployment is at 7%, 8%, or 9%.
However, I think the author is likely wrong on a key point that lies behind the Fed’s (supposed) continued focus on fighting future inflation. The FOMC believes that they can always produce inflation through the printing press, and I agree. The author of the Philadelphia Fed piece implies that the velocity of money in a liquidity trap converges on zero (because if there is any floor to the decline in velocity, then some amount of quantitative easing must increase prices or output or both). Pointing to Japan and the supposed failure of QE is a bad example, because they didn’t pursue QE for very long or very aggressively. I guarantee that if you increase the money supply tenfold, prices will rise. It is of course less clear that if you increase the money supply a scant 20% it will have any important effect in a liquidity trap situation. The author just has the scale wrong, while the FOMC firmly believes that protracted deflation can only happen if there is a failure of political will that prevents such aggressive action.
This debate probably matters, because we are caught between some disinflationary forces and some strong inflationary ones. In my opinion, the former are ebbing relative to the latter, and inflation is likely to turn higher in late Q3 or early Q4 (although there are a significant amount of moving parts right now, to be sure!). But whether the Fed decides (oddly) to be hawkish in the depths of a huge recession or decides to be dovish and try to protect against a second leg of the crisis is very much a question mark. The variance of potential outcomes favors a conservative investment position.
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On Tuesday, the only economic data due is the Empire Manufacturing index (Consensus: 20.00 from 19.11). I have no opinion on this indicator and doubt it provokes a market response unless it is quite weak.
