Archive for March, 2010

How Does Your States Crediting Rating & Tax Rates Compare

March 30th, 2010 Michael McDonough Comments off

The table below outlines the credit ratings for US states along with individual and coporate income taxes for each state:

Source: Bloomberg


Boeing’s 787 Faces Critical Wing Test Today

March 28th, 2010 Michael McDonough 2 comments

**Update 3/29: Boeing calls initial results of new wing stress test ‘positive’**

Before any new aircraft design is put into service it’s required to pass a wing stress test, which stretches the wing to 150% of the most extreme stresses it will face while in service.  Reasonable enough.  However, what I didn’t realize is that about one year ago, during the same test, the 787 wing had a catastrophic failure at only 100%, causing significant delays in the program.  Unlike past aircraft, the 787 is the first aircraft constructed using composite materials, versus traditional aluminum, arguably making these tests a bit more significant.  The good news is scientist believe they’ve solved the weakness, and their word will be tested today.  But, another failed test could mean more significant delays for the program, and bad news for Boeing.

To my surprise the fact the 787 failed this test a year ago wasn’t nearly the most concerning fact I came across in my research.  Apparently the Airbus A380 also failed this test.  However, unlike the 787, which is being retested, scientists assured authorities they knew what caused the problem, and would be able to fix it without another test.  The plane maker’s comments was apparently enough to convince authorities and from what I can tell the A380 went into service without ever passing the test. I am not an engineer, nor a plane expert, but working in the financial world I know enough not always trust people who perceive themselves as experts in any given field (look at the latest financial crisis).  I am not saying the A380 is an unsafe airplane, but I would have definitely felt a lot more comfortable flying in it in bad turbulence knowing it had passed the test.  Had they tested the world’s first commercial jet liner, the de Havilland Comet, a bit more back in in the late 40’s maybe they might have realized the catastrophic effect of square windows and pressurization.

An older 787 wing test (while not connected to the plane):


In The World of Rates, What Goes Down Must Come up; Expect Higher 10Y and Mortgage Rates

March 27th, 2010 Michael McDonough Comments off

Next week the Fed will cease purchasing agency MBS, to an industry outsider this innocuous sounding fact may not garner much attention, but the reality is the implications are likely very significant, and are already making themselves apparent in the market.  Former Fed Chairman Alan Greenspan recently referred to last week’s jump in U.S. interest rates as a ‘canary in a mine’ towards further increments in the future.  Mr. Greenspan’s fears stem from the federal government’s massive–unprecedented–deficit, which is not a U.S. exclusive phenomena.  Outside of the U.S. I expect pressure will be put on rates from the U.K. to Japan, with Japan (debt to GDP approaching 200%) being the most susceptible to a loss in investor confidence over the short-term as it rolls over a significant amount of debt on a very near-term basis.

Source: Bloomberg

But, I digress back to the Fed.  Since the start of 2009 the Fed has begun purchasing up to $1.25trn of Agency MBS securities, these purchases have helped keep interest rates low and combined with the first time home buyer tax credit stoked pretty solid gains in home sales through November of 2009.  However, since then an extension to the first time home buyer tax credit has proved itself impotent in stirring new demand, and next week as the Fed stops purchasing MBS, mortgage rates will likely continue on last week’s upward trajectory, putting any housing recovery into further jeopardy.  To help show the correlation between mortgage rates and the Fed’s MBS purchases I created the chart below.  The chart shows the 4wk moving average of the net change of the Fed’s MBS position, overlaid with 30Y mortgage rights:

Source: Bloomberg

As the chart demonstrates, when the Fed’s purchases of MBS goes up, rates go down; and as their purchases go down rates generally go up.  I continue to expect that as a result of the termination of the Fed’s MBS purchase program 30Y mortgage rates will likely rise anywhere in the vicinity of 25 to 50 basis points, which could be further exacerbated by rising treasury yields.  Rising rates will put further strains on a stalling housing recovery, and may force the Fed to reinitialize the program, or come up with another means of supporting the real estate sector.  However, as I mentioned in the beginning of this entry, the bigger story over the months ahead could lie in U.S. and international rates markets, where risks may not be properly priced in given weakening fundamentals, partially due to Keynesian policy responses to the recent crisis.  On that note, I expect we will see 10Y treasuries yielding above 4% (to as high as 4.5%) over the short-term, and as for Japan and some of the other troubled European nations, beware.


First Portugal, Then New Home Sales, Next…

March 24th, 2010 Michael McDonough Comments off

What a day, I wake up to the news that Fitch has downgraded Portugal, leading to a strong sell-off in Euro–reaching a ten month low against the dollar. This news was not tremendously surprising, and I expect the situation in Europe will get far worse before getting better, especially if Greece doesn’t find a funding source before its first massive debt payment on April 20th.  Aside from Greece I am also very concerned about several of the other so-called ‘PIIGS’ as well as the UK.  Pending how this situation unfolds if risk is rebalanced across Europe (to Germany), other more ’secure’ European nations could come under the scrutiny of worried investors.

Greek Monthly Debt Payment Schedule:

Source: Bloomberg

The day progresses, its then announced new home sales unexpectedly tumbled -2.2% on a monthly basis in February (compared to a consensus forecast of +1.9%).  The sales number was actually the lowest in the series recorded history, which tracks back to 1963.  As I highlighted in a column last month on titled ‘Housing Recovery Starts to Buckle’, I do not believe last year’s budding recovery, fueled by a then effective first time home buyer tax credit, will provide enough force to navigate the headwinds facing the sector. A now impotent stimulus combined with the likelihood of higher mortgage rates over the near-term, as the Fed stops purchasing MBS on March 30th, should prove too much to bear for the sector making any future recovery modest as best.  The sector is still being besieged by foreclosures and now rapidly growing inventories of existing and new homes for sale. 

Inventory of New & Existing Homes:


Source: Bloomberg


Economists Warn Fed Could Hike Discount Rate Before Next Meeting

March 18th, 2010 Michael McDonough Comments off

Economists and investors alike are speculating that the Fed could announce a second hike to the discount rate, after increasing its spread over the fed funds target rate to 50bps–compared to its historical level of 100bps.    Some investors, despite Fed comments to the contrary, perceived the move as prelude to more significant tightening, be it through a reversal of quantitative easing and/or eventual rate hikes.  Further adjustments could have a similar psychological effect on investors, especially given expectations that the Fed could remove or alter the phrase ‘extended period’ from its statement as early as April’s meeting–a clear sign tightening is quickly approaching.

Fed Funds Target (white) Vs. Discount Rate (orange):

According to the latest Federal Funds Implied Probability data, calculated by Bloomberg, the vast majority of investors anticipate no changes to the Fed’s target in April, but looking further out that number diminishes to  66.5% in June.  In an environment of high unemployment, subdued inflation, and what could be tepid growth, I expect August would be the earliest we could expect a Fed rate hike.  Nevertheless, news of another discount rate hike will almost certainly reverberate through the markets, spooking some skittish investors.

Categories: Fed News, US Tags: , ,

Could Higher Industrial Production Result in Less Hiring?

March 15th, 2010 Michael McDonough Comments off

February’s surprise 0.1% increment in industrial production came despite severe winter weather during the month that was expected to hamper production.  Amongst the index’s biggest gainers were computers and information processing equipment, which each rose roughly 1%.  As Bloomberg put it these increments ’signal the pickup in U.S. business investment is being sustained’.  However, could these gains come at the expense of job gains?  Afterall, one of the primary functions of computers and ’information processing equipment’ is to bolster productivity. And let us not forget, productivity gains have exploded since the onset of the financial crisis, while employment has fallen off a cliff.  It may be too early to tell, but the possibility exists that companies could be investing in new cheaper technology rather than investing in new expensive employees to support output and profits–a trend which could continue for a while…

U.S. IP y/y:

Source: Bloomberg


China’s Tightening Tool Box…

March 12th, 2010 Michael McDonough Comments off

The wheels of tightening may be gaining momentum in China, after February’s higher than anticipated inflation release.  High inflation leading to negative real deposit rates may entice investors to withdraw deposits and invest in more speculative assets, potentially spurring what is arguably already a bubble in the country’s housing sector.  I believe that China has been avoiding an increase in its deposit rates, at least before tightening by the U.S. Fed, in order to avoid further spikes in hot-money inflows (from investors looking to take advantage of interest rate differentials and anticipated appreciation in the RMB).  But, China’s inflation may have passed a threshold forcing the government to act.

Chinese Consumer Prices on an Annual Basis:

Source: Bloomberg

So what does further tightening in China look like?  First off we will likely see China continue removing excess liquidity through open market operations, increasing the yields and issuance of PBOC paper.  As the chart below illustrates, China has already begun this process, but thus far has proven to not be enough.

China People’s Bank of China 1Y Reference Yield:

Source: Bloomberg

China will most likely continue raising its reserve required ratio (RRR), which they have already increased to 16.5% from 15.5% since the start of the year.  I expect the RRR will move to it’s historic high of 17.5% over the next several months.

Chinese RRR:

Source: Bloomberg

A recovery in Chinese exports and inflationary concerns should reignite a gradual appreciation in the RMB, which was suspended at the onset of the global financial crisis.  (For more on this please see my recent piece on the RMB NDF curve).


Source: Bloomberg

Finally, the coup de grâce in Chinese tightening will be any hike in the country’s reference deposit/lending rates.  This would be a clear indicator that Chinese authorities mean business, and the country’s tightening cycle is approaching full swing.  Many analysts suspect we could see a hike in this rate within the next three weeks. possibly as early as next week.  Reverberations from this move would be felt globally, especially in the material and global transport sectors.  Easy money and large increments in new lending spurred almost insatiable demand from the country for raw materials for both final use and speculative purchases.  But, let us not forget, despite creating short-term volatility, these moves are necessary to guarantee China’s future economic growth.  Therefore, China’s tightening cycle will likely lead to quite a few buying opportunities both inside and outside of the country going into the future.

Chinese 1Y Deposit Rate vs. Fed Funds Target:

Source: Bloomberg


One Month’s Not a Trend, But January’s Trade Data Could Point To A Slowdown in Global Trade

March 11th, 2010 Michael McDonough Comments off

Trade, the life blood of the global economy, has begun rebounding nicely since the trough of the global economic crisis.  But, January’s US trade data unexpectedly displayed a decline in both exports–the first decline in nine months–and imports, leading to a smaller US trade deficit, but also implying a potential slowdown in global trade.  As I said, one month does not indicate the start of a trend, but this is something that should be monitored moving forward.  The chart below illustrates the relationship between the U.S. trade deficit and the Baltic Exchange’s Baltic Dry Index (BDI).  As you can see the sharp decline in the US trade deficit during the economic crisis–indicative of a slowdown in global trade–coincided with a collapse in shipping rates as measured by the BDI.

US Trade Deficit (White Line) vs. the BDI (orange Line):


Where’s the Unemployment Rate in Your State?

March 10th, 2010 Michael McDonough Comments off
Here’s the latest state-by-state unemployment data from the BLS.  The arrows indicate an increase or decrease in the rate from December 2009 to January 2010. 
Source: BLS

Chinese RMB Appreciation Always Seems Six Months Away (But It’s Coming)…

March 9th, 2010 Michael McDonough Comments off

Since the start of this year I have been a proponent of the belief that China will once again begin to gradually appreciate their currency as exports recover, and inflation begins to creep back into the Chinese economy.  As the chart below illustrates,  investors in the CNY NDF market appear to share this view.  But, excluding the curve from 3/10/09, significant RMB appreciation always seems to be six months away.  The magnitude of the appreciation has grown from September, but is still six months off.  In addition to inflationary fears, speculative capital inflows have buffeted China due to interest rate differentials and the expectations of eventual RMB appreciation, placing further pressure on the currency.  What I believe this data shows is that appreciation in China is inevitable, while the actual timing and magnitude remain in question.  But, I do expect we will see the Chinese government reinitialize the RMB’s gradual appreciation within the next six months.  This move will be expedited if export growth remains robust, while inflation continues to rise.

RMB NDF Curves

Source: Bloomberg