Posts Tagged ‘US’

This Week’s Critical Government Bond Auctions, & Worries for Spain

June 8th, 2010 Michael McDonough Comments off

Keep an eye on these government bond auctions, especially for Spain and Portugal, as a bad auction can provide the catalyst for further risk aversion:

June 9th:
09:00 GMT Germany: 2y Schatz Auction €6bn
09:30 GMT Portugal: 3y and 10y auctions €1.5bn
09:30 GMT UK: New 2020 Gilt £3.75bn
17:00 GMT US: 10y Note Auction $21bn

June 10th:
02:00 GMT Japan: 5y JGB Auction ¥2400bn
08:30 GMT Spain: New 3y SPGB Auction €4.5bn
17:00 GMT US: 30y Bond Auction $13bn

June 11th:
09:00 GMT Italy: 5y and long end BTP Auctions €7bn

*Data compiled by Barclays

Spain has a signiifcant amount of debt coming due in July, which won’t go unnoticed by investors, especially if their upcoming auctions fair worse than expected:

Source: Bloomberg


Risk Aversion the New Norm

May 21st, 2010 Michael McDonough Comments off

Global markets may be converging on a new ‘volatile’ norm as investors revalue risk, as governments begin the painful process of deleveraging to more sustainable debt levels.  Thus far fears of sovereign defaults have remained contained to the usual suspects—fundamentally weak nations—leading investors to flock to the safe-havens of the U.S., Japan, and Germany.  Risk aversion has pushed 10Y German Bund yields down to a multi-decade low of 2.632%; while 10Y U.S. Treasuries are yielding 3.113% from nearly 4% in April.  Yet, safe-haven debt levels are in most cases worse than their weak counterparts, especially in the case of Japan, meaning deleveraging is a unilateral prescription.  I won’t beat a dead horse on who could be the next Greece, but I do want to emphasize that deleveraging is a painful process, which can adversely impact growth.  Eventually, in the U.S. tough austerity measures coupled with substantial tax increments will be necessary, transforming the fuel of the nascent economic recovery, fiscal stimulus, into fiscal drag.  Japan’s likely the most at risk of the safe-havens with a vast amount of its debt financed domestically, by what is now a shrinking and ageing population; meaning external financing will ultimately be necessary.  This could cause investors to reassess Japan’s stability.  The good news is while tough measures in the US are necessary— creating significant economic headwinds— it should allow the nation to avoid the fate of Greece.  Meanwhile, I recommend monitoring investor sentiment toward Japan as the canary in the coal mine for the U.S.

Categories: Asia/China, Europe, US Tags: , , ,

US Equities Outperforming The World

May 17th, 2010 Michael McDonough Comments off

As of this morning, not only have US equities (as measured by the MSCI)outpaced their global counterparts, but on a year-to-date basis it’s the only index still showing gains, albeit somewhat modest.  Interestingly, as of this week the spread between the MSCI US and MSCI World index reached its highest spread of the year, mostly due to losses in Latin America and emerging Europe. 

MSCI Indices:

Source: Bloomberg



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.


An Economic Wrestling Match For Our Future

December 14th, 2009 Michael McDonough Comments off

As the invisible hand of the market continues wrestling the imprudent hand of governments; consequences will be felt across the globe as one hand hits the table…

Government stimulus and monetary policy has undoubtedly led us out of one of the worst recessions since the Great Depression, but what impact will these policies have on the future?  Many economists agree that the current growth period has been significantly bolstered by fiscal stimulus, which has failed to substantially address a lack in final demand and create what many would consider to be a sustained recovery.  Let’s take a look at this chart published by Goldman Sach’s chief economist Jan Hatzius depicting his firm’s view on the medium term impact of the fiscal stimulus package on GDP:

GS Fiscal Stimulus on GDPSource: Goldman Sachs

Not pretty, especially considering there are no indications that final demand is prepared to take the lead as this recoveries growth engine.  Given the nature of politics and the election cycle it makes sense for some politicians to be more concerned over short-term outcomes versus long-term consequences, at least if they want to retain their jobs.  And who wants to be unemployed right now?

Funds for the government’s stimulus package do not just appear; they were borrowed.  Not only were they borrowed, but they were borrowed at teaser rates subprime Vegas home buyers would have been happy with several years ago.  It is my belief over the long-term the government’s soaring debt load combined with an eventual increment in rates will lead to substantially higher taxes in the US and lower growth prospects for the country.  What we have done is borrow from future growth for the gains we are realizing today.

Turning to the central bank, copious amounts of liquidity have been poured into the financial system to help stave off deflation and support asset prices.  These funds have not yet triggered significant inflationary concerns, because they have simply made up for a slowdown in the velocity of money.  What I mean is the fed’s injections counteracted an essential halt in lending markets; making up for borrowed money that would have existed to prop prices.  But, this also means that as banks turn back on the lending spicket excess liquidity in the system can quickly turn into fuel for inflation.  This will force the Fed to react by withdrawing liquidity from the system, and hiking the target rate.  The big question will if the fed can remove excess  liquidity faster than inflation can take root, and if so will unemployment still be at uncomfortably high levels?  Probably.

All of these questions will be answered in time, but I have no doubt we will be paying for today’s growth well into the future.  Will it be worth the price? We can only hope.


Chinese Consumers May Have Only Begun to Teethe

November 9th, 2009 Michael McDonough Comments off

Since China opened the flood gates to foreign investment in the 1990s, the country has significantly outpaced the developed world, especially the US, in terms of economic growth (see Chinese vs. US real GDP growth chart).

Chinese GDP

Consequences of China’s success have included increased urbanization (see population chart) and a burgeoning middle class.  Never before in China’s modern history have so many had so much, and with a population of over 1.3bn this has created more than just a blip on the map.

China Pop

One statistic that best represents China’s blossoming middle class is domestic car sales, which have risen quite dramatically over the past five years (see domestic Chinese auto sales chart). But these increments are likely just the tip of the iceberg.

China Autos

Prior to the global financial crisis, Chinese consumption was experiencing solid growth on the back of rising incoming bolstered by large levels of investment and a strong export industry (see consumption and income chart).

China Consumption

However, as economic turmoil spread around the globe, it became clear decoupling was more myth than reality, forcing the Chinese government to react.  Realizing the frailties of an export-oriented growth model in the face of an external crisis, the Chinese government introduced an unprecedented US$586bn stimulus package designed to stoke domestic demand.  The result: Chinese consumption remained robust while domestic demand in the US faced significant declines (see chart US retail sales vs. China).

China US Retail Sales

Over the course of 2009, US corporations with high exposure to the region sought relief in China to help offset significant losses back home.  One measure of China’s resilience over the US market is the fact that on a year over year basis, Chinese imports from the US fell by only -US$842mn, while Chinese exports to the US plummeted -US$5.9bn (albeit from a higher base) (see yearly change chart).  Additionally, not all goods sold by US corporations in China are imported; many US companies have partnerships with Chinese companies and produce goods domestically.  The list of companies that admitted to benefiting from strong consumer demand in China include Intel Corp., Caterpillar Inc., Coca-Cola, Alcoa Inc., Altera Corp., and Cummins Inc., just to name a few.  Recently, Ford Motor Company announced the construction of a third factory in China to produce high-end sedans for sale in the country.  There is no doubt the short-term effects of strong Chinese domestic demand has been positive for western companies. The question is, is it sustainable into the future?

China Trade

The answer to that appears to be yes.  Increments in consumption over the past decade may only be a drop in the bucket compared to the country’s full long-term potential. China’s government has realized the shortcomings of its investment and export led growth strategies, and will continue to focus on policy toward domestic demand.   As Chinese Premier Wen Jiabao put it, “to boost domestic demand is a long-term strategic policy for China’s economic growth and the way for us to tackle the financial crisis and stave off external risks.”

But how much slack is in the system? China may have the world’s third largest economy, but on a per capita basis, China doesn’t even rank among the top 100 nations, falling between Armenia and Iraq (see per capita GDP chart). However, its performance in this metric has rapidly been improving.

China US per capita gdp

According to McKinsey Global Institute (MGI), present day China, at least in terms of per capita GDP, holds a striking resemblance to the US circa 1850, the same period in which the US was undergoing its own industrial revolution.  However, unlike the US in 1850, China’s consumption as a portion of GDP is amongst the lowest in the world — herein may lie the key to China’s true potential (see chart China’s personal consumption to GDP vs. US & Japan).

China US Cons/GDP

According to MGI, by 2025, with the adoption of effective government policies, the proportion of GDP attributable to consumption could recover recent losses begin catching up with the rest of the world.  MGI estimates that under a best case scenario, China would be able to enlarge consumption’s share of GDP from the present level of 36% to 50% by 2025, while elevating nominal GDP to US$13.2trn, versus US$4.4trn in 2008.  These estimates are arguably overly optimistic, but nevertheless the implications of such a jump are enormous—even MGI’s baseline forecast with policy changes has consumption/GDP moving up to 45.2%.  If these forecasts come to fruition, China’s share of global consumption would jump to between 11% and 13%, meaning a quarter of all new global demand would be derived from the country.  Applying linear growth rates to the organization’s forecasts, we can interpolate the projected growth of Chinese consumption through 2025 (see chart consumption forecast).  Putting this into dollar terms, Chinese household consumption could increase from US$1.4trn in 2007 to US$6.6trn – US$5.2trn – in just 18 years. Contrast this to the past 20 years, during which Chinese household consumption increased by only US$1.3trn.  Considering the effect US$0.7trn in consumption growth has brought China since 2000, any realization toward China’s full potential could surely change the world as we know it.

China forecast

Source for all Charts: MGI & Bloomberg


Is a Falling Greenback Leading to Smooth Sailing for Shippers?

September 18th, 2009 Michael McDonough Comments off

I have received several inquiries regarding the recent divergence between the BDI and my dry bulk shipping index (DBSI), and thought I should touch on the subject.  First and foremost I believe that a large portion of the divergence can be explained as a US dollar story.  Also, recent weakness has been mostly isolated to larger capesize vessels, which means shippers with low or no exposure to that sector have been somewhat buffered.  Prior to the global financial crisis, a weakening dollar helped lead to an unprecedented surge in commodity prices and shipping rates, this had a direct positive impact on shippers’ asset values and rates.  As the crisis hit investors around the globe became more risk averse and flocked into US government debt.  This liquidation of risky assets caused a massive retrenchment in commodity prices and a significant rally in the US$.  Now however, as investors again grow less risk adverse, the value of the greenback has begun to depreciate, and with it we are again seeing a rally in commodity prices and flows back into riskier assets.  However, unlike the prior example we have not seen, and are unlikely to see, any significant appreciation in shipping rates over the near-term, more on this later.  But, speculation over what some believe may be a V-shaped recovery have potentially over-valued some assets that could experience a possible sell-off, leading to a interim increase in risk aversion and an appreciation in the dollar.  Don’t get me wrong, I do believe the overall global economy is improving, however, I feel it will be at a more measured pace with some volatility, and in this context I believe some debt spreads and equity markets could be overvalued.  This is especially true in the shipping sector.

Source: Bloomberg & Capital Link

Source: Bloomberg & Capital Link

The chart below overlays my DBSI with the inverted US$ index, and as you can see the correlation over the last few months has been very significant.  This relationship also explains why the DBSI has largely been ignoring declines in the shipping rates.  At least over near-term, it appears that a bet on the sector essentially equates to a bet against the US$.  As I mentioned yesterday, another reason the temporaneous breakdown in the relationship between shipping rates and the DBSI is shippers’ higher proportions of fixed long-term contracts, reducing the sensitivity to the BDI, however, this also limits upside.  In conclusion, an appreciating greenback will only move shippers’ stocks up so far, without a corresponding increase in shipping rates, which is not on the horizon.  Therefore, with the bleak outlook for shipping rates combined with the potential for what I believe could be another market correction before growth returns on a more measured pace, I would be hesitant to place any long positions on the sector at current values.

Source: Bloomberg & My Calculations

Source: Bloomberg & My Calculations

As an aside:  FBR Capital Markets, this morning published a bearish report on the dry bulk sector due what they believe will be relatively few order book cancellations.  The company said, “After our recent meeting with the largest and most advanced shipbuilder in China, China Shipbuilding Industry Corporation (CSIC), in Beijing, China, we reiterate our Underweight position on the dry bulk industry. CSIC confirmed our thesis that there will be fewer-than-expected order book cancellations.”  My DBSI returned some recent gains yesterday falling -1.1%.  The index is still realizing a weekly return of 9.1%


US Railroad Activity Not a Bright Spot for Shipping Rates

September 2nd, 2009 Michael McDonough Comments off

As seaborne shipping acts as the bridge for global trade, the US’s railroad and trucking systems are the backbone of domestic bulk transport. It goes without saying that at some point the majority of goods imported to or exported from the US likely find themselves traveling on a rail car or truck before reaching their final destination. Therefore, I wanted to analyze those sectors for any potential relationship to the BDI. Step one in this process, was finding an appropriate indicator to compare railroad activity against the BDI. This step was straight forward as the Association of American Railroads (AAR) publishes a weekly report measuring railroad freight volumes by company. In the chart below I graphed the BDI against the number of cars on line for CSX on a weekly basis.


Source: AAR & Bloomberg

As you can see from the chart above the correlation between rail car volume and the BDI over the past year has been very significant., and in some cases railroad activity actually led the BDI. One possible cause for this relationship is coal. Nearly one third of US railroad volumes are coal shipments, and in 2007 36mn tons of this coal was exported. Given the relationship between the BDI and railroad volumes, diminishing railroad activity in the US is yet another factor painting a macabre picture for the shipping industry. On a year to date basis coal and grain railroad shipments are down 9.3% and 22.4%, respectively. Metal and ores, which make-up only about 3% of US railroad volumes are down over 50% year to date.

But, in order to fully grasp the implications trucking and railroads may have on shipping it is critical to understand the supply and demand factors driving the sectors along with the outlook and physical linkages between the sectors. I could open a dialogue on this immediately, but will wait until after an upcoming industry conference I am attending where I should have the opportunity to speak with the management of some major US railroad and trucking companies. Expect an update on this come mid-month.

P.S.  I apologize for not having any real-time updates today, as I am in the process of relocating offices.


Fed Leaves Rates Unchanged, But Begins to Scrap Treasury Purchase Program

August 12th, 2009 Michael McDonough Comments off

As expected the Fed announced no changes to the target range for the federal funds rate, which currently stands at between 0% and 0.25%. The market was trading up  prior to the announcement on what was generally expected to be a more constructive economic outlook from the Fed.  In fact the Fed did seem more optimistic on the economic outlook stating that “Information received since the Federal Open Market Committee met in June suggests that economic activity is leveling out.” They go on to say that they believe conditions will continue to improve, and that their current monetary policy stance will remain in place for an extended period of time.  They also announced, as expected, that the Fed will begin to slow and eventually stop purchasing US treasuries come October.

FOMC Statement:

Press Release

Federal Reserve Press Release

Release Date: August 12, 2009

For immediate release

Information received since the Federal Open Market Committee met in June suggests that economic activity is leveling out. Conditions in financial markets have improved further in recent weeks. Household spending has continued to show signs of stabilizing but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing but are making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.

The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve is in the process of buying $300 billion of Treasury securities. To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

2009 Monetary Policy Releases


Payrolls Beat Forecast, Unemployment Falls

August 7th, 2009 Michael McDonough Comments off

Payrolls in the US fell by -247,000 in July, with the unemployment rate moving to 9.4% from 9.5%.  This compares to last month’s revised change of -443K, and a consensus forecast of -300K.  This number exceeds both the streets and my own expectations.  The drop in the unemployment rate was caused by a reported decrease of -422K to the workforce.  Manufacturing jobs fell -52K after falling -131k in June.  The service and goods producing sectors lost -119K and -138K, respectively.  Jobs in the construction industry diminished by -76K.  Education and health services added 17K new jobs compared to 37K in June.  Finally, government employment rose 7K, after falling by 40K a month prior.

This positive surprise in payrolls will likely lead to a rally in today’s trading, as the market continues to demonstrate well rounded improvements.  It is not unusual for the labor market to lag an overall economic recovery, so look for this data to improve even further over the coming months.  But, putting this number into perspective, we are still far from what would be considered healthy levels for the economy.  So far in 2009 the US has lost 3.6mn jobs, compared to 6.7mn since the recession began. But, we are on are way there.  This data may also help support the case that the current recession is at or near an end point.

Change in Payrolls