Leading Indicators... Growing Strength

Trying to catch up news from earlier this week. It has been a quiet economic week thus far (not many economic releases), but the latest leading economic indicators shows more signs of strength. The LA Times details:

The index of U.S. leading indicators rose in March by the most in 10 months, a sign the economy will keep growing into the second half of the year.

The 1.4 percent increase in the New York-based Conference Board's measure of the outlook for three to six months was more than anticipated and followed a revised 0.4 percent gain in February.

Manufacturers are ratcheting up production and factory workers are putting in longer hours as companies rebuild inventories and ship more goods overseas. Further improvement in the job market will help sustain the economy's recovery from the worst recession since the 1930s.

"The economy really seems to be gaining momentum, with better-than-expected data coming from a wider variety of sources," said Russell Price, a senior economist at Ameriprise Financial Inc. in Detroit. "The sectors that were doing well appear to be doing even better and those that were struggling appear to be seeing signs of renewed activity."

And the strength excluding money supply, interest rate spread, and stock prices (i.e. eliminating the pure liquidity mechanisms and/or financial assets driven by the liquidity - though an argument can be made to include all of the leading indicators as being affected).



Source: Conference Board

More on the Housing Overbuild

Note: I will be traveling this week, thus posts will be very light / I will not be able to respond to comments in a timely manner.

Last week, EconomPic asked 'What Housing Overbuild?' showing that even during the bubble, the number of units built didn't appear to be extraordinary on a per capita basis. Reader dblwyo gave Calculated Risk a heads up on the post, which responded over the weekend with some great additional insight in the post Housing: Impact of Changes in Household Size:

If we look at a long term graph of housing starts, we notice that there were more starts at the peak in the '70s than during the recent housing bubble. If we plotted housing starts per capita, or per total households, the surge in housing starts during the last decade would not look extraordinary at all (ht Dave).

But it was extraordinary ...

He then details his reasoning as to why housing starts were extraordinary as compared to the 1970's.

The key is household formation.

Household formation is a function of changes in population, and also of changes in household size. During the '70s, the baby boomers started moving out of their parents' homes, and there was a dramatic decrease in the number of persons per household. And that lead to a huge demand for apartments (the surge in total starts).

In other words, it is not only the growth of the population that matters, but also the number of people within each house (i.e. if there were 4 individuals per house and now there are 3, you need more houses all else equal). As a result, there were too many units built this past cycle as the number of individuals in each home did not continue to contract at the same pace as it did during the 1970's.

Because of the changes in household size, the U.S. needed far more additional housing units in the '70s and '80s than in the '90s and '00s. If we could normalize the housing start chart by household formation, we would see that the last decade was indeed extraordinary!

The following chart summarizes a table he built using data from the Census showing the above phenomenon.



Using the household formation data from the Census, I was able to create the following chart, which attempts to show the normalized housing starts by household formation Calculated Risk details.

More specifically, the above chart shows the annual number of housing permits issued in each year divided by the number of households formed on average over a ten year period (i.e. the normalization part). This in theory removes some of the chicken or the egg issue as to whether:

• Households are formed, which drives building of new homes
• Building new homes adds supply, which allows new households to be formed

This revised analysis does remove the spike in permits per capita from the 1970's and shows housing builds were indeed well above the long term average of ~1.1 permits per new family* during this bubble period. But if you are going to label periods of home building that were 0.40 more homes above "ordinary" levels as extraordinary, I think you must label periods of home building 0.70 homes less than the "ordinary" level, extraordinary.

Which once again brings up my question as to the possibility that we'll go from an housing overbuild to a shortage within a 5-10 year period?

Outside of a huge reversal in the number of persons per household that may result from a prolonged economic slump, if the number of new homes remains near these historic low levels, I think it is possible.

Source: Census 1 / Census 2


* I figure the level is greater than 1 due to depreciation of existing stock (new homes to replace old housing) plus second homes.

EconomPics of the Week (4/16/10)

Must Read (if I do say so myself)
Investing in a Low Return Environment... It's All Relative

Economic Data

The Good
More on Oil's Impact on Consumption
Inventories Growing to Meet Final Demand
What Consumer Slump?
Housing Permits "Bounce"
What Housing Overbuild?
Empire Manufacturing Index Soars
CPI Remains Low... Core at Lowest Level in 6 Years...

The Bad
Consumer Sentiment Sinks in April
Small Biz Continuing to Struggle
Petroleum's Impact on the Trade Deficit
Treasury Budget and Reliance on the Private Sector
Capacity Utilization Increases (Remains Low)

Asset Prices
Goldman's Stock Crushed... All the Way to Last Month's Level
Treasury Purchasing: China + U.K. = Full Picture
China Heating Up... Consumer Style

And your video of the week... the Shins' Sleeping Lessons

Goldman's Stock Crushed... All the Way to Last Month's Level

By now, most of you have heard that Goldman Sachs was charged with fraud. So has Goldman's stock taken a hit?

As of this writing they are down 14% on the day, all the WWWWAAAAAAYYYYY back to March 2nd levels.

So is Goldman more valuable today after being charged with fraud (given the new economic / regulatory outlook) or last month pre-charge?

And people still claim the market is efficient...

Source: Yahoo

Consumer Sentiment Sinks in April

Bloomberg details:

Confidence among U.S. consumers unexpectedly fell in April to the lowest level in five months, indicating Americans are discouraged about the labor market.

The Reuters/University of Michigan preliminary index of consumer sentiment dropped to 69.5 from a reading of 73.6 in March. The gauge was projected to rise to 75, according to the median forecast in a Bloomberg News survey of 69 economists.

Lagging confidence threatens to restrain household spending, which accounts for about 70 percent of the economy. While recent figures showed retail sales picked up in March, a 9.7 percent unemployment rate and mounting home foreclosures are risks for the recovery.

Source: St. Louis Fed

What Housing Overbuild?

My earlier post regarding housing permits got me thinking... how do the permit figures compare historically on a per capita basis? I understand this isn't perfect as this is a flow (new houses added) vs. stock (total existing houses), but it was pretty surprising to me.

Surprising in that the bubble build quite frankly doesn't look that huge and surprising that we are now at extreme lows.



And vs. the 50 year average of 0.000495 permits per capita (in the chart below, the zero line is equal to the 0.000495 level).



Is it possible we'll go from an overbuild to a shortage within a 5-10 year period?

Source: Census

Housing Permits "Bounce"

Businessweek details:

Builders broke ground on more U.S. homes in March than anticipated and took out permits at the fastest pace in more than a year, a sign of growing confidence that sales will stabilize.

Housing starts climbed to an annual rate of 626,000 last month, up 1.6 percent from February’s revised 616,000 pace that was higher than initially estimated, Commerce Department figures showed today in Washington. Building permits, a sign of future construction climbed to the highest level since October 2008.

The gain in part may be due to milder weather following the February blizzards, combined with a rush to have properties available for buyers seeking to qualify for a government tax credit that expires at the end of June. The jump in permits also signals builders anticipate demand will hold up even as foreclosures climb and the jobless rate hovers near a 26-year high.

It looks like the jump in permits was solely due to the south (with new permits jumping 18% month over month).

And some longer term perspective of the "bounce".

Source: Census

Treasury Purchasing: China + U.K. = Full Picture

WSJ gets it wrong... again.

China continued selling U.S. Treasurys for the fourth straight month in February, though it remained the largest foreign holder, the Treasury Department said Thursday.

Overall, foreigners were net buyers of long-term U.S. financial assets in February, according to the monthly Treasury International Capital report, known as TIC. China remained a net seller of Treasurys, with its holdings falling $11.5 billion to $877.5 billion, following net sales of $5.8 billion in January.

Heavy Treasury sales by China at the end of last year initially set off fears that the largest creditor nation to the U.S. might be shifting out of U.S. assets. But major upward revisions to the data in late February showed that China hadn't ceded its position as top Treasury holder to Japan, as initially thought.

As detailed previously, a lot of China's purchases are through the United Kingdom, thus the "revisions". As a result, a better picture can be seen combining the two...



For full details see my previous post China Sells Treasuries... or Did They?

Source: Treasury

Empire Manufacturing Index Soars

Reuters details:

A gauge of manufacturing in New York State rose to a six-month high in April as new orders advanced and employment continued to improve, the New York Federal Reserve said in a report on Thursday.

The New York Fed's "Empire State" general business conditions index rose to 31.86 in April, the highest since October and up from 22.86 in March.

Economists polled by Reuters had expected a figure of 24.

The survey of manufacturing plants in the state is one of the earliest monthly guideposts to U.S. factory conditions. The employment index rose to 20.25 in April, the highest since March 2006, and up from 12.35 last month. New orders rose to a six-month high of 29.49 in April and up from 25.43 last month.

Source: NY Fed

Capacity Utilization Increases (Remains Low)

Business Week details:

Capacity utilization, or the proportion of plants in use, rose to 73.2 from 73 percent in February.

Industrial capacity utilization was estimated to rise to 73.3 percent, according to the Bloomberg survey median. The rate averaged 81 over the past four decades. Economists track plant operating rates to gauge factories’ ability to produce goods with existing resources. Lower rates reduce the risk of bottlenecks that can force prices higher.

Excess capacity is one reason Fed policy makers see little risk of inflation. Fed Chairman Ben S. Bernanke yesterday said the rate of increase in consumer prices was “subdued,” and said “moderation in inflation has been broadly based.” He also said economic growth will remain “moderate” as the economy contends with weak construction spending and high unemployment.

The chart below shows the historical relationship between the change in capacity and headline CPI. Please note that the below chart only reflects the change in the year over year figure, thus the 2.8% jump in CPI is the difference between the latest 2.4% print and March 2009's -0.4% print.



Another way to view it...



Source: Federal Reserve / BLS

China Heating Up... Consumer Style

We've (U.S. officials) been clamoring for years for the Chinese to shift from their export dominated economy to a more balanced economy with greater internal demand (which in theory would help the U.S. trade balance by increasing our exports to the nation). In fact, many economists have been hopeful that increased consumption by China's private sector would help offset any potential slump in demand from the developed world (i.e. U.S., U.K., and Europe). It looks like this may actually be happening.

Per the First China Invest (via FT Alphaville):

After the government succeeded in sustaining fixed asset investment, and therefore GDP growth, last year by doubling bank lending, this year it is the turn of the consumer. The one area of new lending which is still seeing significant growth this year is consumer financing, which accounted for 50% of new lending in March. As a result, new consumer lending may overtake new consumer deposits for the first time since 2007.

Good news right? Showing that nothing is easy in this world... not so fast.

After the government tightened lending to the property sector, the data seems to indicate that the Chinese consumer is tapping the consumer loan market (and even credit card balances) to not only consume goods, but also to acquire properties. This in turn is driving up home prices dramatically, which can be seen from the following data.

• We’ve just seen Chinese GDP rise 11.9 per cent in Q1.
• And urban house prices increased 11.7 per cent in March.
• And retail sales are up 17 per cent.

Lets put that 11.9% rise in year over year GDP in perspective.



Nothing the revaluation of the Yuan can't cure right?

Perhaps not.

Morgan Stanley's Andy Xie in the China Daily (via The Mess that Greenspan Made):

Actually, Xie believes that growing expectation of the yuan’s appreciation in financial markets is the most important reason for China’s vast property bubble. Massive hot-money inflows would spark excessive liquidity and speculation, fueling China’s property bubble. According to Xie, in a normal economy, currency appreciation cools inflation by decreasing import prices. However, China imports mainly raw materials, equipment, and components. A modest currency appreciation would do virtually nothing to curb inflation.

In other words, an increase in the value of the Yuan may just allow China to purchase MORE commodities, thus actually adding fuel to the already hot economy.

Interesting times...

Source: Bloomberg

Inventories Growing to Meet Final Demand

Reuters details:

U.S. business inventories rose slightly more than expected in February to their highest level in seven months as businesses restocked to meet strengthening domestic demand, a government report showed on Wednesday.

Department said inventories increased 0.5 percent, the largest increase since July 2008, to $1.33 trillion - the highest since July. January inventories were revised up 0.2 percent, after being previously reported as being flat. Economists polled by Reuters had expected a 0.4 percent rise in February inventories.

Inventories are a key component of gross domestic product changes over the business cycle and a sharp slowdown in the pace of inventory depletion is driving the economy's recovery that started in the second half of 2009.

The below chart shows business sales and production. Production accounts for the change in inventories by taking the sales and adding/subtracting the change in inventories over a given period (3 months in the chart below) to show growth in the amount actually produced to meet final sales.

It is interesting to note that while inventory levels jumped to an eight month high, the impact of inventory rebuild (or lack of depletion) on final GDP peaked in November at a 9.2% three month change and is now down to 2.0% (still quite strong) through the period ending February. As a result, impact of inventory on GDP will be MUCH smaller in Q1 than Q4 (for a full explantion go here).

Source: Census

CPI Remains Low... Core at Lowest Level in 6 Years

Marketwatch details:

U.S. consumer prices rose 0.1% on a seasonally adjusted basis in March due mainly to an increase in prices for fresh fruits and vegetables, the Labor Department reported Wednesday. The overall gain matched expectations of economists surveyed by MarketWatch. The core CPI - which excludes food and energy prices - was unchanged in March, while analysts had expected a 0.1% gain.

In March, overall food prices rose 0.2%. Bad weather pushed up fresh fruits and vegetables prices, which rose 4.6%. Energy prices were unchanged in March. In the past year, the CPI has risen 2.3%. The core rate is up 1.1% in the past year, the smallest gain since early 2004. The last time the year-over-year core increase was smaller was in January 1966. Shelter prices were down 0.1% last month.

As can be seen below, the majority of the increase remains in transportation (i.e. fuel). All other categories point to a complete lack of inflationary (and potential disinflationary) pressure on final consumption at the moment.



Source: BLS

What Consumer Slump?

Marketwatch with the details:

U.S. retail sales rose 1.6% in March, aided by strong demand for autos, building materials and new clothes. The Commerce Department said sales totaled $363.2 billion - the fifth gain in the past six months. Retail sales are 7.6% higher compared to one year earlier. Excluding autos and trucks, March retail sales climbed 0.6% to $300.5 billion. Economists surveyed by MarketWatch forecast sales to climb 1.3%, with sales excluding autos up 0.6%. Also, retail sales in February were revised slightly higher.

Source: Census

Small Biz Continuing to Struggle

While we've seen an improvement in sentiment among "big business", small businesses continue to struggle. The NFIB details:

The National Federation of Independent Business Index of Small Business Optimism lost 1.2 points in March, falling to 86.8. The persistence of index readings below 90 is unprecedented in survey history.

“The March reading is very low and headed in the wrong direction,” said Bill Dunkelberg, NFIB chief economist. “Something isn’t sitting well with small business owners. Poor sales and uncertainty continue to overwhelm any other good news about the economy.”

The index has posted 18 consecutive monthly readings below 90. In March, nine of the 10 Index components fell or were unchanged from February’s not-so-great readings.

It appears worse when looking at all the areas of small business that continue to struggle...

Employment

After a devastating period of employment reductions, employment change per firm hit the “zero line” in March. Since July 2008, employment per firm fell steadily each quarter, logging the largest reductions in survey history (35 years). The February reduction of just 0.1 per firm indicated a substantial slowdown in the bleeding, and the March reading of 0.0 confirms that workforce reductions have ended.

Capital Spending

The frequency of reported capital outlays over the past six months fell two points to 45 percent of all firms, one point above the 35-year record low reached most recently in December 2009.

Sales

The net percent of all owners (seasonally adjusted) reporting higher nominal sales in the past three months improved 1 point to a net negative 25 percent. Widespread price cutting continued to contribute to reports of lower nominal sales.

Disinflation

The weak economy continued to put downward pressure on prices. Eleven percent of the owners reported raising average selling prices, but 29 percent reported average price reductions.

Earnings

In March, earnings trends declined with a net negative 43 percent of owners reporting positive profit trends.

Access to Credit

Regular NFIB borrowers (35 percent accessing capital markets at least once a quarter) continued to report difficulties in arranging credit.

Source: NFIB

Investing in a Low Return Environment... It's All Relative

There seems to be a growing number of articles these days detailing the concern that rising rates will have a dramatic impact on bond performance going forward (see WSJ's The Risk of Rising Interest Rates and the NY Times' Interest Rates Have Nowhere to Go but Up). While I am less certain that rates will in fact rise over the near term (call me a contrarian), I think these articles miss the broader picture and as a result are focusing too much on rising rates rather than the issue facing investors across all asset classes. Specifically, that an investor (unfortunately) is required to take on a much higher level of risk than in the past to get any level of attractive absolute return.

But, since these articles have focused on bonds, lets focus on bonds.

Looking at the Barclays Capital Aggregate Bond Index "BarCap Agg", one of the most widely used benchmarks to represent high-quality investment grade bonds, the chart below shows the yield to worst "YTW" and the duration of the index going back 20 years. As can be seen, these two levels have crossed as the yield of the benchmark continues to ratchet down to historic lows.



Why does this matter? Well if the YTW is less than the duration, that means if interest rates rise across the yield curve by 100 bps (i.e. 1%) or more in the next 12 months, then the yield of the portfolio (i.e. carry) will not make up for the loss an investor realizes from the price impact of rising rates (this ignores convexity, but a duration of 1 roughly means that if rates rise 1%, the portfolio sells off by 1% all else equal).

Lets dive deeper and take a look at the ratio of YTW to duration. At the end of March, the YTW of the BarCap Agg was 3.46%, while the duration was 4.68 years (3.46 / 4.68 = ratio of 0.74). At this point, if rates rise by 74 bps across the entire yield curve, the price impact of the portfolio = -3.46% (-0.74 * 4.68), exactly offsets the yield of the portfolio 3.46%, thus TOTAL returns over a 12 month period would equal zero (again, ignoring convexity).

Below is a historical look at that ratio (we'll call it the Duration Coverage ratio) vs. 12 month forward returns of the BarCap Agg. Interestingly enough, the ratio has closely tracked performance. One thought is that the Duration Coverage ratio shows how much an investor is being compensated for taking risk; when the ratio is low, they are not being compensated much (thus the lower returns on a going forward basis).



So bonds are rich and duration should be avoided at all costs? Hardly.

This type of thinking made sense when one could focus solely on absolute terms. There is no question that an investor is not being compensated much in absolute terms to take on duration risk. But, this should not be a surprise when one considers return expectations for less risky investments. Shown below is the difference between the yield on the ten year and two year Treasury... it is now at historic wide levels (the green line).



As a result, while an investor is not being compensated much to take on duration risk in absolute terms (the ten year yield is low), they are in relative terms as the two year bond was yielding a measly 0.96% at the end of March. The chart below shows the same rolling Duration Coverage as the chart above with one exception... that being the YTW is adjusted by subtracting out the two year Treasury yield to put it in "relative" terms. This changes the story completely. Rather than appearing rich, the relative duration coverage now seems cheap compared to historical levels.



And THAT'S the problem with investing these days (and not just with bonds). With risk-free rates hovering near zero, an investor must take a much larger amount of risk to achieve any level of absolute return. This concept is even more meaningful for an investment in risk assets, such as equities and commodities, as the downside risks of those asset classes are MUCH higher than even the worst case rising rate scenario on an investment in the BarCap Agg.

As a result, the question for all investors should be how comfortable you are taking risk to get a return ON your capital and not just a return OF your capital?

The issue is that a lot of investors don't realize this question needs to be answered.

Source: Federal Reserve / Barclays Capital

Petroleum's Impact on the Trade Deficit

Reuters details:

Stronger U.S. demand boosted imports 1.7 percent during the month to $182.9 billion. Exports edged only 0.2 percent higher to $143.2 billion, but that was still the best showing since the depths of the global financial crisis in October 2008. Analysts had expected the trade deficit to widen in February to around $38.5 billion. The Commerce Department lowered its estimate of January's gap slightly to $37.0 billion.

U.S. imports of consumer goods such as pharmaceuticals, electronics, toys and clothing and foreign services such as travel were the highest since October 2008. Imports of industrial supplies and materials were the highest since November 2008.

While U.S. imports of crude oil was relatively stagnant in February (the average price of crude trended lower in February, but has since rebounded), continuing my higher price of oil on economic growth thought, the below chart shows the impact of the rising price of oil on the nation's trade balance.

While we have collectively import 2% less petroleum as a percent of total imports from a year back, we pay 6% more as a percent of total imports.

Source: Census

Treasury Budget and Reliance on the Private Sector

The AP details:

The budget deficit for March showed a dramatic decline as the Obama administration formally entered a lower ultimate cost for the government's $700 billion financial bailout program.

The Treasury Department said the deficit for March totaled $65.4 billion, compared to a $191.6 billion imbalance a year ago. However, $115 billion of that improvement occurred because the administration lowered its estimate of the total costs for the Troubled Asset Relief Program.

Even with the change, the administration is still projecting that the budget deficit for the entire year will surpass last year's all-time high of $1.4 trillion.

The below chart shows the year over year change in receipts and outlays. This is where things will be interesting to watch. On one hand you have receipts leveling and possibly beginning to grow (a good thing) while on the other hand you have government spending no longer being a "stimulus" to further growth.

In a nutshell... this is where private demand needs to take over for further recovery. While recent data has shown relative strength in the private sector, that strength will be even more important going forward as the public sector will no longer be relied upon for marginal demand.

Source: Treasury

More on Oil's Impact on Consumption

Last Friday, I asked "at what point does the price of oil become debilitating?".

Fortunately for me, James Hamilton attempts to answer that question. First, he points out the concern:

Ten of the 11 recessions in the United States since World War II have been preceded by a sharp increase in the price of crude petroleum. Oil had been holding around $80/barrel over the last month, but traded as high as $87 last week, leading the Financial Times to ask whether oil could give the "kiss of death to recovery."

Before we jump to his conclusion, lets take a look at what James states the spike in oil price from 2009 lows means to the consumer.

Americans buy a little less than 12 billion gallons of gasoline in a typical month. With gas prices now about a dollar per gallon higher than they were a year ago, that leaves consumers with $12 billion less to spend each month on other things than they had in January of 2009. On the other hand, the U.S. average gas price is still more than a dollar below its peak in July of 2008.

12 billion gallons per month of gasoline is a lot, but according to the EIA, total crude use is almost double the level used in gas (about 18.5 million barrels per day x 42 barrels per gallon x 365 days / 12 months = 24 billion gallons per month). Using this "total" level and comparing it to personal income based upon market prices at each point, we can see how much of a drag the spike in oil would have impacted 'consumption ex oil'. We can also see why "this time" may not be so bad... the overall level of personal income that is allocated to oil is currently not much higher than what we saw pre-crisis (and much lower than 2008 levels).



Another way to look at this data is as a change over one and two year periods.



So while perhaps not a drag, the concern I have is that the price of oil is no longer the source of "stimulus" it was when the price of oil collapsed and Americans found themselves with much more disposable income (as much as 4% more to be specific).

In James Hamilton's post, he provides details for some indirect reasons higher oil prices caused a drag on the economy as well (reallocation of capital away from American business [i.e. small cars]) that he does not see re-emerging and concludes:

So to return to the question posed at the beginning: $87 oil is certainly not helping the recovery. But I would be very surprised if it proves to be the kiss of death.

Sources:

Personal Income: BEA
Oil Prices: EIA
Total U.S. Crude Consumption: EIA

EconomPics of the Week (4/9/10)

Asset Prices
Low Quality Tide
Long Fixed Income. Short Almost Anything Else
Short Fixed Income. Long.... Almost Anything Else
Hedge Funds Roar in March
Greek Borrowing Costs Soar

Economic Data
Unemployed to Job Openings Remains Elevated
Consumer Credit Contracts from January Bounce
ISM Services Jump
U.K. Produce Prices Soar in March

Other
Regarding the Decline in Birth Rates
Mortimer... We're Back!
The Religious Construction Collapse

And your video of the week... to celebrate Mr. Bernanke... Bloc Party's "Helicopter"



Are you hoping for a miracle?

U.K. Produce Prices Soar in March

The AP reports:

Oil prices rose above $86 a barrel Friday on a weaker dollar and after robust U.S. retail sales in March pointed to growing consumer demand in the world's biggest energy market.

By early afternoon in Europe, benchmark crude for May delivery was up 84 cents to $86.23 a barrel in electronic trading on the New York Mercantile Exchange. The contract fell 49 cents to settle at $85.39 on Thursday.

"The oil market is behaving the same way as we have seen during the past several weeks: 'one step back, two steps forward,'" said a report from Commerzbank in Frankfurt. "Supported by benign equity markets, sustained bullish sentiment and a slightly weaker U.S. dollar, the oil price recouped the losses of the previous two days."

This is definitely a sign of a recovery, but at what point does the price of oil become debilitating?

An example... this morning the United Kingdom had its highest producer price index print in two years. Per ecPulse:

PPI input for the month of Mach at 3.6% higher than the revised prior reading of 0.6% from 0.1% while on the year rallied to 10.1% from the revised previous reading of 7.5% from 6.9%.

PPI output for March rallied to 0.9% from 0.3% and on the year climbed further to 5.0% from the revised prior reading of 4.2% from 4.1%.

As can be seen, this jump is almost entirely due to the cost of energy (it has not yet fed into other goods / services) and elevated producer prices will be difficult for businesses to pass through to end consumers.

Source: Statistics.UK

Greek Borrowing Costs Soar

Bloomberg details:

Greek bonds dropped, sending the yield premium over German debt to the widest since the euro’s inception, and stocks tumbled on speculation that the bailout of Europe’s most indebted nation will unravel. The yen rallied.

The Greek 10-year spread to benchmark German bunds widened to 436 basis points at 8:15 a.m. in New York. Greece’s ASE Index of stocks slid as much as 5.2 percent, the most in four months, and the cost of insuring against a default by the nation climbed to a record. The Stoxx Europe 600 Index tumbled 1.1 percent and futures on the Standard & Poor’s 500 Index slipped 0.4 percent. The euro weakened for a fifth day against the dollar, and the yen advanced versus all of its 16 most-traded counterparts.

Source: Barclays Capital

Long Fixed Income. Short Almost Anything Else

I think it's fair to classify today's market performance as simply a reversal of Monday (the one exception being gold).



It may be worth while keeping an eye out for that shiny metal...

Source: Yahoo

Regarding the Decline in Birth Rates

The NY Times reported the link between recession and reduced birth rate:

American births fell in 2008, updated government figures confirm, probably because of the recession. The one exception was the birth rate among women in their 40s, who perhaps felt that they did not have the luxury of waiting for better economic times.

The birth rate for women in their early 40s rose 4 percent over the previous year, reaching its highest mark since 1967. The rate for women in their late 40s also rose, slightly. But birth rates fell for teenagers, as well as women in their 20s and 30s.

“Women are postponing births to those later ages, above 40,” said James Trussell, director of the Office of Population Research at Princeton.

Paul Krugman questions the link:

Doesn’t it take nine months from conception to birth? Abortion aside, to reduce births in the first three quarters of 2008 in response to a recession that started in Dec. 2007 would have taken pretty impressive rational expectations.

What are we missing?

First the data, then the missing piece.

The data seems to support the initial theory. The chart below shows the change in GDP by state on the x-axis and the change in the number of births by state (in 2008 [red] and 2009 [blue]) on the y-axis. In both years it appears that the birth rate had a relationship with GDP growth, thus individuals may have in fact based having a child as much in late 2007, as in late 2008 (i.e. predicting the downturn).



But was it a "prediction" or was the pain already felt? I believe the missing piece is HOW the recession began.... with a crash in the value of one's home. By the summer of 2007, the year over year change in the value of homes was pretty much down in all regions of the United States. Is it a surprise potential parents are less willing to have kids (expensive) when your largest investment tanks?

The chart below shows the relationship beween the change in the price of a home (Case Shiller) and birth rate change (I took liberty to match metro area to states). The y-axis remains the same as the chart above (change in birth rate in 2008), but the x-axis is now the annual change in the case Shiller home index from June 2006 to June 2007 (i.e. WHEN these couples would have been "trying" to have kids born in early 2008).

So were people able to predict the downturn or was it simply that the recession as defined by the NBER lagged the pain felt by potential parents?

I'll go with the latter.

Source: CDC / BEA

Consumer Credit Contracts from January Bounce

Been on the road away from it all this morning / early afternoon. It looks like I missed an interesting day of news. CNN Money details one of those pieces of information:

Consumer borrowing dropped in February, after increasing for the first time in a year during the previous month, according to a government report released Wednesday.

Total consumer credit fell a seasonally adjusted $11.5 billion, at an annual rate of 5.6%, to $2.448 trillion in February, the Federal Reserve reported.

Economists predicted a decline in total borrowing of $0.7 billion in February, according to a consensus estimate from Briefing.com.

"February's decline reflects on the still dire state of the economy," said Yasmine Kamaruddin, an economic analyst at Wells Fargo.

"Even if we have seen retail sales and personal expenditure increase in past months, we haven't seen these gains translate into the use of credit because consumers faced with unemployment and slow wage and salary growth are still shying away from taking on credit," she added.

Can't agree completely with Ms. Kamaruddin, as we detailed at EconomPic the paying down of debt outstanding is actually declining in the consumer sector (it's just that defaults are outpacing paydowns that has caused the level to shrink).



Source: Federal Reserve / BEA

Unemployed to Job Openings Remains Elevated

Calculated Risk provides some additional details:

According to the JOLTS report, there were 4.96 million hires in February (SA), and 3.957 million total separations, or 4 thousand net jobs gained. The comparable CES report showed a loss of 14 thousand jobs in February (after revision).

Layoffs and discharges have declined sharply from early 2009 - and that is a good sign.

However, hiring has not picked up - and even though total separations were at a series low, there were few jobs added in February (according to JOLTS). This low turnover rate is another indicator of a weak labor market.

Source: BLS

Hedge Funds Roar in March

EconomPic detailed last week that an assortment of hedge fund managers earned more than some of the largest corporations in the world in 2009. It looks like March may have been the launching pad for some nice paydays for 2010.



Source: Barclay Hedge

Low Quality Tide

Bloomberg details:

Speculative-grade bonds with the highest rankings may offer the best returns after trailing the riskiest debt in a record credit-market rally.

Goldman Sachs Group Inc. is recommending high-yield, high- risk bonds with rankings in the BB tier, the first below investment grade on the Standard & Poor’s scale. Pioneer Investment Management Inc. favors BB and B bonds, the next lowest bracket, while saying the riskiest debt is overvalued. Debt ranked in the BB category gained 39.1 percent in the past 12 months, underperforming the CCC tier by 66 percentage points, according to Bank of America Merrill Lynch index data.

Junk bonds have rallied at an unprecedented pace since December 2008 after the market seizure that followed the failure of Lehman Brothers Holdings Inc. Companies are issuing record amounts of the debt as the economy improves, corporate default rates decline and the Federal Reserve holds interest rates at near zero, spurring investors to seek higher yields.

“BBs have been in an unloved space, too risky for investment-grade investors but not risky enough for high-yield investors,” said Alberto Gallo, a strategist at Goldman Sachs in New York. “That has preserved a lot of value.”

Below is a chart showing the outperformance of BB's vs. CCC's. What it also shows is the outperformance of Ca-D's... that is securities in default.



A rising tide (in this case massive liquidity) lifts all ships... in some cases a LOT more than others.

Source: BarCap Live

Short Fixed Income. Long.... Almost Anything Else

Source: Yahoo

ISM Services Jump

ISM details what respondents are saying:

• "Business conditions have returned to normal (pre-recession). Our business is up significantly since 2009. We are very positive about the upcoming year." (Information)
• "Demand for loans, credit cards, mortgages and equity lending is expected to continue to increase." (Finance & Insurance)
• "Brisk business activity continues as more projects get 'green light.'" (Utilities)
• "Observing some relaxation on several fronts regarding spending and hiring. Still very cautious, but making investments where they make sense." (Retail Trade)
• "Limited funding available for development [and] expansions." (Accommodation & Food Services)
• "The economy appears to be holding its own; however, state and local funding is projected to decrease next fiscal year." (Educational Services)

Source ISM

Mortimer... We're Back!

After a few years of financial service worker salaries moving closely with the broader market (it is important to note that the level remained about 30% higher), the financial services sector has seen a spike in recent months.



That didn't take long...

Source: BLS

The Religious Construction Collapse

Reuters reports:

Supercheap, few-questions-asked loans were a temptation even churches could not resist, but now they are paying for their sins as the debt crisis enters the house of God.

Long considered among the safest of borrowers, churches gambled on real estate at a time when credit copiously flowed and lenders were startlingly lax.

But places of worship have since been battered by the economic downturn. Donations have dipped, investment returns have plunged and bank credit is still hard to come by.

"You build it and they will come. It really was true through the years," said Brad Hampton, executive pastor at the Faith Center of Rockford, Illinois. "They like newness," he says of younger churchgoers.

The decline in religious construction ended post-Internet bubble and never re-emerged with the residential / commercial boom and subsequent collapse.



Source: Census

EconomPics of the Week (4/2/10)

Opinion / Other
Does the U.S. Pay Too Little in Taxes?
When Investors Makes More than Corporations
Is Inflation Understated?
Explantion of How a Zero Boundary Causes a Steep Yield Curve

Economic Data
Are Americans Already Back to Their Old Ways?
Back in Black: Jobs Added, Unemployment Rate Stays...
ADP Employment... Not Yet "Back in Black"
Employment vs. Population Growth
Has the Inventory Rebuild FINALLY Arrived?
Chicago PMI Shows Expansion, but at Slower Pace
European Unemployment to 11 1/2 Year High
Confidence Rebounds... Remains Low
Japanese Production Takes a Breather
Japanese Consumer Showing Signs of Life

Asset Classes
For All the Recent Concern About the Treasury Sell Off
Housing Prices Flat Year-over-Year
UK Housing: The Benefit of a Weaker Currency

And your video of the week... The National with Mistaken for Strangers

Employment vs. Population Growth

The good news is non-farm payrolls jumped by 162,000 in March. The thing to keep in mind is that the population has grown by 211,000 per month (on average) over the past 10 years.



We're getting there, but until we grow faster than the population, unemployment levels will remain. This also shows how far fetched the low unemployment rates were in late 2007.

Source: BLS

Back in Black: Jobs Added, Unemployment Rate Stays at 9.7%

WSJ details:

U.S. employers created jobs at the fastest pace in three years in March, but nearly one-third came from temporary hiring for the Census, indicating the labor market has still some way to go to recover.

The Labor Department said in a report Friday that nonfarm payrolls rose by 162,000 in March, the largest gain since March 2007. That compared to a revised 14,000 drop in February, when the number was likely depressed by the blizzards that hit the East Coast.

Economists polled by Dow Jones Newswires were expecting payrolls to rise by an even higher 200,000. The February figure was revised upward from an originally reported 36,000 decline.

Taking into account revisions to prior months, the U.S. economy added an average of 54,000 jobs a month in the first quarter, fueling optimism about the job market's recovery.

However, the 2010 decennial Census accounted for 48,000 of the employment boost. Since those jobs will be lost in the second half of the year, economists cautioned not to read too much into the headline figure.

As a reminder of the labor market's continued weakness, the unemployment rate stayed at 9.7% last month, in line with economists' expectations. The jobless rate is calculated by the Bureau of Labor Statistics using a different, household survey.

Source: BLS

Explanation of How a Zero Boundary Causes a Steep Yield Curve

This post will hopefully explain Paul Krugman's great interpretation of the yield curve... it's caused by the zero bound on the front-end of the curve. First to Paul...

As I tried to explain last time, to a first approximation you can think of the long term rate as reflecting an average of expected future short-term rates. Short-term rates, in turn, tend to reflect the state of the economy: if the economy improves, the Fed will raise short-term rates, if the economy worsens, the Fed will cut. So long-term rates can be either above or below short rates.

Except that now they can’t. If the economy improves, short rates will rise; but if it worsens, well, they’re already zero, so there’s nowhere to go but up. This implies that there has to be a positive term spread.

At first this confused me and apparently I was not alone. Crossing Wall Street details their personal misunderstanding:

Where I really lose Krugman is when he seems to imply that the steep yield curve is the result of nominal short rates being near zero. I have no problem accepting that the curve should be positive but I don’t get how that ought to impact its unusual steepness. After all, the two-ten spread recently hit an all-time record.

Lets see if I can explain with an example and (of course) a few charts.

Yield Curve Due to Zero Bound Rates

Assuming longer term rates only reflect futures expectations of rates, lets also assume there is no view of interest rates... an investor thinks that for each period from here on out, there will be a 50% chance of a rate hike and a 50% chance of a rate cut (lets assume 25 bps).

Non-Zero Bound

If the Fed Funds rate was 4%, then next period will either be 3.75% or 4.25%. The period after that 3.5% or 4% (if there is a cut period 1) or 4% or 4.5% (if there is a hike in period 1). In this case there is no expectation of a yield curve steepening because each possibility is as likely (a 50 bps drop in 2 periods or a 50 bps hike in 2 periods). The four outcomes are 4% (cut, hike), 4%, (hike, cut), 3.5% (cut, cut), or 4.5% (hike, hike). An average of.... 4% (i.e. rates went nowhere on average).

Zero Bound

This is where things get interesting. The Fed Funds rate is zero. They cannot go negative. Thus, flip your coin for a 25 bps hike or cut. If you get hike, rates rise to 25 bps. If you get a cut... well, you can't cut any more. Go to period two. Now under the initial hike, rates can go back to 0% or jump to 50 bps. Under the initial cut, they can only go to 25 bps or stay at 0%. Thus, the four outcomes in period 2 are 0, 0, 25 bps, and 50 bps. An average of 18.75 bps (they went up).

Analysis

Starting at the zero bound and running this same scenario for 200 periods (and averaging the outcome of 15 samples), we get the following outcomes.

Example 1

Example 2

Running this hundreds of times (built a nice little spreadsheet I must say), the charts all looked roughly the same (just different scales).

I hope this was helpful...

Has the Inventory Rebuild FINALLY Arrived?

Marketwatch details:

The U.S. manufacturing sector expanded for an eighth straight month in March, boosted by stronger orders and production, the Institute for Supply Management reported Thursday.

The ISM manufacturing diffusion index rose to 59.6% in March from 56.5% in February, the ISM said. It was the highest reading since July 2004.

Higher numbers indicate more firms are growing.

Economists surveyed by MarketWatch were looking for the index to strengthen to 57.5%. Seventeen of 18 industries were growing in March, the private industry group said.

Diving deeper into the details, we see an important shift in inventories as companies are stating they are actually building inventories. The below chart details respondents stating they were building, shedding, or maintaining inventory levels.

GDP has seen a recent boost due to the slowing of inventory contraction (details here), but a real build in inventories will have an even larger impact on future GDP figures and hiring.

Source: ISM

When Investors Makes More than Corporations

Comparing the 2009 personal earnings of the top five hedge fund managers and the most recent fiscal year's net income for some of the world's largest corporations.



While these corporations employ millions of people, hedge funds support hundreds / thousands. The result is even greater inequality and capital flowing from productive means (business investment / innovation) to goods for the rich (yachts and indoor basketball courts*).

Source: The Big Picture

Not that I wouldn't have an indoor basketball court if I was worth billions

Update:

Reader Economists Do It With Models counters that wealth transfers to hedge funds does flow its way back (at least in some portion) to the economy.

I object just a tad to your characterization of the productivity of corporation net income versus private net income. Yes, the rich people are buying luxury goods, but they are then employing the people who make those luxury goods. On the other hand, if the rich people aren't buying things with their piles of cash, they are investing it, which provides funds for the development of other businesses. Corporations may be plowing their earnings back into their businesses, but they may also be distributing them as dividends to shareholders and whatnot. Perhaps some of those shareholders are even wealthy people who are going to use the proceeds to, oh I don't know, buy some yachts. :)

At least yachts are safe under any scenario!

Is Inflation Understated?

Doug Kass (via The Street) makes the case that inflation is not nearly as "in check" as headline figures would have you believe (and a potential source for the upturn in interest rates over the past few weeks).

The current artificially low readings on inflation and its salutary impact on real incomes might create the false illusion that the U.S. consumer appears poised to contribute to a self-sustaining domestic economy. Indeed, the recent strength in first-quarter 2010 retail sales is now being comfortably extrapolated by many managements, strategists and analysts.

The reasoning behind the understatement is a combination of headline CPI being made up by ~1/4 owner's equivalent rent "OER", which is dropping dramatically as it has become a "renter's market". Unfortunately in Doug's eyes, with 2/3 of all U.S. household's owning there homes, this "relief" is not uniformly felt (detailed previously at EconomPic here). In addition, as the U.S. economy becomes more integrated with the global economy, he believes it isn't only price levels in the U.S. that matter. Back to Doug.

As an aside, a critical eye would question the myopic focus on the U.S. CPI within the context of a global economy. Global inflation rates matter over here (and so does the policy reaction to those rates over there). China and India's inflation rates are heating up -- there is no OER in their calculations of inflation -- and China's policy actions to deal with this are especially important to us. In fact, one could argue that, at times, the Chinese inflation rate could be more important for the U.S. than the U.S. inflation rate.

I think Doug has an interesting take on the global aspect of inflation, especially if the United States were to devalue its currency relative to its trading partners (this will make imports more expensive, all else equal going forward). I also think that in many cases, government data needs to be taken with a grain of salt. All that said, if the reported numbers are to be believed, they just don't seem to show that inflationary pressures are heating up.

The below chart shows the headline figure, the "core" figure (ex food and energy), and the "core less shelter" figure for comparative purposes. While the headline ex shelter CPI did increase over the last year, it still remains relatively low at 2.6%.

Source: BLS