The deepest — eternal — philosophical question: What matters, and what doesn’t?
Today anyway, PRK ballistic-missile plinking does not matter. You can’t pick up a box of these things like .22 ammunition at the hardware store. Maybe they’ll run out.
A bomb in the London underground? Uh-uh. Old hat.
Memo item: interest rates rose this week, only a little, the 10-year T-note from 2.05% to 2.19%, but mortgages still below 4.00%. The rate rise broke a two-month straight-line decline, but at today’s level we’re still within an inch of the lowest since the election.
Will not matter: new economic data will be hurricane debris, noisy and unreliable.
The last pre-hurricane data are wobbles, not trends: year-to-date core CPI up-ticked from 1.6% to 1.7%. And June-July retail sales were revised down from a gain of .6% to .3, August’s disappointing also, up .2% versus the .5% forecast. That consumer slippage has pulled Q3 GDP forecasts down to 2.2% from 3%.
Does not matter: financial publications have been whining about the “dollar falling.” It has, relative to the euro — solely because the ECB may end its QE, and the steady-as-she-goes US economy (and hurricanes) may delay the next Fed rate hike. The currency movements are not proxies for national greatness, just reacting to short-term changes in national interest rates.
The juicy stuff: tax reform. If significant tax cuts appear, rates will rise. “Reform,” which if it happens will not be reform, could hurt rates, help them, or most likely not matter.
Timing of tax changes… I’ve got a long-time friend, brilliant architect and builder, 800 score on his math SAT but spare with words. Favorite movies: original “Three Stooges.” Talks with his eyes, if at all. Decided decades ago that most conversation does not matter. Every client tries to pin him down on timelines usually beyond his control, and so he adopted a unique method to discourage poking at him without bringing offense.
When will the plans be done? “Two weeks.” The building permit? “Two weeks.” While a backhoe excavates the foundation… When will the windows be in? “Two weeks.” When will you paint? “Two weeks.” When can we move in? “Two weeks.”
My friend says he’s never met Donald Trump, but has heard of him.
Most people after repeated receipt of the “two week” treatment stop asking. Markets reached that conclusion about tax reform many months ago, ignoring the flow of new two-weekers like the one promised this week.
Markets could be right that none of this matters because nothing will happen. However, ignoring all possibilities may magnify the result if something does happen.
First, a tax cut. The president insists that we will have a yuge cut for the middle class. The problem: the middle class is yuge, which requires a yuge amount of money to be given away and we don’t have any. We’ve got a structural deficit near $600 billion per year, guaranteed to rise until we do something about the cost of health care. Cost, not coverage, which means taking on the Medical Mob, and civilian dreamers of house calls by Marcus Welby, MD. Both parties would rather pay protection.
The only way to find yuge money is to pretend: the cut will heat up the economy and produce more revenue which we can give away in advance. Having tried that fairy tale previously, markets doubt that Congress will again vote for it. And of course markets know that we do not need a tax cut, at best resulting in pointless overheating and Fed whacking.
The chance for reform is trickier because we have to wait two weeks to know what it might be.
Potential reform has the same problem as repeal and replace. An angry out-of-power party stewed for eight years in its own echo-pot. In power they discovered that their best idea boiled down to canceling health insurance for 20 or 30 million Americans. Uh-uh.
The essential concepts for tax reform: 1) broaden the tax base and reduce rates, 2) remove distortions from the code which encourage tax-gaming instead of productive economic decisions. The first one fails because we already tax everybody and everything that has any money — did that in 1987 — and we’re so hungry for revenue that since 1987 we’ve re-raised tax brackets. Nothing to trade, no deal.
The second… Republicans have had a variety of hallucinations. A simple code, tax returns on a postcard. 320,000,000 of us in a $20-trillion economy… economic life has not been simple for a long time, and the code is appropriately complex. Fewer tax brackets: so what? Computing percentages is not complicated; complexity comes from defining taxable income and eligible deductions, and millions of us constantly trying to invent evasive edges.
The worst idea is already dead: Paul Ryan’s massive tariff on imports. The scary part: he still doesn’t understand why it was a bad idea. As bad, but domestic consequences only, these twins: immediately write off all capital expenditures instead of depreciating over time, and disallow interest deductions by corporations and unnamed others. These twins are anti-reform, increasing uneconomic distortions: the first would encourage unneeded investments to get a write-off; and the second intended to bring more tax revenue to give away in cuts would produce yuge chaos.
The one mildly defensible effort: to reduce US corporate taxation to a rate comparable with the rest of the world. The problem: being the world’s biggest and most productive economy brings complications. 80% of US businesses are “pass-through” LLCs, S corps, partnerships, and sole proprietorships taxed at personal rates. If corporate rates drop below personal ones, every pass-through business will convert (or try) to C corporation, with all of its awkwardness, double-taxation of dividends, AND collapse revenue at the new and lower corporate rate.
Who would like to explain all of this to the president?
In the absence of a line outside his door… “Two weeks.”
The next move in the 10-year T-note is going to depend on the economy, and as above the data stream will be garbled for a couple of months:
The 2-year T-note is the Fed guide, and despite the increase this week really has not changed since June, and soon to be hostage to new appointments to the Fed. “Two weeks.”
The NFIB monthly survey of small business by components is net neutral:
Overall optimism is still unhinged from reality, conservative respondents hanging on to the post-election burst. Which, if it lasts long enough will be a new reality — but an old, reliable, real-time economic indicator no longer:
Revised this morning, smack on Fed forecast:
Mortgage interest rates increased this past week as economic data was mixed. Economic data stronger than expected included the NFIB Small Business Optimism Index, July JOLTS Job Openings, Jobless Claims, the August Consumer Price Index (CPI), and the September New York Empire State Manufacturing Index. August CPI was up 0.4% on expectations that it would be up 0.3%. Year over year, CPI is up 1.9%. Economic data weaker than expected included the August Producer Price Index (PPI), August Retail Sales, August Industrial Production and Capacity Utilization, and the University of Michigan Consumer Sentiment Index. The Treasury auctioned $56 billion of 3 Year Notes, 10 Year Notes, and 30 Year Bonds which were met with somewhat weak demand. North Korea launched another missile over Japan, increasing global tensions. President Trump continues to call for tax cuts. There is increasing belief that the European Central Bank may begin winding down its quantitative easing at its October meeting.
The Dow Jones Industrial Average is currently at 22,243, up almost 450 points on the week. The crude oil spot price is currently at $49.87 per barrel, up over $2 per barrel on the week. The Dollar strengthened versus the Euro and Yen on the week.
Next week look toward Monday’s Housing Market Index, Housing Starts and Import and Export Prices, Wednesday’s Existing Home Sales and FOMC Meeting Announcement, Thursday’s Jobless Claims, Philadelphia Fed Business Outlook Survey, and FHFA House Price Index, and Friday’s PMI Composite Flash as potential market moving events.
We interrupt our hurricane coverage for news from the outside world.
The football season has begun: Kansas City beat New England 42-27. NFL Commissioner Roger Goodell attended the game, was laughed at and then booed, a working-life experience much like being Chair of the Federal Reserve.
Economic data were sparse but instructive. The purchasing managers’ ISM survey of the service sector found acceleration in August, from July’s 53.9 to 55.3 — any reading over 50 reflects growth, and mid-50s is lovely.
On the inflation front, one principle: sustained inflation can only get going if incomes rise. The second-quarter measure of unit labor costs (which includes wages and benefits) was revised down to 0.2%, less than 1% annualized.
Long-term rates continued a gentle decline, the all-powerful 10-year T-note down to 2.05% and taking mortgages to 3.875% and even lower in some cases. The causes of the rate decline are as before: extremely low yields on comparable government bonds (German 10s now 0.312% and Japan’s negative 0.004%), also disbelief in any stimulus to come from this Administration or Congress, and persistently low inflation leading to recalculation of the Fed’s intentions.
Hurricane News: Some financial media suggest that these hurricanes may slow the economy and press rates lower. They will cause a great deal of human suffering, certainly, and harm to local household finance, and some limited damage to commerce; however, Congress will inject a few to several tens of billions in disaster relief and repair which will stimulate overall economic activity. Much like infrastructure spending in general, a temporary boost leaving things as-were before (except more deeply in debt), unless investments focus on long-term genuine productivity.
Stick with the non-weather world. Preliminary storm tracks from the Financial Forecasting Center have the Fed exposed to a Category 5 storm. Yellen’s term is up in February. Will she be re-appointed? Or Gary Cohn, ex-Goldman and White House Economic Czar? Or any of a half-dozen others under consideration? And who will replace Stanley Fischer as Vice Chair? And fill the four-of-seven vacant seats for Fed governor?
Begin at the beginning. All modern nations have a “Fed” — a central bank assigned the unique duties as legal counterfeiter. These banks create or destroy money and credit (not the same things) in order to preserve the highest possible economic growth with the least inflation. Even authoritarian nations employ and respect these banks. Possibly more important than the change in Fed leadership, the head of the People’s bank of China is soon to retire. Brilliant and charming Zhou Xiaochuan has been governor of the PBOC for 15 years; his excellence has allowed him at 70 to overstay China’s mandatory retirement at 65.
All of these banks are anti-democratic star chambers: good people appointed and given great power often used in ways contrary to the wishes of elected governments. Since the first bank with these powers (the Bank of England, ca. 1875) the world has gravitated to unanimous central banking because we know that we can’t be trusted with money, and neither (certainly) can our elected representatives be trusted.
The Fed appointments ahead will fuel all sorts of financial-market anxiety, and the commentariat and media will do all possible to boost anxiety into flaming panic.
Don’t buy it.
I hope for Yellen, of course, although others would be fine. Cohn is a “deal guy” not equipped for an exceedingly political job, and he may be out of favor anyway. Some people mentioned are “formula” nuts, who would constrain Fed latitude by mathematic process. Others would limit the Fed out of pro-market zealotry.
The president’s decisions will be like his others. He has shown some talent for appointments, notably the entire foreign policy and defense team. Others have been doctrinaire. The president is a self-avowed fan of debt, and regards default as a beneficial tool. Other than criticizing Yellen during the campaign as “very political,” has expressed nothing about Fed policy except that he likes low rates.
Hurricane tracks we can forecast. Not random events. The coming appointments will be well nigh random, but while floating in a choppy sea, cling to this spar: no matter who gets appointed, the Fed’s task will be the same. And the rules are the same. Allow or encourage monetary policy and regulation too loose or too tight and you’ll be punished. Fast — far faster than in the old days of Greenspan and before.
No matter who leads the Fed, within weeks the new Chair and governors will be stuck where the old ones have been: inflation is not rising as it should as unemployment falls. And inflation may not be in an extended process of rising, as the Fed consensus has assumed, but may be falling, and the Fed’s recent rate hikes as small as they have been a mistake.
No countdown to landfall. Just watch the show as it unfolds, and unfolds, and unfolds.
Before charts, brief political notes for the brave and not touchy-partisan. If it were not for the hurricanes, Mr. Trump’s Wednesday flip to warm-huggies for “Nancy and Chuck” and unprecedented humiliation of McConnell and Ryan and his own staff would receive a great deal more coverage.
“Unprecedented…” Imagine a president — any president — treating Senate Majority Leader Lyndon Johnson this way. Or Howard Baker, Mike Mansfield, Bob Dole, or Robert Byrd. Or Speaker of the House Sam Rayburn, John McCormack, or Tip O’Neill. Humiliate any of these people, and the rest of your presidency would be an agony beyond conceiving.
We are in a time of leadership by miniature people, perhaps a decadent end-game of times too fat. But Wednesday’s Oval Office show was enough to awaken micro-men.
All of the fables of selling one’s soul to the Devil in exchange for favor presume that the Devil keeps his word. It’s the soul-seller who later tries to writhe his way out of the deal. Ryan and McConnell sold their souls in exchange for a Republican majority and legislative accomplishments which would grow the base and Party. But all along, a year and a half now, Mr. Trump appealed to the Tea Party base and behaved badly to all others. Just one week ago the Republican leadership in Congress laid plans to work around a difficult White House and get some things done.
Now McConnell and Ryan have neither souls nor deal. Treasury Secretary Mnuchin and Budget Director Mulvaney today got a House GOP reception like Godell’s in Foxboro.
Trump’s entire business career has been based on intimidation and bravado, and whenever wearing out the deal partners in a particular city, move to New Jersey. He does not understand that Congress cannot be intimidated, and there is not another one to move to. Nor does he understand that our entire government was structured from the beginning to prevent anyone from giving orders. Build consensus or nothing.
The dominant media/commentary response to Wednesday has been to see an opening for bipartisan progress. The reality is exactly the reverse. Everyone in both parties now knows the deal: no soul and no deal. The chances for legislation which would aid the economy have receded.
The US 10-year T-note fell all week long, and politics were part of this leg down. Note the pop up on Wednesday on false hopes of bipartisanship:
The 10-year in the last year. Now, no telling how far down this run can go. There is no rate support all the way back to the false-hope election:
The Atlanta Fed tracker is perfectly happy, 3.0% GDP in train:
The ECRI long-term index is consistent with Atlanta, choppy but happy:
Mortgage interest rates improved again this past week as limited inflation is calling into question whether the Fed will increase the Fed Funds rate as well as curtail its balance sheet. The European Central Bank left its benchmark rate unchanged and did not indicate when it would withdraw its quantitative easing. Geopolitical concerns are supporting interest rates as well as North Korea has added a hydrogen bomb and short range missiles believed to be able to reach Japan and Guam. President Trump agreed to extend the debt limit through December. Hurricane Irma is expected to hit Florida this weekend. Economic data was limited. Of note, the July Trade Deficit, Q2 Productivity, and July Wholesale Inventories were better than expected. July Factory Orders, the August ISM Services Sector Index, Jobless Claims, and Q2 Unit Labor Costs were weaker than expected. Jobless Claims were up substantially due to Hurricane Harvey. Also of note, President Trump is pushing for tax cuts this year.
The Dow Jones Industrial Average is currently at 21,841, down almost 150 points on the week. The crude oil spot price is currently at $48.17 per barrel, up almost $1 per barrel on the week. The Dollar weakened versus the Euro and Yen on the week.
Next week look toward Tuesday’s NFIB Small Business Optimism Index, Wednesday’s Producer Price Index (PPI), Thursday’s Consumer Price Index (CPI) and Jobless Claims, and Friday’s Retail Sales, Empire State Manufacturing Survey, Industrial Production, Business Inventories, and Consumer Sentiment Index as potential market moving events.
The last week of summer vacation has brought a burst of new and healthy data, and a modest drop in long-term interest rates, mortgages below 4.00%. But the best stories in this last quiet week are reflections on human nature.
August payrolls plus-189,000 slowed from early-year gains, and the prior two months were revised lower. The purchasing managers’ ISM index in August rocked back up to 58.8 from 56.3, now about as high as it gets. The gain in average hourly earnings slowed in August, but from a fast July, the year-over-year steady at 2.5%. The Fed’s favorite measure of inflation (personal core expenditures deflator) is stuck on the low side, up 0.1% in July. 2nd quarter GDP was revised up to 3.0% annualized, putting the first half of 2017 dead-on the Fed forecast at 2.1% growth — and will out-perform when the 3rd is added in.
These results will not change the Fed’s plans to begin to reduce its balance sheet in September, nor the good chance of a rate hike in December. Yellen may not be reappointed, but will do what she feels she should do until the last day.
The decline in long-term rates is thin and fragile. US 10-year T-notes traded as low as 2.10% this week, but the prior low in July was 2.15%, so hardly a breakthrough. And with the Fed moving the floor upward, economy fine, it’s not a good idea to bet on lower. As it is, the principal force pulling down is global distortion: Japan’s 10s are no longer a market and barely trade at all: the BoJ wants its 10s to yield zero, and so they do, 0.001% today.
The ECB has a different problem: Eurozone economies are in a bit of recovery, inflation off the floor, hence the euro suddenly $1.18 and rising after a long time below 1.10%. A stronger euro will hurt those economies, but we must fight inflation, mustn’t we, and German 10s are trading 0.385%. Thus US 10s look good no matter what the Fed intends.
Then… humanity. After the 2011 Fukushima tsunami, media there and here rediscovered “tsunami stones” (google says: tsunamiishi), inscribed blocks emplaced as long as 600 years ago: “Do not build homes below this point.” The Japanese are a serious and studious people, respectful of ancestors. Heed the ancient warnings? Not just homes but nuclear plants? NooOOOoo.
Japan was settled a few thousand years ago. Houston: in 1836, but long enough to notice a few things. The geology under Houston is clay and sand deposited by recurrent flooding. Also non-absorbent, although pavement is even less so. Downtown Houston’s elevation above Gulf-level: fifty feet and flat. The nearest Gulf embayment is 25 miles away. At a drop of two feet per mile, drainage is pokey.
Humanity evolved to get the bear out of the cave, not to admire its ancestry or to plan for future ursine migration.
This time of year brings a more easily remembered event, the annual consequence of back to school. In summer kids visit strange places and alien gene pools of disease. Back to school produces a mass exchange and recombinant disaster, especially for the defenseless immune systems of parents. Some Septembers I thought I had malaria. Maybe dengue.
Tie together these aspects of human nature, and you’ve got three days to prepare yourself.
Congress comes back on Tuesday. Harvey has temporarily accomplished the impossible, driving the Trump Show off of CNN and FOX, and quieting even the star himself.
Raising the national debt limit will have top priority, and if we’re lucky will consume all of September. Any political wound tentatively healing will be re-opened.
Next up: tax “reform.” The Game of Tsunami Stones.
Tax cuts are routine. Early in every presidency, every one wants to pitch goodies out of the limousine motorcade. Clinton and Bush I were the only exceptions in modern times, both accomplishing the impossible: trading spending restraint for increased revenue. They had to, to offset the foolishness of early Reagan, which even middle Reagan began to fix.
These spending/tax deals were made possible by the greatest tax reform in US history in 1987, the great trade of closing loopholes in exchange for lower rates of tax. That reform was so well done that we don’t need another.
There is no basis for a new trade. Time has passed: brackets have gone back up, and even more loopholes have been closed. Example: in 1987 the mortgage interest deduction was capped at the interest on $1 million in mortgage debt, plus $100,000 in home equity line of credit. Inflation has erased 54% of that benefit. And the deduction has been greatly limited for households earning more than $250,000 in taxable income (together with most itemized deductions).
It’s human nature not to be able to remember 1987, or much since, especially something like tax calculations. Worse by far: human fondness for being misled. The prior administration put all chips on soaking the rich. Too bad: mostly pre-soaked. The Prior Occupant empaneled the National Commission on Fiscal Responsibility and Reform, whose report is one of the best public works in US history. It demolished the favorite nonsense of both parties, which have ignored it since, and next week will resume their flows of argument, both making Houston effluent look clean. If we are lucky, this new “reform” effort will fail altogether and Congress and the administration can think the unthinkable: compromise on the nation’s actual needs.
Our real problem, of course: half of our people are not equipped to compete in global commerce, and their tax-paying ability is crimped. Focus every effort on getting them into the game and we’ll have more revenue and less need for spending.
The 10-year US T-note in the last year. The Trump Trade has fizzled about as far as it can:
The US 2-year T-note is the Fed telltale. The overnight cost of money, the Fed funds rate is currently pegged in a range 1.00%-1.25%. The 2-year T-note paying 1.35% is thin gruel, and has not begun to price-in a December hike:
The economy has over-performed since winter. We do not need a tax cut:
Mortgage interest rates improved slightly on the week on mixed economic data. Economic data stronger than expected included the August Consumer Confidence Index, August ADP Private Jobs, the second look at Q2 GDP, Jobless Claims, the August Chicago Purchasing Managers Index, and the August ISM Manufacturing Index. The ISM Manufacturing Index reached its highest level since July 2011. Economic data weaker than expected included the July U.S. Trade Deficit, July Personal Spending, July Pending Home Sales, the August Unemployment Rate, August Non-Farm and Private Jobs, August Hourly Earnings, July Construction Spending, and the University of Michigan Consumer Sentiment Index. The Treasury auctioned $88 billion of 2 Year Notes, 5 Year Notes, and 7 Year Notes which were met with reasonably strong demand. When Congress reconvenes it will need to address the debt ceiling to avert a government shutdown. Tax cuts will likely be discussed as well. North Korea fired a missile over Japan increasing geopolitical tensions and moving some money into the relative safety of Treasuries.
The Dow Jones Industrial Average is currently at 21,992, up almost 200 points on the week. The crude oil spot price is currently at $47.04 per barrel, down almost $1 per barrel on the week. The Dollar strengthened versus the Euro and Yen on the week.
Next week look toward Tuesday’s Factory Orders, Wednesday’s International Trade and ISM Services Sector Index, Thursday’s Jobless Claims and Productivity and Costs, and Friday’s Wholesale Trade as potential market moving events.