Janet Yellen Testimony Economy Strong Enough For Rate Hikes

The US economy is healthy enough to absorb gradual rate increases and the reduction of the Federal Reserve’s balance sheet, Fed Chair Janet Yellen testimony before Congress on July 12, 2017.

Federal Reserve Chair Janet Yellen told Congress on Wednesday that the bank hopes to keep raising a key interest rate and also intends to begin this year, the reduction of its bond holdings.

Yellen took note of several factors, such as household wealth and job gains that she said should fuel growth.

In what could be one of her last appearances on Capitol Hill, Yellen portrayed a market that, while growing gradually, continued to add jobs, gained from continuous household consumption and a recent leap in business investment, and was currently being supported too by stronger economic conditions overseas.

She blamed the economic slowdown in the first half of 2017 on inflation. She said Fed officials are watching developments closely to be certain price gains go back toward the 2 percent inflation target of the Fed.

Janet Yellen Testimony Freak Out Over Inflation

Janet Yellen seemed a little freaked out over the big drop in inflation over the last few months.

I take Yellen’s comments on inflation to mean that the economy should not have the CPI plunging in this part of the economic cycle. In fact, just the opposite should be occurring. But she added that it was considered by officials as an anomaly; inflation is predicted by the Fed next year.

Many economists believe the Fed, which has raised rates three times, will increase rates yet another time this year.

The Fed continues to anticipate that the development of the market economy will justify gradual increases in the federal funds rate over time while reductions in the Fed’s holdings of more than $4 trillion in securities will probably start “this year”.

In her prepared testimony before the House Financial Services Committee, Janet Yellen testimony repeated the message she’s been sending: the market has improved enough that it no longer requires the support the central bank began providing in 2008 in the aftermath of a serious financial crisis and the deepest recession since the 1930s.

In light of the continuing expansion, the Fed plans to keep raising its benchmark rate of interest and to lower its investment holdings, Ms. Yellen said in prepared testimony. She did not offer details concerning the time of the next actions of the Fed. Analysts expect the Fed to begin shaving its bond portfolio before the end of 2017.

The economy began the year with a slow growth rate of just 1.4 percent, it has regained momentum in recent months, aided by strong job gains, a revival of business investment and a strengthening of international markets.

Bottom line: the market is at full employment and the Fed is moving rates. As the Fed reinvests some of the bond holdings which mature monthly, they will decrease that reinvestment to reduce their balance sheet which will mark the beginning of QT (quantitative tightening). Many believe that QT began this year when the Fed did a series of rate hikes.

The Fed needs to keep policy accommodative to keep on supporting the recovery, but may hit a “neutral” rate quicker than anticipated. Estimates are that inflation has been dropping so fast that we could be near zero right now. Yellen has said the Fed expects estimates of the inflation rate to grow over time.

Yellen said in her testimony that as it stands rates “might not need to rise all that much farther” to reach neutral.

Yellen said growth remains moderate with business investment and consumer spending picking up, and the US economy is benefiting from growth in other countries too.

A strengthening in economic development abroad has provided significant support for U.S. manufacturing production and exports, Yellen said.

The Fed slashed its key policy rate to near zero to fight the worst economic recession since the 1930s, and kept it there for seven years before nudging it higher in December 2015. It left the rate unchanged before increasing it again in December 2016, March 2017, and June 2017 of this year.

At its June meeting, the Fed indicated that it expected to start decreasing its $4.5 trillion balance sheet after this year, a measure that could put slow upward pressure on longer-term prices for such things as home mortgages.

Yellen said, the market seemed to be in a virtuous loop of hiring, investment and spending which should increase resource usage somewhat further, thereby fostering a quicker rate of wage growth and price increases.

The Janet Yellen testimony was fairly uneventful except for her comments on falling inflation which seemed to baffle the Fed as to why this was happening at this point during the economic cycle.

Low Gas Prices Are Not Good For Consumers or the US Economy

Low gas prices are not good for consumers or the US economy. Remember back in late 2015 and early 2016 when oil prices fell which pushed down the price of gas?

We had headlines in the MSM that lower oil prices were a big boost to consumers and so consumer spending was going to rise. It didn’t happen that way.

Gas Prices and Jobs

Lower gas prices mean lower profits for the energy sector which provides good paying jobs for millions of Americans. It’s not just direct energy sector companies either. Real-estate in and around major oil fields saw a crushing drop and mortgage default rates surged when oil drilling rigs went idol back in 2015 and 2016.

Lower gas prices are a net loss for the US economy because of the loss of jobs that accompanies the price drop. While we fell for the MSM headlines back in 2015 and 2016, let’s not fall for it again. Lower prices at the pump do not result in a meaningful increase in consumer spending.

Gas Prices Pull Down The Stock Market

Lower fuel costs pull down the stock market and not just in the US either but around the world. If oil prices were to average $40 a barrel this year, oil-exporting countries would have to sell upwards of $100 billion in various investments to cover their balance of payments deficits. We know this because it’s exactly what happened in late 2015 and early 2016 when oil fell.

It’s not just oil-exporting countries that would be selling. Oil is the primary holding of the world’s largest sovereign wealth funds. Those oil positions extend margin credit to fund managers who use that margin to buy appreciating assets around the world. When oil goes down, it’s like a giant global margin call that goes out and forces fund managers to reduce positions or infuse new money into the fund to meet the margin call.

According to JPMorgan’s estimates, a $40 average Brent price this year would result in the sale of $67 billion in government bonds, $24 billion in equities and another $19 billion in corporate bonds, hedge funds and cash over the course of the year.

Charting margin debt (red line), West Texas Intermediate (brown line), and the S&P 500 (blue line), you can see the effect that oil prices have.

Notice how oil leads both margin debt and by extension the S&P 500.

Not only does the black gold pull down the stock market via the reduction of margin debt, it also results in lower earnings and hence the earnings recession we experienced in 2015. You can see this relationship by charting S&P 500 earnings (green line) over the price of oil and margin debt.

Oil began plunging in 2014 and that drop showed up in earnings about 6 months later. Notice that when oil turned up in February of 2016, earnings again turned up about 6 months later.

Low gas prices are not good for consumers or the US economy. Traders need to watch the price of oil. It’s all about the oil. So goes oil, so goes the US economy.

Economic Growth Up On GDP Revision From Consumer Spending

GDP for Q1 was revised upward to 1.4% on an increase in consumer spending. The US economy enters its ninth year of economic growth in July.

The first GDP estimate for Q1 was originally reported at 0.7%. So Q1 GDP grew at twice the rate as originally thought. That’s great. Obviously 1.4% growth is not great but to have GDP growth at twice the rate than originally thought is awesome.

The idea that the Federal Reserve has hiked rates too far, too fast, and thus was crashing GDP is pushed a little ways off with this Q1 GDP upward revision. Clearly economic growth is not slowing as rapidly as everyone originally thought.

Some economists suspect the Q1 GDP number still underestimates the true rate of increase in the US. Regardless of the upward revision to GDP, President Trump’s stated goal of quickly boosting annual GDP to 3% remains a struggle.

Economic Growth

Analysts estimate that the U.S. market will grow at a 3% rate in the April-to-June interval, although the downturn in equipment orders and shipments reported earlier this week increases the danger that industry investment will supply less of a boost than expected.

A sustained average economic growth rate of 3% hasn’t been achieved in the US since the 1990s. The U.S. economy has grown an average of 2% since 2000.

Initial indications that GDP has accelerated in the next quarter are unlikely in the face of recent data on retail sales and manufacturing production.

United States Economy Teetering On Collapse

The United States economy is teetering, despite what the stock and job markets are saying. The US economy is consumption-centric. Growth in the current recovery has focused on three sectors that have fed through to consumption in its various forms: autos, energy, and financial services.

The scariest set of financial indicators to emerge in decades reveals what is crushing the dreams of record numbers of young, middle-class and older Americans.

While nationwide unemployment is down to 4.3 percent, policy experts and economists are warning of disturbing signals in the economy.

As any industry veteran can tell you, those on the sell-side are the second-to-last to surrender to a downturn in economic activity. A 401K Advisor or money manager will not produce negative forecasts when their most important objective is keeping its customers completely invested in risky assets.

United States Economy

The Citi Surprise Index shows a big disconnect between the economy and Wall Street.

The disconnect will not last for long as the chart above shows. Either the economy improves a lot over a short period of time, else the stock market comes plunging down to earth. It’s easier for the stock market to come down than it is for the Federal Reserve and republicans to somehow get this economy going, a feat that has remained elusive for the last 8 years.

Debt is what has kept the United States economy going for the last 8 years. Debt placed a floor under and then helped commercial property reach for the skies. Debt kept dying retailers alive. Debt also caused back-to-back years of record car sales.

Salaries for the typical American worker have hardly grown for decades, well-paid middle-class jobs are disappearing, and lots of the new jobs are from the low-wage service sector.

Consumers are being crushed by high healthcare costs and it partially explains why the American population grew at a small 0.7 percent this past year, the lowest rise since the Great Depression. As Russ Zalatimo of HudsonPoint Capital said, the tendency around recessionary times is that the birth date really drops like we are now seeing.

Bank of America Merrill Lynch stated autos are headed for a “decisive downturn” that will trough in 2021 at about a 13-million-unit annualized rate, down from last year’s blistering record 17.6 million. A week earlier, Morgan Stanley, whose numbers aren’t quite as grim, also reduced its revenue forecast, recognizing that the best days of this cycle have come and gone.

With the Trump White House scrambling to advance different measures to fuel economic growth – tax reform, infrastructure spending, maintaining jobs from fleeing abroad, some analysts say more radical steps are desperately needed.

Manufacturing isn’t just dead, say analysts. But it’s no longer dominated by smokestacks and rudimentary assembly. There are about 360,000 jobs in US manufacturing that are vacant and not being filled and companies are saying, “We need people to fill them.”

Meanwhile, retailers are currently choking on their debt as profit margins implode. Restaurants today employ 10.6 million individuals.

According to the Tax Policy Center, Trump’s tax reform could cause overall tax cuts of $6.2 trillion over the next ten years.

Losses on securities backed by automobile loans are piling up even as the unemployment rate has hit 4.3 percent, the lowest since 2001.

Additional evidence that the United States economy is teetering is becoming more and more apparent in credit card delinquencies. Experian reported that the domestic bank card default rate climbed to 3.53 percent in May, a four-year high. There are even nascent signs that families have started to struggle to make their mortgage payments.

Trader Alert – So Goes Oil Prices… So Goes the US Economy

Lance Jepsen of GuerillaStockTrading has issued a trader alert regarding oil prices. So goes oil, so goes the US economy.

Traders and investors are looking for a continuation of strong earnings to justify high stock valuations, now trading near their highest levels since 2004.

Most of the expectation for a recovery in earnings is predicated on oil prices being around $47 to $55 a barrel. If you don’t get those numbers, you do not get the strong earnings the stock market needs to warrant the high S&P 500 P/E ratio of around 25.

Oil Prices

U.S. crude futures have been pressured lower by a supply glut. They’ve averaged over $48 per barrel so far this quarter, however, traded around $43 on Friday and are down over 20 percent from February, when they hit an 18-month high.

U.S. stocks are in the ninth year of a bull run that has been fueled of late by bets on pro-growth policies from U.S. President Donald Trump. But with the timetable for reforms extending further into the future, earnings are regarded as a crucial support for stock prices.

Revenue expectations have dropped for 10 of 11 industry groups since early April.

The benchmark S&P 500 stock index as a whole is expected to deliver 7.9 percent profit growth, down from 15.3 percent in the first quarter, and below the 10.2 percent forecast in April, Thomson Reuters data shows.

While lower oil prices can help some sectors such as industrials and transports, as well as boosting consumer sentiment, high expectations for earnings growth mean any stumble will be felt broadly.

Energy industry profits are seen up an incredible 683% from a year ago according to Thomson Reuters data. Without energy, profit growth estimates drop to 4.8 percent for the quarter.

Central Bank Balance Sheet Reduction Could Crash the Market

The central bank balance sheet reduction could crash the market according to David Quintieri (link above). The Fed is engaging in its most dangerous policy move in the last 10 years with its simultaneous moves to raise rates and to unwind its $4.5 trillion balance sheet.

One of the things I don’t understand about this unwinding move from the Fed is who will buy all that toxic debt? If memory serves me correctly, most of the Fed’s balance sheet is garbage toxic debt (mortgage-related securities) that no one wanted to buy and to divert a complete crash of the US economy almost 10 years ago, the Fed swooped in and bought this radioactive toxic debt. Who would want to buy this debt?

Central Bank Balance Sheet Reduction

My own economic ignorance aside as to who would be willing to buy this toxic debt from the Fed, the Fed has never before had to find buyers to shrink its balance sheet. The unwinding of the Fed’s balance sheet is going to be a big challenge IMO.

Current US law states that the Federal Reserve has to be reimbursed by the US Treasury once it realizes the losses by selling the bonds. Interest rates are going up so central bank balance sheet reduction must take place. If the Fed sells a bond at a loss, that loss must be reimbursed to the Fed by the US Treasury. Congress has to send the Fed the money it lost. Congress needs to raise the debt ceiling to a high enough level to reimburse the Fed for its losses on the toxic mortgage backed securities it sells. In other words, central bank balance sheet reduction adds to the national debt.

How Not Following the Consumer Price Index Makes You a Rookie

Something important happened on the Consumer Price Index today and if you’re not following it, you’re a rookie. Don’t be a rookie. Listen to what the CPI is saying.

Consumer Price Index Is Saying Fed Should Not Raise Rates

A common theme that you will continue to hear me drive home is that the economy is too weak for the Federal Reserve to hike rates. Today, the CPI confirms that IMO.

The CPI missed. The CPI forecast was for no change at 0%, the actual number was -0.1%. That is a big miss for this indicator folks.

Don’t be that rookie that follows the Fed press conferences after rate hikes where Yellen says the economy is growing at a moderate pace and everything is fine. Everything is not fine and I think the CPI release today confirms that.

Maneco64 posted this video on YouTube today about the Consumer Price Index and I think he nails the analysis.

Bear Market Coming If Trump Agenda Does Not Move Forward

A bear market is coming if President Trump’s agenda does not move forward quickly. I have been saying for months now that the Federal Reserve is hiking rates not because we are in a strong economy that needs cooling off but instead to save pension fund holders and others who depend on the income generated from bond yields.

The Trump rally ended back in March. That was the turning point when the markets started pricing in the reality that President Trump was being blocked even on a common-sense travel ban from radical Muslim countries that support terrorists and that generally dislike America. If a common-sense travel ban can’t even get put in place, how does Trump’s economic agenda have any hope?

Bear Market Coming As Economy Slows

We are six months into Trump’s presidency and we have no clear plan for raising the debt ceiling when the government runs out of money in August. We have no big comprehensive corporate tax reform yet. We have no tax cuts for working Americans yet. We have no repatriation of trillions of overseas dollars yet. We have no massive infrastructure plan to boost the economy yet. Meanwhile, the Federal Reserve continues to hike rates.

The chart below shows the effects of rate hikes on commercial and industrial loans.

The arrows mark the three rate hikes since the end of the Great Recession. When the Fed hikes rates next week, we could have commercial and industrial loans drop below the zero line and signal a contraction for the first time since the Great Recession.

Today, there’s a greater chance that a bear market will happen than not happen because of trend logic. Trend logic is the idea that a trend will continue until it actually ends. Assume continuation of the previous trend until proven otherwise. The Federal Reserve is on a rate hike up-trend. Commercial and industrial loans are in a downtrend. Assuming these trends continue, the yield curve will go flat or inverted within the next few months. The only thing that will stop this gloomy scenario from taking place is if one of those trends change.

The only thing capable of preventing the next bear market is if Trump’s economic agenda moves forward on tax cuts and infrastructure spending, or if the Federal Reserve does not raise rates in June. Since I see neither of these outcomes happening right now, rather than assume a magical trend change appearing from out of nowhere, it’s better to assume continuation of the previous trends until proven otherwise.

Peter Schiff gave an excellent speech at Cambridge House recently about the deteriorating US economy, check it out:

China Buying Chicago Stock Exchange Deal Delayed

China’s deal to buy the Chicago Exchange has been delayed by the SEC. Hallelujah, the SEC does have some commonsense after all. Reuters reports (link above) that a long-term objective of China is to list Chinese companies in the United States through CHX, which has locations in Chicago and New Jersey.

China Buying Chicago Stock Exchange Is a Bad Idea

China buying the Chicago Stock Exchange is a bad idea IMO. China is a communist country and as such they don’t abide by the same transparency that U.S. listed companies do. Why does this matter?

The Chinese have manipulated their currency and business markets for their own maximum advantage at the expense of US workers. Chinese money bought corrupt politicians that caused the collapse of the entire manufacturing sector in the US. That’s not the behavior of a friend or “most favored nation”. In fact, I think the evidence suggests that China is more an enemy of the US than it is a friend.

Currency manipulation and a push to outgrow America has led to fake Ghost Cities across China.

Much of China’s debt is not secured and so many Chinese companies borrowed money with fake collateral and so where does that leave investors if the company goes bankrupt?

Moody’s recently downgraded China’s debt and how do the Chinese respond? With contempt and anger rather than admission of the problem inherent to all communist systems.

Stock exchanges have listing requirements. Violate the listing requirements and your stock gets booted from being listed on that exchange. If China buys the Chicago Stock Exchange and then lists Chinese stocks on that exchange, that’s a huge conflict of interest! Of course China will change the Chicago Stock Exchange listing requirements to favor its stocks. It will be the China Stock Exchange as a market inside the US economy and it will lack transparency because Chinese companies lack transparency. What about the Chinese companies that claimed to have collateral to bail out investors in case of a bankruptcy? No worries, the Chicago Stock Exchange won’t have any requirement of Chinese companies to secure collateral.

Not only should the SEC reject China from buying the Chicago Stock Exchange, but every China ADR that’s listed on US markets should be reviewed by the SEC and possibly delisted if they lied on their books and fail to prove they have collateral for their debts. China companies must provide the same transparency that US companies do and the Chinese government has to be willing to prosecute businesses inside China on behalf of the SEC. That’s fair trading for US investors and US companies IMO.