Daily Economic Update: August 22, 2023

U.S. yields start the day down slightly with the 2Y at 4.99% and the 10Y at 4.31%, both still near multi-decade highs as speculation remains high that Powell might indicate r-star is higher.  Tech stocks, shrugging it off.  In labor news American Airlines pilots look to get a raise and UAW strike remains possible as they are set to vote on striking.  Speaking of labor yesterday's NY Fed Survey of Consumers on Labor conditions the lowest wage workers would be willing to accept for a new job rose to an all-time high of nearly $80K.  If you're interested in a summary of the latest debate on the Phillips Curve, I found this substack post by Marcus Nunes to be a good read.  On the day ahead we get sales of existing homes, speaking of which see this post

XTOD: Not only is the 10yr Treasury yield at a 15-year high today, but at 37 months it's also the longest correction of any since the early 80s bull market began.   No one active in the bond business today, including Fed officials, knows these uncharted waters

XTOD: "If global real interest rates returned tomorrow to their historical avg of roughly 2%, given the existing level of US govt debt & large continuing projected deficits, the US would likely experience an immediate fiscal dominance problem." -Charles Calomiris, 6/2/23

XTOD: ... an economy operating under conditions of fiscal dominance would have to make, how such a period could end (i.e., either through a prolonged phase of double-digit inflation or a full-blown debt crisis), and what role fintech, crypto, and other forms of decentralized ....finance will play in such an economy given the government’s need to fund itself without losing complete control over inflation.

XTOD: Which R-star to believe? The @RichmondFed  R* or the  @NewYorkFed  R*? ..And yes, I can already hear many of you muttering under your breath "I don't believe in any R-Star!"

XTOD: When inflation is below target, their solution is a higher inflation target. When inflation is above target, their solution is a higher inflation target.

XTOD: Just shows how downright dumb is the proposal for a higher inflation target when "higher inflation target" is good for all seasons!

XTOD: Billionaire Day Traders: 1._____2. ___ 3. ____ 4. ____ 5.____The second list isn't blank on accident.

XTOD: Some are surprised that 40% of U.S. women have tattoos. A major social class divide. Very few upper and upper middle class women have them. But just about every working class woman under age 40 I know has at least one tattoo. My guess is 70-80% of non-college grad women.

Daily Economic Update: August 21, 2023

J-Hole week is upon us.  The week starts off with rates up 3-4bps with the 2Y ~4.97% and the 10Y re-approaching 4.30%, but it will be capped off on Friday by Powell's 10am speech at the Jackson Hole Symposium.  The recent rise in yields has been attributed to everything from growth, inflation and selling by central bank reserve managers.  Overnight China cut it's 1 year loan Prime rate by 10bps to 3.45% as they continue to deal with their slowing economy.  In between today and Friday there is some Fedspeak and otherwise Thursday's jobless claims and durable goods reports are highlight.

Ahead of J-Hole, we have Nikileaks out with an article about r-star (the neutral rate) and how it might be higher post Covid.  Speaking of r-star, there was an interesting paper in March 2022 from Fed researchers that posited what follows (in fairness with respect to persistent low rates, but it wouldn’t be inconceivable that this same feedback loop can work with higher rates): “an incomplete information setting where the central bank and the private sector learn about r-star and infer each other's information from observed macroeconomic outcomes. An informational feedback loop emerges when each side underestimates the effect of its own action on the other's inference, possibly leading to large and persistent changes in perceived r-star disconnected from fundamentals. Monetary policy, through its influence on the private sector's beliefs, endogenously determines r-star as a result. We simulate a calibrated model and show that this `hall-of-mirrors' effect..”

TTOD: How many people know about Winnie the Pooh and Xi Jinping? Is it just me who knew nothing about this?

TTOD: "Not only do high interest rate policies directly lead to significant increases in interest payments as a percent of GDP, but they also indirectly raise interest payments if they slow the economy..."

TTOD: Expectations about returns in choosing how much to save and in what was the driving force in the mechanisms I described in this thread

TTOD: 2. Without nominal rigidities, the price level would indeed behave like an asset price, reacting to future changes in monetary and fiscal policies.  John Cochrane would be (largely 😊) right. Shifts in aggregate demand would be absorbed automatically by changes in interest rates.

TTOD: Fiscal theory of the price level easily adds sticky prices! That’s what most of the book is about, and the whole literature, starting with Leeper 1991 who didn’t even present the flex price case. A fiscal price level jump becomes a drawn out but finite  inflation with sticky prices — exactly as happened.

TTOD: “Conceptually, if the economy is running above potential at 5.25% interest rates, then that suggests to me that the neutral rate might be higher than we’ve thought."

TTOD: In sum, the pandemic may have flipped us from a savings glut to a savings shortage almost overnight.  If so, markets have more adjustments to make (fixed income and equity).

TTOD: But it's not the lower interest rates that caused the increase in investment. The desire to invest was already there, based on the expected productive consequences of that investment, and the lower interest rates simply accommodated this desire...The problem in China's speculative property market in the past two years hasn't been expensive mortgages, but rather the perception that prices will no longer inexorably rise, and so there is no longer any reason to buy property. In that case the only way lower mortgage...

TTOD:  The heart of Hudson Yards' microgrid is a cogeneration system that consists of four Jenbacher J620 gas engines.  Each engine generates approximately 3.3 MW of electrical power.  These things are beasts.

TTOD: Doctors transplanted a genetically modified pig’s kidney into a brain-dead person more than a month ago. It’s still working.

TTOD: I've never felt more bearish  Inflation ?  You need risk seeking financial credit creators 

I don't see any...  And we got an $18 trillion behemoth with huge excess capacity to make stuff that will eviscerate companies granting 6% plus wage growth in the West. Go on, I dare you, raise wages in this environment and face commercial extinction

Residential Housing: Is this graph a fair representation of the "cost to buy"?

I have seen some form of this graph going around social media for a few months. This graph shows the cost to buy a home (the mortgage payment) exceeding the cost of renting by ~$1,000.00 / mo. Usually the conclusion reached by the author of the post is that home prices will have to fall, which may or may not prove accurate.  There is a lot to debate in a simple graph like this, including whether the comparison of the properties that underly the data are of similar characteristics (geography, square footage, finishings, age, etc.).  There can also be a debate around whether or not home prices are too high and whether rents will rise or fall.

Those topics might be interesting, but they are not the topic that interest me today.  

What interest me today is solely related to the "cost to buy", the mortgage payment, and whether or not how you frame that monthly payment might influence a person's conclusion around the value of that payment.

A unique feature of the U.S. mortgage market is that loans are generally freely prepayable by the mortgagor/borrower.  In financial terms, the borrower is long an option to prepay. Without getting into all the details, most homeowners will refinance their current mortgages if interest rates fall and they are able to reduce their monthly payments.  The holder of the mortgage loan asset obviously is aware of the fact that their cash flow stream could be curtailed which poses two problems for them: one, they don't know how long they will receive payments and two, if they get prepaid they will now likely have to reinvest in a lower yield environment.  The mortgage originator/lender needs to be compensated for this risk.

In an interest rate environment with higher yields and higher volatility, the value of the prepayment option being sold by the lender to the borrower will rise.  The mortgage borrower will need to pay more in their monthly payment to compensate the lender, but will equally be acquiring a more valuable option, a point that seemingly is never discussed.

The point being, when you decompose mortgage rates, there is a benchmark, or risk free component, typically considered to be the 10-year treasury yield and there is the cost of the call option that allows the borrower to prepay the mortgage without penalty.

My question is, if you represented the above "cost to buy" as a mortgage payment split into two components, the first being the monthly mortgage payment excluding the value of the option (the sum of the benchmark rate and what is known as the Option-adjusted spread) and second being the amount of the monthly payment that is for the option, if that would change any conclusions reached when people read these graphs?  I'm open to hearing thoughts.

I am also sure that someone with a Bloomberg Terminal can find and use the Z-Spread and OAS Spreads to calculate the value of the option embedded in the mortgage rate.

Daily Economic Update: August 18, 2023

It's another no U.S. data summer Friday.  Yields are down to start the day with the 2Y down 2bps to 4.91% and 10Y down 5bps to 4.23%  UK retail sales came in weaker than expected at -1.2%, EU inflation came in at 5.3% (lowest since Jan 2022), while Japan inflation came in above expectations at 3.3% on headline.  Of course China remains a concern this week and it feels a little risk-off into the weekend.

All investors seem to be aware of the risk in China, but in case you need a reminder, Biden called its economy a "ticking time-bomb" and Ray Dalio said China needs to "follow this beautiful deleveraging process now because the debt-burdended balance sheets and burdensome debt service payments are freezing the economy."   Given we've all known about some debt issues in China, why is all of this still news?  Evergrande has been in the news for like a year?  Is any of this "new" information or are we just past the idea that prices "fully reflect" all available information (any form of efficient market hypothesis)?

Speaking of concepts that feel somewhat forgotten, it feels like the concept of Equity Risk Premium is something forgotten that will soon become a topic of discussion, in much the same way that "Term Premium" has returned to a point of discussion for bond investors. "Term Premium" in Treasury bonds is defined as the compensation that investors require to compensate them for the risk that interest rates may change over the life of the bond.  It would seem that more uncertainty for the path of Fed policy would result in higher term premiums (though it doesn't appear there has been much impact yet on term premiums) For stock investors, as yields rise it's clear you discount future cash flows by an increasing amount, however, the question becomes: are yields rising because the economy is stronger and therefore you expect equities to deliver more cash flow in the future or are other monetary and fiscal factors solely responsible for rising risk-free rates?  Setting that aside, the Equity Risk Premium is the extra amount you need to discount cash flows from a stock to compensate you as an investor in the stock fairly for the risk of that stock. Given the inherent uncertainty in the macroeconomy at present it would seem risk premiums might rise.  In short, stocks seem to fall when it turns out the discount rate used to support their price is too low and it’s difficult to estimate the correct premium ex-ante.

TTOD: "Multiple compression is a bitch." - Benjamin C. Spero 

TTOD: Bitcoin "flash crash?" Fell $2,000 in minutes. No idea why. Working to find out.

TTOD: “Pessimism about China is becoming entrenched. In Bank of America’s latest Asia fund manager survey from early Aug, 84% of respondents said they believed Chinese equities were in the middle of a structural derating—in other words, a lasting contraction in the proportion of overall investment allocated to the country’s stocks.

TTOD: "Neutral rates?" New definition time: The rate at which the economy is neither expanding or contracting, and the rate at which non-banks and banks can compete on level playing field for lending market share. 

 TTOD: The FOMC may soon be setting monetary policy for Argentina. This sounds drastic but if the alternative is ongoing hyperinflation then it would be an improvement. The key issue, IMHO, is whether the Argentina government can credibly commit to dollarization. TTOD: This is deep in the economic weeds, but I just saw the SF Fed blog arguing that household excess saving will be depleted soon. I doubt it. We estimate excess saving will end the quarter at close to $1 trillion. The more excess saving the more resilient the consumer and economy.

TTOD: Everything in this @NewYorkFed  remote work survey is interesting, but this especially: Business leaders mostly don't expect to pull back from offices further. 

TTOD: It’s going to be pretty freaking hilarious when there’s an NYC office space shortage in like 12 years

TTOD: A brand new mini-continent is found. It is rapidly populated, and you are made supreme leader. How do you get a monetary system started?

TTOD: Succession director Mark Mylod still worries about Kendall Roy 

TTOD: Fewer relationships, nurtured genuinely, yield richer emotional dividends.

Daily Economic Update: August 17, 2023

U.S. yields continue their march higher with the 10Y crossing 4.30%, a YTD high, and the 30Y hitting a decade high of 4.42%.   I'm sure you're familiar with "Post-Keynesian economics" right?  My lay understanding (courtesy of Alex Williams blog) is that expectations play a major role in this school of thought.  Expected demand, drives investment, which drives employment, which leads to wage increases, which allows workers to buy the products being produced which creates a virtuous cycle, one in which demand creates supply by driving investment without curtailing current consumption. "A boom begets a boom".  Obviously there are sectors in the economy not doing well with higher rates, but at least for now it looks like consumption is hanging in there, just look at Walmart earnings today.  
As we get closer to J-Hole be prepared to hear more and more about R-Star estimates.  There was a Reuters article here and a St. Louis Fed post trying to grasp what is a restrictive Fed Funds rate.

On the day ahead, jobless claims, Philly Fed.

TTOD: Another day, another upward revision over at the Atlanta Fed’s GDPNow..this is good for the US economy in much the same way that fentanyl is good for one’s well-being. I’ve never taken that particular drug, but I imagine that it makes one feel good—for a while...So what’s wrong with 5.8% RGDP growth? Nothing, as long as NGDP growth is below 5%. But let’s be real; if RGDP comes in at 5.8%, then NGDP growth (which is what matters) will be 8% or 9%. And that would increase the risk of recession in 2024......On the other hand, Bloomberg says there’s a 100% chance of recession by October, so perhaps the Atlanta Fed is wrong......So this growth (if it happens) would be the lagged effect of exactly what?

TTOD: The Fed went on one of the most aggressive rate-hiking cycles in history  It's been 18 months yet the unemployment rate hasn't budged, GDP growth is accelerating & housing prices didn't crash  Can we just admit that no one really understands how the US economy works?

TTOD: I would guess that these higher long-term rates are with us to stay — and if I had to bet, I think I bet that they’re more likely to go higher, than to go lower.

TTOD: Either a major productivity boom is unfolding right before our eyes or the economy is running too hot. Here's hoping for the former!

TTOD: Would there be demand for a hedge fund with 8-year lockups that doesn't send out monthly statements?

TTOD: Saudi Arabia’s stockpile of US Treasuries has fallen 41% since early 2020, to the lowest level in more than six years. China sold $11.3 billion of the debt in June to bring its holdings of US Treasuries to the lowest level since mid-2009.

TTOD: Do not throw away perfectly good food: 1. Put leftovers in Tupperware 2. Place Tupperware in fridge 3. Let it go bad 4. Then throw it away

TTOD: The world record for the longest pee of 508 seconds, lasting nearly 8.5 minutes, was achieved by a man named Andrew Stanton in 2018. This remarkable feat took place in the United Kingdom. While this may seem like an unusual record, it's important to note that records like this can sometimes be a result of unique circumstances or physiological variations.

Daily Economic Update: August 16, 2023

After a couple of days of full flights, full resorts, establishments that seem to still face some staffing issues and seeing plenty of cranes in the sky, it's hard to to see the coming recession in real life. Maybe the bond market sees the same as yields remain up on the week.  On the day the 2Y is down 3bps to 4.92% and the 10Y is down 3bps to 4.19%.  Across the pond, UK inflation fell to 6.8% with core at 6.9% and wages rising.  All the talk this week has been about China and their  real estate and shadow bank concerns.  Speaking of Asia, remember when we were all worried that the U.S. was becoming Japan, mired in secular stagnation despite (or because of) high public debt?  Instead what if the U.S. is turning into the Japan on Tuesday that posted a 6.0% annualized GDP for Q2? Well the Atlanta Fed's GDP now is at 5.0% for 3Q2023 in the U.S., maybe the U.S. is turning into Japan after all, just in the exact opposite way that everyone expected. On the day ahead it's Housing Starts and Building permits a 830am ET and FOMC Minutes at 2pm ET.

TTOD: Rich Men North of Richmond by Oliver Anthony tapped into the zeitgeist of the silent majority

TTOD: I don't think The Song was astroturfed, but I do now wonder if it was lip-synced. I'm not a sound designer but...

TTOD: I'm told songwriters from @AEI @Cato and  @AFPhq  gathered at George Mason this weekened to rebut the declensionism and grievance-onomics of  @AintGottaDollar 's Rich Men from Richmond. The result is a powerful new ballad for the Old Right:   "Every Feller's a Rockafeller"
Your revealed preference, is to work all day
Your marginal product, determines your pay
And thanks to government aid, like the ol’ ACA
Your standard-uh-livin’ just keeps risin’ away....

TTOD: GDP now forecasting tracking 5.0% GDP growth in Q3.If you exclude 2020 their forecasts at this stage have a standard deviation of ~1.5pp. But their forecasts at this stage are also biased upwards by ~1pp.So all in roughly a 70% chance growth is between 2.5% and 5.5% in Q3.

TTOD: ERC pumping $30 billion a monthly certainly helps...the well-heeled.

TTOD: Future historians will marvel at the amount of time economists in the 2020s devoted to calculating various measures of inflation. They will also wonder why such a bad analogy as landing a plane was used to explain the effects of monetary policy to the public.

TTOD: Reading this from @R2Rsquared ; I'm happy to grant that we should ditch the notion of the Phillips Curve as a causal-story tool for setting unemployment to reach target inflation, but then what is the path from interest rate policy to lower near-term measured inflation?

TTOD: When the CB raises nominal interest rates, agents want to save more in nominal vehicles as opposed to real ones. The relative value of nominal vs real must rise. Inflation must fall. This happens as: (i) banks want to deposit more at the CB rather than lend to projects, (ii) investors and firms prefer to park resources in nominal accounts rather than invest them in real projects, (iii) households prefer nominal savings instead of buying durables or others. All of these--less lending, less investment, less spending--often will raise unemployment, but that is a side effect, not the causal channel.   Usually u will rise when i rises (and I expect it will soon), but this is not necessary for pi to fall.

TTOD: 2. He thinks of the price level very much as an asset price I think of the price level as the result of millions of uncoordinated nominal price decisions by individual price setters, who do not care about the price level, but care about their relative price.  3. In my way of thinking, the only way to get inflation down (leaving out happy commodity price shocks, etc) is to induce price/wage setters to want to decrease their relative price/wage, leading to a general adjustment of nominal prices, and a slowing of inflation.  3. In my way of thinking, the only way to get inflation down (leaving out happy commodity price shocks, etc) is to induce price/wage setters to want to decrease their relative price/wage, leading to a general adjustment of nominal prices, and a slowing of inflation.

TTOD: Must read blog (and series of blogs!) by @JohnHCochrane  on what we really know on the impact of interest rates on inflation. Summary: very little. A tiny thread on identification explaining the last blog with an analogy, specially for non-economists. 

TTOD: aight imma need you to see my man flacco on the 5th floor. if you can't get to the 5th floor, say you're muslim and you want to attend "jumah".  if that dont work, go to medical like 5 times and ask about flacco. tall flacco from the bronx. there are 50 flaccos.  next, when you approach flacco you must make a bird noise. do not make direct eye contact and make sure it is a cooing type of bird, not a chirping type of bird, but it shouldnt be 100% coo.  if he doesnt acknowledge you, quickly remove yourself. if he nods his head up slowly, you may say "hunnit" send you. i, martin shkreli, am "hunnit". that is a long story you need not concern yourself with at this stage.  flacco will give you the rest of what you need to know.

Daily Economic Update: August 11, 2023

We start the day with yields down about 1bp, 2Y down to 4.827% and 10Y at 4.10% (it was under 4). Overnight news of continued weakness in China with concerns around bad real estate debt and slowing bank lending. In the UK, GDP posted a surprise growth number in 2Q, expanding 0.2% where forecast were flat with growth in manufacturing and construction. On the day ahead in the U.S. it's PPI and survey about how consumers feel about gas prices (UofM)..

TTOD: via James Galbraith (Aug 9, 2023) "Back in 2021 and early 2022, a posse of prominent economists...all of Harvard...[argued] that inflation, fueled by federal spending, would prove “persistent"...But...inflation peaked on its own in mid-2022 (owing partly to sales from the US Strategic Petroleum Reserve). There was no persistence, no surge from the 2021 fiscal stimulus, and no wage-driven inflation from low unemployment.....There also has been no recession, unemployment has not risen, and higher interest rates have not deterred business investment.. Residential construction took a hit, but the construction sector overall soon shook that off, and the banking crisis earlier this year has not led to financial contagion. A recession remains possible, of course, but so far there are very few warning signs...These happy circumstances have led some observers to congratulate Powell...But ...There is no way, under any theory or precedent, that rate hikes beginning in January 2022 could have knocked back inflation by July of the same year...Whatever its consequences down the road, the Fed’s policy tightening has been irrelevant to the inflation slowdown so far ...why haven’t 18 months of rising interest rates had any perceptible effect on employment, investment, or growth?"

TTOD: We’ve all thought about it. Some of us have studied it. But I have studied it more than anyone. The geography. The strategy. I know how to do it. HOW TO INVADE, OCCUPY, AND PARTITION CANADA

TTOD: 1. Zillow signed rents declining 2. Vacancy rates rising 3. Apt supply booming “.. suggest that further declines in rental inflation are barreling down the pipe.”

TTOD: Yep. The rest of the 2020s in China will be a big game to figure out who takes the losses from the real estate bubble.

TTOD: Today I learned Eddie Vedder wrote Better Man as a teenager and played it with his previous band, Bad Radio. The song was so personal, he didn’t want to perform it with Pearl Jam, but eventually he was convinced.

Daily Economic Update: August 10, 2023

CPI day in 'merica. U.S. yields relatively flat at the open, 2Y at 4.80% and 10Y at 4.00%. While today's CPI will look backwards, markets are paying attention to the re-acceleration in commodity prices with crude up around ~$84/bbl (it was under $70 to start July). There's a headline about olive oil prices rising due to droughts in Spain and the Bloomberg Pizza Index (not a joke) being up 13.5% YTD. Elsewhere, to our South, an Ecuadorian presidential candidate was assassinated by a drug cartel. We've got the Maui wildfires (crazy images). We have China dealing with property defaults and Biden signing an order to restrict US investment in Chinese tech (haven't we seen that before?).   
On the day ahead it's CPI, Jobless Claims, 30Y Auction and Fedspeak

TTOD: a lot easier to get at using housing policy than interest rate policy. Housing inflation rose because rents rose, so the Fed hiked, so we slowed the rate of...building more units to rent...to slow inflation. "The price of this rose so we're going to make it more expensive to produce by raising funding costs" is not an unfair way to describe the strategy here. The hope on the Fed's part is that enough people feel broke enough to slow the rental market, not to let the supply side work

 

TTOD: You ever notice the people betting on higher interest rates are super angry?

 

TTOD: If you want to talk, don’t be a coward and lie about someone speaking in the audience—show up at the debate and say it to my face. I’ll be there…waiting for you.

 

TTOD: Michael Lorenzen throws the 14th no-hitter in Phillies history. His family's reaction is everything.

 

TTOD: Today the U.S. can produce around 30,000 artillery shells a month. In 1995 the army could produce 867,000 shells a month

 

TTOD: Salary envy among tech workers when they heard about UPS drivers getting $170,000 per year. Some tech workers on social media pointed out the salary boost could make the drivers' salaries more competitive with white collar employees — and big tech workers responded with a mix of ire and appreciation for the union.

"This is disappointing, how is possible that a driver makes much more than average Engineer in R&D?" a worker at the autonomous trucking company TuSimple wrote on Blind, an anonymous jop-posting site that verifies users' employment using their company email. "To get a base salary of $170k you know you need to work hard as an Engineer, this sucks."

 

TTOD: I will not relent. We are on the verge of a global margin call. A credit event is coming. No one is prepared.

 

TTOD: Eugenics will be the single greatest moral danger and threat to humanity in the 21st century. People are talking about it without even knowing that they're talking about it—and that, to me, is the most worrying sign.