Daily Economic Update: August 25, 2023

 J-Hole day is upon us. 2Y Treasury is trading 5.03% and the 10Y is trading 4.24% both up slightly.  Atlanta Fed GDP now rises again, now at 5.9% for Q3, while across the pond German Ifo business confidence fell again and was below estimates.  Why we care so much about central bank speeches is a wonder of the modern world, but I guess if you're of the view that the Fed acts largely through expectations then speeches matter a lot.  Of course there is also a saying that actions speak louder than words and eventually people won't care about what you say unless you eventually follow through.  Last year Powell basically said there would be pain and I guess there was if you were were certain institutions, but for the market writ large that pain has been hard to see and inflation has come down nonetheless.  

On the day ahead we get UofM Consumer Sentiment data, Powell's speech and Lagarde's speech. 

XTOD: My experience with Jackson Hole is that the actual contents of the speech rarely matter. It’s an opportunity to identify the point of maximum pain, and squeeze

XTOD: All the *s should be "dismissed with prejudice" https://thefaintofheart.wordpress.com/2016/08/10/the-fed-wastes-time-star-trekking/

XTOD: Lots of people beating up on Larry Summers over his chart making recent disinflation look just like the mid-70s disinflation, which reaccelerated. Indeed, problematic on many fronts. But the biggest issue is that the story was very different. Mid-70s disinflation was achieved via a huge rise in unemployment; reasons to wonder what would happen as U came down again.  This time no rise in U at all, so completely different process. Oh, and a lot of the inflation resurgence was about the Iranian revolution and oil prices 

XTOD: Nike down record 11 days in a row

XTOD: Tiger 🐅 Global is doomed

XTOD: Here’s a great primer by Popular Info on what “shrink” and “organized retail crime,” is, and why corporations and media like to make it sound like it’s all shoplifting.

XTOD: The Sopranos 2023: Adriana starts an OnlyFans... This is not a meme. Drea De Matteo announced last night on IG that her OF is now live

Treasury OFR compares the plight of Office to that of Malls

Researchers from the Treasury Office of Financial Research has a brief out today titled Work from Home and the Future Consolidation of the U.S. Commercial Real Estate Office Sector: The Decline of Regional Malls May Provide Insight.  In the report the authors provide the following key points:

• Workers have a preference for work from home which may become permanent and if it does employers who recognize and adapt to that reality will have an advantage obtaining and retaining talent.
• Office demand may be even weaker than reported due to the high level of space that is currently being subleased by existing tenants and that structural vacancy rates may be as high as 50%.
• The authors discuss how e-commerce up-ended regional malls and the negative feedback looped that ensued; retailers left malls, leading to fewer shopping options, making malls less attractive for shoppers, leading more tenants to leave.
• The preference for work-from-home is much like that of e-commerce and may lead office down it's own negative feedback loop that will need to ultimately culminate in finding a new "highest and best use" (I like the nod to accounting terminology out of ASC 820) for these properties, most likely with significant reduction in current value. 
  
• It is not clear that appraisers have fully baked in the possibility of structural vacancies, instead continuing to focus on in-place leases and some assumption that the future will be like the past and not yet reflecting the risk premium that would be required to actually sell an office to a new owner.
• Because the OFR is focused on financial stability as one its mandates, they highlight 3 risk to financial stability due to declining office values: 

1. Significant losses for financial institutions holding debt and equity positions tied to office
• $3.2 trillion of total value is current in the office sector and losses of over $180 billion are plausible
• This loss of value would happen over time but would hit direct lenders and exposed CMBS.
2. The loss of tax revenue for municipalities
• Commercial property taxes make up a significant portion of municipal revenues and may be difficult to replace which could deteriorate municipal balance sheets.
3. The high cost of repurposing the buildings
• Unlike malls, offices don't sit on large land parcels around their buildings, offices tend to be in dense areas and cannot be easily transformed into warehouse or distribution or storage centers.
• There are likely a number of challenges to convert office to multifamily.
• The most likely outcome is to demolish the buildings.

While the brief is certainly not prognosticating that office is doomed, it does outline the risk which are generally known by market participants.  The question is exactly what scenario the market is pricing in for office and whether or not it's reflective of the risk posed in this brief.

Daily Economic Update: August 24, 2023

Apparently 8/24 is the date that more people call out sick than any other date.  After bonds rallied solidly and stocks rose on Wednesday, Thursday starts with 2Y up ~3bps at 4.98% and 10Y up ~1bp at 4.21%.  WSJ article with quotes from former St. Louis Fed President Jim Bullard where he calls recession fears overblown and mentions the possibility of the Fed going to 6%.
Stocks look to rise following Nvidia post-close earnings beat on news that we're all just generative AI running on their chips after all. We get jobless claims and durable goods orders on the data front today.

XTOD: Don't forget. Yellen has unholy powers to make you buy bonds. Even if you don't want to

XTOD: Love it.  Every fleeing H4L on silly survey data ahead of Jackson Hole

XTOD: Everyone buying a house is like “well, rates will come down, so can just refi” and that’s why rates are so high to begin with.

XTOD: The Kremlin continues to target and attack Ukraine’s ports and food exports. This time, Russian forces destroyed 13,000 tons of grain that was destined for Egypt and Romania.

XTOD: Books that endure don't look like good books; they are almost always very poorly written, but address fundamental topics. Masterfully crafted ones generate excitement; they look like "great works", get prizes, impress academics, critics, & empty suits, then fade away.....3)Samuelson on Keynes's General Theory:  "a badly written book, poorly organized; any layman who bought it was cheated of his 5 shillings ... not suited for classroom use... arrogant, bad-tempered. polemical...abounds in confusions.  (...) In short, it is a work of genius."

XTOD: A very thoughtful look at designed insecurity and how it manifests itself in the financial world and beyond. https://nytimes.com/2023/08/18/opinion/inequality-insecurity-economic-wealth.html?smid=tw-share via  @nytopinion   +  @astradisastra

XTOD: Still one of the most important market dynamics to watch: inflation-adjusted Treasury yields (magenta, inverted) are at cycle highs, yet valuations (blue) remain lofty. No knowing how/when the lines converge again, but the gap is not likely sustainable

XTOD: Brazil’s former president may be arrested because of expensive watches sold at Philadelphia suburban Willow Grove Mall   inquirer.com/politics/phila… via @phillyinquirer

Daily Economic Update: August 23, 2023

U.S. yields start the day lower, with the 2Y down 4bps back at 5% and the 10Y down 6bps at 4.26%, both back to where they were pre-SVB (remember SVB?).  Eurozone PMI contracting further with German manufacturing continuing to weaken.   Some retail earnings weren't great on Tuesday, but really where are there still Macy's anyway??..and stop stealing from Dick's [insert if Staples sells Staples then...videos here].  There are some academic and non-academic theories connecting a rise in retail theft (or "shrinkage") to inflation.  Generally those theories are that either: (a) rising prices make some goods more expensive so people steal them and (b) rising prices creates an incentive to sell stolen goods below retail prices on the black market.  As we wait for Powell at J-Hole on Friday, attention has turned to bashing Biden's trip to Maui, counting Trump arraignments, Republican primary debates, or, dare I say mask-mandates?  On the day ahead we have S&P PMI's, new home sales and 20y auction today.

If we're going to keep talking about R-Star, can we at least give my man Knut Wicksell some credit?  Wicksell believed that while you could not see the natural rate, you could see the impact of policies that kept rates above or below this rate by looking at trend growth rates. Today, our central bankers discuss their interest rate policy relative to this neutral rate or “R-Star” to determine if their policy is restrictive or not. 

“Nature’s productivity has a strong tendency to keep up the rate of interest” – Irving Fisher ....read the Febezzle article 

XTOD: Confession: in the past 3 years, I've never listened to a single podcast that someone has sent to me. I'm maxed out.  Always feels like main point can be summed up in a tweet or a paragraph rather than expecting me to block out 1-3 hours.

XTOD: Time to scrap ALL stars. ystar, ustar rstar

XTOD: Zoltan: “The west dreamt of the Brics as a lapdog, that they would accumulate dollars and recycle them into Treasuries, but instead of that they are renegotiating how things are done.”  Who opened this door?   “The signal moment for them in the past 18 months, argues the former Kofi Annan aide Mousavizadeh, was not Russia’s full-scale invasion of Ukraine in February 2022 nor Nato’s rediscovery of its purpose, but the freezing of Russian central bank reserves, which dramatically underlined once again the power of the US dollar.  “For middle powers, it was the equivalent of someone going in and seizing embassy property.”

XTOD: Interesting article, but with a pretty bizarre quote from Zoltan Pozsar: “The west dreamt of the Brics as a lapdog, that they would accumulate dollars and recycle them into Treasuries, but instead of that they are renegotiating how things are done.”.....I don't think he understands at all how the international balance of payments works. If he were the only one, it wouldn't matter, but he repeats a very common confusion....There is a popular conspiracy theory (sometimes called the petrodollar conspiracy) that claims that the main purpose of US foreign policy is to trick or cajole foreigners into buying US Treasuries so as to lower the borrowing cost for the US government...This is total nonsense. Net foreign purchases of US assets is just another name for US trade deficits, and the US has been eager to reduce its trade deficits, which is just another way of saying that the US wants foreigners to stop buying US assets..BRIC countries want to do exactly what Pozsar says they don't want to do, and the west wants them to stop doing exactly what Poszar says the west wants them to do.

XTOD: Microsoft $MSFT just announced the public preview of Python in Excel - Tech Crunch

XTOD: Unexpected inflation can lead to redistribution, hurting creditors and possibly workers.  But steady, expected inflation gets built in to interest rates and wages—it does not hurt workers or creditors.  To a first approx think of real wages as unrelated to average inflation.

XTOD: Crash coming.  Haven’t used that word in forever.  Retail is getting taken out back today.  The consumer is not strong.  Airlines all failed miserably and household savings is 90% below it’s peak of 2020/2021.  Asset prices and real estate prices are going to fall with rates pushing above levels not seen since 2007.  Credit conditions are tightening and we have record debt levels.  This is the most obvious precursor to a recession I have seen since the financial crisis.  Takes time and more layoffs, but it is coming.  I haven’t been this bullish on the vol market since the beg of 2022

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.