Friday, November 13, 2015

Unconventional Monetary Policies Likely Mean Rate Hikes Nearly Complete...Not Just Starting


  • The Fed's utilization of Quantitative Easing or QE alongside ZIRP since '08 was an extension and amplification of the Fed's interest rate policy.
  • QE was the Fed's means to foster congress and business alike into massive spending absent the penalty of free-market based higher interest rates.
  • When the Fed began it's taper and subsequently ended QE, this was tantamount to starting the "new normal" rate hike cycle from peak "accommodation".
  • I propose the Fed is already 18 months into this hiking cycle and in the later stages likely culminating in early 2016...prior to a new cycle of accommodation.        

Way back in 2013, there was a similar debate to what we face now.  Would the Fed ever end it's quantitative easing (QE) policies?  Ultimately, the Fed made the call to taper and then ended QE entirely in late 2014.  This was taken as a first sign of "normalization".  But strangely, interest rates fell by a third on the Fed's departure from QE to the dismay of nearly all economists.  In fact, on the curtailment and/or outright abandonment of nearly all traditional sources of treasury buying...interest rates collapsed?!?  Said again, on record supplies of existing and new debt vs. collapsing demand - interest rates fell by a third!?!  Those curious to know who did buy...check the link.

QE was simply a means by which the Fed outright artificially created demand for Treasury debt to allow record stimulus via Congressional deficit spending from '08-'14.  So long as Congress could spend more and pay less in interest costs, thanks to the Feds cover, everybody was happy.

But what I didn't contemplate was the fact that the conclusion to the Fed's unconventional manipulation of its federal funds rate was also the start of the effective hiking cycle. The Fed's FFR hike cycle effectively began when the Fed initiated it's taper over 18 months ago. So, now the debate, will the Fed start a hiking cycle seems misguided. I'd say the Fed is actually already in the later stages of this unconventional hiking cycle with a finish line of a .5% or 1% maximum rate the likely peak. And then a new interest rate cycle is entirely likely...a cycle that sees the Fed move rates well into negative interest rate policy or NIRP the new acronym replacing ZIRP.

First - a quick review of the interest rate cycles since 1981 comparing rates, the accumulation of federal debt, and growth of full time jobs during each cycle.

This second chart highlights the duration at the minimum interest rate during each cycle...lengthening as the interest rate cuts lost effectiveness.

Thirdly, the chart below shows the federal funds rate which hit ZIRP in 2008 and was accompanied by the Fed's new tool, quantitative easing. But QE, like interest rate cuts, lost it's effectiveness each time it was used and greater durations were utilized to have the intended impact.

But with the Fed's final announcement of the taper so too the clock began ticking on the Fed's hike cycle from peak accomodation. Given the poor economic performance nationally and internationally juxtaposed against financial markets euphoria...either the Fed quickly wraps up this hike cycle (and make clear the next "accommodation" is imminent) or very negative market forces could see a repeat performance of the '00 and '08 market collapses.

Lastly, as the chart below highlights, the deceleration of the growth in the core population coupled with minimal wage gains has been the primary reason for slowing economic growth. This has been offset by declining interest rates and ramping deficits. However, core population growth will only decelerate further for the next decade (and that assumes continued strong immigration) so greater deficits and negative interest rates seem a good bet...not rising rates or lower deficits.

BTW - The bulk of the dollar gains (about +18%) have come since the end of QE but is the dollar's pause at these levels pricing in a new hiking cycle or pondering the next accommodation just around the corner?

For better or worse, new lows in the 10yr treasury and new highs for equities are the likely imminent outcome of a negative interest rate policy that only furthers the great divide between slowing economic and ramping financial activity (corporations paid to take loans with which to buyback their own shares). I'd anticipate some dollar softening as the Fed finally admits the "new normal" is long on "new" and short on "normal"...but the impact to be muted for commodities as NIRP continues to incentive producers to bring new capacity online in a world of massive overcapacity and decelerating global demand.  Unfortunately, the sustainability of such a system is premised on ever greater central control and diminishing free market price discovery...such is the price of the "new normal".

Thursday, November 12, 2015

Can You Spot The Interest Rate Cycle That's Different? The Fed Can't!!!

As the Federal Reserve discusses and prepares the nation for a potential December interest rate hike, seems appropriate to compare the "success" of the latest cycle with previous interest rate cycles.
  • Federal debt incurred per net full time job growth per interest rate cycle (below).

  • The percentage of net new full time job growth per population growth (below).

  • Interest rate cycles compared with average interest rates over the cycle, full time job growth, and federal debt incurred per cycle.

  • Duration of interest rates at the minimum rate per cycle prior to initiating rate hikes.
  • Below, federal debt growth per interest rate cycle vs. full time job and population growth per cycle.

Apparently, this is what passes for "success" in the Fed's eyes in the new normal!?!

Tuesday, November 10, 2015

Interest Rate Cycles In Review - Are We Ready For The Next Installment?

  • Since the 1981 peak Federal Funds Rate, the Fed has concluded 5 interest rate cycles...and now is contemplating rate hikes to complete the 6th cycle.
  • Rate cycles have seen progressively lower rates, longer durations at minimum rates, and greater debt incurred per cycle.
  • However, the lower rates for longer and greater debt are creating fewer jobs at greater cost than previous cycles.
Apparently, the Fed has determined their policies of zero interest rate policy, QE, and a hoard of accommodative acronyms have succeeded and rate hikes are likely to be deemed appropriate come this December. But before the Fed pulls the trigger, let's put the latest cycle in context by comparing it to previous interest rate cycles since 1981, comparing the following:
  • IR's (Interest Rates) and Durations at minimum IR's
  • Federal Debt
  • Full Time jobs
  • Population growth
  • Federal Tax Receipts
Folks are welcome to believe what they will and make their own determinations regarding the Fed's policies and their effectiveness. Hopefully the following data will spark some conversation regarding if higher interest rates to slow economic activity are "appropriate" at this time or if the Fed has another agenda?


Since 1981, the Federal Reserve has dropped the federal funds rate from 19% to zero which has incented an equal and opposite creation of US federal government debt (below).

Not surprising that a 99.5% drop in the cost of credit since 1981 has resulted in a 1,200% increased utilization of that cheapening credit in America (below). However, the 1800% increase in debt among the federal government leads the way (above).

The below chart highlights the growth of debt among households, financial, and non-financial plus the federal government. All rose until '07...but the response by the different sources to ZIRP since has been wholly different.

Since 2008, with the implementation of ZIRP, 96% of all new US credit and debt has been thanks to the federal governments takeover of the student loan and car loan markets, mortgage backed securities, and federal deficit spending (below).


In short, credit and leverage are being substituted as the US and world population growth is decelerating...population growth has shifted almost entirely to the retirees among the wealthy nations and young among poor nations with minimal earnings, savings, and/or little to no access to credit.
First, the OECD nations ran short on growth among the young replaced by growth among retirees...

And then the developed nations turned to Asia for growth, particularly China...but China (like Japan, S. Korea, Taiwan, and most of developed Asia) has run into declining core populations and resultant declining demand.

And the 2 charts below, China's 0-64yr/old population growth is over, its housing driven credit bubble (which maintained demand during the deceleration) has popped, exports flat to declining.

Impetus for GDP and earnings growth is extinguished. All that's left for China is government debt and QE, like its developed nation role models.


And India...

And now the world...

The chart below shows the growth of the 0-64yr/old population globally...33 OECD nations plus China, Russia, and Brazil vs. the rest of the world.

The chart below shows the slowing growth of the 15-64yr/old population and the rise of debt to maintain demand despite the decelerating population growth. Note the decline in US oil consumption since '05 coinciding with decelerating population growth and the debt ramping since (I have noted the same impact across most developed nations... now coming to developing nations). Note, at least another decade of core population deceleration is coming (and that's assuming continued strong immigration and lax immigration policies...otherwise, significantly lower core population growth and/or outright contraction is possible).

And below the 25-54yr/old population and jobs among that segment. The flattening core population coupled with the far larger employment declines in this segment is being offset by rate cuts and large credit increases.


Below, all 6 interest rate cycles since the 1981 interest rate peak...we are currently waiting for the Fed to hike rates to complete the 6th cycle.
Each cycle has seen successively lower average rates, decelerating full time job creation, and accelerating debt growth.

Duration (in quarters) of minimum interest rates per interest rate cycle prior to rate hikes.

Below, interest rate duration at minimum rates and debt accumulation per IR cycles.

Longer durations at minimum IR's are leading to more debt but not more full time job growth. Full time jobs vs. federal debt growth per interest rate cycle below.

Below, interest rate cycles comparing duration at lowest rates prior to rate hikes, full time job growth, and federal debt growth during IR cycle.

Interest rate cycles comparing full time jobs growth, population growth, and federal debt growth. Interest rate cuts and debt are being substituted for declining job creation, inadequate to keep up with population growth in the past two interest rate cycles.

Federal tax receipts growth per IR cycle vs. full time jobs growth. A chasm is growing between rising receipts and slowing jobs growth. Rising tax receipts seem to have more to do with asset appreciation than sustainable income growth.

Annual federal tax receipts compared to full time jobs. Each peak in new federal tax receipts heralded an impending economic slowdown...'00, '05, and '13 prominently standout.


Young vs. old...full-time jobs from '00-'07 vs. '08-'15. Since '00, '16-54yr/olds have seen declining full time jobs. All job gains are among the 55+yr/olds.


Core Population Growth Decelerating, Rising Rates, and Peak Debt?

The chart below highlights the slowing core population growth, 0% federal funds rates, and ramping debt in place of organic growth over the past decade. Assuming further decelerating core population growth coupled with rising rates...there is little there to suggest accelerating economic growth and far more likely recession.

Are we ready for another round of Federal Reserve hikes almost surely to be quickly followed by more cuts...almost sure to take us to negative interest rates? And the rate cuts aren't likely to create net new jobs. Perhaps we should discuss who further rate cuts do serve and at who's expense.

Monday, November 2, 2015

China...Fictional Fairytale Vs. Factual Truths

The fictional story of China I often read is that of 7% annual GDP growth, fast rising wages, and growing middle class consumerism underpinning so many corporations growth and revenue estimates. However, the non-fiction reality is a different story all together. That of Chinese credit growth quadrupling since '07 as the primary trigger for the doubling of wages and tripling of GDP over that period.

A quick review from 2000 should help offer some perspective:

  • '00-->'07 global credit grew $55 T (China was up $5 T or 9% of the global total). Chinese core pop grew by 120 million (9.5% increase vs. China's '00 total population). China wages rose 2.3x's, GDP 2.9x's. China represented 30% of global growth in oil consumption.
  • '08-->'14 global credit grew $57 T (China credit grew by $21 T or 37% of global credit growth). China's core population rose 42 million (3% increase vs. China total '08 population). China wages rose 2x's, GDP 2.9x's. China represented 56% of global growth in oil consumption.
  • '15-->'21 China's core population will fall an est. <-11m> (or a -1% decline vs. China total population and the decline will only accelerate thereafter).

To maintain China's GDP and wage growth in the '15-->'21 period, particularly as global exports are decelerating and China's core population is shrinking, China will likely need to quadruple its credit base again. This would be no easy fete as this would equate to an increase of $84 trillion or $12 trillion a year!

The gazillion dollar question is if China's core population is sure to decline, and China credit isn't likely to quadruple again (again, that would be $84 t or $12 trillion/yr over the next 7 years); how likely is China's wage and GDP growth to maintain its pace over this next 7 year period??? China's rise of oil consumption? China's shopping mall bonanza? China's housing surplus? China's role as pre-eminent driver of global growth...or any growth (period) in China??? Or perhaps contraction is the most likely outcome and the implications for commodities to consumer goods will be decelerations and/or contractions for oil, steel, apple iPhones. You name it and growth of Chinese demand is set to collapse (not necessarily demand itself, but growth in Chinese demand at anything resembling the past 15 years is highly dubious).

Below, Chinese total GDP, total Credit, PPP (Purchasing Power Parity) of per capita earnings, juxtaposed with decelerating annual core (15-64yr/old) population growth. Plainly, credit growth was substituted for decelerating population growth to maintain overall growth.


The below chart shows the growing importance of China's annual change in oil consumption vs. the rest of the world.

Below, by period, China vs. the world total growth in oil consumption. In the most recent period, China's growth in consumption of oil rose in excess of the remainder of the world.

China growth of oil consumption (%) vs. the world (x-China), by period is shown in the chart below. China's increasing role in rising oil consumption is quite obvious in the most recent period. However, I could highlight the growth in consumption of copper or steel or...or...or. Amazing for a nation representing about 1/6th of the global population to outgrow the remaining 5/6ths of earths inhabitants. Clearly, decelerating growth and even potentially outright declines in China's oil consumption are the pre-eminent factors presently weighing on the price of oil.


China's 0-64yr/old population will shrink for decades (chart below)...despite China's politically implemented one child policy, nearly all nations that have moved from high to low birth rates have been unable to revert back to higher birth rates. This is true across the EU where nation upon nation have unsuccessfully offered incentives of all sorts to increase birth rates. The story in Asia is the same in Japan, Taiwan, S. Korea, and China all seeing significantly negative birth rates...and Asia (incl. India) in total has fallen from 5.8 in 1950 to 2.1 children per female of child bearing age as of 2015...and still falling. China's softening of its one child policy a couple years ago and outright abandonment now are likely to have little, if any, impact on this. And China's net emigration isn't likely to reverse itself...but probably more plausible than birth rates rising significantly.


From '14-'16 China is building 65% of all new global retail space...nearly doubling existing shopping mall square meters within China. The chart below highlights the annual change and total sq/m's...all while China online shopping is growing by leaps and bounds and China's shopping population is now declining. The same story goes for growth in China skyscrapers, growth in China office space, and massive infrastructure growth for a declining under 65yr/old population?!?


Again, in a nation faced with decades of a shrinking 0-64yr/old population (representing fewer potential buyers every year)...a massive overhang of 50 to 100 million vacant housing units (primarily high end units) seems about the worst possible scenario.


This is where the story gets very interesting. From '00 until July '11 (July of '11 representing the US debt ceiling debacle), China had recycled 56% of it's US $ trade surplus back into US treasury bonds (chart below). Suddenly in July '11, China ceased accumulating treasury bonds and began selling despite continuing to run record $ trade surplus'. Since July '11, China has not purchased (net) a single US fact China has sold $45 billion since July '11 while taking in excess of $1.25 trillion in surplus dollars.

  • '00-->July '11 $2.3 t trade surplus...+1.28 t (56% of dollars recycled into T's)
  • July '11-->'15 $1.25 t trade surplus...<-$45 b> (-4% of dollars recycled into T's)

It's pretty clear China's reaction to the US Congressional determination to monetize rather than prioritize (via taxation / spending) was a loss of confidence in US treasury paper promises. It's pretty well known China shifted from purchasing zero yielding paper to accumulation of physical assets...including gold. In fact, if China simply shifted the 50% of trade surplus dollars that had been buying treasurys and instead purchased gold (the $'s have to go somewhere!), China would now easily hold well in excess of 10k tons of gold and be the worlds greatest physical reserve of gold. A quick review of the Shanghai Gold Exchange balance of trade seems to support this thesis.


Also entirely noteworthy, since July '11, not just China but most natural sources of dollar trade surplus' (BRICS, OPEC, domestic public (US banks, pensions, insurers)) have decreased or entirely ceased buying treasury's (chart below). And on a general slowdown and/or abandonment of the US Treasury market by the largest buyers, US interest rates have not only not risen...but fallen by a third?!?

Since July '11, the chart below shows three primary sources, (none with trade surplus dollars in need of recycling), have taken over. The Federal Reserve, the BLICS (Belgium, Luxembourg, Ireland, Cayman Islands, Switzerland), and Japan (in the midst of record trade and budget deficits).

The pivot by BRICS, OPEC, etc. turning away from US Treasury's to initiate and maintain ongoing physical gold purchases coincided with a simultaneous and ongoing collapse in the price of gold (gold's price peaked in July '11 and has fallen by a third since?!?). Suffice to say, when the price of something collapses on ongoing record (physical) demand and the price of something else rises on a collapse in demand...these are not typical free market responses. When the largest and most fundamental markets act contrary to supply and demand...when the cornerstones of a market are seemingly removed...the validity of the market signals in general are clearly up for debate?!?

Of course, the extent of China's swap from Treasury's to gold is unknown and not made public. So, how that plays out and whether that will act as some sort of trump card to be played later against China's other issues is a mystery.

Will this mystery have a surprising plot twist? Unfortunately, that is well beyond my pay grade and I have no "inside sources". All I can offer is publicly available data detailing a story well worth reading whose conclusion will likely change the way we view the world!