Chapter 11 Filings Soar, C&I Lending Growth Stalls (Unpeaceful, Uneasy Feeling)

Real GDP growth is above 3%, unemployment rate is near 4%, and other economic indicators are flashing green. Yet, I have an unpeaceful, uneasy feeling.

Chapter 11 (bankruptcy) filings are rising and are back to Great Recession levels.

Source: https://www.abi.org/ and http://www.uscourts.gov/statistics-reports/caseload-statistics-data-tables

Another indicator, commercial and industrial lending from commercial banks, is approaching a flat stall. Even real estate lending is slowing again YoY.

Throw in our Federal government debt of over $20 trillion and skyrocketing consumer debt,

So, The Federal Reserve was wildly successful in terms of lowering interest rates and encouraging the Federal government and households to gorge on debt. Wait, households are responsible for the Federal debt!

Perhaps we are already gone!

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2017 Ends On A High Note: NY Fed NOWCAST Has Q4 GDP At 3.87% (Dow Up 38% Since Nov 4 ’16 Despite 4 Fed Rate Increases)

Well, some good economic news on the US front. The New York Fed’s NOWCAST GDP forecast model has Q4 GDP at … 3.87%.

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The Dow Jones Industrial Average (DJIA) is up 38% since November 4, 2016 despite 4 rates increases from The Fed.

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I don’t think that The Fed should include more cowbell.

Q3 Unit Labor Costs Decline To -0.70% YoY As Retail Landscape Changes (With Robots)

The title from Quartz says it all: “There are 170,000 fewer retail jobs in 2017—and 75,000 more Amazon robots.”

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As more and move firms move to robots in effort to reduce costs and increase efficiency, we are likely to see further declines in unit labor costs in business.

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The decline in big-box retail stores (and their closings) demostrates the paradigm shift in American employment.

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I often wonder how long it will be before universities go mostly to on-line teaching to avoid the problems of some faculty teaching 20 year-old material from graduate school and using stale Harvard/UVA business cases? It is just a matter of time.

A scene inside Jeff Bezos’ Amazon warehouse.

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US GDP QoQ Grows At 3.3% Pace, Fastest Since 2014 (Equipment Purchases Lead The Way) – Yield Curve 10Y-2Y Steepens

According to the BEA, US Gross Domestic Product (GDP) grew at a 3.3% QoQ (Annualized) pace, the highest since 2014.

But what drove the rise in Q3 GDP growth of 3.3%? It wasn’t personal consumption expenditures (PCE) that actually fell from 3.3% in Q2 to 2.3% in Q3. The big contributer was gross private domestic investment that rose from 3.9% in Q2 to 7.3% in Q3.

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And leading the investment charge was nonresidential equipment purchases, rising to 10.4 in Q3. This has been the highest sustained rise in equipement purchases since the US exited The Great Recession.

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On the news, the 10-year Treasury note yield rose around 6 basis points.

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And the US Treasury 10Y-2Y curve steepened to over 60 basis points.

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US Industrial Production Rises To 2.88% YoY, Capacity Utilization Rises To 77% (M2 Velocity Still Dead)

Call it rebound from the horrible hurricanes in Texas, Florida and even Georgia. The October Industrial Production numbers are out and IP YoY climbed to 2.88%.

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Capacity utilization rose to 77%, although it is still below the Fed target (not spoken of recently) of 80%. The last time was 80% Capacity Utilization was during the housing bubble.

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The problem is that M2 Money Velocity (GDP/Money Stock) remains at an all-time low.  Although we are seeing a stabilization in labor force participation.

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The US Federal Reserve is printing currency (M2) at a rate almost twice as fast as Industrial Production growth.

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Here is a photo of a young Janet Yellen contemplating print more and more money.`

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The U.S. Yield Curve Is Flattening and Here’s Why It Matters (Will The Fed Cause Yield Curve Inversion?)

Bloomberg has an interesting article this morning of the US Treasury yield curve.

(Bloomberg) — If you haven’t been paying attention to the persistent flattening of the U.S. yield curve, you’re way behind it.

 Peter Cecchini, chief market strategist at Cantor Fitzgerald, calls it “the most important thing to have a clear idea about now.” Billionaire fund manager Bill Gross says we’re rapidly approaching a point at which the trend will induce an economic slowdown. Others claim it’s only natural, with the Federal Reserve raising short-term interest rates in the face of stubbornly low inflation. 
To put it simply, the Treasury yield curve measures the spread between short- and long-term debt issued by the U.S. government. It’s the extra compensation that investors demand to lock away their money for an extended period.
 
No matter which theory of flattening you subscribe to, the world’s biggest bond market is sending a signal that traders can’t ignore. The longer the trend continues, the more likely its effects could spread to bank earnings and the real economy, while at the same time it would limit the Fed’s ability to respond when these risks emerge.
To get a sense of just how dramatic this trend has been, here’s a look at a handful of curve measures now versus the start of 2017. In trading Monday, they were all close to the flattest levels in a decade.
  • From two years to 10 years: 72 basis points, down from 125
  • From two years to 30 years: 119 basis points, down from 187
  • From five years to 10 years: 33 basis points, down from 52
  • From five years to 30 years: 80 basis points, down from 114

Everyone has their favorite theory for why this is happening and what it means for the economy and the markets, and all of them likely play a part so here’s a breakdown of each one:

It’s the Fed’s Fault

The simplest reason for the flattening comes from looking separately at what’s going on with short rates, the most sensitive to Fed policy expectations, and longer-term yields, which take their cues from the outlook for inflation and economic growth.

After years of balking at tightening monetary policy for fear of disrupting markets, Fed officials finally stuck to their plan in 2017, earning bond traders’ trust in the process. The two-year Treasury yield is at the highest level since 2008 as investors prepare for a rate hike in December, and begin to build up expectations for further increases next year.

With short-end yields climbing, the curve historically tends to flatten as longer-term rates rise more slowly. But since the start of 2017, 10-year and 30-year yields have actually declined. And the culprit behind that appears to be stubbornly muted inflation.

Even with U.S. jobs growth humming along and unemployment at the lowest level since 2000, the Fed’s preferred gauge of price growth was running at just 1.6 percent in September. It fleetingly rose above the central bank’s 2 percent target at the start of the year, but has since struggled.

This all raises the specter of what some call a potential “policy mistake” from the Fed.

That narrative “has ruffled a few feathers,” BMO Capital Markets strategists Ian Lyngen and Aaron Kohli wrote in a note last week. “Growth is moving at a solid clip and the labor market is ostensibly at full employment — so why aren’t we in an environment with a steeper curve and higher yields?”

Their conclusion is the Fed has built up a reputation as an inflation fighter. That means going forward, traders should expect a lower yield range for 10- and 30-year Treasuries than they might have otherwise.

Supply and Demand

Another factor pinning down longer-term yields: forced buyers, both in the U.S. and elsewhere.

Asset-liability managers like insurance companies and pension funds are always seeking duration, and 30-year Treasuries are among the best ways to get it. Combine that appetite with increased demand from passive mutual fund giants like Vanguard and BlackRock, and you’ve got a recipe for a sustained bid on the long end of the Treasury curve.

If that wasn’t enough, Treasury recently announced that it wants to focus increased issuance in bills and shorter-dated coupon maturities, like two- and five-year notes. That creates relative scarcity at the long end of the curve and a premium at the short end to absorb the extra supply.

Some see it as no coincidence that on the day of the Treasury’s refunding announcement, the yield curve from five to 30 years flattened by the most in two weeks.

“For all the discussions about the yield curve these days, one factor that is really driving positioning in the Treasury market is the expectation of future Treasury issuance,” Ben Emons, head of credit portfolio management at Intellectus Partners, wrote in a note.

Draghi’s Driving

To Cantor Fitzgerald’s Cecchini, those looking only within the U.S. to understand the yield curve are missing the bigger picture.

The global bond market is still awash in central bank purchases, he said, most notably from the Bank of Japan and the European Central Bank. And over the course of the past few years, the yield spread between 10-year Treasuries and German bunds has grown wider, creating an opportunity for overseas investors to add U.S. debt.

The ECB, led by Mario Draghi, announced last month that it plans to keep buying bonds through September 2018, albeit at half the current pace from January. It’ll also continue to reinvest proceeds from maturing debt for an extended period. The bank’s main refinancing rate has been pinned at zero since early 2016, sending yields negative on trillions of dollars of debt from Germany to Italy and the Netherlands.

“As long as the ECB continues to buy the long end of the curve, they’re in control of developed market long-ends, including Treasuries,” Cecchini said in a telephone interview. “It’s very hard to draw from history in this environment. The lessons from history only make sense if facts and circumstances are close to what they were.”

History’s Guide

If one does take history at face value though, the $14.3 trillion Treasuries market is sending a warning about the economic outlook. Yield curves are the flattest in a decade, and it’s no coincidence that about 10 years ago marked the start of an 18-month recession. The yield curve has proven a reliable indicator of impending economic slumps when it inverts, and short rates exceed longer-term yields.

Lacy Hunt, chief economist at Hoisington Investment Management, sees a good chance of an inverted curve as soon as a year from now if the Fed continues to shrink its balance sheet. He says the tightening policy will likely choke off credit growth and curb excess reserves, slowing the economy and suppressing inflation.

Banks typically prefer a steeper yield curve because they generate income from the spread between long-dated loans and deposits that are priced on shorter-term rates. Without the gap, their performance suffers.

It’s already starting to show this year: U.S. financial stocks have trailed the S&P 500 as the yield curve has flattened. While banks’ lending margins have increased slightly from their 2015 lows, they remain below the average of the past 30 years, according to the Fed.

A potential increase in the cost of credit is at the heart of what worries Janus Henderson Group’s Gross.

“In a highly levered economy with a lot of debt, and that typifies the U.S., we don’t have to go flat, perhaps another 20 to 30 basis points of tightening would be enough in order to induce certainly a slowdown in the economy,” he said on Nov. 3.

The flattening trend may be a warning sign, or — to borrow one of the phrases Gross helped to popularize — it might just be “the new normal.” Either way, it’s a trend that’s poised to dominate bond traders’ decisions in the months to come.

I agree with Lacy Underall Hunt. Further rate increases and a Fed balance sheet unwind could lead to an inversion of the US Treasury yield curve. Inversion is when the 10 year T-note yield is below the 2 year T-Note yield. Inverted Treasury curves occur several months before entering into a recession.

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Here is the US Treasury Actives curve today compared with December 1, 2006 when the yield curve was last inverted, mostly in the short-end of the curve.

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Initial Jobless Claims Near 44 Year Low! (Too Bad Wage Growth Is Roughly 1/3rd Of 1973 Wage Growth YoY)

US initial jobless claims rose slightly to 239k for the week ending November 4th. But initial jobless claims remain near the 44 year low.

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If we look at the 4 week moving average of initial claims, it too is at a 44 year low.

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Now that is an impressive feat! Now if only earnings growth would return to 1973 levels. Current YoY wage growth is roughly 1/3rd of 1973 wage growth.