Monthly Archives: July 2015

Market Stalls, Fed Holds, Greece Defaults (July Economic Update)

Federal Reserve & the US Economy
The Federal Reserve met last week and said they are planning on raising interest rates 0.625% in 2015, but they don’t expect to start until September and will probably do it over the course of two or more quarters with spaced hikes.  However, their criteria for hiking interest rates makes no sense, as the jobs that are being produced are not high paying jobs and under-employment  numbers (people between the ages of 18-62, who no longer receive unemployment benefits and can’t find a job) continue to grow and are currently around 95 million.  Normally, interest rates are raised because the economy is growing too quickly, however the Feds have lowered their own US growth rate estimates from 2.8% at the beginning of the year to 1.6%.  So why are they raising interest rates?  Is it to save face or give off an impression of strength, because the US economy is losing momentum, not gaining it?

The FDIC issued an announcement that, since 2008, banks are larger and more complex and their entire insurance fund covers only a fraction of one percent of all deposits in the system. The balance of the FDIC’s insurance fund compared to the amount of deposits in FDIC insured banks is called the ‘reserve ratio’ and it is set at a statutory minimum of just 1.01%, but the FDIC is not even meeting that mark and said they don’t expect to until at least 2020.  The FDIC went on to say that their current tools and business models are “not sufficient to mitigate the complexities of large institution failures.”  In other words, the FDIC doesn’t even have the minimum reserves to meet their regulatory mandate; much less handle any kind of banking crisis.  Most banks in the US are illiquid with extremely low reserves and have most of their money in mortgage backed securities, just like in 2008.

Fed Says Job Gains Pick Up Staying on Track for 2015 Rate Rise (6-17-15)
Fed Decision Day Guide Interest Rate Projections Gradual Pace (6-17-15)
Even the FDIC Doesn’t Think It’s Ready for the Next Banking Crisis (5-14-15) Simon Blank SMC

Greece is in Default
June 30th was the due date for Greece to pay off the IMF, the EU and the rest of their creditors.  IMF chief Christian Lagarde said, “Greece will immediately be considered in default unless it pays about 1.5 billion euros ($1.7 billion) due to the fund on June 30.” Greek banks are now closed for the next 6-10 days, after which citizens will be able to take out 60 euros per day and 120 euros per week for pensioners.  Greek Prime Minister Tsipras has defiantly refused every deal he’s been offered by the EU, the IMF and other Greek creditors.  The international credit raters have all given Greek securities junk bond status.   Two weeks ago, the IMF withdrew from the bailout meetings, saying they are no closer to an agreement than they were four months ago.  Tsipras addressed the Greek Parliament and said that the IMF should be held criminally responsible for what they’re doing to Greece.

Last week, the Greek parliamentary speaker refused to accept their own central bank’s annual monetary policy report, which urged a deal with creditors, arguing that “odious” debts shouldn’t be repaid.  The EU Finance ministers left Greece after Tsipras called for a July 5th referendum vote by the Greek people, but he has called for a no vote on accepting the proposal from Greek creditors.  For all practical purposes this vote will also determine whether Greece remains in the EU.  Whether they stay in the EU (if they can) or exit, they will still be in default.  Leaving the euro would actually give them more options and control over how they pay or don’t pay back their creditors, and in their valuation of their former currency, the drachma.  The EU and IMF could not relent on their demand for repayment, because there are too many other EU countries in only slightly better positions than Greece, who are next on the list to be dealt with.

Tsipras Lashes Out at Creditors as Merkel Seeks Greek Solution (6-16-15)
IMF Warns No Leeway on Payment as Merkel Urges Greece to Bow (6-18-15)
Greece’s Ruling Party Goes to War With Its Own Central Bank (6-19-15)
Greece’s Tsipras Calls for ‘No’ Vote in July 5 Referendum (7.1.15)
The Greek Referendum Outcomes Explained in One Chart (7.1.15)
Fitch Cuts Ratings on Greece Deeper Into Junk (6-30-15) WSJ

The Sovereign Bond Crisis
There has been a worldwide sell-off of sovereign debt securities.  In a June 6th article Bloomberg wrote, “This is shaping up as the worst quarter for sovereign bonds in almost 30 years.  The Bank of America Merrill Lynch Global Government Index is down 2.9 percent since the end of March. If it holds, it’ll be the biggest quarterly loss since the third quarter of 1987.”   The article went on to say that officials around the world are taking unprecedented measures to head off deflation.  The European Central Bank and the Bank of Japan are both buying record amounts of government debt to pump money into their economies.   “We’ve come into a bear market for bonds,” said Shane Oliver, head of investment strategy at AMP Capital Investors Ltd. in Sydney.

Regulators and government officials are becoming increasingly worried about rising volatility in government bond markets.  Federal Reserve and European Central Bank officials have publicly discussed the issue in recent weeks, and the head of the U.K.’s Debt Management Office said swings could cause investors to balk at buying its bonds at auction.  Volatile trading in government-bond markets has drawn scrutiny from the IMF, the Bank of England, the Fed and the U.S. Treasury Department.  A June 22nd Bloomberg article said TCW Group Inc. (a large investment management firm) is taking the possibility of a bond-market selloff seriously: “We never realize what the tipping point is until after it happens … We’re as defensive as we’ve been since pre-crisis. If you distort markets for long periods of time and then you remove those distortions, you’re subject to unanticipated volatility,” said Jerry Cudzil, TCW Group’s head of U.S. credit trading, who traded high-yield bonds at Morgan Stanley and Deutsche Bank AG before joining TCW Group.

Sovereign Bonds Head for Biggest Quarterly Slump Since 1987 (6-12-15)
Bond Market Volatility Triggers Alarms (6-8-15) WSJ
Bond-Market Crash Has Wall Street Banks Divided on What’s Next (5-17-15)
Major Money Manager Braces for Bond-Market Collapse (6-22-15)

US Oil
The WSJ reported more than 126,000 US oil industry workers have lost their jobs, and that number will double if the US crude oil export ban isn’t lifted.  Amid news of a pending nuclear deal with Iran, some OPEC countries have struck agreements with refineries in Asia to avoid losing market share when Iranian oil comes back on the market.  If U.S. policy will allow Iran to export oil, shouldn’t it allow America to do the same? Clearly, our allies would rather get their oil from America than Iran if given the choice. But without the ability to export, the U.S. is not even in the game.  Why isn’t Congress quickly passing legislation to enable US oil producers to sell crude oil to the rest of the world?  As we get closer and closer to maximum storage capacity, is Congress going to let all the oil drilling companies shut down and oil workers be laid off?   The moment this happens, the markets will know oil will have hit bottom and the price of oil will immediately start its inflationary cycle up.  This will help the markets, but will hurt American businesses and people.

America’s Self-Punishing Oil Expert Ban (6-21-15) By: Harold Hamm
The Oil Expert Ban: A Relic of the 1970s (4- 24-2015) By: John Hess

World Currencies
At the end of May, the Obama Administration said it had many concerns about the Chinese Yuan. The next day the IMF said it did not agree and that they were planning on adding the Yuan to its list of qualified reserve currencies.  The IMF has recognized seven international currencies that qualify as underlying currencies for the IMF and World Bank to use for loans to help nations create infrastructure and provide debt relief in times of difficulty.  The Yuan will become the eighth currency to be classified as a ‘reserve currency.”  The financial markets are experiencing tremendous currency volatility.  The British pound is rising, while the euro, the US dollar and the Yen are falling.  In the wake of the Greek default, both the euro and US dollar are dropping and some say this could cause the Federal Reserve to not raise interest rates.

IMF Says Yuan is Now Fairly Valued (5-27-15) Mark Magnier
IMF The Dollar Is Moderately Overvalued (6-4-15) Bloomberg Video
Pound Beats World as Upbeat Britain Contrasts with Euro Gloom (6-20-15)
Dollar Outlook Dims After Fed Projects Lower Interest-Rate Path (6-8-15)
Dollar Falls as Escalation in Greek Crisis Raises Uncertainty (6.29.15) WSJ

What’s Next
In a June 10th article the WSJ reported that the World Bank downgraded its outlook for global economic growth this year amid a broad-based slowdown in emerging markets and softer output in the U.S.  The article went on to say, the WB now expects the world economy to grow by 2.8%, which is 0.2 percentage points slower than it estimated in January. “There is a structural slowdown under way … Increasingly, they have difficult growth prospects going forward,” said Ayhan Kose, the lead author of the report. “Global growth has yet again disappointed,” said World Bank Chief Economist Kaushik Basu.

In a June 9th article in the WSJ the CEO and co-founder of Blackstone wrote: “…new capital, liquidity and trading rules are interrelated, and locked-up markets and rapidly falling securities prices will force banks to reduce assets and hoard liquidity in order to satisfy applicable regulatory tests. With individuals suffering losses and companies not able to raise capital, the economy will contract with layoffs, lower tax revenues and pain for middle- and lower-income Americans.” 

In his latest Investment Outlook, Bill Gross describes what events might trigger a retail exodus, and says investors should hold enough cash to ride out the storm without participating in a fire sale caused by rising rates or some manner of exogenous shock.  While private equity and hedge funds have built-in “gates” to prevent an overnight exit, mutual funds and ETFs do not.  Thus, “…a rush for liquidity on the part of the investing public, whether they be individuals in 401Ks or institutional pension funds and insurance companies, would find the “market” selling to itself with the Federal Reserve severely limited in its ability to provide assistance.” 
The Bank of International Settlements (BIS) critiqued global monetary policy in its annual report. The BIS claimed that central banks have backed themselves into a corner after repeatedly cutting interest rates to shore up their economies.

Hold an appropriate amount of cash so that panic selling for you is off the table.
Source: Gross Says Hold Cash, Prepare For “Nightmare Panic Selling” | Zero Hedge
Bond King Bill Gross Warns Hold Cash Prepare for Nightmare Selling Panic by ETFs & Mutual Funds (6-30-15) by ZeroHedge |
World Bank Cuts 2015 Global Growth Forecast as Emerging Markets, US Slow (6-10-15)
How the Next Financial Crisis Will Happen (6.9.15) WSJ
Central Bank Financial Repression Has Left Global Economy Defenseless In Next Crisis (6.28.15)

In Conclusion
Greece is not the only country that is about to default; on June 30th, Puerto Rico said it will not be able to meet its debt payments to creditors later in the week.  Just like the EU will not bailout Greece, the U.S. has said it will not bailout Puerto Rico, which is a not state, but is a U.S. territory and considered a “Domestic Protected Nation.”  The WSJ reported that Puerto Rico is $72B in debt (which is higher than any other state), its unemployment rate is 12.4% and there are heightened concerns that the commonwealth’s problems could affect the greater $3.7 trillion market for debt sold by U.S. state and local governments.

The New Asian Investment Infrastructure Bank (AIIB) gathered this week for a ceremonial signing of the new World Bank which will be in direct competition with the current US controlled world bank.  Simon Black wrote in hisMay15th newsletter, “Will you be prepared when everything we take for granted changes overnight? Just think about this for a couple of minutes.  What if the US Dollar wasn’t the world’s reserve currency?  Ponder that… what if…?  Empires Rise, they peak, they decline, they collapse, this is the cycle of history.  This historical pattern has formed and is already underway in many parts of the world, including the United States”.  Greece, Puerto Rico, Cypress, Argentina, Nicaragua, the former USSR weren’t planning on defaulting, nor are the US, Japan or other EU nations, however, poor fiscal policy, too much debt and devaluation of a nation’s currency will lead to default.

Puerto Rico on the Edge of a Default (7.1.15)
Puerto Rico Urges Concessions From Creditors (6.30.15) WSJ
AIIB Tests Beijing’s Management Style (6.29.15) WSJ
Beyond the Greek Impasse (6-30-15) By George Friedman |
(NOTE: The above article entitled, “Beyond the Greek Impasse,” is an excellent analysis of the Greek crisis.)