The Fed

With all the commotion in Europe, the Fed seems to be keeping a very low profile. Could it be that Fed officials are finally coming to the conclusion that the Fed can’t fix all of our problems? They certainly can’t fix Europe’s problems with our monetary policies.

Besides, now that the latest European crisis has pushed US Treasury bond yields to record lows, what exactly would be the point of another round of quantitative easing? The only point would be to try to push stock prices higher. There certainly has been a strong correlation since early 2009 between rising stock prices and quantitative easing.

Yesterday, Bill Dudley, the president of the FRBNY, offered us an update on the Fed’s latest thinking, suggesting that he and his colleagues are ready to pull the trigger and provide easing if necessary:

(1) “Given our forecast of stable prices and a still slow path back to full employment, there is an argument for easing further. But, unfortunately, our tools have costs associated with them as well as benefits. Thus, we must weigh these costs against the benefits of further action.”

(2) “As long as the U.S. economy continues to grow sufficiently fast to cut into the nation’s unused economic resources at a meaningful pace, I think the benefits from further action are unlikely to exceed the costs. But if the economy were to slow so that we were no longer making material progress toward full employment, the downside risks to growth were to increase sharply, or if deflation risks were to climb materially, then the benefits of further accommodation would increase in my estimation and this could tilt the balance toward additional easing.”

(3) “Under such circumstances, further balance sheet action might be called for. We could choose between further extension of the duration of the Federal Reserve’s existing Treasury portfolio and another large-scale asset purchase program of Treasuries or agency mortgage-backed securities.”

Today's Morning Briefing: Wary and Weary. (1) A weekend on a lake with lots of bears. (2) Other than Europe, all is well. (3) Record low safe-haven yields. (4) A bubble in risk aversion? (5) Still underweighting Europe, while overweighting US. (6) Stay Home vs. Go Global. (7) When dollar peaks, Risk On will be safe again. (8) Europe will recapitalize banks after Greek elections. (9) With US yields near zero, what would be the point of QE3? (10) Bill Dudley is ready to do right by US economy. (More for subscribers.)

Fiscal Cliff

Washington has been kicking the budget deficit problem down the road for some time. Indeed, the government has been operating without a formal budget for the past three years. The road ends in a “fiscal cliff” at the start of next year, when lots of tax hikes and spending cuts are scheduled to occur simultaneously as a result of all the can kicking. Before that happens, there could be another fight between Democrats and Republicans over raising the debt ceiling.

Last week, the nonpartisan Congressional Budget Office warned that the scheduled fiscal drag under current legislation will precipitate a recession next year unless Congress acts quickly to avoid such a calamity. According to the CBO’s estimates, the tax and spending policies that will be in effect under current law will reduce the federal budget deficit by 5.1% of GDP between calendar years 2012 and 2013. In this scenario, growth in real GDP in calendar year 2013 will be just 0.5%, with the economy projected to contract at an annual rate of 1.3% in the first half of the year and expand at an annual rate of 2.3%. That’s it? That’s the horrible fiscal cliff? Even the CBO notes that “such a contraction in output in the first half of 2013 would probably be judged to be a recession.”

On Sunday, Fareed Zakaria interviewed former Republican Sen. Alan Simpson and former Clinton White House Chief of Staff Erskine Bowles on CNN’s “GPS” program. Reuters reported that Bowles said they are working with a bipartisan group of 47 Senators and as many House members to frame a compromise to avert the fiscal cliff. He said, "I believe this group will come together during the lame duck," after the November 6 elections. Bowles co-chaired a presidential commission on reducing the federal deficit with Simpson. Their plan failed to win enough support to move forward, but is held up by many moderates as a model for a potential deal.

No matter who wins in November, the White House is likely to turn more fiscally conservative. Why would Obama do so? If the Supreme Court strikes down ObamaCare, the President will scramble to replace it with another legislative centerpiece to define his legacy. His fiscal stimulus programs were duds: It’s debatable whether they stimulated any job creation at all. Without the need to play to his political base in a second term, the President might actually embrace the Simpson-Bowles fiscal plan proposed by his very own deficit reduction commission during December 2010. A Republican trifecta is also a possible scenario for the November race. If so, then the Republicans will move quickly to prove that they are fiscal conservatives and willing to reduce not only the deficit but also the overall size of big government. Once again, the winner could be the Simpson-Bowles plan.

Today's Morning Briefing: Energy Revolution. (1) Back to the future. (2) The consequences of cheap abundant energy. (3) High-Tech Revolution led to Energy Revolution. (4) The US is leading the way again. (5) Keep on trucking. (6) Coming soon: heavy-duty pickups running on natural gas. (7) Lots of worries for the short term. (8) Confidence in the future has been declining since 2000. (9) Lower gasoline prices didn’t boost confidence during May. (More for subscribers.)

Energy Costs & Reshoring in the USA

No one is talking about “peak oil” anymore. Instead, the buzz is all about the technological revolution in the energy industry, which is dramatically boosting the proven reserves of oil and natural gas. The epicenter of this revolution is the United States. However, the new technologies are being introduced around the world in France, Poland, China, and other countries that might be suitable candidates. The plunge in the price of natural gas in the United States is likely to lead a global decline in energy costs. The price differential between crude oil and natural gas may be starting to decline after having spiked at a record high earlier this year.

Cheap natural gas prices at home and rapidly rising labor costs in China should boost US manufacturing. A new study by the Hackett Group found that US companies are exploring reshoring as an option for nearly 20% of their offshore manufacturing capacity between 2012 and 2014. “This repatriated capacity could roughly offset the jobs that will otherwise move offshore, indicating that the great migration of manufacturing offshore over the past several decades is stabilizing.” The Hackett Group's research found that the cost gap between the US and China has shrunk by nearly 50% over the past eight years, and is expected to stand at just 16% by 2013. This trend is largely driven by rising labor costs in China and falling energy costs in the US.

Last Thursday, Reuters reported: “Vast reserves of natural gas and oil unlocked from underground shale deposits have slashed the price of U.S. natural gas to a fraction of costs in Europe and Asia, making it some of the cheapest energy in the world. That is cutting production costs at U.S. factories, making 'Made in America' a more attractive option and driving investment in everything from foundries to chemical plants. The shale energy revolution could also turn the United States into a net exporter of many fuels in little more than a decade, transforming energy from the economy's Achilles' heel to a source of strength.”

If environmental concerns raised by new drilling techniques don’t lead to regulations that snuff out the boom, America will become a net energy exporter in just over a decade. Truck stops around the nation are adding tanks of LNG because it is substantially cheaper than diesel. Trucks transport roughly three-quarters of American freight, so lower transportation costs could provide a big boost to the economy. The resulting boom could add between a half percentage point and a full percentage point to annual real GDP growth over the next 10 to 15 years.

Today's Morning Briefing: One Nightmare & 12 Dreams. (1) The end is near, or maybe not. (2) Will Wisconsin vote make or break public unions? (3) What if Supremes overturn ObamaCare? (4) Fiscal cliff is only a 1.3% drop! (5) Simpson and Bowles pushing their plan again. (6) What if Greeks vote to stay? (7) What if Obama wins, or loses? (8) Unyielding Mullahs will yield. (9) Peak oil has peaked: Look out below! (10) Incomes rising in China. (11) Second recovery in US. (12) Dreaming about a new high for stocks. (13) Adding risk back into recommended portfolio during June. (14) “The Best Exotic Marigold Hotel” (+ + +). (More for subscribers.)

The Dollar & Commodity Prices

I tend to worry about the outlook for global economic growth when the CRB raw industrials spot price index is falling. The same goes for copper, which is included in this index. However, some of the recent weakness in commodity prices is attributable to the strength in the dollar. On the positive side, lower commodity prices can provide a boost to profit margins, as long as final demand grows and doesn’t fall into a recession.

The recent drop in the price of oil would also concern me if it was unambiguously related to weakening global economic activity. But again, the stronger dollar can explain some of the recent weakness in oil. Another important factor in the oil market is that the Saudis are doing their best to flood it in order to increase the effectiveness of sanctions imposed against Iran. The sanctions seem to be working, and yesterday’s news that the Iranians may be starting to budge on the nuclear issue helped to send the spot price of a barrel of Brent crude oil down by $3.00 to $106.21, the lowest since December 19, 2011. The nearby futures price of gasoline has dropped by 54 cents since March 26. This morning’s WSJ reports that during yesterday’s negotiations, the Iranians balked at making any concessions unless the sanctions are lifted. However, the price of oil is up only slightly this morning.

Lower gasoline prices should lift consumer confidence and spending this summer in the US. The Gallup Economic Confidence Index rose to a new high last week for the first time in the four-plus years of this poll. Rising confidence may also reflect improving labor market conditions. If so, then auto sales should continue to rebound, and home sales should finally start to recover.

The Europeans may not be quite as lucky since a weaker euro to some extent offsets the drop in oil prices. However, fuel prices are a major component of budgets and inflation rates in emerging economies. They get a direct economic boost from lower oil prices, and can provide more monetary stimulus when inflation is ebbing.

Today's Morning Briefing: More Grand Plans, Again. (1) A list for the bulls. (2) Grand Plans buy time. (3) Getting ready for a Grexit. (4) Strong dollar weakens commodity prices. (5) Why are oil prices falling? (6) US growing. (7) Sentiment is bearish, which is bullish. (8) April and May data confirm housing recovery. (9) Lots of weak indicators in Europe and China. (More for subscribers.)

Stock Market Indicators

Our Fundamental Stock Market Indicator (FSMI) is currently still bearish. Our FSMI is a good coincident indicator that can confirm or raise doubts about stock market swings. It fell for a sixth week to 100.1 during the week of May 12 since hitting a cyclical high of 109.3 in March. It fell 0.7% during the latest week, and 8.5% over the six weeks. Our FSMI is the average of our Boom-Bust Barometer (BBB) and Bloomberg’s Weekly Consumer Comfort Index (WCCI). The BBB increased for the second straight week (by a total of 2.5%) after falling the prior four weeks (by 6.6%).Jobless claims--a BBB component--fell for the second straight week (based on the 4-week average), from 384,250 to 375,000. The CRB raw industrials spot price index, another component, is falling again. The WCCI dropped for a fourth straight week, after having recovered to a new cyclical high.

Stock market sentiment Indicators are also turning more bearish. However, from a contrarian perspective this means that they are actually turning more bullish. The Investors Intelligence Bull/Bear Ratio dropped to 1.44 this week. It was at an 11-month high of 2.45 seven weeks ago. Bullish sentiment fell from 39.4% a week ago to a seven-month low of 38.3%. Bearish sentiment jumped to 26.6% from 20.4% two weeks ago, which was the lowest since last May. Those calling for a correction sank to 35.1% from a multi-decade high of 40.9% two weeks ago. The AAII Bull Ratio declined sharply for a second week from 55.4% to 33.9% the week of May 16. That’s the lowest reading since June 8, 2011. AAII bullish sentiment fell from 35.4% to 23.6% over the two-week period; bearish sentiment jumped from 28.5% to 46.0%. (See our Stock Market Indicators.)

Today Morning Briefing: In Governments We Trust. (1) The poster child for reckless governments. (2) The well-meaning road to ruin. (3) Fitch cuts Japan. (4) Japan has tried it all: Keynesian stimulus, ZIRP, and QE. (5) Scrambling to fashion another Grand Plan in Europe. (6) Is Europe “shovel ready” and ready for Eurobonds? (7) Growth financed by debt is “nonsense.” (8) The Golden State is our Greece. (9) Gov. Moonbeam dreaming about raising revenues with highest tax rates in the USA. (10) Wisconsin could put some holes in Democrats’ cheese. (11) Meet the true 1%. (12) Morning in America. (More for subscribers.)