Yesterday evening the Federal Reserve Open Market Committee (FOMC) finished its two-day meeting and issued its statement on its thoughts. There was no change in interest-rates and in truth none had been expected. There were one or two changes of nuance in its statement and I will discuss them below. One clear change was that this time the vote was unanimous in favour. For all of 2010 Bank President Hoenig had maintained an honourable stance in my view and dissented at every meeting. As I wrote earlier this week, after the changes to the FOMC, there were 2 Bank Presidents Mr.Fisher of Dallas and Mr.Plosser of Philadelphia who by their speeches and their past record (both had dissented in 2008 more than once) were possible dissenters. But either they got cold feet or they have changed their minds.
The FOMC Statement
I have aggregated together the main section concerning the economy to show the main relevant points.
the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. ……. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Although commodity prices have risen, longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward.
Here we have a minor nuance change indicating a minor improvement in employment and unemployment but we get a more major change with the mention of “commodity prices have risen.” However on the subject of inflation the FOMC seems to have ignored the rise in core inflation that took place in December as it uses the phrase “trending downward.” Just for reasons of clarity they use core Consumer Price Inflation as an indicator of underlying inflation whereas I think that there are several flaws in this ( for example is there a reader of this blog who has not used food and energy today?)
If we look at the rate of asset purchases which means purchases of US government debt or Treasury Bonds we also got a change.
In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011.
In total this looks the same but missing compared to the December meeting statement was this ” a pace of about $75 billion per month”
We have some nuance changes here of which one had a fairly immediate impact. The US Treasury Bond market decided that it did not like the implications of the omission of the pace of asset purchases and began a sell-off which raised yields across the board. For example ten-year yields rose by 0.11% to 3.43% and yields on the thirty-year or long bond rose by 0.13% to 4.6%. So nuance can have an impact and this is in a way yet another sign of the power and influence that central banks wield at this time. In the US government bond market what the FOMC thinks always has an impact but these days it is the largest buyer too.
State of the Union Address analysed
There was some hope for fiscal deficit hawks when President Obama said this in his speech on Tuesday.
A critical step in winning the future is to make sure we aren’t buried under a mountain of debt,………..We have to confront the fact that our government spends more than it takes in.
But in truth the speech was much longer on hyperbole in this area than action. In essence we were back to his existing strategy of spending to achieve growth to hopefully reduce the fiscal deficit and national debt in the future as there was in terms of action only this.
we freeze annual domestic spending for the next five years. This would reduce the deficit by more than $400 billion over the next decade, and will bring discretionary spending to the lowest share of our economy since Dwight Eisenhower was president.
The ending of that sentence sounds rather good as if the US is on top of its budget problem does it not? Rather inconveniently for such a view the very next day the Congressional Budget Office reported on the fiscal deficit.
The Congressional Budget Office’s Report
For 2011, the Congressional Budget Office (CBO) projects that if current laws remain unchanged, the federal budget will show a deficit of close to $1.5 trillion, or 9.8 percent of GDP………..The deficits of $1.4 trillion in 2009 and $1.3 trillion in 2010 are, when measured as a share of gross domestic product (GDP), the largest since 1945—representing 10.0 percent and 8.9 percent of the nation’s output, respectively.
Against these numbers President Obama’s plan to save US $400 billion over a decade looks a lot smaller. If you remember that the last time the CBO did such a report it indicated a deficit of US $1.07 trillion for 2011 then it shrinks even more because since then the 2010 tax cut raised the projected budget deficit for 2011 by US $430 billion. So he spent as an extra more in 2010 than he plans to cut over the next decade!
There was also a lot of talk about future spending in President Obama’s address let me give you some examples.
We’ll invest in biomedical research, information technology, and especially clean energy technology – an investment that will strengthen our security, protect our planet, and create countless new jobs for our people………….80% of America’s electricity will come from clean energy sources………We will put more Americans to work repairing crumbling roads and bridges.
As you can see some rather expensive promises were made here. Such clean energy projects come with a very high bill and hyperbole such as “countless new jobs” is pretty much misleading. So in fact we are in danger of deficit increases rather than the reductions talked about. It is not my intention here to say that a stimulus measure in itself is a bad idea merely that President Obama is saying one thing and appears to be doing another. His hope is that economic growth from such stimulus measures will over time reduce the deficit, the problem as indicated by the CBO is the way the deficit is increasing in the meantime. We are back in a way to our old friend of “kicking the can down the road”
US Housing Market problems mount
Over the past two days we have had reports on both existing home sales via the Case-Shiller report and new home sales from the Census Bureau. If we take them in the order they came out then the report on existing home sales showed prices falling across the twenty cities that it measures. Indeed “Home prices fell in 19 of 20 ” cities and in a more chilling move.
eight markets – Atlanta, Charlotte, Detroit, Las Vegas, Miami, Portland (OR), Seattle and Tampa – hit their lowest levels since home prices peaked in 2006 and 2007, meaning that average home prices in those markets have fallen even further than the lows set in the spring of 2009.
The new home sales figures were not quite as grim as there was some improvement between November and December with sales increasing from 280,000 to 329,000 if one takes the numbers on an annual basis. Unfortunately however they were still down 7.6% on the 2009 numbers and was in fact a record low.
So taking both numbers together the US housing market still looks very troubled and remember the foreclosure scandal is still grinding on in the background.
Japan’s credit rating is downgraded by Standard and Poors
Today had looked like it was going well for Japan as an announcement was released saying that her exports had risen by 13% in December compared with a year earlier and the Nikkei 225 equity index had risen by 76 points to 10,478. Then came the announcement from Standard & Poors that it was lowering Japan’s credit rating by one notch to AA-.
I have a section on Japan’s economic situation and in particular established themes for her situation in my articles on the 20th of May and the 12th of January 2010. Let me recap them.
1. Reducing the National Debt
2.Shoring up the National Pension System
3.Raising economic productivity
4.Increasing the birthrate so Japan has future income earners to support an ageing population
5.Ending the spectre of deflation and disinflation
6.Boosting domestic consumption
7.Getting economic growth to be at least twice long-term interest rates.
In the meantime there has been plenty of talk by the Japanese government but much less action ( a familiar theme for politicians!). The Standard & Poors statement addresses this directly.
Specifically, we expect general government fiscal deficits to fall only modestly from an estimated 9.1% of GDP in fiscal 2010 (ending March 31, 2011) to 8.0% in fiscal 2013. In the medium term, we do not forecast the government achieving a primary balance before 2020.
If we look at the size of Japan’s national debt then the International Monetary Fund forecast that it would reach some 250 % of her economic output as expressed by her Gross Domestic Product by 2015. Those who argue that this is sustainable have looked to the fact that Japan’s savings culture means that she has very little reliance on overseas buyers of her government bonds making her unlike both the US and UK in this respect. It is also true to say that Japan has assets as well as debts as according to Standard & Poors.
Japan is the world’s largest net external creditor in absolute terms, with projected net assets of an estimated 254% of current account receipts at year-end 2010. The country’s current gold and foreign exchange reserves of over US$1 trillion are second only to China’s.
Against this we have in essence point four from above the changing population dynamic means that her dependent population is rising and her working population is shrinking. This is likely to mean that savings will be spent as an ageing population means rising healthcare costs for example which means that as time goes by these debt levels are likely to look unsustainable.Another way out of this would be economic growth but tucked away in the report was something of an indictment of Japan’s performance in her “lost decade.”
Falling prices have matched Japan’s growth in aggregate output since 1992, meaning the size of the economy is unchanged in nominal terms.
Care is needed here as whilst Japan does have plenty of problems as I have indicated above they are slow movers in the main and this is unlikely to be something that blows up like the peripheral Euro zone crises. However there is a steady drip drip from the problems that Japan has and if current trends continue she is heading for potential insolvency.
Also there is the situation of her government bond yields which at a closing level of 1.24% this morning for her ten-year maturity represent an incredibly low-level if you look at the comparable ones from the US of 3.43%, the UK 3.69% and even Germany 3.19%. This leads me to two thoughts.Firstly if you are bearish on Japan’s long-term position then there may be plenty of money to be made should this yield adjust accordingly. Secondly it contradicts the view often expressed in the mainstream media that government bond yields slavishly follow credit ratings as Japan has been AA for quite some time and yet her bond yields have represented more of a AAAA rating!
In short it has been a better day for the US fund manager who has his mortgage in Japanese Yen as he feels that they debt dynamics will lead to an implosion in Japan and a collapse of her currency,however he has a lot of ground to make up if we allow for recent Yen strength.