Monday, September 17, 2012

Fed Throws Granny Off The Cliff

At last week's press conference, Fed Chairman Ben Bernanke defended his low-interest rate policy even though it is punishing savers. Specifically, he said, "My colleagues and I are very much aware that holders of interest-bearing assets, such as certificates of deposit, are receiving very low returns. But low interest rates also support the value of many other assets that Americans own, such as homes and businesses large and small. Indeed, in general, healthy investment returns cannot be sustained in a weak economy, and of course it is difficult to save for retirement or other goals without the income from a job. Thus, while low interest rates do impose some costs, Americans will ultimately benefit most from the healthy and growing economy that low interest rates help promote."

A liberal group that supports the Democrats recently ran an ad that shows a Paul Ryan stand-in throwing an old woman in a wheel chair off a cliff. The message was that Ryan doesn't care about elderly Americans.

But isn't the Fed's low interest rate policy sending the same message? Elderly Americans are the ones that depend most on income from interest. They are the ones that keep their savings in relatively safe assets, such as savings accounts and the certificates of deposit that Chairman Bernanke talked about. Bernanke believes that his low interest rate policy is good for America in the long run. So far, the evidence on that is debatable. What is clearly true, however, is that for elderly Americans, the long run is not very long. They have already saved for retirement. Now they must depend on the income their savings generate, which thanks to Mr. Bernanke, is virtually zero. Does the Fed Chairman really want people in their 80s and 90s taking money out of the bank and putting it into the stock market?

Karen Dynan of the Brookings Institution has a paper out titled, "What's Been Weighing on Consumption?" Here's an interesting line from her paper: "Although interest income typically falls along with interest rates in cyclical downturns, the decline in such income in the current cycle has been materially larger than in the past (just as the sustained low level of interest rates is unusual by past experience)."

And here's an interesting paper from William McBride of the Tax Foundation titled, "The Great Recession and Volatility in the Sources of Personal Income." He includes an interesting table that breaks down income from source. The data is from the IRS and unfortunately it only goes up to 2009, yet is shows interest income falling precipitously after 2007. No doubt, an updated table would show an even sharper drop.

Is the Fed's low-interest rate policy really helping the economy? Perhaps a little. Since high interest rates are not what ails the economy, it isn't clear why the Fed keeps trying to drive them lower. What is perfectly clear, however, is that low interest rates are punishing savers, especially elderly savers. Now who's really the one "throwing Granny off the cliff?"

Monday, September 10, 2012

A Preview to the Fed's Announcement

President Obama's recent speech at the Democratic National Conference seemed to focus a bit too much on the tough road ahead. Perhaps astute traders took that to mean that the next day's jobs report would be disappointing. It sure was. Nonfarm payrolls increased by an incredibly anemic 96,000. What's worse, the gains for June and July were revised down from 64,000 and 163,000 to 45,000 and 141,000, respectively.

Furthermore, the one piece of good news turned out to be an anomaly. The unemployment rate fell from 8.3% to 8.1%, but only because more people dropped out of the labor force. I have been beating the drum for some time about the deteriorating employment participation rate. It just keeps on falling. It is now down to 63.5%, the lowest it has been since September 1981!

So why didn't the stock market sell off on the news? Because, in their twisted logic, investors seem to believe that the worse the jobs numbers get, the greater the odds for more monetary stimulus from the Federal Reserve. In fact, if the jobs numbers had been strong, stocks probably would have sold off.

The Fed's Open Market Committee will meet this Wednesday and Thursday. The Fed will then provide its economic projections and Chairman Bernanke will hold a press conference. Investors will be listening carefully and hoping for more stimulus. Chances are good that something (perhaps QE3) is on the way. It remains doubtful, however, if it will do much good. After all, high interest rates are not what ails this economy. The Fed's announcement might boost stocks, but only temporarily. With Europe facing recession, growth slowing in China, and the U.S. economy stuck at less than 2% growth, the returns from more monetary stimulus could be meager at best.

Thursday, September 06, 2012

Stocks Rally on ECB, Jobs, and ISM

Another day, another rally fueled by a central bank. Just a few weeks ago, Mario Draghi, president of the ECB, promised to do whatever it takes to defend the euro. Today, he announced a new "unlimited" bond-buying program dubbed outright monetary transactions (OMTs). Draghi said the ECB would focus on buying bonds that mature in one to three years. There are some hurdles that must be cleared before the ECB executes these so-called OMTs so it isn't entirely clear just how much money the ECB will throw into troubled economies. Other than giving us a new acronym, however, it is unlikely that the ECB will be able to prevent a recession in the European Union.

Stocks got a further boost from better-than-expected numbers about the U.S. jobs market. The ADP report showed a gain of 201,000 jobs in August; and the July estimate was revised up by 10,000 to 173,000. In addition, initial jobless claims fell to 365,000 for the week ended September 1. Both the ADP jobs report and initial jobless claims are on an improving trend.

There was more good news. The ISM services index came in at 53.7 for August, which was better than expected, better than the July estimate, and more importantly, better than the critical level of 50. This means that the services sector is expanding. This is especially critical since the manufacturing sector has been contracting for three months in a row.

As welcome as today's rally is, investors should remain cautious. After all, in the long run, how well the stock market does depends on corporate profits and the health of the overall economy. There is good reason to worry about both. For example, FedEx Corporation recently reduced earnings guidance for its fiscal first quarter, which just ended on August 31. Management blamed the weak global economy. Because FedEx's customers include most of the world's corporations, it is a bellwether of how the business sector is doing. As for the economy, it remains stuck at below 2% annual growth. What's worse, things are even deteriorating in the world's strongest major economy. A key manufacturing index in China fell to a nine-month low.

Despite the need for caution, stocks could still move higher. Tomorrow we get the all-important nonfarm payroll figures. The market is expecting to hear that 130,000 new jobs were created in August. Given today's ADP number, that expectation appears easy to beat. As for the unemployment rate, the expectation is that it will remain steady at 8.3%.

President Barack Obama addresses the Democratic National Convention tonight. When he takes the podium, he will already know what tomorrow's payroll announcement will be. No doubt he will play it close to the vest, but you can bet that a lot of investors will be looking for hints of what to expect in the morning.