The BondBeat - Bitly

The BondBeat Monday, December 11, 2017

See GP disclaimer HERE

What’s On OUR Minds In addition TO what was SENT OVER THE WEEKEND -- thematic charts (wages FAIL to rev UP, jobs market NOT tight -- see low skilled wages -- ie SECURITY GIG; Rosy on WAGES goin AWOL; MULTIPLE JOB HOLDERS UP -- happy holidays; SOME visuals on UST supply -- for more see this mornings TECHS … and more … CLICK HERE if you missed it -- and we’ll add this to the debate Bloomberg’s latest MACRO VIEW: Mon 12/11/2017 3:50 AM

Agriculture Prices Provide a Warning to Bond Bears: Macro View (Bloomberg) -- Cheaper eats are great, but maybe not if you’re one of the many expecting a sustainable bump in bond yields next year. • Falling food prices risk wrecking the forecasts -- seen pretty much every December for years now -- for yields to climb in the new year. Ten-year Treasury rates haven’t closed a year above 2.45 percent since 2013. • Bond bears seem to struggle to incorporate structural disinflationary pressures that have come from technology and globalization • The Bloomberg Agriculture Subindex on Monday hit its lowest level since the series began in 1991. Technology and science are making the agriculture industry increasingly efficient, and there are still plenty of production gains to be made globally • Combined with the overhang of energy supply that’s capping oil prices -- and therefore processing, transport and distribution costs -- that means the long-term trend remains one of cheaper food prices • And food prices are a key component of consumer price index baskets around the world. The impact is global, real and seems to be constantly underestimated. Since Saturday, China, Denmark, Norway and the Czech Republic have all released CPI prints where the annual rate was both decelerating and below expectations. Food prices were specifically cited in China’s case • None of this is to argue that bond yields can’t spike higher for short periods. It’s just an argument to highlight that structural disinflationary pressures from technology remain strong and shouldn’t be dismissed. With several major central banks indicating that the marginal bias is to tighten policy, that will further crimp price rises. And that doesn’t bode well for a sustainable broad rise in developed-market yields • NOTE: Mark Cudmore is a macro strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice To contact the reporter on this story: Mark Cudmore in Singapore at [email protected]

AND SO … a visual Mr. Cudmore neglected to offer and so, WE do for you to consider:

So yer saying we eat AND put gas in our car and should consider FOOD? Oh, ok. How about we move right along then and continue to NOT mention BITCOIN or LOWFLATION being imported from China (did you see inflation data over weekend?) and move right along to another fan fav -- tax reform and repatriation to support high and rising equity valuations … because, you know, trees DO grow to the sky. IF a believer, then whatever you do, do NOT read Shilling’s latest view piece

Markets Risk Overvaluing Earnings Repatriation Domestic plant and equipment spending isn’t being held back by a lack of money. By A. Gary Shilling December 11, 2017, 6:00 AM EST ...My firm’s analysis shows that domestic plant and equipment spending isn’t being held back by a lack of money. Far and away the biggest driver of capital spending is the level of operating rates. When they’re low, there’s plenty of excess capacity and little need for more. In October, the Federal Reserve reported the nationwide rate at 77 percent, far below the low 80 percent rates that triggered capital spending sprees in past years. Consequently, plant and equipment spending in this business recovery has been centered on cost-cutting and productivity enhancement. Another misconception is that more capital spending leads directly to a surge in productivity. Our analysis reveals that the correlation between year-over-year changes in

plant and equipment outlays and productivity changes is very low. The strongest relationship between capital outlays in a given quarter and productivity is four quarters later, but that correlation is only 15 percent. Why is this? Adding more machines that are similar to what’s already on the factory floor doesn’t do much for increasing output per hour worked. Also, the productivity fruits of new technologies can take years or even decades to ripen. In my judgment, today’s productivity-laden new technologies such as biotech, robotics and self-driving vehicles will spawn huge productivity gains in future years, but are not yet big enough in relation to the overall economy to move the productivity needle significantly. ...Repatriation of foreign money won’t affect pretax earnings since those profits are already booked on consolidated statements. Reserves for tax liabilities may decline, however. Earnings brought home could be used for stock buybacks and dividend increases, but most of that money is already invested in the U.S. -- 95 percent, according to a Brookings study of 15 companies with the largest cash balances. That money resides in Treasuries, U.S. agency securities, U.S. mortgage-backed debt and dollar-denominated corporate notes and bonds. Apple, with $246 billion domiciled abroad, stated in its annual report: “The Company’s cash and cash equivalents held by foreign subsidiaries is generally based in U.S. dollar-denominated holdings.” Microsoft’s annual report says that more than 90 percent of its $124 billion in deferred cash was invested in U.S. government and agency securities, corporate debt or mortgage-backed securities. Those funds held abroad can’t be used to compensate U.S.-based employees or for capital investment without paying U.S. taxes, but if Apple wanted to do so, it easily could do just that from its U.S. cash hoard, by issuing bonds or taking out loans from banks that are only too happy to lend to a firm with such substantial assets, be they at home or abroad. Investors may benefit from repatriated earnings via stock buybacks and high dividends. But don’t expect a high wage-led burst of consumer spending or a surge in plant and equipment outlays. Oh, OK so high and rising equity ‘valuations’ can/will continue … but at WHAT true cost? We’ll leave that to YOU to contemplate -- along with the meaning of life -- as we all ALSO contemplate the meaning and VALUATION of 3s (1130a) and 10s up for auction in short order ahead of bonds tomorrow … all so as to clear the docket for Yellen’s swan song. Have a great start to the day and week and let us know however we can help as you get those bids in early and often!!?? Best, Saul/Steve

** from this past weekend ** Hey I know, wanna talk about the yield curve? How about Phillips Curve, instead? I know, let’s think about how Stanton hits the curves (and fastballs … and takes the pressure OFF)

Some THEMES -- following up on how we presented what it is we tried to present FRIDAY, before NFP … some THEMES with supporitve visuals FIRST, allow me to bore you to tears with a few NFP-related visuals. Wage Growth Fails to Rev Up Even in Tight U.S. Job Market: BBG Chart

U.S. wage gains are stuck in the slow lane even as the job market steadily tightens. Average hourly earnings increased 2.5 percent in November from a year earlier, less than projected, and were revised down for October, Labor Department data showed Friday. Meanwhile, payrolls advanced and the unemployment rate held at an almost 17year low. The disappointment on wages -- the theme throughout this economic expansion and one reason inflation has stayed low -- comes as the Federal Reserve gears up for its Dec. 12-13 meeting.

U.S. Job Market Not Looking Very Tight Based on Low-Skill Wages: BBG

...However, the following chart shows that the entire pickup over the last year can be traced to a single industry: security and armored car services, which only accounts for 0.6 percent of private-sector employment, but has seen wages shoot up by almost 20 percent.

Removing security and armored car services from the picture knocks the 3.9 percent wage growth for the bottom quintile down to 3.3 percent. That means it’s been more than a year since workers in the other low-paying industries have seen any acceleration in wage growth. America’s Factories Are Pumping Out Some Job Growth: BBG Chart

Where The Jobs Were In November: Who's Hiring... Who Isn't: ZH

AWOL -- Accelerating Wages on Leave (looks permanent): Rosy, FRI … Like I said, there is no sense quibbling over the veracity of today’s report. But I’ll take a stab at it anyway. Not everything came up smelling like roses. The ranks of the selfemployed rose 14k -- this is normally a counter-cyclical metric. Part-time work for ‘economic reasons’ jumped 48,000 last month. And maybe this is more of a social than an economic comment, but married men lost 175,000 jobs in November. This is either bullish for beer consumption, the NFL Network, divorce lawyers or quite possibly all three. All kidding aside, if there was one blemish in this report, just a bit of a dark lining in what was a very silver cloud, it was the complete stagnation in the transports. Whether it was air, rail, truck, or water, this was the one area, among the most cyclical

segments of the economy, which did not create one net new job last month. At the same time, the industrial sector posted a job gain that topped 30,000. So what do you think a technical strategist, especially a Dow Theorist, would label this report if it was the equity market? Answer -- a non-confirmation. Not just that, but i have rarely seen a healthy jobs market that was not associated with accelerating wage growth. This is simply not happening... AND one more we’ll offer to think about … IF jobs are SO plentiful WHY then are MULTIPLE JOB HOLDERS UP into the holidays …

I know, I know… everyone’s willing to beg/borrow/steal AND WORK MULTIPLE JOBS to put that new iPhone X under the tree for love one?? Ok, ENOUGH … turning quickly TO supply with 3yr auction and 10s at 1pm … 3s vs 2s5s (not roll-adj): CHEAP, RSIs are stretched and slow stochastics (momentum) on verge of BULLISH CROSS and MAY just have enough rate hike(s) priced IN:

AND should Dept of Treasury throw a party and NO buyers show up, Dealers ARE SHORT:

AND as far as 10s go, well, we’ve been on and about shorter-term T-line back to March (2.45) that almost doesnt show up on a 5y daily … there’s just not much ‘there’ there so I won’t labor the point

And again we ask what IF Treasury threw an issuance party and nobody showed UP? Well, at least DEALERS are short here, too -- first time since May!!

For the evil spec position, click up POSITIONS pdf and AND THEN, since on the topic OF issuance, there’s this Net EGB Supply Goes Well Into Negative Territory Amid Year-End (Bloomberg) -- Net EGB supply turns well into negative territory next week given the maturing BKO on Dec. 15 worth EUR13b. Austria and Italy have both canceled supply with only Germany and Spain in the market. •

•

•

• • • • •

Front-loading of ECB QE will likely continue before Dec. 21 (the last day of QE purchases in 2017), with net QE flows likely to fall this month to around EU50b; latest ECB asset-purchase data shows continued front-loading, with EU62.4b of purchases in November (similar to October and September) Support for core rates from a flow perspective will then reduce, with stretched valuations versus fundamentals, just ahead of large seasonal increase in supply in early 1Q 2018, see more here Year-end dynamics have likely driven Schatz yields lower to -74bp; swap spread volatility may grow into year-end given cross-currency basiswidening and spillover effects into German general collateral SUPPLY/REDEMPTIONS: EGB supply decreases to EU6b Dec. 12: German will tap EU3b 0% 2019 Dec. 13: U.K. to sell GBP0.8b 0.125% I/L 2036 Dec. 14: Spain to sell 0.05% 2021, 1.45% 2027, 5.75% 2032 NOTE: Auction calendar at ECO20 WE

With central planners meeting here/there/everywhere in the week ahead, and Yellen’s final press conference coming … I thought the following from Bloomberg’s Ira Jersey was interesting. In fact, it stopped ME dead in my tracks as I ponder whether or not the Fed cares about the yield curve. Fed Could Kill the Economic Patient by Steepening Yield Curve A potential Federal Reserve prescription to steepen the yield curve could end up harming the patient. Some suggest the Fed doesn't want to further flatten the curve, which naturally happens during hiking cycles. The Fed has two ways to cause a steepening -- stop hiking, or sell long-maturity bonds. (12/08/17) 1. Flat Curves Are a Symptom, Not the Disease Many believe a flat yield curve is a disease that causes illness to the economy. This leads some to think the Fed wants to avoid a flatter yield curve. However, the phenomenon is actually a symptom of the medicine designed to ward off higher inflation in the future. Flat curves are nothing more than the markets pricing slower growth and inflation far into the future compared with that expected in the near term. So should the Fed choose to try to increase inflation expectations, or steepen the curve?

The exhibit shows survey-based, long-term inflation expectations. For a long period from 2000-08 this survey was trendless, but since 2013 there's been a noticeable downtrend. Market-based inflation measures have also seen a similar trend. (12/08/17)

2. Good Prescription: Stop Hiking to Steepen Curve If the Fed believes that flat curves are the disease and not the symptom, it has several options. An obvious one is to stop hiking rates. Doing so while growth remains tepid but stable and unemployment is low would likely prompt the curve to steepen noticeably. Pricing out 2018 and 2019 hikes would likely steepen the two-year/10-year Treasury curve by 50 bps -- and perhaps more if long-end rates sell off on fears the Fed would be behind the curve on inflation.

Bear steepening of the Treasury curve is a rare occurrence. In fact, the last time this happened was in late 2016, as markets expected fiscal and monetary stimulus would combine to increase inflation. Curves steepened as market-based inflation expectations and Treasury yields rose. (12/08/17) NEXT, thinking about China’s next/greatest export … DISINFLATION? Yeah, gonna go there again … sorry, but have to given release of this data under darkness of (a Saturday)night December 8, 2017, 11:54 PM EST

China Factory Inflation Eases as Consumer Prices Remain Subdued: BBG

And finally, something new and different – a couple EQUITY RELATED hits/visuals – and a reminder – anytime a bond guy shoves an equity opinion your way, be very cautious. Of stocks AND of stocks OPINION from a bond guy … but still … these. First, David Tice – remember him??

Enjoy the rally while it lasts: Famed Wall Street bear warns 'the market is going to suck' next year: CNBC • •

Surging stocks could go even higher, but then succumb to a market that's "going to suck," David Tice told CNBC. The decline could be as deep as 50 percent, the permanently-bearish investor said.

AND THEN THERE IS THIS …

December 8, 2017, 4:43 PM EST

It Could Be a Perfect Year for the Stock Market: BBG  Rotation out of tech abates as Nasdaq rises four days in a row  Equities back to gains in December with seasonality in favor

Always end on a high note, right?

AND I’m done … have a great start to the end of the week. Best, Steve

Items of Interest

EconoDay Economic Calendar AND, ripped from the BBG:

Bloomy’s Fed-speak Calendar DecTAPER 7th, 2017

GPs Key Econ Indicators November 6, 2017 -> Our “Economic Graph Package” is used by some of our clients to include in their monthly or quarterly reports. We have most of the major economic indicators included to give an accurate snapshot of the economy.

GPs 5yr & Under Summary November 3, 2017- > this is our chart package we call the “One to Five Year Daily”. It tracks agency bullet spreads to Treasuries, date to date, to compute the real maturity spread levels (in basis points) out to five years. We track agency callables against agency bullets and Treasuries. We compare equal maturity dates when tracking these spreads because the effective durations of callables are not stable. So over time we have a consistent methodology that we use to determine “value”. Please give us a call for more in depth explanation. GPs Index Spread Summary November 6, 2017-> We use certain Merrill Lynch indices, which are described at the top of each graph, to try and determine optimal entry and exit points for each sector. Though the indices should have similar durations, they commonly don’t match precisely so we’ve included the green line (which should be read off from the right axis) to allow you to take the curve into account when looking at historical spread relationships.

GPs Daily Pivots DecTAPER 11th, 2017 -> the pivot point is essentially a mechanism for analyzing the short-term supply and demand factors affecting the market. It has limited applications for long- term decision making. Professional futures floor traders, also known as locals, are the biggest proponents of the pivot technique. Scalpers, brokers, market makers, and other short-term traders also use the technique, while upstairs or longer-term traders occasionally look at the pivot for ideas of what the floor traders are doing. The pivot point is basically the weighted average price of the previous trading day, calculated as the average of the previous trading day’s high, low, and closing prices. It represents the major point of inflection each day. Unless there has been significant market news between the previous trading day’s close and the current trading day’s opening, locals often try to test the near term support, resistance, and pivot point. For example, many floor traders cover their shorts and go long into the pivot level if the market opens above the pivot point and starts to sell off.

MMO for December 11, 2017 Chair Yellen is likely to keep things simple in her final quarterly press conference. The FOMC will stay on schedule with another rate hike, and we don’t expect any fireworks in the messaging that accompanies this week’s policy move.

December 12-13 FOMC meeting preview • • • • •

The FOMC probably won’t incorporate the tax cut into its forecasts this quarter We expect only minimal upward drift in the dot plot The Fed’s GDP forecasts may inch up again… …but the inflation forecasts are likely to be static Probably only one dissent, but a second “no” vote is not out of the question

…Inflation Forecasts.

The FOMC’s inflation forecasts will be less supportive in the near term. The median projection for the 2017 YOY growth rate of the core PCE price index will probably remain at last quarter’s level of 1.5%. The median forecast for 2018 slipped a tenth of a percent to 1.9% last quarter, and we doubt that the Fed has seen enough in the price data over the past three months to push that back up to 2% in this week’s SEP. On the contrary, some committee members may be influenced by the fact that the Board staff (according to the FOMC minutes) lowered its 2018 core inflation forecast slightly at the November meeting. Like many market participants, we think the disinflation trend has turned the corner in recent months and that 2018 will see a moderate rebound in core consumer price trends. However, the FOMC is still waiting for more concrete data to support that view.

In The Press NOW:

December 9, 2017 UP AND DOWN WALL STREET

The Greatest Investment Bubble …But

the size of Bitcoin pales against what really is the biggest bubble in the world. That would be the trillions of dollars worth of bonds with negative yields, contends David Rolley, co-team leader of the global fixed-income and emerging-debt group at Loomis Sayles. According to JPMorgan’s latest tally, there is some $10.1 trillion in global government bonds with yields below zero—or 40 times as much as Bitcoin. That is down from the peak of $12.7 trillion reached in July 2016 in the wake of the market panic following the Brexit vote. Of course, this isn’t the product of wild-eyed speculators’ relentless chase of a market’s accelerating ascent, but the result of sober central bankers’ monetary policies. The European Central Bank has been buying 60 billion euros’ ($70.6 billion) of bonds per month. The Bank of Japan, meanwhile, is acquiring Japanese government bonds in sufficient quantity to keep its 10-year yield pegged near zero percent. In addition, JPMorgan also notes, euro-denominated corporate bonds total €847 billion, equal to 40% of the sector, a reflection of ECB buying. Among the bonds the ECB has snapped up are securities of Steinhoff International Holdings (SNH.Germany), which last week delayed its financial results and was investigating “accounting irregularities,” resulting in a 60% one-day drop in its shares.

The real effect of the negative bond yields has been to exert a downward gravitational pull on interest rates everywhere, even in places where they never fell below zero, as in the U.S. dollar market. Clearly, however, a security that guarantees a loss (if held to maturity) can’t be rationally priced. Only if its yield falls further, and its price rises, does it make sense. That’s what makes it a bubble. …“I am completely amazed at the nonchalance with monetary policy, and some do not even mention it as a risk factor,” he writes in a client note, after listening to sell-side prognosticators’ 2018 market predictions. “Let me know if you’ve seen one forecast that includes a lower P/E multiple due to $1 trillion of liquidity that is being removed by the Fed and the ECB alone in 2018 on top of more Fed rate hikes. I haven’t seen many.”

December 9, 2017 BARRON'S COVER

Outlook 2018: The Bull Market’s Next Act Wall Street strategists see U.S. stocks rising 7% in the coming year, fueled by earnings growth. …The outlook isn’t entirely rosy: Interest rates are headed higher, stocks are expensive, and a tax overhaul could still stall or fail. But so long as corporate earnings keep climbing and the Federal Reserve raises rates in a measured way, the strategists see more room for gains. …The

strategist got a few important things right last December in looking ahead to 2017. They predicted that stocks would rise this year, speculative activity would revive, and financial stocks would do well again after gaining 20% last year. Indeed, financials are up 20% this year. The strategists were too timid, however, in their market forecasts; their mean prediction put the S&P 500 at 2380 at the end of the year. That now seems highly unlikely, barring a sudden last-minute rout. …ED

YARDENI, PRESIDENT of Yardeni Research, is no stranger to Wall Street but a newcomer to our panel—and its most exuberant bull. He sees the S&P 500 ending next year at 3100, which would reflect a gain of about 17% from current levels. Just don’t give all the credit to tax relief, he says; a second year of global economic growth could ignite fresh enthusiasm for stocks. Corporate earnings growth remains a relative novelty for investors. In the three years prior to 2017, S&P 500 profits were flat at about $118.

…WHILE ALL OUR STRATEGISTS expect stocks to head higher in 2018, some see a yellow light, not a green one, suggesting that the bull’s days are numbered. Morgan Stanley’s chief U.S. equity strategist, Mike Wilson, anticipates a “belowaverage year,” with the S&P 500 up about 4%, to 2750, compared with a roughly 13% annual gain since 2012. Although earnings will rise next year, he says, this is a “late-cycle environment for the American economy and equity markets.” …Market strategists expect U.S. stocks to outperform bonds again in 2018, especially with interest rates rising. The Bloomberg Barclays U.S. Aggregate Bond index is up only 3% this year, and 10-year Treasury yields have fallen to 2.38% from 2.45%, although they have rebounded from a low of 2.04% earlier in the year. (Bond prices move inversely to yields.) The strategists’ 2018 year-end consensus forecast for the 10-year Treasury yield is 2.8%. “It’s hard to like bonds,” says Yardeni, summing up the prevailing view.

Dec. 10, 2017 2:22 p.m. ET

EU Officials Warn of Risk to Global Trade

European Union officials said the U.S. is threatening to cripple global commerce by undermining the World Trade Organization, ahead of a gathering of officials from 164 countries on Sunday in Buenos Aires. Updated Dec. 10, 2017 6:46 p.m. ET

Senate Bill’s Marginal Tax Rates Could Top 100% for Some

Some high-income business owners could face marginal tax rates exceeding 100% under the Senate’s tax bill, which lawmakers rushing to write the final measure are working to prevent. Dec. 11, 2017 5:30 a.m. ET

Small Investors Face Higher Taxes Under Senate Proposal A little-discussed provision in the Senate tax bill could lead to a higher tax bill for millions of small investors and may cause many to unload stocks before year-end to avoid those costs. Dec. 10, 2017 8:00 a.m. ET

U.S. Sets January Push for $1 Trillion Infrastructure Revamp

The White House is preparing to roll out a long-delayed infrastructure rebuilding plan in January, asPresident Donald Trump’s advisersbet that voterswant a $1 trillion roadand-bridge-building plan—even though it is opposed by some lawmakers.

Dec. 11, 2017 5:30 a.m. ET

Emerging Markets Barrel Ahead Despite Tightening Fed Emerging markets, long vulnerable to the whims of central banks in the developed world, now seem to be more Fed-proof than ever, as they are enjoying what some analysts call a “Goldilocks” moment.

Once the W.T.O.’s Biggest Supporter, U.S. Is Its Biggest Skeptic

The Trump administration isn’t alone in criticizing the World Trade Organization. But it may be the only country trying to subvert it.

GOP sacrifices precision for speed as it rushes tax bill ahead The $1.5 trillion legislation was introduced in the House a little more than a month ago and is now hurtling toward passage without any hearings, which is unusual for a bill of such magnitude. And it has picked up some new provisions that have surprised industry groups, Democrats and even some Republicans.

GOP tax plan diverges wildly from Trump’s promises to the middle class The bill was supposed to deliver benefits to average working families, not corporations, with a 35 percent tax cut President Trump offered on the campaign trail. But the final product is looking much different, the result of a partisan process that largely took place behind closed doors, faced intense pressure from corporate lobbyists and ultimately fell in line with GOP wish lists.

8.8 million Americans face a major tax hike if the GOP eliminates the medical deduction The deduction started in 1942 to help people deal with costs that hit when someone has cancer or needs round-the-clock care. The House version of the tax plan would scrap the deduction; the Senate bill would make it more generous. But the two plans must be reconciled.

Why these researchers think most Americans could end up losing under the GOP tax plan Paying for the tax cut by reducing programs that help the poor and middle class would leave many Americans in the bottom 60 percent in a worse spot than they would have been without the tax cut.

Americans are drowning in debt. Here’s where they have it the worst. Rates of past-due debt are generally highest in southern and western states and lowest in the upper Midwest.

Published 12:58 p.m. ET Dec. 8, 2017 | Updated 4:06 p.m. ET Dec. 8, 2017

Jobs: November employment report offers positives, negatives for U.S. workers Published 7:00 a.m. ET Dec. 10, 2017

3 steps to tame your debt in an hour or less

US economic cheer points to series of Fed rate rises Impending tax cuts and buoyant markets underpin sunny outlook

Fresh warnings to debt-ridden China of living on borrowed time 10 Dec 2017 - 7:26am

Chinese local governments accused of faking economic data 9 Dec 2017 - 8:21pm

China set to unveil economic prescription for next 12 months 10 Dec 2017 - 9:11am

Mainland stock declines to end in 2018, small caps tipped to enter the fray 11 Dec 2017 - 4:52am

When China’s leaders meet at the end of each year to judge the state of the economy and set policy priorities for the next 12 months, they do so behind closed doors and only release a summary of their findings when the meeting is over.

From The Blog-O-Sphere: Here you’ll find postings and research from the likes of Barry Ritholtz’s Big Picture, Pragmatic Capitalism, Kimble Charting and Zero Hedge - along with everything else we stumbled across that WE need to point out …The point of all this is to pass along things that strike us as interesting – even though they may NOT be our very own…

Dec 10, 2017 4:35 PM

Bank of America: "We've Seen This Movie Before: It Ends With A Recession" In a merciful transition from Wall Street's endless daily discussions and more often than not- monologues - of why vol is record low, and why a financial cataclysm will ensue once vol finally surges, lately the main topic preoccupying financial strategists has been the yield curve's ongoing collapse - with the 2s10s sliding and trading at levels last seen in April 2015, and with curve inversion predicted by BMO to take place as soon as March 2018. And, according to at least one other metric, the yield curve should already be some -25bps inverted. This is shown in the following chart from Bank of America which lays out the correlation between the US unemployment rate and the 2s10s curve, and which suggests that the latter should be 80 bps lower, or some 25 basis points in negative territory.

Here is some additional context from BofA's head of securitization Chris Flanagan, who views "the recent sharp flattening of the yield curve, which has seen the 2y10y spread go from 80 bps to almost 50 bps since late October, as the natural course of events at this stage of the economic cycle. Unemployment is low, and probably

headed lower, and the Fed is intent on raising rates to stave off future inflation; we've seen this movie before and it typically ends with a flat or inverted yield curve. Based on history (and gravity), we think the most likely path forward is that the 2y10y spread reaches zero or inverts sometime over the next year or so and that recession of some kind follows in 2020 or 2021. (Given that the curve has flattened 30 bps in just over a month, projecting an additional 50 bps flattening over the next year is not really too bold.) Of course, much can happen along the way to change that outcome, but for now that seems to us to be the most likely course of events to us." Here Flanagan openly disagrees with the BofA's "house call" of a steepening yield curve, and explains why: We note that flattening is not the house call: BofAML rates strategists believe the curve will steepen due to easier fiscal policy, higher deficits, and a higher inflation expectation and the Fed will require higher 5y-10y yields as a precondition to flattening or inverting the curve. We recognize that the flattening process has already taken longer than we expected a few years back, due to multiple dovish Fed hikes, and we acknowledge the potential for what we think would be steepening detours along the way. In our Year Ahead Outlook, we tried to be especially mindful of the fact that a year is a long time and a lot can happen along the way. This would be a good example. Nonetheless, the Fed's recent intentness on tightening in the face of low inflation readings makes us believe the last 50 bps of flattening likely will be achieved over the course of 2018.

.. Finally, for some timing context, BofA shows the following chart of GDP growth

vs the yield curve: the curve hit zero by the end of 2005 and inverted in 2006; economic growth steadily slowed in 2006 and 2007 but it wasn't until 2008 that the downturn accelerated. Credit spreads widened and began anticipating the downturn in mid2007, after the curve had been flat for over a year.

December 7, 2017

QE Unwind is Really Happening: Fed Assets Drop To Lowest Level In Over Three Years Fed’s assets drop to lowest level in over three years. The Fed’s balance sheet for the week ending December 6, released today, completes the second month of the QE-unwind. Total assets initially zigzagged within a tight range to end October where it started, at $4,456 billion. But in November, holdings drifted lower, and by December 6 were at $4,437 billion, the lowest since September 17, 2014:.

The Econtrarian Saturday, December 9, 2017

Don't Expect an Investment Boom if the Corporate Tax Rate Is Cut December 11, 2017 Don’t Expect an Investment Boom if the Corporate Tax Rate Is Cut It appears as though the rate on U.S. federal corporate profits is going to be reduced. Although U.S. corporations may be considered “people” in terms of the First Amendment, they are not “people” when it comes to paying taxes. Corporations are de facto tax collectors, not tax payers. Real people ultimately pay the taxes in one way or another on the profits that corporations earn. So, why don’t we relieve corporations of their tax-collecting duties and tax their shareholders directly on the accrued profits of corporations in which they own shares as Laurence Kotlikoff, Boston U. econ professor and 2016 write-in presidential candidate, has suggested? If this were done, the tax on dividends and, thus, the double taxation of corporate profits would be eliminated. Alas, this kind of tax reform is not in the cards, but a cut in the corporate profits tax would be a step in the right direction.

One of the arguments being made in favor of the cut in the corporate profits tax rate is that it would unleash a torrent of investment on the part of corporations. In turn, this increase in business investment would enhance the potential real growth in the economy and would increase the capital-tolabor ratio. An increase in the capital-to-labor ratio would raise the productivity of labor, which eventually would lead to an increase in real wages. Whoa, Nellie! There are some ugly facts that counter this beautiful hypothesis. For starters,

profits from domestic corporate operations after federal tax as a percent of GDP are relatively high in an historic context, as shown in Chart 1. From 1955 through 2016, the high in nominal after-tax corporate profits from domestic operations as a percent of nominal GDP occurred in 2012 at 7.6%. In 2016, after-tax profits relative to GDP stood at 6.9% vs. a median value of 5.5%. Despite corporate after-tax profits being relatively high, real business fixed investment (structures, equipment and intellectual property products) as a percent of real after-tax corporate profits is not exceptionally high, as shown in Chart 2. In 2016, real business fixed investment was 191.5% of real after-tax corporate profits. Although this was above the median of 174.5%, it was well below the record high of 323.7% of 2000 or the nearrecord high of 300.7% in 2008. So, despite U.S. corporate after-tax profits currently being high absolutely and relatively, real business fixed investment currently is not particularly high compared to real after-tax profits. Although a decrease in the corporate profits tax rate would, all else the same, increase after-tax corporate profits, it is not clear from the data presented in Charts 1 and 2 that an increase in after-tax corporate profits would result in a big increase in business fixed-investment spending.

…Before betting that a cut in the corporate profits tax will result in an investment boom, it might be instructive to see what nonfinancial corporations have been using their after-tax profits for in recent decades. The data in Chart 4 show that starting in the mid 1980s, nonfinancial corporations stepped up their dividend payments and equity retirement (share buybacks) relative to their after tax profits. How could the sum of dividend payments and equity retirement be more than 100% of after-tax corporate profits in some cases? Corporate borrowing.

In sum, by all means, cut the tax rate on corporate profits. But don’t expect the taxrate cut to unleash a torrent of business investment spending. Currently, corporate after-taxprofits already are high relative to GDP, yet business fixedinvestment spending relative to after-tax profits is not exceptionally high. Moreover, in recent decades, corporations have shown a preference for using after-tax profits to pay out dividends and buy back shares rather than make capital investments. Paul L. Kasriel Founder, Econtrarian LLC Senior Economic and Investment Advisor Legacy Private Trust Co. of Neenah, WI [email protected] The Econtrarian 1-920-818-0236 “For most of human history, it made good adaptive sense to be fearful and emphasize the negative; any mistake could be fatal”, Joost Swarte

FRIDAY, DECEMBER 8, 2017

No jobs boom yet, but...

The November jobs data were slightly better than expected (+221K vs. +195K), but from a big-picture perspective, jobs growth remains at best moderate. Private sector jobs, the ones that count, are increasing at a 1.6-1.7% annual rate, as they have been for most of the past year. Ho-hum. However, small business optimism looks strong, particularly in regard to future hiring plans. Small businesses are almost sure to be the main engine of jobs growth going forward, so this is very good news. Chart #1

Chart #2

As Charts #1 and #2 show, there hasn't been any change in the underlying rate of growth of private sector jobs for most of the past year. Indeed, the pace of hiring this year has been slower than it was in prior years…

…As I mentioned earlier this week, though, the market has still not priced in a stronger economy. Optimism is building, but the market is still in a "show-me" frame of mind.