Last week, interest rates moved slightly lower, with the 10-year T-Note falling about 7 basis points from 0.71% to 0.64%, a retracement of 37% toward the 0.51% August 4 low. Like its brethren, the 30-year T-Bond fell 10 basis points from 1.45% to 1.35%, a 38% retracement to the 1.19% low (also August 4). Some of the up-move had to do with the “Inflation Scare” discussed in last week’s blog. But most of the up-move was the result of the sheer volume of new debt coming to market. When a Treasury auction doesn’t go so well (Reuters Headline: “U.S. sells $25 bln 20-year bonds to tepid demand”), rates naturally rise. So, why the re-emergence of the downtrend?
Some of it may be related to the growing recognition that we have yet to see the worst of the Recession, and when we do, the Fed will have little choice but to print more money. The chart below, which shows retail sales making a new high (with 28 million people still unemployed) is all you really need to know. The April $1,200 stimulus checks and the extra $600/week of unemployment benefits actually grew personal income (PI) at a $2.2 trillion annual rate (12% annualized growth). And, as I write, we are still awaiting the next installment from Congress.
At the same time as retail sales and PI were smashing records, the savings rate established some new records of its own, currently standing at 19% of PI. Consumers haven’t taken any vacations lately. Nor have they gone to many restaurants. In fact, most leisure activities have been curtailed. Thus, the rise in the savings rate. What we do see, however, is a significant rise in spending on home improvements (look at HD, and LOW revenues and earnings). And the one sector of the economy that is doing well is new home construction, especially in the suburbs (Housing Starts +22.6% in July!).
There have been discussions in the economics blogosphere about where the Fed’s balance sheet will get to when the real bite of the Recession is felt. As of August 19, the size of that balance sheet is $7.01 trillion. For context, it was $3.76 trillion a year ago on August 21, 2019 (which was still bloated from the ’08-’09 Recession). That’s an 86% ($3.25 trillion) expansion. It appears that the Fed will re-double that effort when the chips are down. Some of the bloggers say that the balance sheet will have to top $10 trillion, i.e., $3 trillion more. Doing the math, for every $1 trillion added to the money supply (Fed’s balance sheet), the annual growth in M2 rises about 7 percentage points. As of August 19, the Y/Y growth in M2 was 22.4%. Adding another $1 trillion puts that growth rate near 29%, and $1 trillion after that puts it at 36%. A third $1 trillion ramps it up to more than 42%! The table below, from my blog of two weeks ago, shows the rate of money growth in the world’s more important economies. None of these economies show money growth even close to the U.S.’s, much less what it may turn out to be when the Fed expands its balance sheet to cope with the real, but belated, Recession impacts.
Gold is priced in dollars. There is a very strong relationship between its value and the value of the dollar (see chart). Imagine how fast the value of the dollar will fall and the (dollar) value of gold rise if the U.S. money stock grew 42% while the rest of the world continued to expand their money stocks at the rates shown in the table. The scariest issue here is the possibility that the world no longer uses the dollar as the reserve currency!
What’s the Fed Thinking?
In the minutes of the recently held Fed meetings (July), the Fed chiefs indicated that it would continue to expand its balance sheet, as needed. This was no surprise. Discussed at the meeting was a strategy of pegging the Treasury yield curve (i.e., pegging rates for the 1, 2, 5, 10, 20 and 30-year securities). In the minutes, the Fed indicated that it was not going to implement this strategy at this time. When that was revealed last Wednesday, there was a brief back-up in yields.
But, the real kicker was the Fed’s view on the economic outlook. The Fed gave two scenarios, both of which are given an equal probability. In all of my many years of Fed watching, I have never seen them gravitate toward a pessimistic scenario or come off as a worried bunch. But they did in July. In this scenario, the virus has a second wave, more businesses close, GDP falls again, unemployment rises, and deflation prevails.
And their view on the recent upward move in the CPI (i.e., the “Inflation Scare”) is that the negative impact of the pandemic on aggregate demand more than offsets upward price pressures due to supply issues. Well, at least for now. (My comment: The money creation, supply issues and some demand improvement will eventually lead to inflation.)
The Economy
Recent data show some slight improvements in the high frequency data. For example, OpenTable restaurant bookings are slightly higher in mid-August than they were in mid-July (but, still, down more than -50% from their February levels), and TSA passenger counts are up, as are the retail sales and housing starts alluded to earlier. But, as explained, we are still living on the sugar high of free money, and it appears more is on its way. The real economic consequences come when the helicopter money stops.
Employment
As expected, August showed some deterioration in the weekly state Initial Claims (IC) data (week of August 15). IC rose +53k (not seasonally adjusted- NSA) from +839k to +892k, as businesses, now well past any PPP requirements and realizing that the nascent recovery has flattened, continue to lay workers off. These ICs must fall toward their more normal 100k-200k levels for the economy to regain its swagger.
But there was some good news on the employment front, albeit not covered by the business news media! State Continuing Claims (CC) data (week ended August 8) fell -936k (NSA) from 15.201 million to 14.265 million, as some businesses were allowed to re-open. Despite the fall, this number is still mind-bogglingly high! For context, a year ago, this number was 1.619 million (about 11% of the current level).
Unlike the state numbers, the Pandemic Unemployment Assistance (PUA) (the supplemental program created by the CARES Act to aid the self-employed and independent contractors not eligible for the state unemployment programs) new weekly Initial Claims (IC) (week ended August 15) rose +53k from 490k to 543k. The PUA Continuing Claims (CC) data has a 2-week lag, so the latest data there are for the last week of July (week ended August 1). In that week, PUA CC rose +502k, from 10.723 million to 11.225 million. The combined state and PUA data (lagged back to August 1) still shows 28.1 million people unemployed.
The conclusion here is that employment is still a mixed bag. The mid-August state data does show hope. As seen in the chart, the downtrend in the unemployment levels continues.
Bankruptcies (BKs)
Below is an update to the weekly BK chart that I have included in this blog for the past few months. The annual BK rate reached 275 in mid-August (publicly traded companies from the Bloomberg database). As of August 20, the annual rate stood at 273. For context, in 2019 there were 139 BKs of publicly traded companies, and there were 118 in 2018. I expect this rate to accelerate when the helicopter funding ends.
Conclusions
- The economy remains on a free-money induced sugar high;
- The consequences of the Recession are still “down the road;”
- When those consequences do present themselves (rising BKs, stubborn unemployment, foreclosures, loan losses, evictions…), the Fed will have no choice but to print more money;
- The result is that the intermediate term prospect is for continued dollar weakness vis-á-vis other currencies;
- That means rising gold prices and ultra-low interest rates.
