March 28th FOMC meeting

This will be Ben Bernanke’s first FOMC meeting as Fed Chairman and the consensus from the “pros” is that the Fed will increase the Funds rate by 25 basis points to 4.75%. But there is more than a month remaining before the meeting and Mr. Bernanke stated last week in his appearance before Congress that the Fed’s decision will be “data dependent.” I have often written that we only see life as we experience it and for the past 18 years we learned the “Greenspan” way where the FOMC basically approved whatever Alan wanted and whenever he wanted it….But this Fed Chairman may be different…Ben Bernanke served as a Fed Governor from 2002-2005 and has attended many FOMC meetings and there is no reason to believe that he will run the Fed in the same way as his predecessor…. We just might see something similar to recent events in England where the Bank of England’s Monetary Policy Committee (similar to our FOMC) publicly announces member votes and they are NOT all unanimous. In August of 2005 the MPC voted 5-4 to cut short term rates and that decision overruled Mervyn King (Chairman) who wanted no change in rates.

Although the press has spent much time giving us many reasons why the Fed must raise the Funds rate (inflation fears, strong economy, etc.) have we forgotten so quickly that historically changes in monetary policy take at least 12-18 months to have an effect on the US economy. In a March 2004 speech Mr. Bernanke said: ” Because monetary policy works with a lag the ability of policy makers to stabilize the economy depends critically on our ability (Fed) to peer into our cloudy crystal balls and see something resembling the future.” In 2005 he spoke he opinioned that the Fed should NOT tighten when the yield curve was inverted. Now in February 2006 we see the 3 month Treasury bill yielding 4.58% and the 10 year Treasury note at 4.56% so the curve is slightly inverted….why the 3 month bill and the 10 year note???? In 1996 Fed Chairman Greenspan asked the New York Fed to study the effect of the yield curve on future economic activity and create probabilities of recession based upon the spread between the 3 month bill and the 10 year note. http://www.newyorkfed.org/research/current_issues/ci2-7.html This study found that when the curve has a spread of 2 basis points there is a 25% chance of an impending recession and a spread of 25 basis points increases the probability to approximately 35% and a 50 basis point spread equates to a 40% probability. The purpose of the Fed is to implement a monetary policy that insures economic stability NOT a recession and a 1/3 chance of an economic downturn is more than the Fed wants to risk in almost any type of low inflationary environment. The 3 month Treasury bill closely tracks the Fed Funds rate so if the Fed does raise the Funds rate to 4.75% that would increase the chances of a recession to the 35% level. Two Fed Funds rate increases would increase the probability to almost 40%….and this is just one of the many reasons that I remain the lonely voice of reason and believe that the Fed will NOT raise the Funds rate on March 28th. There is one more important part of this yield curve relationship and that is the part that the Fed can NOT control…the interest rate on the 10 year Treasury note currently at 4.56%, If this rate were to decline (more of a probability in the summer of 2006) it would create a wider inverted curve with the current Funds rate of 4.50%. I know this is probably more than many of you want to know about interest rates but it is important to be aware of facts that never seem to make it to the daily newspapers and other media sources that so often help frame the opinions of many business people and investors.

BOTTOM LINE: I continue to believe that long term rates will plunge to new lows later in 2006 as the inflation fears that are so prevalent fade away with the reality that inflation is 2%……and not climbing…..

100 year mortgage loans???

John Crudele wrote an article in today’s New York Post that suggests home mortgage lenders should begin to offer 100 year mortgages so that parents can pass on their house and mortgage to their kids. With many of today’s mortgage products now interest only I’m not sure why this would be popular to homeowners but it is an interesting thought. http://www.nypost.com/business/62260.htm

Rising Air fares

Jet Blue and Southwest Airlines announced that they are raising air fares to offset rising costs (oil) and the entire airline industry in watching closely to see if this price increase has traction for the first time in many years. If we were in an inflationary spiral (late 1970’s/early 1980’s) this would not be a big news item but airlines have found it difficult as consumers only spend more $$$ on items when they are able to cut back on other purchases. Last fall the increasing price of oil toward $70 drove gasoline prices over $3 per gallon but forced many shoppers to cut back on non-essential items thus cutting demand and prices and offsetting the oil prices inflationary impact on the US economy. http://www.boston.com/business/globe/articles/2006/02/23/jetblue_southwest_to_raise_air_fares/

Can you name the Iceland currency???

Did you even know that Iceland had a currency?? It is the krona and yesterday it fell almost 5% in value as the “hottest” trade is causing a massive amount of pain to worldwide speculators who are borrowing money in low yielding currencies (yen at 0.01%) and investing the loan proceeds in high yielding (10%) currencies (krona). Although volatility in the US market is at a 40 year low the next global economic accident waiting to happen is sure to come from the hedge funds that have grown exponentially in size in the last few years and travel the globe electronically 24/7 in search of higher returns with what they hope is minimal risk…..when this accident occurs it is going to be very ugly…..do you remember Long Term Capital in 1998???

Tokyo real estate

I am often asked about good locations for the purchase of real estate income properties…how about Tokyo where for the first time in five years we see office rents increasing and vacancy rates falling…..The Bank of Japan is looking for a reason to raise its overnight lending rate from 0.00% and with the economy growing at a 5%+ rate, the stock market climbing and real estate ending a 10 year+ price decline the risk/reward ratio looks favorable….In the US big city apartment buildings appear to offer one of the worst risk/reward ratios (99% of US investors believe that there is NO risk in real estate) as a New York research firm found that apartment prices are more than 20% overvalued based on current building rents with the president of the research firm stating that soberness and prudence are warranted……my forecast is unchanged….the real estate market won’t crash….after a pull back in prices that allows the late comers to pile in we will see a 5-10 year slow erosion in prices….my favorite expression for 2006 to real estate investors is: “never confuse a bull market with brains”…those that have the common sense to get out now will live to invest another day and those that stay will be waiting many years before they ever see any appreciation with condos my #1 pick for worst performance by an asset in 2006.

Looking to buy a home??? Try Tucson

According to the Arizona Star the supply of homes is the highest in nine years as there were 6,499 homes listed for sale in January an increase of 87.3% over January 2005. I’m sure you could find a mortgage lender who would be happy to lend 100% of the purchase price as 43% of first time home buyers in 2005 put down 0% down according to a study released Tuesday by the National Association of Realtors. Don’t forget the Tucson weather is always nice in the winter….http://www.azstarnet.com/allheadlines/116830

Looking for a job?? Many CEO positions available

According to the consulting firm Challenger, Gray & Christmas there were 1,322 CEO departures in 2005 compared with just 663 in 2004. The computer and health care industries had the most turnover but I have a feeling that the leader in 2006 will be real estate companies…..

It’s been a warm winter

The warmest winter (39.5 degrees) in over 100 years has skewed many of the recent economic statistics (housing starts, etc) and is making the US economy appear stronger than it actually is…normal January seasonal adjustments have added much to the inflation scare and should be offset by weaker February numbers but never lose sight of the important fact that the Fed has never been able to correctly predict in advance their upcoming changes in interest rate policy. Every inverted yield curve of the last 35 years has brought comments from Fed officials that “this time is different” and so far every instance has the same result….recession……..Last week Mr. Bernanke said: “I think at this point in time that the inverted yield curve is NOT signalling a slowdown” and he mentioned the strong January economic data. This may be true in January and February but I remind the Fed Chairman of his own words (see the top of this e-mail) that Fed decisions made today will not be felt for 12-18 months and by then the inverted yield curve will have taken its toll on the economy and especially the housing sector. Caroline Baum of Bloomberg wrote an excellent piece earlier this week showing how many incorrect predictions have been made by members of the Fed just before turning points in monetary policy: http://www.bloomberg.com/apps/news?pid=71000001&refer=columnist_baum&sid=aW3tleW8A76o

I have been studying interest rates and worldwide economic conditions on a daily basis for over 40 years and I am constantly reminded that the more things appear to change the more they really stay the same….History does repeat itself….unfortunately NOT when most expect…….

I welcome your comments and questions………..

February 13, 2006

The NEW Fed

The times they are changin….it’s been just two weeks since Alan Greenspan left his throne and somehow he has become a bigger story outside the Fed than he was the last six months inside the sanctuary…..Poor Ben Bernanke (new Fed Chairman) as he has taken office and is preparing for his first BIG speech on Wednesday to the House Financial Services Committee. Mr.Greenspan just couldn’t stay away from the bright lights in a singleweek he spoke to a “very private” dinner at Lehman Bros. for its best clients and was paid $250,000 for his comments about interest rates. This one hour of consulting was more than he earned from Uncle Sam ($180,100) in all of 2005. He also managed to consult (free) the Bank of England, spoke via television ($120,000) to a private Japanese investment firm and has an agent marketing ($5 million??) a book proposal to major US publishers. Wow! He has hit the ground running BUT is this really what a former Fed Chairman should be doing just days after leaving the most powerful financial job in the world??? I remember previous chairman Paul Volcker’s retirement where he flatly refused to comment to any public or private entity about interest rates for over a year because he wanted to avoid the limelight for the new Fed Chairman (Alan Greenspan). It would be nice if Mr. Greenspan would have the same respect for the new Fed Chairman but it appears that the BIG $$$ is just too much of a temptation….is he worried that there won’t be a demand for his comments in a year???? Yes he is the greatest central banker that ever lived but if he keeps opening his mouth to the highest bidder his credibility will be diminished in short order.

The Fed announced last week that the next FOMC meeting has been extended by one day and will now take place on March 27th and March 28th with the much anticipated interest rate announcement taking place on Tuesday March 28th at 11:17am. I am probably the only person in the country who believes that the Fed will NOT raise the funds rate by 25 basis points…why they want a more inverted yield is beyond me…..don’t they remember the 1996 NY Fed study showing the chances of a recession rise dramatically when the curve inverts????

Snow in Central Park

27 inches of snow fell in Central Park New York on Sunday and soon investors (gamblers??) will be able to trade financial contracts on the Chicago Mercantile Exchange pegged to snowfall levels at Logan airport in Massachusetts and Central Park. The contracts will cover the months between October and April of each year and with commodity fund growth going parabolic we will soon see many armchair weather forecasters sitting in front of their televisions rooting on the upcoming storms headed east. The weather channel’s ratings will soar and instead of Sunday football capturing the nations attention we will now have everyday weather junkies trying to hit it big with snow flurries……

The world is upside down???

It was 90 degrees in Los Angeles on Sunday and the wettest month of the year is always February in Southern California so what is going on???? Someone donated 1000 umbrellas to Food on Foot and we couldn’t sell any at Sunday’s feeding (people paid us $2 each and then told us to keep our umbrellas)…..

Did you know that the US Post Office is actually making a profit??? Even stranger it has used these profits to retire its entire $11 billion of long term debt. The reason is not better service but e-commerce…shipping items that are purchased on the internet and shipped from factory to consumer. Yes UPS and Fed Ex are also seeing a profit surge but I find it incredible that the post office can actually make a profit…..

With commodity prices going higher and higher (oil, copper, aluminum, etc.) many South American countries are awash in BIG dollar profits and are using this money to retire debt. Last week Brazil announced that it has bought back $2.3 billion of its outstanding bonds and last month Argentina paid off its entire $9.5 billion of debt to the International Monetary Fund.

State lotteries compete on the web

Many states are finding lottery sales slowing and are considering web-based lottery games that will compete with offshore gambling. Although the Justice department seems to believe that online gambling is illegal this might only apply to interstate wagers (not intra-state). With online gambling totaling $12 billion and lotteries only representing $2 billion this is a fertile area for states to raise $$$ without having to raise sales or income taxes as will be needed when (not if) the real estate market slows down to a crawl……

Ethanol

According to Sweden’s Minister of Development (does the US have one of these??) there will no need for petrol by 2020 as Sweden will be fully converted to ethanol as the fuel of choice…did you know that Rudolph Diesel planned his first engine to run on peanut oil and Henry Ford designed a version of the Model T that ran on ethanol that was made from corn??? the more things change the more they remain the same…..

China

According to last week’s People’s Daily the supply of real estate in China is growing rapidly as the floor space of vacant houses was 114 million square meters at the end of November which was 14% higher than one year ago. US investors that are looking for bargains might want to go house hunting in China but if your not going to change residences I’m not sure who you could flip it to in the next year for a profit??….If you are only interested in land there is 167 million square meters of vacant dirt just waiting for the right buyer but mortgage lenders aren’t ready for those 100% no doc, no asset, no income loans yet so you will have to pay all cash…..

China’s economic growth is very impressive but somehow its securities companies lost $2 billion in 2004 and even more in 2005. Almost all of the 130 companies are insolvent and it’s not surprising to see the Shanghei Stock Exchange in a 5 year bear market. The savior for China will be allowing US firms to invest in these bankrupt Chinese companies but the CSRC (Chinese Securities Regulatory Commission) said last month that it was halting all foreign deals until the end of 2006.

Japan: The end of a long recession??

Commercial and Industrial loans are the lifeblood of an economy and the strength in the US of these borrowings is the main reason the Fed won’t ease until August 8th. In Japan a milestone was hit in January as bank lending did NOT decline for the first time since 1998. The Bank of Japan is anxious to end its ZRP (Zero interest rate policy) and with real GDP growth of 3%+ the Japanese interest rate train should soon be leaving the station headed for higher levels. This could be very beneficial to the US trade deficit as a pickup in Asian demand for our exports could soften the blow from a weakening real estate market that has created over 50% of the new jobs in the US since 2001.

Retirement

Last Thursday saw the US Treasury auction of a new 30 year bond and demand was heavy as many pension plans try to match long term liabilities with this new long term asset. In an effort to cut costs 12% of large companies have terminated their retiree heath-care benefits and 71% boosted premium contributions. The most amazing stat is that 42% of private sector workers over the age of 21 do NOT have any retirement plan……

Better than a sleeping pill

If you can’t seem to get to sleep tonight you should try reading the January 2006 Senior Loan Office Survey released by the Fed last week. There isn’t much new material and the survey only encompasses 56 domestic and 19 foreign banks. If you finish the 38 pages without falling asleep you deserve an internship at the Fed’s statistics compilation department. http://www.federalreserve.gov/boarddocs/SnLoanSurvey/200601/fullreport.pdf

From the archives: A Greenspan memory

January 3, 2001: After a conference call (in between FOMC meetings) the Fed lowers the Fed Funds rate by 50 basis points
as Alan worries about an economy that is losing steam and a stock market that opens the year with a sharp decline.

February 7, 2006

Flat Yield Curve

Ben Bernanke has only been in office as Fed Chairman for one week but unlike previous Fed honchos (Miller, Martin, Volcker & Greenspan) he is starting with a clean slate. With the US treasury 2 year at 4.60 and the 10 year at 4.57 we have a flat yield curve where there is no incentive to invest in long term treasury securities when there is no pick up in yield.Or is there a hidden benefit?? The Fed Funds rate is at 4.50% with everyone except me predicting an increase on March 28th (next Fed meeting) to 4.75%. Thursday brings back a missing link in the Treasury auction schedule…the 30 year bond. $14 Billion will be auctioned as part of a $188 Billion (due to huge budget deficit) borrowing need in the 1st quarter of 2006. We will read much about higher long term rates due to this heavy supply of new treasury bonds but remember that it is “future inflationary expectations” not the issuing of bonds that sets bond prices/interest rates. I continue to believe that there is NO reason for the Fed to tighten further as it would only create a more inverted (long rates above short rates) yield curve that historically precedes an economic slowdown. There isn’t a day that goes by where I don’t receive a call from someone asking “could this time be different?”….maybe but if you are going to bet on a rare occurrence make sure that the reward is substantially more than the risk you are taking and I just don’t see that for 2006.

Inflation and the Economy

Friday’s job number of +193,000 looks good on the surface but when you factor in the third-warmest January in over 100 years and an increase of 47,000 construction jobs it becomes apparent that unless we have taken on South American weather patterns February will bring harsh winter weather and a cut back in jobs…..Yes the unemployment rate dropped to 4.7% BUT could that be part of a civilian participation rate that has fallen below 66%??? If the number of people looking for a job continues to drop it really won’t matter how many new jobs are created each month as the “politically” correct unemployment rate will suddenly show a “strong” US economy…..Last week Kraft announced that is will close 20 plants and eliminate 8,000 jobs because it is finding it “difficult” to pass along recent commodity price increases…..This is important as in an inflationary environment price increases find no resistance in the marketplace……It’s more than interesting that with energy prices up almost 50% in the last year we still have an inflation rate of just under 2%….One of the key components of inflation is wage increases and according to the ECI (Employment Cost Index) labor costs (wages AND benefits) rose just 3.1% in the last year versus 3.7% (2004) and 3.8% (2003). The strength in consumer spending has come almost solely from home equity withdrawls and real estate appreciation and that is NOT going to continue in 2006.

Housing

Did you know that the average newly built house in 2005 had 2,412 square feet of space up 63 feet from 2004??

From Sacramento we see that default notices are on the rise….flat home prices in 2005 and homeowners that have 100% leverage results in very few avenues to find $$$ to make those high mortgage payments. Is this the beginning of a new trend??? Probably not as I see many “grave dancers” ready to pounce on the first pull back in home prices as these investors wait for the correction in a life long bull market in real estate prices. If it were only that easy…I’ve lived through many booms and busts and although I do NOT see a crash… a slow, major correction in home prices (especially condos) is on the way and this train won’t be making many stops to passengers that wish to disembark http://www.sacbee.com/content/business/v-print/story/14158360p-14986377c.html

Ethanol

President Bush last week spoke about the US addiction to oil and suggested that we must find new sources of energy. With high oil prices ethanol has become a hot topic for consumers, investors and politicians. Almost 50% of cars in Brazil run on ethanol and many parts of the US are gearing up for alternative fuel consumption. Whether it be corn, sugar, wood chips or prairie switchgrass this is going to be the “hottest” growth area for the next decade and millions if not billions will be made by savvy investors who create efficient who create cheap methods to convert, produce and transport ethanol. Unfortunately many areas of the US are finding it cost-prohibitive to transport the fuel from production facilities. The closest plant to Massachusetts is in South Bend, Indiana…but this will change quickly if the price of gasoline stays above $2.50 per gallon. Stay tuned…….we are at the beginning of a tidal wave of change in the energy sector (similar to when the internet began)
http://www.boston.com/business/technology/articles/2006/02/06/ethanols_merits_are_debated/

Tax Cuts

2005 saw six states cut taxes (mostly in sales tax rates) as high real estate prices and sales increased tax collections more than budgeted for last year. 2006 should see a carryover especially in the coastal states and this will give many states the opportunity (rare) to cut taxes and maybe even pay down long term debt. The real estate boom is a great example of the “a rising tide lifts all boats” lesson that has helped create the biggest surge in consumer spending in over 25 years. http://rfs.rockinst.org/exhibit/9038/Full%20Text/SFB74.pdf

Save your pennies

Each penny consists of 97.5% zinc and 2.5% copper (remember when it was all copper??) and the price of zinc has risen almost 100% in the last 6 months so if zinc rises 45% more a penny will actually be worth more than one cent (melted)…this reminds me of a period 20 years+ ago when silver rose to levels that turned kitchens into furnaces as many people sold or melted their silverware and began to eat with plastic utensils….you never know it could happen again although i think the metals sector is way over done and in need of a major correction….BUT with so many commodity funds being created and money flowing from around the world prices for many of these raw materials have soared to levels unthinkable just a few months ago….

P.S.

It’s only been a week and I already miss Alan Greenspan…so for the next few e-mails I will share some Fed memories in hope that I can become more comfortable with the change in leadership at the Fed….

February 4, 1994…a monumental day in Fed history as Mr. Greenspan declares that Fed policy will no longer be shrouded in secrecy and the FOMC publicly announces that it is raising the Fed Funds rate by 25 basis points to 3.25%