After going through the backlog of news and blog posts and such from last week, I wanted to highlight a few more items today. But before I do a quick comment on Australia:
The weak Australia building approvals figure today is likely to put a dent into the RBA’s hope that investment will smoothly shift from mining capex to residential capex. (Stevens noted that stronger business investment growth is likely a ways off) To be clear, much of the drop in building approvals is likely due to base effects resulting from the building surge over the past 12 months, which peaked in April at a YoY rate of 35%. But this data series is still worth following over the next few months. A 12m average of the series is now lower 2 months in a row and suggests that building approvals growth has plateaued at best, and peaked at worst, although data revisions could of course change that view over time:
Separately, note that a recent Fed research paper concluded that “We find that the Federal Reserve is ultimately buying from only a handful of investor types, primarily households … the key participants are shown to rebalance their portfolios toward more risky assets during this period. These results can be interpreted as supporting, at least in part, the preferred habit theory and the view that the monetary policy transmission is working across asset markets.” The paper also included this interesting chart:
Also an interesting paper from the ECB (h/t Riholtz) noted that “the effect of monetary policy on bank lending is significant and heterogeneous in Germany and Italy, which are characterized by a large number of banks; but it is very weak in Spain and more homogeneous in France, where the banking industry has a higher degree of market concentration.”
Finally, GMO quarterly letter was a good read as usual. The one thing I want to point out is that the GMO authors, staying true to form as long term mean reversion-ists, broadly skirted the question of how long the Fed would hold rates “down.” GMO noted on page 9 that 10y yields “should” be at 4.9% from 2.5% at the end of June, which is composed of a 2.1% inflation, 1.2% term, and 1.6% real premium. And they concluded that because they don’t know, they will take insurance out and overweight cash, even though they expect that they will underperform for some time.
Now, that’s a pretty solid general perspective. But, being a macro oriented person, I think that one could do better. Specifically, I think it makes sense overweight the probability that rates stay “low” or at a “repressed level” for longer. To support that contention, I will present two points.
First, over very long time periods, the yield on the 10y Treasury bond has approximated with nominal GDP growth rate. (The chart below shows that over the past 5 decades, 10y Treasury yields have averaged 23bps below the average nominal GDP growth rate) There are a whole host of reasons why this makes sense and why it is likely to persist, but for the brevity’s sake, let’s just say that this is likely to continue.
Well, as we know, nominal GDP growth has been declining for 30 years, driven by both the real and inflation components. Now I am not saying that this trend will continue forever, but economic momentum has been known to be a reliable indicator for future data. In other words, it makes more sense to bet that, after 30 years of weaker nominal growth, that trend will continue for another 7 years rather than the opposite.
My second point comes from the FOMC itself. Bernanke has indicated that unemployment will have to decline to at least 6.5%, and probably lower, before the FOMC will hike rates. In addition, the FOMC voter forecasts for NAIRU are between 5% and 6%. In other words, the Fed will only maybe start to hike with unemployment at most just 50bps from the top end of its estimate of the “neutral” rate. The implication is that the Fed Funds rate is unlikely to be much above 2% (GMO’s long term inflation estimate) even after unemployment is close to NAIRU. Which suggests that the average real component of the Fed Funds rate over time, as assessed by the Fed, is something closer to zero, rather than the 1.5% GMO estimate.
- US Consumer Confidence declined to 80.3 vs 81.3 exp and 81.4 prev
- Australia Building Approvals dropped sharply by -6.9% MoM in June vs +2.0% exp. The May figure was revised from -1.1% to -4.3%. On a YoY basis, the figure dropped -13%.
- Tue: Japan PMI, Australia Private Sector Credit Growth
- Wed: Month End, Japan Housing Starts, Germany Retail Sales, Unemployment, EU CPI, Unemployment, Canada GDP, US ADP Employment, 2Q GDP, Chicago PMI, FOMC, China PMI
- Thu: EU PMI, BoE, ECB, US Jobless Claims, ISM
- Fri: US Employment,