This Week's Economic Data Was Okay, But Two Big Leading Indicators Have Turned Negative

May monthly data reported this past week included the Index of Leading Indicators, up 0.1 and showing no imminent recession, the Empire State and Philly manufacturing indexes, both of which improved, consumer prices up slightly, housing starts and existing home sales up, and permits down. The 6 month trend in housing is up, but at a more muted pace than over the previous year.

Prof. Geoffrey Moore identified 4 long leading indicators, which take over a year to feed into the general economy: bond interest rates, real M2 money supply, housing permits, and corporate profits after taxes. Three of the four (using purchase mortgage applications as a reasonable proxy for permits) are updated in our look at the high frequency weekly indicators, so let's start with them:

Interest rates and credit spreads

 5.11% BAA corporate bonds up +0.12%2.20% 10 year treasury bonds up +0.08%2.91% credit spread between corporates and treasuries up +0.04%

Interest rates for corporate bonds had generally been falling since being just above 6% in January 2011, hitting a low of 4.46% in November 2012. Treasuries previously were at a 2.4% high in late 2011, falling to a low of 1.47% in July 2012, but in the last few days have retreated back to that high. Spreads have varied between a high over 3.4% in June 2011 to a low under 2.75% in October 2012. After being close to that low 6 weeks ago, interest rates have backed up significantly.

Housing metrics

Mortgage applications from the Mortgage Bankers Association:

+12% YoY purchase applications-3% w/w refinance applications

Refinancing applications have decreased sharply in the last month due to higher interest rates. Purchase applications have also declined, although they continue their slightly rising YoY trend established earlier this year.

Housing prices

Housing prices bottomed at the end of November 2011 on Housing Tracker, and averaged an increase of +2.0% to +2.5% YoY during 2012. This week's YoY increase made yet another 6 year record.

Real estate loans, from the FRB H8 report:

Loans turned up at the end of 2011 and averaged about 1% gains YoY through most of 2012.  In the last several months the comparisons have completely stalled, although this week was positive.

Money supply

M1

M2

Real M1 made a YoY high of about 20% in January 2012 and had generally been easing off since, but recently has increased again.  Real M2 also made a YoY high of about 10.5% in January 2012.  Its subsequent low was 4.5% in August 2012. It increased slightly in the first few months of this year and has stabilized since.

Employment metrics

American Staffing AssociationIndex

Initial jobless claims

  4 week average 348,250 up +3000

Tax Withholding

$111.9 B for the first 14 days of June vs. $103.5 B last year, up +8.4 B or +8.1%$151.0 B for the last 20 reporting days vs. $140.1 B last year, up $10.9 B or +%7.8

In the 6 weeks month, the ASA has deteriorated to being negative compared with last year. After having a great 20-day comparison several weeks ago, for the third time in a row this week tax withholding had a relatively poor YoY comparison. Initial claims remain within their recent range of between 325,000 to 375,000, and have flattened out just as they have in the last 3 springs and summers.

Transport

Railroad transport from the AAR

+1900 or +1.1% carloads ex-coal+4300 or +1.7% intermodal units+5900 or +1.1% YoY total loads

Shipping transport

Rail transport has been both positive and negative YoY in the last several months. This week it was positive. The Harpex index has been improving slowly from its January 1 low of 352. The Baltic Dry Index increased sharply this week and is close to a 52 week high.

Consumer spending

Gallup's YoY comparisons remain extremely positive, as they have been for the last half a year.  The ICSC varied between +1.5% and +4.5% YoY in 2012, while Johnson Redbook was generally below +3%. The ICSC has trended towards the lower part of its range recently, but Johnson Redbook has been close to the high end of its range.

Oil prices and usage

Usage 4 week average YoY -0.4%

The price of a gallon of gas, after declining sharply in March and April, rose again in May, steadied in early June, and has declined for the last week. The 4 week average for gas usage remained slightly negative.

Bank lending rates

The TED spread is still near the low end of its 3 year range.  LIBOR rose slightly from its new 3 year low established last week.

JoC ECRI Commodity prices

Noteworthy this week is the continuing spike in interest rates, as well as the decline in mortgage activity. Both of these are long leading indicators and so raise a warning flag for next year. The third long leading indicator, however, real money supply remains positive. The only other outright negative indicator is temporary staffing, which has been problematic for over a month.

Positives included strong consumer spending once again. More positives included house prices, YoY purchase mortgage applications, overnight bank rates, both rail and shipping transport, and gas prices. Jobless claims and commodity prices rate as neutrals this week.

The sharp rise in interest rates is definitely of concern, but it hasn't lasted long enough to seriously signal a recession next year. Housing is weakening but still positive. In terms of coincident indicators of the economy, consumer spending is still quite positive, and initial jobless claims, while trending sideways for the last month or so, show no signs of rolling over.

Have a nice weekend.

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KRUGMAN: The Fed May Have Just Made A Historic Mistake, And Done More Damage Than It Realizes

REUTERS/Jason Reed

The most important story in the world is the change of direction in U.S. interest rates, which coincides with the change in tone out of the Federal Reserve. On Wednesday the Fed indicated that so long as its economic projections come to pass, it plans to slow down on Quantitative Easing later this year, with an eye towards totally ceasing bond purchases sometime in 2014.

The markets puked on the news, and interest rates shot up, a move that was exacerbated by Bernanke himself saying he was not worried about the rise in rates.

According to Paul Krugman, it's possible this will end up as a "historic" mistake.

If the economy recovers, then fine, whatever, the Fed will get away with it.

But let's say things sputter out again, and it becomes clear that more easing is necessary. Sure, the Fed can ramp back up QE, and step on the gas pedal again. And the Fed has indicated that it retains this ability.

The problem though is that by acting like a traditionally responsible central bank (trying to avoid inflation and bubbles pre-emptively) it can no longer commit to being irresponsible, which is what many have argued is necessary to truly avoid a deflation trap. There's a widespread belief that what's needed is for the Fed to somehow signal that even if inflation runs hot, that it won't step off the pedal until the economy is at full potential output again. By acting pre-emptively just when things seem to be OK, the Fed has blown that tool.

Says Krugman:

So what if recovery stalls, and inflation expectations fall even further? Can the Fed turn on a dime, and send a credible message that it really isn’t so conventional-minded, after all? It’s hard to believe; having already shown itself inclined to start snatching away the punch bowl before the party even starts, it has arguably already given away the game.

I know that the latest had overwhelming support on the FOMC; I’m surprised and a bit shocked by that, and worry that we may have seen incestuous amplification at work.

I really hope that the real economy recovers at a pace that makes my fears groundless. But if it doesn’t, I fear that the Fed has just done more damage than it seems to realize.

Check out his whole post here.

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People Are Making Way To Big Too Big A Deal About A Surging Chinese Interest Rate

All the chatter in China this week has been about a credit crunch in China.

On Thursday, the SHIBOR, or Shanghai Interbank Offered Rate, the benchmark interest rate used in lending activities between banks,  surged to 13.44%. The overnight repo rate hit 25%. 

After the central bank reportedly intervened with targeted injection of 50 billion yuan into the market, interbank rates fell from their highs on Friday, but nevertheless remained at elevated levels.

But how concerned should we be about the rise in interbank rates?

In terms of markets, SHIBOR might not be as important as interbank rates of developed markets, Morgan Stanley's Richard Xu wrote in a research note on Thursday.

He pointed out that the total balance of both official interbank lending and over the counter interbank lending, in which rates are directly affected by SHIBOR, represents only around 8% of total bank assets.

 SHIBOR's impact on the real economy is also limited. 

"We estimate that rates of ~12% on credits to the real economy (such as discounted bill rates) are more directly affected by SHIBOR. The rest – including loans, corporate bonds and interbank NSCA – are affected in a milder way. Despite the 150–300bps surge in SHIBOR this month, rates on the aforementioned types of credit increased ~20–80bps during the same period."

In an excellent piece, FT Alphaville's Kate Mackenzie writes the Chinese central bank has been talking about controlling risks in the banking sector for some time. A meeting of China's State Council saw top policymakers emphasize that the financial system needs reform and that credit should be channeled towards industries with that could drive economic growth. From Mackeznie:

"It all suggests this is a very deliberate move to direct China’s credit into more effective investments — things that will actually make some kind of return, rather than requiring debt rollovers and the like."

We have previously reported that the central bank seems committed to "punishing" banks that had taken advantage of stable interbank rates to fund their purchase of higher-yield bonds. In other words, much of this is calculated, even if the silence on the part of the PBoC has everyone on edge.

For now there hasn't been a bank run at the retail investor level, according to Credit Suisse's Dong Tao. Large state owned enterprises are still flush with cash, though smaller businesses are "struggling with liquidity."

Tao thinks Shibor has peaked though rates will remain elevated. He also thinks the duration of these elevated rates are more important than the rate spikes. "The longer this lasts, the more likely that some banks may face serious liquidity  issues and that would further undermine the creditability between banks, creating a chain reaction," he wrote.

"It is our view that draining interbank liquidity at the interbank market could cause unintended consequences, at a time at which duration and risk mismatch among the banks are severe, account receivables in the corporate sector are surging, and the inflow of FX reserves is decelerating sharply."

So, there definitely is good reason to be worried about risks in China's financial system, and the spiking interbank rates definitely point to a liquidity squeeze. But this suggests that comments in recent days comparing the surge in SHIBOR to the spike in rates in the run up to the Lehman crisis, were overstated.

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The Mortgage Refinancing Gravy Train Just Ended

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After The Fed Shock, Markets Are Set For More Turmoil

Fasten your seatbelts. And expect lots of turbulence.

If that was the message Ben Bernanke was trying to deliver when he said the Federal Reserve could soon start scaling back its massive stimulus program for the U.S. economy, it's safe to say investors received it loud and clear.

In fact, the sell-off in stocks, bonds and commodities that rippled around the globe after Bernanke's remarks looks to some like the dawn of a new period of volatile, disorderly trade - a stark change from the calm that prevailed since the Fed began its most recent bond-buying program last autumn.

"When market regimes shift, they rarely do so in an orderly fashion - look at equity prices collapsing at the end of the dot-com bubble or the height of the financial crisis," said Stephen Sachs, head of capital markets at exchange-traded fund issuer ProShares in Bethesda, Maryland. "It usually gets violent. We're going to face that in interest rates now."

Indeed, the bond market is at the epicenter of the financial market earthquake that Bernanke unleashed. Benchmark yields, which Fed easing had driven to record lows, surged to near two-year highs and are expected to keep climbing as traders come to grips with the prospect of the Fed ending bond purchases by mid-2014.

The aftershocks have rattled markets from Tokyo to Sao Paulo, and assets that had been top performers plunged. U.S. credit markets were hammered, with the gap between junk bond yields and Treasuries hitting their widest so far this year, while global equity markets lost $1 trillion on Thursday alone.

The brute force of the decline caught some by surprise, since Bernanke warned in late May that the Fed could slow its bond buying later this year. Even so, watching long-term interest rates rise 0.4 percentage points for the week - the biggest move in more than 10 years - after trading for months near record lows was a wake-up call.

"People live in denial all the time," said Kim Forrest, senior equity research analyst at investment management firm Fort Pitt Capital in Pittsburgh. "The thinking part of people's brains understood that rates would have to go up sometime. But they weren't ready to be told that reality starts now."

That goes for companies who now face higher funding costs and investors who had borrowed money cheaply to trade.

Investors had been funding trades in riskier markets by borrowing in the stable, low-interest-rate U.S. debt market. But the cost to borrow rises with higher rates and with increased volatility - both of which appear to be here to stay, at least for now.

Dan Fuss, vice chairman of investment management firm Loomis Sayles & Co, which manages $191 billion in funds, said: "Leverage is coming out of the market. These market moves reflect that, but when you get sharp moves like this a lot of people get nervous. That can contribute to more selling."

Bond investors hoping to play "follow the Fed" forever face an even more frightening reality. As Zane Brown, a fixed income strategist at asset manager Lord Abbett & Co noted, a return to a more normal level of interest rates would result in a zero total return over the next five years for investors benchmarked to the popular Barclays U.S. Aggregate Bond Index.

Investors pulled $15.1 billion out of taxable bond funds in the first three weeks of June, according to Lipper, a Thomson Reuters service. That is the biggest three-week outflow from the funds since October 2008, at the height of the financial crisis.

"HYPER-SENSITIVE"

All of this has left traders and investors scrambling to protect themselves in anticipation of a volatile summer.

Trading in interest-rate futures contracts spiked to a record in late May when Bernanke first broached the subject of winding down stimulus. It soared again this week, when some 12.8 million contracts changed hands on Thursday, according to CME Group, well above May's daily average of 7.9 million.

Volume in S&P 500 index options rose to 2.3 million contracts on Thursday, a new one-day record, while overall options volume of 33.3 million contracts made it the busiest day since Aug. 9, 2011, four days after Standard & Poor's stripped the United States of its top credit rating.

Since Bernanke has insisted that winding down bond purchases depends on continued economic improvement, traders now have to assume nearly every economic data release will have the potential to whipsaw financial markets.

"Across the board, we have seen people paying up for insurance in the options market," said J.J. Kinahan, chief strategist at online brokerage firm TD Ameritrade. "The market is going to be hyper-sensitive to anything that the Fed says, and the three major reports on employment, retail sales and housing will continue to dominate the eyes of the market."

The CBOE Volatility Index, a gauge of anxiety on Wall Street, jumped 23 percent on Thursday to 20.49, the first time this year it has exceeded 20, an often-used dividing line between calm and stressed markets. It closed at 18.90 on Friday.

Signs of concern about high-flying assets like emerging markets can be seen in the options market, where more than 1.35 million contracts in the iShares MSCI Emerging Markets exchange-traded fund traded on Thursday - 82 percent of which were put options, generally used to protect against losses.

The Merrill Lynch MOVE Index, a measure of expected volatility in the U.S. Treasury market, rose to 103.7 on Friday; that index sat at 50 in early May, a multi-year low.

The uncertainty the Fed has sowed by telling markets they are on their own means the days of almost uninterrupted gains that have prevailed since late last year are over. And that brings problems of its own for investors and the market.

For one thing, violent price swings make investors more vulnerable to big losses, prompting them to sell assets simply to reduce their value-at-risk (VaR) levels, a statistical method for quantifying portfolio risk over a given period of time.

Rack up enough of these forced liquidations and it is not hard to see how a sell-off in one market can spread quickly to other assets and other parts of the world.

Bob Lynch, head of G10 FX strategy at HSBC, said this was a factor driving the bond and equity sell-off in late May "and could be an important input driving financial assets lower in the current environment."

"It is too early to tell if the market reaction to the Fed is just noise or the beginning of a greater sell-off in U.S. equities," said Mike Tosaw, portfolio manager at RCM Wealth Advisors, an investment advisory firm in Chicago.

"Over the course of the last month, we have been taking money off the table in the stock market and keeping the cash for the time being. Early next week, we plan to evaluate if this is a buying opportunity in stocks or if we need to run for the hills." (Additional reporting by Doris Frankel in Chicago and Gertrude Chavez-Dreyfuss, Jonathan Spicer and Herbert Lash in New York; Editing by Martin Howell and Tim Dobbyn)

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Filmmaker's Short Video Is The Best Explainer You Will Find On Why Brazil Erupted In Protest

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MARK YOUR CALENDARS: We've Got 7 Huge Fed Speeches Coming Up This Week

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