The economic and financial outlook remains uncertain

Despite a steep rise in bond market interest rates in recent months, the supposed reasons for the yield rise do not, in reality, adequately justify the move. That does not preclude a further bond yield rise, but it does suggest that the rise will be eventually reversed.

There are numerous factors behind the market's mistaken yield rise, including the Fed's indication that it will soon begin tapering its $85 billion monthly purchases of Treasury and  mortgage securities. The market reaction is both a response to the promised first step in an eventual reversal of the Fed's accomodative policy and a wrong-headed assumption that the Fed's decision indicates the economic recovery is not only turning more robust, but sufficiently to foreshadow accelerating inflation,which is a key determinant of bond yields. The Fed's expansion of money is also widely but mistakenly believed to make an upsurge in inflation a certainty. The slowdown in World economic growth was thought to have been the major force keeping that Fed induced inflation from occurring. But, disinflation prospects only appeared to be lightening with some dubious signs that the economy in Europe and China was improving  Another force behind the market yield rise has been panic selling by holders of troubled municipal bonds, both by individual investors and by mutual bond funds, which needed to get ahead of withdrawal requests. The rise in equity prices is an additional factor in a shift of investor funds from bonds to equities, which has contributed to the yield rise.

Let us look a little more critically at these various issues. Yes, the Fed is under pressure to at least begin the process of reversing its stimulus. The Fed is trying to prevent outright deflation and create some speedup of inflation. But, the realty is that the Fed expansion is merely replacing private debt in the extended deleveraging process that has years yet to go. There is no inflation risk. Not with huge excess, unused, capacity to produce and still massive unemployment and underemployment. Some cite the formula MV = PT (where M is the money supply, V is its velocity or turnover in terms of GDP, P is prices in GDP and T is GDP  transactions) to attempt to prove that the rise in M, money supply growth, with a stable V, or money velocity,  will necessarily produce a rise in P, prices, in other words, inflation. But, the velocity of the money supply is declining. Nevertheless, there are some in the Fed, and many outside the Fed who do not recognize that truth. However, in order to placate those pressures, Fed Chairman Bernanke has been willing to appear to begin the process. But, he and others likely to be at the helm at the Fed, after Bernanke leaves, including Summers and Yelen, recognize that the economic recovery is both fragile and vulnerable, with no inflation.  One of the few bright spots in the economy had been the recovering housing sector.  But, the rise in mortgage rates has curtailed the housing recovery. That and the still weak employment picture will keep the Fed maintaining an accomodative policy through next year and probably beyond. There is a pronounced shift in employment toward part-time work, of less than 30 hours a week, instead of full-time work. This undoubtedly reflects employer efforts to avoid health-care costs. The labor force participation rate, the percent of the population in the labor force, is at a 35-year low. The non-farm payrolls and unemployment rate are artificially improved by such perverse trends. With all this in mind, the tapering of Fed bond buying will be slight and slow and will certainly not be a precursor of a shift to a restrictive Fed policy for a very extended period of years.

As if this were not enough, the European economy is certainly not out of the woods. More signs of the true state of their economic problems will be evident after the German election. And China has a real estate bubble that has not yet burst. Also, there is a transfer of low cost manufacturing from China, where there are rising costs, to still lower cost producers, which will be disruptive to China's economy. In addition, there are economic uncertainties ahead introduced by the threat of  a US attack on Syria, the potential for a shut down of the Government over a stand off on the debt ceiling, worries over Puerto Rico's finances, unknowns over the Affordable Care Act, and the possibility of a strike against Iran's nuclear facilities.

Where do you invest in the midst of these and other potentially adverse developments. The July decline in durable goods orders to below year ago levels may portend weakness ahead, but it made GE bonds a better buy. One investment to consider is an investment grade Wells Fargo Corporation preferred issue (WFC+L ) with a coupon of 7.5%, yielding 6.7%, that is not callable, but that can be converted by Wells Fargo only when the underlying stock roughly quadruples.

Philip Braverman, President
Braverman Economic and financial Consulting
One Hewitt Square #249
East Northport, N.Y. 11731

The outlook is for further declines in Treasury and high grade bond yields

While the April employment report was stronger than the markets feared, it was certainly not an indication that the US economy is on a vigorous growth path. Indeed, the US economy remains sluggish and even vulnerable to retrenchment in response to a delayed reaction to Federal  tax increases, sequestration, the financial burdens of health care costs and the slowing global economy. That combination promises a continued pattern of restrained inflation (with a persistent risk of deflation), weak commodity prices, and a continued easy Fed policy.

April nonfarm payrolls rose 165,000, only seemingly strong in contrast to the 88,000 rise (before subsequent upward revision) originally reported the prior month. The unemployment rate edged down to 7.5% from 7.6% in March, and not as in the prior month because of a 496,000 plunge in the labor force. But this is hardly a truly strong employment report. This is certainly not an impressive employment gain.considering that it is not even sufficient to meet the job requirements of a normal pace of new entrants to the the labor force. Moreover, the entire rise in  employment contributing to the decline in the unemployment rate was due to a rise in "self employment"-which is often a questionable description of reality.  The broader measure of the unemployment rate, U-6, actually rose to 13.9% in April from 13.8 % in March. And equally significant, there is also an array of  recent weaker economic reports .Average weekly earnings and the average number of hours worked both declined in April, a potentially significant development. Factory orders, a leading indicator, fell sharply in March to 467.3, from 486.8 the month before.  Durable goods order were particularly weak. suggesting business caution. This seems confirmed by a decline in nonresidential spending in March.  While GDP rose at a  respectable 2.5% annual rate in the first quarter, if  recent reports persist the pace of real GDP will be significantly slower in the current quarter. The realty is that the US economy can not be counted on to be the vigorous engine of global economic recovery that many expect it to be.. Except for Germany, all of Europe is either in or at risk of falling into recession. The unemployment rate in both Greece and Spain are at 27%, depression levels. With austerity mandated as the price of  financial assistance, no  imminent economic rebound appears likely in Europe. Japan's economic outlook  remains questionable, despite bold monetary stimulus. And China's estimated GDP growth, reportedly at about a 7% rate, and of dubious validity, is weaker than anticipated. Moreover, China has its own construction bubble that has yet to burst.  This combination will keep inflation subdued and central banks around the globe committed to an easy money and credit policy for an extended period of time. That will not lead to an inflation surge, if at all, for years and years to come .  There is too much of a gap between production demand and capacity, too many unemployed and too much required  further deleveraging of excessive reliance on debt. As a consequence there will likely be a continued downdraft of commodity prices, probably including gold after its recent run-up after India's buying runs its course.

And though it may seem hard to believe, long term US Treasury and other high grade bonds will continue to improve in price and decline in yield as there is increased market recognition that the outlook is for low inflation,or worse, weak economies, commodity price doldrums and persistent central bank easing.

Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square  #249
East Northport, NY 11731

This and earlier reports can be accessed at philipbraverman@blogspot.com

The recent rise in Treasury bond yields will be reversed as economic data turn less buoyant

Signs of improvement in the economy are likely to prove fleeting. But the overwhelming consensus of economists and other forecasters is that the evidence of a step-up in economic activity is not only real but a harbinger of even more robust gains in employment,corporate profits,inflation and economic activity just ahead. It is no surprise then that the credit and equity markets are responding as if there is no doubt that the economy is on a sustainable and strengthening growth path. Thus, when there is the inevitable rude awakening to the realty that the economy is still struggling,keeping inflation only a distant threat and the Fed committed to its current easing course for an extended period,the recent rise in bond yields will be reversed. Much was made of the deceptive drop in the official February unemployment rate to 7.7%, down from,7.9% in January and 8.3% a year ago. However, the number employed is up a mere 1.04% over the past year. It is significant that this 1.04% annual employment growth is at or less than the normal trend growth in the labor force. Thus, the only reason the unemployment rate has declined is because the labor force trend growth has been cut in half to 0.45% over the past year. This is due to a greater than normal drop-out from the labor force of unemployed discouraged workers, early retirees and graduates returning to school. Even the recent growth in employment may be grossly overstated because of reconstruction employment connected to repair of storm damage and replacement demand. Inflated seasonal adjustments may also be responsible for the seeming recent signs of economic strength Also, the increase in Federal taxes and mandated cuts in Federal spending and other major adverse effects on employment have not yet had their impact. But they soon will. Together these depressants on economic growth will likely have a significant adverse effect on employment sufficient to raise the unemployment rate. In addition, other economic indicators cast an ominous shadow on the future. Conference Board Consumer Confidence,for example, showed an increase for February but is still down 2.8% from a year ago. But, the University of Michigan confidence conversely declined in early March to 71.8 from 77.6 in February. There is bound to be a further negative impact on employment and other measures of economic activity as business prepares for the financial burdens of the health care legislation. To prepare for healthcare some businesses will be downsizing, while others will be shifting to part-time workers. Added to these economic negatives is the deflating real estate bubble in China. The Chinese government has moved to restrict real estate speculation by limiting the purchase of investment apartments to one per family. But the damage has already been done with huge overbuilding of unoccupied cities that are too costly for the limited middle class population. The result is a sharp curtailment of the demand for basic resources used in construction. In the meantime, the recession in Europe persists and may well be deepening. In concert, these various developments and trends place a significant drag on the US economy. Philip Braverman, President Braverman Economic and Financial Consulting One Hewitt Square #249 East Northport, New York 11731 I can be reached at philipbraverman@gmail.com