How The US Deficit Is Impacting The Euro

Rusty-Tweed

A weak currency, worsening government finances, high political uncertainty, rising interest rates, are the statements that Rusty Tweed says that plague the U.S government. The U.S Treasury bonds were once regarded as risk-free assets, but now, they are shaky, and the alternative that is available for investors is the eurozone debt. Investors from all over the world and especially those from Europe are minimizing risk by avoiding the U.S Treasuries over the last few months. This is going on even though there is a huge interest rate gap between Europe and the United States.

The levels of the U.S debt as expressed as a percentage of the GDP are close to rising above the Italian debt which is one of the most indebted states in the world. Since the Trump administration is spending $300 billion for new plans and tax cuts of $1.5 trillion, the fiscal deficit of the U.S is widening sharply. By next year, the fiscal deficit might top $800 billion which is almost an additional $200 billion from the 2017 deficit that stood at $665 billion.

Federal Reserve

As we see the balance sheets of the Federal Reserve shrinking, the supply of the new bonds will rise sharply. This will risk higher interest rates that will make the bond market of the U.S government to become more volatile. Bond issuance and debt levels in the eurozone are falling contrary to the story in the U.S. Additionally, the states like Portugal and Spain which used to be hit by the crisis are now enjoying upgrades in their credit ratings.

Threats to the Euro

Study growth of the economy, existing threats to the euro, and continued low costs of borrowing are making investors invest more on Euro bonds. In March, Japanese investors purchased a staggering $2.7 billion Spanish bonds. We still need havens, and if the U.S Treasuries do not stand by their word, alternatives will spring up for investors, and the euro debt will be one of the best havens. This is evident and economic analysis and credit strategists are moving along these lines.

Although it is impossible to beat the liquidity and depth of the U.S Treasury, the once haven is not what it used to be. The U.S government bond market of $21 trillion is the largest in the world, and it is the most liquid. The three biggest states in the eurozone; Italy, France, and Germany have a total of $ 8 trillion in government bonds.

Borrowing Ratio

But when you look at how the US government is borrowing; it is the only developed economy whose debt-to-GDP ratio is going to rise in the next five years according to the predictions made by the IMF. The IMF project that the debt levels of the US will get to 108% by the end of 2018, and 117% by the end of 2023.

This kind of rise will bring about the downgrade of the credit rating which the S&P Global has already warned about unless the budgetary issues are sorted out. Economists like the CEO of Haidar Capital Management which is a macro hedge fund stated that the debt dynamics of the U.S are rising ar a dangerous place.

Rising Debt

As the debt rises, we are going to see private investment walking out as well as foreign interests. The debt-to-GDP ratio of Italy is projected to fall to below 117% from 130% by the end of 2023. The next government is projected to loosen the fiscal disciple in Italy. Generally, the broader spectrum of the eurozone is a good foundation unlike what is happening in Washington.

Additionally, the quarterly current account surplus of the eurozone averaged 1% of GDP for the three quarters that end in December; this is the highest that has been seen in the euro period. This means that more savings are exiting the zone which could boost flows in bonds.

The Change that is going to be seen

 

Euro zone’s debt has foreign demand that is supported by the appeal it has attracted in a currency-hedged basis. But investors are repositioning themselves because of stronger growth and rating upgrades. This means that in case a turmoil exists in the market, there are more options for safe-havens for investors than ever before. To have a clear picture, Rusty Tweed advises us to look at BAML analysis.

The Analysis by BAML

During the 2008 financial crisis, stock returns and Treasury correlations were negative, at a significant 60%. The Treasury became the safe haven after equity prices fell while Treasury prices rose. Now, since the negative correlation is at -28%, it implies that equities and Treasuries are not going to move in opposite directions.

Now, for a preview of the bond market of the eurozone, Italy, for instance, is viewed as a risky market. Although the perception is clear, not only did they hold their ground throughout the first quarter turmoil in the market, but their prices rose.

Millennials and the Housing Market In 2018

Rusty-Tweed

Rusty-Tweed

Although millennials are associated with some negative terms, their buying power is hard to deny. A part of it has to do with buyers’ confidence levels running at a 15-year high and the economy performing well. Unfortunately, as many as 32 percents of all millennials in the United States currently live with their parents. Since these are individuals aged 20 to 36, their total number is around 75 million. So, there are presently almost 25 million young adults who still live at their parents’ homes.

Generally speaking, that number may not seem as impactful given the total population of the United States. It is, however, very impactful indeed. Having 25 million people out of the housing market indicates that there is a ton of untapped spending potential. Meaning, the overall economy is suffering because the housing market is not utilized to its full potential. So, what are some of the main reasons for this situation and how could it be fixed in 2018?

Employment Rates

Even without using empirical evidence, saying that the employment history has a lot to do with homeownership makes sense. Luckily, the United States is currently experiencing some of the lowest unemployment rates in the history. This indicates that the spending potential of young adults is amplified by the fact that most of them have jobs. Meaning, their power to purchase a home will steadily increase until they finally begin taking advantage of their financial abilities.

Interest Rates

Another factor that is undoubtedly motivating people, not just millennials, to buy homes are the low mortgage interest rates. Ignoring their short-run growth, current rates are low when compared to historical numbers. Adding the fact that a lot of experts believe how the average home prices will go up by 5 percent in 2019, the urgency to buy increases. Hence why it is reasonable to expect that millennials buying homes is just a matter of time.

Tax Laws

Although the previous two reasons are supporting millennials’ buying power, there are some issues at hand. The first one pertains to the tax laws that were recently changed. In 2017, President Trump facilitated a major tax overhaul in the last three decades. Doing so reduced the mortgage interest deduction, got rid of the moving expenses itemized deduction, and changed the tax property deduction. Although most of these are easy to understand, it will take some time for investors to get on-board. Meaning, those millennials that are in the real estate sector will need a few months to figure out ways around new provisions to maximize returns.

Low Supply and Rising Prices

Over the past two years, the supply of housing opportunities has considerably deteriorated. Given the high number of people that are not buying, many projects stopped, and homes are not getting constructed as fast. As a consequence, there are fewer homes than people want. When that happens, the equilibrium is shifted, and prices go up. The problem, however, is the fact that these prices are consistently rising. Although real estate investors love the trend, average buyers are not fond of it.

After all, when home prices are rising faster than workers’ salaries, they are unable to buy. Consider, for example, a market where the median property value went from $550,000 to $700,000 in 3 years. If somebody who lives there did not receive the same 27-percent increase in pay during those three years, they would not buy a home. Thus, low supply that causes prices to rise is another reason why millennials may be less likely to buy. Eventually, however, these trends should normalize to put the market back into equilibrium.

From ZIRP to NIRP Part II: The Effect of Low Interest Rates on the US Recovery

The Fed’s Monetary Policies in the Post-Recession Era

At the height of the recession in December 2008, the US Federal Reserve adopted historically low interest rates, slashing the federal-funds rate from 1% to between zero and a quarter percentage point. Like the Bank of Japan, the Fed sought to catalyze economic activity and combat deflation by reducing the cost of borrowing for households, businesses, and banks.

A month earlier, it had also started an aggressive quantitative easing program to inject additional liquidity into the economy, buying back bonds and mortgage-backed securities, and adding more than $3.5 trillion to the Fed balance sheet by 2014. Though its easing program tapered off by October 2014, Fed chair Janet Yellen announced that the central bank would reinvest proceeds from the bonds, in effect, providing another stimulus.

The Tepid Global Economic Recovery

Despite these unconventional monetary policies, America’s economic recovery has been tepid and largely unresponsive. According to Yale economist Stephen Roach, “Real GDP growth in the US has averaged only 2.1% in the 28 quarters since the Great Recession ended in the third quarter of 2009 – barely half the 4% average pace in comparable periods of earlier upturns.”

At the outset, the effects of the near-zero interest rate were partially stifled by already high levels of household and business debt, as well as the fact that prospective borrowers with even the slightest level of risk faced high interest rates. And in 2016, with the Fed maintaining historically low interest rates, there is little reason to suggest that a lack of liquidity and credit is ailing creditworthy households and businesses.

The Downsides of Negative Interest Rates

Even so, the persisting concerns about the health of the global economy and the volatility of the financial system have spurred calls for negative interest rates, to be implemented by charging banks for reserve deposits. While this ought to in theory create a similar stimulus effect to the 2008 interest rate cuts, the benefits of such a policy would be limited by the fact that there is a floor on nominal interest rates, in that depositors can always hold onto their cash. The potential downsides to a drastic policy include tarnishing the credibility of the Fed and heightened uncertainty. Moreover, lowering interest rates from their already low levels would constrain the Fed’s ability to vary its monetary policy in the event of a Japanese-style deflationary trend, and force it to turn to even more unconventional policies such as QE.

Persistently low interest rates also encourage excessive risk-taking and higher leverage, posing risks to financial stability. Those seeking higher nominal interest rates are encouraged to turn to more speculative assets. Low interest rates generally incentivize spending and penalize saving, reducing household interest incomes. The St. Louis Fed notes that “Since peaking at $1.33 trillion in the third quarter of 2008, personal interest income has declined by $128 billion, or 9.6 percent.” Some also argue that low interest rates led to the mid-2000s housing boom and a significant spike in household debt.

While a strengthening economic recovery and declining unemployment (down from 10% in October 2009 to 4.9% currently) may prima facie support the view that the Fed’s unconventional monetary policies are working, Roach notes that weak output and the productivity downturn raise worrying questions about the long-term, especially in the context of frothy asset markets.

An emerging consensus holds that the global economy’s current woes are beyond the abilities of creative monetary policy and financial engineering to remedy, and that they may be exacerbated by excessive risk-taking. As such, Notre Dame economist Eric Sims counsels focusing on structural issues such as demographic pressures, declining productivity, and disruptions born of globalization that have hampered economic growth.

References:

http://www.wsj.com/articles/SB122945283457211111

https://www.bloomberg.com/quicktake/federal-reserve-quantitative-easing-tape

http://www.cnbc.com/2016/02/10/the-danger-of-negative-interest-rates-commentary.html

https://www.stlouisfed.org/publications/inside-the-vault/spring-2011/low-interest-rates-have-benefits-and-costs

http://voxeu.org/sites/default/files/file/Geneva17_28sept.pdf

https://www.project-syndicate.org/print/desperate-central-bankers-by-stephen-s–roach-2016-09

Oil Prices Surge Following OPEC Production Cap

Oil prices surged following news that the Organization of Petroleum Exporting Countries had agreed to cut production and cap output. The international oil benchmark Brent crude rose 6% to nearly $49 a barrel on the back of the announcement.

November West Texas Intermediate crude futures jumped 4.7%, or $2.11, to trade at $46.78 a barrel. US stocks also closed higher overall following the surge in oil prices, with the Dow Jones Industrial Average closing up 110.94 points, ExxonMobil Corp. shares jumping 4.40%. Moreover, the S&P 500 index finished up 11.44 points, or 0.5%, at 2,171.37, while the energy sector jumped 4.3%. Oil prices settled up 5.3% at $47.05 on Wednesday.

The energy ministers from the major oil exporting nations struck the deal during talks held in Algeria in order to limit crude production and reduce the oversupply. The formal details of the agreement will be finalized at the OPEC meeting in November.

The deal stipulates a 700,000 barrel reduction of oil output per day overall, though some OPEC nations will cut their production more than others. Iran, for instance, will be allowed to increase its output. Oil production will be limited to a range of 32.5 million to 33 million barrels per day, down from August’s output of 33.2 million barrels.
“Opec made an exceptional decision today,” Iran’s Oil Minister Bijan Zanganeh said, according to the BBC.

Goldman Sachs expressed skepticism that the deal would successfully limit oil production in the long term, in a note that the investment bank circulated to investors. Goldman said that it would not revise its forecasts for WTI at $43 per barrel by the end of this year and $53 a barrel in 2017.

“If this proposed cut is strictly enforced and supports prices, we would expect it to prove self-defeating medium term with a large drilling response around the world,” Goldman’s analysts said.
Goldman also noted that “compliance to quotas is historically poor, especially when oil demand is not weak,” and that other oil exporting nations not beholden to the quota had increased oil production beyond analysts’ expectations.

References:

http://www.cnbc.com/2016/09/28/goldman-sachs-opec-production-cut-deal-doesnt-change-oil-price-forecasts-through-2017.html

http://www.marketwatch.com/story/us-stocks-close-higher-as-oil-jumps-2016-09-28?siteid=bnbh

http://www.marketwatch.com/story/oil-futures-rally-on-report-of-opec-output-cap-agreement-2016-09-28?siteid=bnbh

http://www.bbc.com/news/business-37502538

http://money.cnn.com/2016/09/28/investing/oil-surges-after-opec-informal-meeting/

America’s Birthrate Declines in 2015

Recent data culled by the Centers for Disease Control and Prevention showed an unexpected drop in births in the US in 2015, which fell by 1% from 2014, contrary to the forecasts of demographic analysts. Moreover, the US fertility rate in the first quarter of 2016 fell to 59.8 births per 1,000 women aged 15-44, tying 2013 figures for the lowest fertility rate on record. The figure translates to less than six births for every 100 women, prompting talk that America is currently mired in a baby bust.

America’s current general birth rate is 13.42 births per 1,000 citizens, according to the CIA World Factbook, a figure which is down 10% from 2007.  For comparison, Mexico’s birth rate is 42% higher, or 19.02 births for every 1,000 citizens.

Closer examination of the figures reveals a dramatic change in the ages that women have children today and provide insight into the declining birthrate. There has been a precipitous drop in teenage pregnancies and pregnancies among women in their 20s, both of which have played a large role in driving down the US birthrate. To put it differently, millennials, who have not been having children, are largely responsible for the declining numbers.

A 2015 study by the Urban Institute found that the birth rate for women ages 20-29 fell by 15% between 2007 and 2012. “If these low birth rates to women in their twenties continue, the U.S. might eventually face the type of generational imbalance that currently characterizes Japan and some European countries, but it is too early to predict or worry about that eventuality,” the report noted.

Social changes have pushed women to bear fewer children and put off pregnancy until later in life. Moreover, the economic pressures exerted by the 2008 recession have likely played the biggest role in disincentivizing childbearing among millennial women. While abortion may seem like a likely culprit for this demographic shift, abortion rates have actually declined since the 1980s, according to The Wall Street Journal.

It will soon become apparent whether millennial women will eventually have more children. The most common age in the US is currently 24 or 25, according to The Wall Street Journal, which means there is a sizeable portion of millennials who may decide to become parents in a few short years.

References:

http://blogs.wsj.com/economics/2016/06/07/behind-the-ongoing-u-s-baby-bust-in-5-charts/

http://www.cnbc.com/2015/04/27/baby-bust-millenials-birth-rate-drop-may-signal-historic-shift.html

http://www.cdc.gov/nchs/data/nvsr/nvsr65/nvsr65_03.pdf

http://www.urban.org/research/publication/millennial-childbearing-and-recession