April 16. What would become of the bomb makers?

What would become of the glaziers, if nobody ever broke windows?  Frederic Bastiat

I’m sure most people know Frederic Bastiat’s parable of the broken window, where the shopkeeper pays a glazier for a new pane of glass, and in that way benefits the economy, which hums along as money circulates.  Bastiat refutes this theory by comparing the visible effects of an action as opposed to unseen costs which may more than counterbalance the initial good. “It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another.”  What is less well known is that the fourth chapter of Bastiat’s treatise is on Taxes.  He might have been right at home with the Freedom Caucus in the US House of Representatives…  “When James B. gives a hundred sous to a Gov’t officer, and receives nothing for them unless it be annoyances, he might as well give them to a thief.”

Well, it’s tax time in the US, due this year on April 18.  Since Trump is apparently seeking more accountability regarding US spending, it might be useful to review a few figures relating to national spending and receipts.  Let’s start with MOAB, the bomb dropped in Afghanistan.  According to some stories, this bomb cost $300 million to develop.  Other news sources cited a price tag of $16 million per unit.  But Business Insider reports that the 22000 pound bomb costs about $170,000 per unit, having received the information directly from the US Air Force.  Does that make sense?  About $7.75/lb.  In comparison, the curb weight of a Ford F-150 is about 4100 lbs, and costs about $30,000 (depending on the model).  Right around $7.31 per pound.  So that price seems to make sense; it doesn’t seem like the taxpayer is getting nicked by that particular purchase.  However, you can drive your Ford F-150 to the Nascar race or use it to tow your bass boat to the lake, while the bomb simply sits idly by like an insurance policy, awaiting a valid target.

I have no idea how to ascertain this figure, but news reports said that 36 had been killed by the bomb.  So that’s right around $4700 per individual (excluding transportation costs).  By comparison, a death penalty in the US apparently costs around $3 million.  So in that sense, it also offers value, and compares to forty murders in Chicago in the month of March.  Absurd?  Yes, because that seem to be the world we are living in now.

We can see the numbers, but we can’t foresee the reverberations on foreign policy.  We can’t know the ultimate responses.  What we do see as knock-on effects in the markets is that uncertainty is on an upswing, whether measured by VIX, or by implieds on other products like gold, or by treasury yields which are at new lows for the year (Ten Yr at 2.23%).  It may have nothing to do with US policy, but stress is also apparent in Europe, for example, the German/Italy ten year spread closed at a new recent high of 213 bps.

There is also some ‘hard’ data to consider.  Retail sales, reported Friday, were lower than expected at -0.2.  Headline CPI was  -0.3%, leaving yoy Core CPI at just 2%.  In response, the Atlanta Fed revised their Q1 GDP Now forecast to just 0.5%, having been as high as 2.5% in late February.   What is also pretty extraordinary is that while the Federal Gov’t collected a record amount of individual and payroll taxes in the first six month of the fiscal year which ended in March, the amount of Corporate Tax collected plunged by nearly 18% (!), from $121,907m in 2016 to $100,234m in 2017 (Circled in red below).  That’s likely a lagging piece of data, but it’s also a splash of cold water for the reflation-istas.

In fact, many markets have given back all of the post-election trade.  For example, the Mexican Peso was 18.52 on Oct 25, declined to 21.95 to the USD in January, and is now back to 18.58.  It’s the same for spreads like 2/10 treasury spread which was around 100 at the start of November, went to 135.5 by the end of December and has been oozing blood ever since, closing the week at 103. Full round turns on the Trump trade.  Industrial commodities like iron ore and copper have also been trending lower since their peaks this year set in February, perhaps having more to do with China than the US, but again, the reflation narrative is being squelched by a variety of conditions.

What hasn’t given back election gains is the stock market.  While warning signs abound, it’s still a fact that SPX was around 2100 just prior to the election, and closed Friday at 2329.  Of course, it may be that because Q1 was so weak, there has to be a strong rebound.  Or that Q1 was so weak, that the Fed can’t possibly continue to remove accommodation.  On the latter, I would note that July FF still indicate just north of 50/50 odds of a hike in June, and that Fed officials continue to prep the markets for balance sheet reduction later this year.

It’s a reasonably quiet upcoming week in terms of economic data.  There are Fed speakers every day, the most important of which is likely to be Fischer on Monday after US markets close.  Industrial Production Tuesday,  Beige Book on Wednesday.



Trade thoughts

In 2001 the Fed had already begun easing in 50 bp increments right from the start of the year, and I thought there might be an inter-meeting cut.  I was long calls, which expired just prior to Easter, but on April 18, just after the holiday (and option expiration), the Fed surprised the market with another 50 bp cut, from 5% to 4.5%.  I cite this time for a few reasons.  First, I think 2001 was the last time the Fed changed the FF target between meetings (though it wasn’t this particular cut, it was later in the year after 9/11).  Second, it shows just how much room the Fed had in those days to change policy to stimulate the economy: in late 2000 the rate was 6.5% and by the end of 2001 it was 1.75%.  Third, the reason for the intermeeting cut:

The severe slowdown in capital spending by big corporations “threatens to keep the pace of economic activity unacceptably weak,” the central bank said in its statement. “As a consequence, the (Open Market) committee agreed that an adjustment” in rates was needed before the Fed’s next regular meeting in May.

While we are currently in a ‘tightening’ cycle, nearly every Fed speaker decries the lame pace of capital spending and productivity.  Again, these factors may be altered by changes in policy, if the Trump administration can put them through.  It’s an open question.



4/7/2017 4/13/2017 chg
UST 2Y 128.2 119.7 -8.5
UST 5Y 191.0 175.6 -15.4
UST 10Y 237.5 222.7 -14.8
UST 30Y 300.0 288.4 -11.6
GERM 2Y -80.7 -85.8 -5.1
GERM 10Y 22.8 18.7 -4.1
JPN 30Y 84.7 78.8 -5.9
EURO$ M7/M8 43.0 34.0 -9.0
EURO$ M8/M9 35.0 30.0 -5.0
EUR 105.91 106.14 0.23
CRUDE (1st cont) 52.64 53.60 0.96
SPX 2355.54 2328.95 -26.59
VIX 12.87 15.96 3.09




Posted on April 17, 2017 at 5:23 am by alexmanzara · Permalink
In: Eurodollar Options

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