Leveling the Playing Field

October 28, 2013

_______________________________________________________________________ In 2009, President Barack Obama was given the Nobel Peace Prize for his "extraordinary efforts to strengthen international diplomacy and cooperation between peoples. The Nobel Committee Chairman Thorbjorn Jagland said We have not given the prize for what may happen in the future, which was nice because I don t think they usually give out the prize for extraordinary efforts to eavesdrop on foreign leaders phone calls. And as if thats not enough, the ongoing Obamacare website debacle led to a presidential press conference where a woman fainted and Obama said something to the effect of Hey, our website doesnt work but we have a nifty phone number you can call instead.

But not all is lost for Obama, who can rest comfortably with the knowledge that the GOP will find a way to waste these political opportunities. Again.

Tuesdays labor reports (originally due at the beginning of October) were weaker than expected, which in turn pushed out expectations for tapering. Rates dropped, stocks hit new highs. Thats the environment right now - weak data leads to all-time highs in equities. Coupled with the government shutdown, which should create about a 0.2% drag to GDP when all is said and done, we think tapering is now a March 2014 event. Tuesdays release showed a gain in jobs of just 148k and dropped the three month average to 143k, 90k below the peak average in February. Unemployment declined to 7.2%, but this was really more of a rounding issue. The previous month was 7.278% and this release was 7.235%. Wage growth indicated no upward pressure, which typically means employees have little leverage and implies a weak job market overall. The lack of increased purchasing power also translates into little inflation. The Fed is looking beyond the usual NFP and UR reports for guidance on tapering. In last weeks Newsletter we discussed some additional employment metrics the Fed may use to help formulate its tapering decision. The average duration of unemployment basically held steady, declining slightly from 16.4 weeks to 16.3 weeks. The employment to population ratio also head steady, coming in unchanged at 58.6%, near the recent lows. President Dudley is looking for two requirements to be met: 1. Broad based improvement in labor market conditions (like those outlined above, not just a strong NFP print) 2. Forward momentum in GDP, meaning growth in excess of 2% President Evans indicated in a speech he, too, is looking for two requirements to be met: 1. Cyclical improvement in the participation rate 2. Steady, solid growth in GDP Sensing a theme here? Adding an average of 143k jobs per month isnt recessionary, but it doesnt suggest enough strength in hiring to warrant tapering. Additionally, GDP will a key factor going forward.

We also believe housing will play a critical role in the tapering decision. The jump in interest rates over the summer had an immediate and measurable impact on the housing sector. The Fed probably wants to see a pick up following the recent 0.50% retracement in 10yr rates. Lastly, the Fed will have a tough time tapering while a dysfunctional Congress cant get a budget passed. We avoided a default and the government re-opened, but both were short term solutions that need to be revisited in early 2014. The debt ceiling will need to be raised by March to avoid another default scenario.

Yellen Confirmation Yellen will meet behind closed doors over the next two weeks with members of the Senate Banking Committee. There will be a public hearing most likely in midNovember, and a few Congressional members will undoubtedly use this as an opportunity to grandstand (not going to mention any names Ted Cruz and Rand Paul). After this, the 22 members of the Senate Banking Committee will vote. Assuming she receives a majority vote (she will), her confirmation heads to the Senate floor where she needs a simple majority. If she didnt already have the necessary votes, she wouldnt have been nominated. Perhaps the WH administration was also eavesdropping on Senate members to ensure she had the necessary support?

Interest Rate Outlook Heres what we wrote last week and the same holds now: Theres a lid on interest rates for the time being and we expect long term rates to be range-bound, quite possibly through year end if we dont get any surprise news. On the 10yr, were close to the 2.50% resistance level, but well need something more negative to break through that barrier. Barring new information that dramatically shifts the mood on GDP, labor, or the budget/debt ceiling, we expect the 10yr Treasury to be rangebound through year end, roughly 2.40% - 2.85%. With the 10yr closer to the bottom end of the range, we think it makes sense to consider locking in rates at these levels.

This Week Wednesday brings the next FOMC rate decision, which of course will be a decision to keep rates unchanged. Unlike last month, there is no talk of a tapering announcement. Also on Wednesday, 29 Congressional members will meet to discuss a budget compromise in an effort to finalize a budget by December 13th. This deadline, of course, means nothing since the real deadline is January 15th. When was the last time Congress accomplished anything ahead of time? Ironically, the two sides are just $100B apart but are using this issue to set the table for next years elections. The final compromise may result in the sequester cuts being reduced by about a third. Theres also a tremendous amount of data due out, much of it from the missed reports while the government was shut down. Consumer confidence could take a hit following the shutdown, but it also feels like the nation is getting desensitized to these Congressional 11th hour bargains. Did anyone really expect the US to default? Industrial production data is expected to reveal continued weakness in manufacturing and inflationary data is expected to remain the same as last month (roughly 1.8%). There really shouldnt be any surprise reports this week, so we expect more of the same.

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Economic Calendar
Day Monday Time 9:15AM 9:15AM 10:00AM 10:00AM 10:30AM Tuesday 8:30AM 8:30AM 8:30AM 8:30AM 8:30AM 8:30AM 9:00AM 10:00AM 10:00AM Wednesday 7:00AM 8:15AM 8:30AM 8:30AM 8:30AM 8:30AM 2:00PM Thursday 8:30AM 8:30AM 9:00AM 9:45AM Friday 10:00AM 10:00AM Report Industrial Production Capacity Utilization Pending Home Sales (MoM) Pending Home Sales (YoY) Dallas Fed Manufacturing Activity Producer Price Index (MoM) Producer Price Index (YoY) PPI Core (MoM) PPI Core (YoY) Advance Retail Sales (MoM) Retail Sales ex Auto (MoM) Case-Shiller 20-city Index Business Inventories Consumer Confidence Index MBA Mortgage Applications ADP Employment Change Consumer Price Index (MoM) Consumer Price Index (YoY) Core CPI (MoM) Core CPI (YoY) FOMC Rate Decision Initial Jobless Claims Continuing Claims ISM Milwaukee Chicago Purchasing Manager ISM Manufacturing ISM Prices Paid 150k 0.2% 1.2% 0.2% 1.8% 0.25% 340k 2871k 53 55.0 55.0 55.0 Forecast 0.4% 78.0% 0.0% 3.5% 9.0 0.2% 0.6% 0.1% 1.2% 0.0% 0.4% 12.40% 0.3% 75.0 Previous 0.4% 77.8% -1.6% 2.9% 12.8 0.3% 1.4% 0.0% 1.1% 0.2% 0.1% 12.39% 0.4% 79.7 -0.6% 166k 0.1% 1.5% 0.1% 1.8% 0.25% 350k 2874k 55 55.7 56.2 56.5

Speeches and Events Day Wednesday Friday Time 2:00PM 9:10AM 11:15AM 12:00PM FOMC Rate Decision Fed's Bullard speaks on Monetary Policy Fed's Kocherlakota speaks on Health Fed's Lacker speaks to Global Group St. Louis, MO St. Paul, MN Philadelphia, PA Report Place

Treasury Auctions Day Monday Tuesday Wednesday Time 1:00PM 1:00PM 1:00PM 2-year Treasury 5-year Treasury 7-year Treasury Report Size $32B $35B $29B