A US economic snapshot in the middle of 2018 — not all is well

Let’s take a quick look at the US economy and where it may be headed in the near term.

While unemployment is said to be very low, the rate is still artificially low due to the uncounted Americans no longer in the workforce because of chronic joblessness.

Producer and consumer pricing are rising — not because of tariffs as the left will cite — due to the excessive capital washing out of the stock and bond market. The stock price run up over the last three years was engineered by the Federal Reserve’s quantitative easing capital finding safe haven in stocks and bonds.

Now that capital is exiting the security markets and finding better treatment with private equity firms that are buying out manufacturing and consumer brand companies, which drives up prices in order for the new owner — the PE firm — to make money from the investment through putting the brands deeper into debt to make special payments to them.

So this capital is not from the average American, but the repercussions are being felt by these average Americans through higher prices. Look at the biggest PE firms raising record amounts for new funds.

Taking a quick look at the US bond market to see where the real problems are. The difference in return rates between lending Uncle Sam money over 2 years versus 30 years.

The 2-year return is 2.61%, the 30-year interest rate is 2.96%. The delta between these two 0.35 percentage points return over 28 years. This is what is called a flat yield curve, since the interest curve is very shallow.

In the environment of the bond market capital is not treated well at all with artificially low returns, so this is pushing additional big money out of the public capital markets and into the private funding markets.

What is the down side of this move? Look at the number of bankruptcies in the retailing sector over the last year. These stores: Toys R US and a dozen or so women’s apparel stores are all closed or limping along because these companies were so leveraged up on debt that they could not pay off their huge debt levels imposed on them by their private equity owners.

But don’t worry about these PE firms because they took their money upfront and more than likely owed some of the companies bonds, which were paid off in the bankruptcy.

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Fed's backdoor plan to spur "growth"

The Dow on Wednesday spent the last five minutes at the close over the 18K mark to close at 18005, breaking the psychological barrier.

Thursday sees the index opening below the mark in a sell off as the dollar tries to get off the floor and gain strength.

You can see what the Fed is doing without Fed chief Janet Yellen saying it out loud.

Look at the dollar index for the year. The dollar was in the 92 range, now it’s in the 85 range, which is a big move in the currency pits.

Currency wars are the play if you can’t raise rates to cheapen the dollar, just have Treasury print more money to drive down the value.

In a currency war, you can’t grow economically on your own, so you try to steal growth from other countries by making it cheaper to do business in dollars.

This is why you see countries in South America going belly up. They were highly leveraged to the dollar and when it fell could not compete against us.

Look at the M1 money supply as measured by the Fed. It has soared this year and as it has the dollar index has weakened.

Look at the yield curve on US Treasury bonds. The spread between the 10-year and 30-year bonds has flattened so severely it’s now about 80 basis points.

Historically that should be 200-300 basis points in a tight market.

So the secret backroom move by the Fed is to cheapen the currency to combat stagflation and the anemic rate of inflation by printing greenbacks.

This action has the added benefit of cheapening the US debt as inflation grows, but will probably do little for ordinary Americans struggling to get by.

Bond vigilantes are back

Bond vigilantes reared their heads on last Thursday taking the 10-year US treasury to 2.42%.

The largest sovereign market participants grew tired of funding the US with a money losing investment.

While Fed chair Janet Yellen has been saying she is concerned that inflation is muted and is below the Fed benchmark of 2%.

Main St. is scratching its head saying where is Yellen looking? There is price inflation throughout the economy. Sure gas prices have declined, but grocery staples are up.

Well Yellen needs to keep the strawman of low prices and inflation levels to keep borrowing rates low. Low rates mean lower costs on US borrowing.

However, the largest of the bond shops are looking for other investments to put their money to work.

Jeff Gundlach the new Bond King of Doubleline Capital –– who recently came out and said what I been saying all along that the Fed would not raise rates this year –– is moving some of his money into making bridge loans on commercial property in order to get a better return rate on its $47B in assets under management.

A byproduct of this rise in rates –– and a decrease in price –– will be that bank stocks should rise as a result of steepening yield curve, which essentially means more profits for the banks if they loan the money out. Something the banks have been loathe to do.

Tomorrow we’ll talk about where this bond cash is being deployed.