Sunday, October 27, 2013

Guest Post: 3rd Quarter Economic Review by Dorothy Jaworski

QE3 Taper—Never Mind

If you are a fixed income investor, you are still shell shocked. Throughout the summer, the great bond market selloff of 2013 continued on. Treasuries, Agencies, mortgage backed securities, corporate, municipals- all were battered because the markets believed that the Federal Reserve was about to cut the amount of, or “taper,” its $85 billion of monthly purchases of long term bonds.

The Fed had been telegraphing a taper since April and May, when Bernanke and the Fed governors began giving mixed signals. By the time the September FOMC meeting arrived, 100% of Wall Street believed the taper would be $5 billion to $20 billion per month. What did the Fed actually do? Nothing. Well, never mind!

So why did the Fed decide not to taper QE3? I can see five reasons: 1) the government shutdown and its negative effect on GDP was looming, 2) data releases had become weaker, including housing data, and job growth was weakening, 3) the markets had already tightened long term rates, as unwelcome as that has been, 4) the velocity of money remains at a 50 year low, and 5) a nascent upswing in consumer and business loans this year could be cut off, reverting to deleveraging. The Fed’s own mixed messages caused the extreme selloff. They have no one to blame but themselves.


We landed on the shores of Europe in August. What we experienced was the vacation of a lifetime. What we saw were beautiful old cities, castles on the riverbanks of the Rhine, breathtaking cathedrals, and the wonders of Paris and the friendship of citizens of the small towns near Metz. What we know is that we will go back. What we felt and learned was that the European people are confident that the worst of the recession is over in Euroland.

GDP reflects that, too, as Europe’s economy grew by +0.3% in 2Q13 and is expected to grow by +0.2% in 3Q13. Perhaps part of the reason for our bond market selloff is that the flight to quality due to Europe’s prior problems is abating.

She Devil to Head the Fed

Janet Yellen, affectionately nicknamed “She Devil” by Washington and Wall Street, has finally been nominated by the President as Fed Chairman. Her nomination had been in doubt until Lawrence Summers withdrew from consideration. Wall Street gets the Chairman they want—the one with a decade of Fed experience and the one most likely to continue Bernanke’s policies. She spent time in the Fed with the Maestro, Alan Greenspan. She has hopefully learned to deal with a crisis aggressively and to take actions and make statements that are credible, not like the mixed messages we received for the past six months regarding QE tapering.

I feel bad for Ben Bernanke; he will not get to finish what he started. When “normal” recovery finally arrives, She Devil will get the credit. If all goes well, she will take over as FedChairman at the beginning of February, 2014.

But it will not be all smooth sailing for our favorite dove. She will inevitably face crisis and have to deal with it decisively. Greenspan faced the 1987 stock market crash when he was new and in the late 1990s, faced the Asian currency crisis and the collapse of Long Term Capital Management, and the stock market crash of 2000.

Bernanke, as we all remember well, faced the bursting of the housing market bubble and the 2008 financial market crisis with the Lehman Brothers bankruptcy. We must believe that the toughness implied by her nickname will guide her through trouble.

Government Shutdown and Default Danger

We are in the middle of the 18th government shutdown since 1976. One estimate is that 83% of the federal government is still functioning—something about “essential”—so it is not much of a shutdown. We have great Washington drama with both sides refusing to give ground on their issues. But give they must, negotiate they must, to avoid the unspeakable horror of a default on US debt that would destroy trust in our nation and trust in the dollar.

A drop dead date of October 17th for default was given by Treasury, but this date seems suspect, with expected receipts in October of $200 billion and $25 billion in interest payments due, it is hard to understand why default would occur mid-month. Maturing debt could be rolled over and replaced with new debt without breaking the debt ceiling.

But regardless of when that date arrives- someone, anyone in Washington, are you listening? Debt default is not an option. You must act now. As this newsletter goes to press, only days before the October 17th date, I cannot imagine that a default will occur. I must believe that a midnight deal will happen.

The shutdown is impacting the release of economic data of government data, the timing of which is poor as the data had been weakening prior to the doors of 17% of the government being closed on October 1st. The private data being released has been weak, most notably the ADP private payrolls report, which showed measly job growth of 166,000 in September, after 159,000 in August.

Remember, the government payroll report for August showed measly growth of 169,000 for the month, with the labor force participation rate down to 63.2%, the weakest since the late 1970s. The unemployment rate continues to drop, most recently to 7.3% in August, from hundreds of thousands of workers exiting the labor force. This is not a good trend.

Jamie Dimon

We were hoping that there would be a savior to the great bond market selloff of 2013, a voice of reason able to reassure the markets. We usually look to the Fed, but not this time. We were hoping it would be someone like Jamie Dimon. But, alas, we learned in the 3Q13 J.P. Morgan earnings release why he has been in hiding—he has his hands full of legal issues.

JPM reported the first quarterly loss since Dimon’s tenure as CEO with $9.3 billion in legal charges in the 3Q13. This brings the legal reserve at the Bank to an astounding $23 billion! We know he continues to defend JPM from the ongoing extortion fines (recently $900 million) from the federal regulators, UK regulators, and the SEC over the London Whale’s bad trades. We know he continues to defend Bear Stearns from the ongoing demands of state and federal regulators for more and more money for mortgages that defaulted.

But $23 billion—Wow! Stay tuned.

Thanks for reading. DJ 10/13/13

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with First Federal of Bucks County since November, 2004.

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