QE 3 UNLIKELY AND WILL NOT SOLVE INFRASTRUCTURE DEFICITS

QE3 is now at zero hour for any announcement out of Jackson. Markets have been pricing in expectations and pundit positions are every where. Conversely, why should the Fed say yes to QE?

A presidential election is a few months off, and the Fed must sustain neutrality. Political neutrality is a major Fed mandate, which neutrality is also expected of those elected. A quid pro quo.  Also, equity prices haven't fallen over  time despite overall caution in company guidance and reductions in revenue. Earnings per share have been revised down over time which seems natural against overall economic developments. But declines in revenue were surprising. Declines in revenue tell of limits in sustaining earnings.

Noted cash with some companies and considerable excess reserves among banks tell of hesitancy to engage opportunity. Hesitancy of course arises from ultimate insecurity in fiscal policy and regulatory behavior.For the Fed, insecurity tells of cash hoarding and inflation potential once hoards are released.Especially with market advantages gained by M&A activity over a few years.

Progression in economic indicators have been touted. For July results reported in August, retail sales, industrial production and durable goods orders have shown an advance. But, after how many months of decline or teetering on loss. Do they now show a climb out of a hole or a developing hole? Regional Fed manufacturing results have been very weak and moving into trending decline for some time.

Crude and gasoline are in a new place with demand obviously having increased due to world development. Still, technology and price differentials have created supply opportunity and advantages. For such opportunity to be realized, infrastructure development needs to occur in order to move product to refining centers and then global markets. It's occurring, but at what cost both financially and in gross petroleum flow.

Can QE3 cure hesitations among companies and banks, and then bring cash to markets? No. Can QE3 solve petroleum infrastructure problems? No. Once infrastructure gets addressed, can QE3 open new markets? No.

Totality of consideration puts QE3 at not likely now. Should it happen later or even now, diminishing returns will be realized.

Expected by the Fed is a tale told similar to ECB's leader of how all will be protected, should the need arise.

  

FED MINUTES TELL MAJORITY WANTS QE3, BUT CONVICTION FOR QE3 REMAINS HESITANT

Speculation on a third round of Federal Reserve Bank quantitative easing, or QE3, found much more certainty in its occurrence. On Wednesday, Federal Open Market Committee (FOMC) minutes were released revealing existing Federal Reserve sentiment. Based on Fed discussions, QE3 looks to be a matter of time rather than “if”.

Quantitative easing amounts to the Fed increasing monetary supplies by buying government securities such as treasuries from banks. Banks thereby receive an infusion of cash. Then, expectations are for banks to lend their new cash. Past experiences have revealed, however, increases in commodity values and equities. Also realized in past QE is treasury prices decline and yields increase while the dollar falls due to flooding liquidity.

Oil prices, being driven in dollars, are fraught with a balance between cheapening U.S. dollars and increasing demand driven by comparatively cheap dollars.

With oil prices having been in decline for a considerable period, starting certainly last April, increases in U.S. dollar isn't a cause, U.S. dollar has increased but not to a degree explaining crude price declines. Rather, supplies have increased against a decline in global demand, simple. Implied is further QE might not ultimately drive up demand for oil, and thereby U.S. or global production. Rather, QE3 could raise petroleum prices through speculation driven by past pricing experience, only for economies to ultimately see a further decline in demand and production due to price.

Data also reveals QE's association with increases in GDP, here in the U.S. and abroad. It can have a positive influence. But that influence is experienced only during the period of exceptional easing operations. Once it ends, we return to what existed otherwise. Similarly, cash infusions brought by QE certainly create reserves to be used later, during better economic times. Suggested is potential inflation later once economies improve. However, when will economies improve. Recovery is now a new normal.

Saying this, FOMC minutes of Wednesday reveals QE3's likelihood, but not its conviction. Where minutes say “Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.” Other comments, apparently in the minority, point out QE3 risks.

According to FOMC minutes, “A few participants were concerned that an extended period of accommodation or an additional large-scale asset purchase program could increase the risks to financial stability or lead to a rise in longer-term inflation expectations.”

Through FOMC minutes, alternatives to QE3 were addressed but overall rejected. Namely was discussion on other central bank activities. ECB's zeroing of interest charged on deposits was considered, but rejected. ECB's efforts are conducted under different money market conditions from U.S. conditions. FOMC also looked at Bank of England's Funding for Lending Plan. Such plan looks interesting, but open to bank gaming. This plan was rejected because minutes say “importance of institutional differences between the two countries was noted.”

FOMC comments appear to tell of a majority seeing progressing weakness, as opposed to a soft patch. QE3 looks like a matter of time, with reservation of hesitancy among some members. Where will any substantial and sustainable data of economic growth come from?

AGAINST GLOBAL WEAKNESS, MACHINERY HOLDS SPECIAL STRENGTH

U.S. GDP BETTER THAN EXPECTED IMPLIES INFLUENCE OF OIL AND GAS

Q2 GDP did sound off better at 1.5% growth versus an expected rate of 1.2%. Though GDP shows sequential decline, it remains in growth. Caution  arises through a variety of more current data mentioned on this space yesterday.

Remarkable, however, is sustained pricing and production witnessed in machinery. Resilient strength is known in vehicle production (with sales flat or in decline). Also accounting for growth is a bottom in housing ownership which is renewing a rental market. With it comes increases in multi-occupant residential construction. We then have improved technologies demonstrating a renewed petroleum and natural gas industry here in the U.S.

All create positive business ramifications. From vehicles, structural construction and development of oil and gas fields, machinery is confirming a fundamental strength. But this strength is only as strong as its underlying causes.

INDUSTRIAL PRODUCTION RESULTS SHOW SUSTAINED STRENGTH IN NAICS 333, MACHINERY

North American Industrial Classification System (NAICS) is how the Fed and other economic data collectors classify data into groups. NAICS 333 is composed of real machine manufacturers, like Caterpillar and Deere, from there it goes into the manufacture of metal work machinery, engines, turbines, power transmission and industrial machinery which includes; saw mills, rubber and plastics, textiles and pipe production machinery. 

Last Industrial Production report from the Federal Reserve, dated July 17, tells a tale of overall weakness on a quarter over quarter basis for all items. For example, where manufacturing was up 5.6% Q4, and up 9.8% Q1….it was up only 1.4% for Q2. Keeping in mind Industrial Production is a lagging indicator, Q3 could show deeper weakness given more concurrent indicators reported on this site.

Optimism is found, however, in some fundamental items on the Industrial Production report. Machinery sales is chief in that Q4 saw an annual increase of 8.5%, up a giant 21.9% in Q1, and through a tough Q2, it was up 8.8%.

Machinery weighs heavily and significantly on the Industrial Production report at 5.41% of durable manufacturing, where motor vehicles are at 5.33%, computers and electronics at 6.25%, transportation equipment at 4.30%  and miscellaneous at 3.12% (all values are weighted against the overall index).

Sustained sales in machinery over quarters compare with noted and known strength of motor vehicles which were up 23.9% Q4, 41.0% Q1 and up 18.2% Q2. Miscellaneous Industrial Production is like autos with robust growth and sequentially up from a rise of 2.3% Q4, to 9.9% Q1 and up 13.5% Q2 (sequential Q2 growth, unheard of among indicators and shows outstanding performance).  

Computers and electronics saw a rise of 1.0% Q4, 8.8% Q1 and 5.1% Q2. For transportation equipment, data shows a progressing sequential decline from 17.7% Q4 all the way down to -.1% Q2.

From Industrial Production data over quarters, one can garner sustained strength in machinery, vehicles and miscellaneous production. Computer and electronics hang in there, but not to the degree of machinery, and other items. Transportation equipment is in sequential decline.

All told, machinery has proven itself for months to be consistent and sustained in production, as with automobiles. Next factor to look at is pricing durability over the period.

IMPORT/EXPORT PRICING OF MACHINERY HOLDS STRONG

Import/Export data from the Bureau of Labor Statistics provides this information. Dated July 12, 2012, information shows import machinery pricing up 2.4% and export pricing up 2.8% (Y/Y). Compare such result with other leads on manufacturing being computers and electronics for example. This area is down on imports  -1.8% and up some .4% on exports (Y/Y).

Versus other major items on the BLS import/export data set, machinery manufacturing especially with exports holds pricing strength. This along with sustained and continued demand tells of foundational economic strength.

Revealed in GDP is a base of resiliency. It appears vehicle and petroleum production in North America are proving to be anchors in filling what consumption exists. Consumption feeding car sales and petroleum are giving demand to machinery demand. 

Q2 GDP STRENGTH COULD TURN INTO PROGRESSING Q2 INDICATOR WEAKNESS FOR A Q3 DECLINE, OR SUSTAINING MODERATE GROWTH

Current situation is that retail sales show auto sales in decline, while data from car manufacturers show flat results. Compare this with industrial production data which shows cars still in a rate of good but reduced production. Oil and gas are in a serious issue of oil and gasoline declining globally with consumption, but consumer prices staying high due to refiner limits on end use product supplies. Housing is so infant, any growth is magical. 

Through what window are drivers of this economy looking, and perhaps seeing only their own reflection.  Chart below is the Dow Jones Industrial Machinery Index, an idea to be kicked around, especially after today.

Say China goes into deep easing and more spending on infrastructure, say Euro Zone goes into similar levels of bond purchases as known before or even more, say interest rates are generally relaxed among developing countries such that carry trades become a secure proposition.

Could we then be one step forward with global easing, but then learn at the end of easing we are really four steps back. At some point, fiscal policy aside from austerity alone must step to the plate and take a real swing.....good, bad, or indifferent, action matters. 

Fed Regional Indicators and Q2 GDP, Industrial Production and Importance of Numbers Now

Q2 GDP and Industrial Production introduce a new round of Fed regional indicators for July

Fed regional indicators for July demonstrate continuing weakening entering Q3, as they did entering Q2. Putting Fed regional data into perspective is Q2 GDP and June's Industrial Production results. Regional indicators proved over Q2 to ultimately become a lead on GDP and other indicators, suggesting decent correlation.

GDP ended Q4, 2011 at 4.1%, Q1 at 2.0% and initial Q2 data showing GDP down to an increase of 1.5%, but still higher than an expected decline to 1.2%. Nearly all areas showed quarter over quarter decline with personal consumption expenditure down to a 1.5% increase v. Q2's 2.4% increase. Personal expenditure on durable goods fell into decline, down a -1% against a Q1 increase of 11.5% and expenditure on nondurable goods was flat.

Telling is motor vehicls' contribution to GDP where output provided .72% in Q1, the number fell to  .13% in Q2. Motor vehicles have been a major force of economic growth. Such a result comports with the Retail Sales report as opposed to month over month car company reports.

Providing support to GDP was a slowing of the rate of decline in Federal government spending which declined to -4.2% in Q1, then to -0.4% in Q2. Where exports strengthened in Q2 to 5.3% v. Q1's 4.4%, the strength was offset by an increase in imports (which reduce GDP) to 6.0% in Q2 from 3.1% in Q1.

All told it appears that an uptick in government spending helped to support otherwise slowing production. Also a strong dollar encouraged import purchases offsetting positive increases in exports. Motor vehicles declined significantly while staying positive and....

June's Industrial Production results released on July 17 show a significant quarter over quarter decline in production. Total industrial production grew in Q2 by 2.2% against Q1's rate of 5.8%.  Manufacturing grew in Q2 by only 1.4% v. Q1 at 9.8%.

Breaking manufacturing down into durable and nondurable manufacturing, the durable side saw Q2 growth at 6.2% compared with Q1 at 16.3% with wood products, nonmetalic mineral products and primary metals falling into negative territory. Automobiles show continued strength but waning momentum. Q2 saw motor vehicle production grow at 18.2% against Q1's growth rate of 41.0%.

Nondurable manufacturing went from a Q1 advance of 3.5% to a Q2 contraction of -3.4%. In fact all items composing nondurable manufacturing went into significant contraction aside from printing/support and plastic/rubber products.

It appears that progressing weakness witnessed in Fed regional indicators month over month through Q2 did show up in GDP and industrial production. Concern is that where Fed regional indicators demonstrated volatile results which were inclined to weakness in Q2, such a trend might move into more consistent results inclined to consistent weakness. Implication could be deeper declines in GDP.

 Fed regional indicators are showing Q2 weakness with Q2 revisions and Q3 GDP implications

July's regional indicators are generally either in contraction, or if they happen to be up, they're not up by much. Empire State Manufacturing Survey has managed to keep its head above water. General business conditions improved a little in July going to 7.39 from June's 2.29. But one can't help notice how new orders fell into decline in May and progressed to July's -2.69 from June's 2.18.

Empire State does show improvement in shipments up to 10.28 from 4.81 in June, employees have increased, prices paid for raw materials continues in decline where prices received for finished goods ticked up a little from 1.03 in June to July's 3.70. Overall, the indicator is bouncing, but when it is bouncing up, the gains tend to be diminishing.

Kansas City Fed Manufacturing Index is like Empire, only stronger indications of weakness exist. Kansas City’s composite index showed a 3 in June and improved to 5 in July. Contrary to this 2 point improvement are continued declines in nearly all items. Production showed a decent 12 in June and down to 2 in July, for the same period volume of shipments were 12 and in July -3, new orders are in sequential but relaxing contraction with June at-7 and July -4, average employee workweek is sequentially in contraction, prices paid for raw materials are up substantially and prices received for finished goods are contracting or flat.

Advancing items for Kansas City Fed Index are inventories, perhaps a consequence of production overshooting demand; and employment, perhaps due to similar reasons as with inventories.

Philadelphia Fed Survey, which started contracting entering May, remains in relatively steep contraction, despite a modest July improvement from June’s-16.6 to July’s -12.9. Positives do exist with new order improving in July to -6.9 from June’s -18.8 and shipments show similar improvement as with unfilled orders. What is most encouraging is pricing strength returned to Philly suggesting return of demand. Namely, prices paid were up in July to 3.7 against a -2.8 for June and prices received a positive 1.6 from -6.9 in July.

Adding to significantly contracting Fed regions is Richmond Fed Manufacturing Survey. Its composite index puts July at a contraction of -17 v. a contraction of -1 in June. Real problem, and unlike Philadelphia is shipments, new orders, backlog orders and capacity utilization which are contracting from  -16 to -27 versus a mild June of contraction.

Dallas Fed Manufacturing Survey moved into a dichotomy of significant contraction against growing weakness. Dichotomy is in business activity contracting to -13.2 in July from June’s 5.8 and production sustaining at a positive 12.0 in July from a June strong result of 15.5. Where business activity is in contraction, production side items in contraction are growth rate of new orders at -3.1 v. June’s 1.6 and unfilled orders at -1.6 v. June’s 7.6. Also in contraction are inventories with materials’ inventories at -3.0 against a June 1.1 increase and finished goods’ inventories down -8.0 where June was down -7.7.

Appears to be a dirth of demand driven destocking in Dallas. Low demand destocking can be seemingly confirmed with prices paid for raw materials up sequentially, but prices received for finished goods down -5.5 for July and down -5.8 in June.

Looks like Empire is struggling to stay above water and Kansas City should be underwater, but bloated inventories are creating a false positive in Kansas City. Philadelphia remains in significant decline, but showing pricing strength and perhaps growth in demand. Richmond does not look healthy at all and looks anemic. Dallas, where is this dichotomy going? Could be destocking driven by demand declines.

Overall, Fed regional indicators remain volatile, but even more inclined to weakness.

 Advancing indicators are a minority against declining indicators, showing a real trend

Other indicators are in contraction. Namely, Chicago Fed National Activity Index in sequential decline with June down -.45 and July down -.15 but the 3 month moving average down for all four months sequentially. ISM Manufacturing Index is down sequentially June to July with June at 49.7 (below 50 tends to show contraction) and July an improved 49.8.

 Leading Indicators are also down for a first time in a long time. Results are down in July at -.3% v. June up .4%. Essential strength for Leading Indicators is spread in yields (for banks) between 10 year Treasuries and Fed Funds rate. (I tried to borrow at Fed Fund rates and buy Treasuries for the carry trade, got denied, they told me I’m not a bank, I had no choice but to agree)

Currently, it does look like indicators that can sustain positive territory are in a real minority. Even then, they have their ugly points. In majority are indicators in decline, with month over month dynamics continuing into July progressing into pattern weakness.