Wednesday, March 30, 2016

This is what "printing money" looks like

Since late 2008, when it launched the first of its three Quantitative Easing programs, the Fed's accusers have bemoaned its massive money-printing, sure that it would lead to the debasement of the dollar, the advent of hyperinflation, and the end of the world as we know it. I was part of that crowd initially, but soon realized that the Fed's massive expansion of bank reserves was not inflationary because it simply offset the banking system's incredible demand for safe, dollar liquidity. I've had many posts over the years which have expanded on this theme.

I've been an avid student of monetary policy and inflation ever since I spent four years living in Argentina in the late 1970s. As I recall, inflation averaged about 125% a year while I lived there, and during a visit to the country in the mid-1980s I was fascinated to watch hyperinflation unfold: prices almost tripled within the span of three weeks. A year ago I wrote a post on the subject of inflation and Argentina, in which I explained that the conditions in Argentina that allowed a huge increase in inflation don't exist here in the U.S., fortunately. The government of Argentina relies on direct printing of money to finance its deficit, whereas the U.S. government finances its deficit by selling bonds. When the Argentine government needs to finance a budget shortfall, it can "borrow" money directly from its central bank in exchange for an IOU, which in practice is never repaid. This shows up on the central bank's books as "Loans to the Federal Government." In essence, the Argentine central bank simply runs the printing presses whenever the government needs money, and the government pays its bills with funny money.

Here's what it looks like when a central bank "prints money" and high inflation results:

Argentina's most recent bout of money printing and high inflation started back in 2009, when the government started running a deficit that needed to be financed by money printing. By early 2010, the growth in the supply of currency in circulation in Argentina was nearing 30%. Currency in circulation has grown at an annualized rate of about 30% ever since, as the chart above shows—in the past six years, the supply of currency has expanded almost five-fold, from 82 billion to 400 billion pesos. In the U.S., in contrast, currency in circulation has been growing at a 6-7% annual pace for decades, and strong offshore demand for greenbacks has been the main driver of that growth.

True money printing results in higher inflation because there's basically too much money chasing too few goods and services. Printing money with no solid backing and in excess of the public's need for money simply causes the value of money to fall and prices to rise. We see this in the chart above, with the early signs of money printing showing up in the black market (referred back then as the "blue" rate of exchange) in mid-2010. Since March of 2010, the peso has fallen by almost 75% against the dollar, and inflation has been running around 30% per year. We don't know for sure how much inflation there's been, because the government office charged with measuring inflation was long ago told to just make up the numbers. The government of Cristina Kirchner didn't want to acknowledge what it was doing, but everyone who lives there knows that inflation was been very high for many years.

The new government of Mauricio Macri has vowed to stop the money printing, but it hasn't happened yet. The problem is that Argentina still can't finance its deficit by borrowing money legitimately. That may change soon if the government is able to mend relations with its foreign creditors and if it manages to rein in its excessive spending. I'm optimistic it will happen, and if it does we should see slower growth in currency, a gradual stabilization of the peso, and stronger growth in the economy. Big changes are afoot in the southern part of Latin America, and it could get pretty exciting if Brazil joins the reform movement.

Monday, March 28, 2016

China's gift to us: cheap goods

When it comes to trade with China, Donald Trump has it all wrong. The Chinese haven't been taking advantage of us by running a huge trade deficit, they have been giving us a huge gift in the form of ever-cheaper goods (e.g., iPhones, HDTVs). And what did they do with all the money we paid them for those cheap goods? Well, they ended up investing it all here, mostly in Treasury notes. So, at the end of the day we got lots of cheap stuff, and we got to keep our money to boot. Sounds like a sweet deal to me.

The last time the Chinese devalued their currency big-time was at the beginning of 1994, when the yuan plunged almost overnight from 5.8 to 8.7 to the dollar. Following that one concerted move, which was designed to kickstart China's goal of becoming a major exporter and economic player, the Chinese adopted a pegged/managed exchange rate policy, a legitimate monetary policy strategy. In a currency peg regime, the central bank buys up any net inflows of foreign currency in order to keep those inflows from pushing up the value of its currency. Similarly, the central bank must sell foreign currency whenever there are net foreign currency outflows which would otherwise push down the value of its currency. Rising foreign exchange reserves are thus indicative of capital inflows, whereas a decline in forex reserves signals capital outflows.

As the chart above shows, China's currency rose in stages from 1994 through 2014, driven by a continuous influx of foreign capital which the central bank bought up, accumulating some $4 trillion in forex reserves as a result, most of which was invested in Treasury notes. In effect, the money we paid China for its wonderfully cheap durable goods was reinvested right back into the U.S. economy by the Chinese central bank.

Since mid-2014, capital has been leaving the country, and the central bank has been selling its reserves, which have fallen from a high of $4 trillion to $3.2 trillion as of the end of last month. Why have capital flows reversed? Because China is no longer a magnet for foreign capital. China's economic growth rate has slowed as its economy has matured, so there is no longer a mad dash on the part of global capital to invest in China. In addition, the government has been relaxing capital controls, making it easier for money to leave, in preparation for the yuan's acceptance as a major currency by the IMF. 

Since 1994, the net effect of China's exchange rate policy was a doubling of the real value of the yuan vis a vis the currencies of its trading partners, as the chart above shows. That's right: for the better part of more than 20 years China's currency has been adjusted higher—not lower—against other currencies, after taking into account relative differences in inflation. China became an exporting and manufacturing powerhouse not because it cheapened its currency to unfairly compete, but because it worked hard to become a world-class manufacturer. China became a world class exporter in spite of the fact that its currency was steadily appreciating for two decades. This is not unfair competition, its healthy economic development. The productivity of Chinese workers has skyrocketed, as have the living standards of the Chinese people. And what's good for China is good for the world.

Most of what China has exported is what we call durable goods. China managed to make fantastic and innovative products in an ever-cheaper fashion, and the benefits of that productivity miracle were shared by all the world's consumers. Since China first launched its exporting and manufacturing boom in 1995, cheap imports have resulted in a continuous decline in the price of durable goods in the U.S., which shows up in the blue line in the chart above. Since 1995, durable goods prices on average have fallen by one-third. That's the first time in recorded history that durable goods prices in the U.S. have declined on a sustained basis. Meanwhile, the prices of other things—services and nondurable goods—have continued to rise.

The story is relatively simple: technology, coupled with the rise of China's manufacturing prowess, has driven down the prices of manufactured goods and boosted the productivity of labor. Labor is more productive today, thanks to computers, technology, and the internet. It takes less and less input from people to make more and better things as a result.

As the chart above also shows, durable goods prices have fallen by one third over the past 20-some years, while the prices of services (a reasonable proxy for labor costs) have risen by over two thirds and non-durable goods prices have increased by over 40%. This has led to the most amazing change in relative prices in modern times, and it's a gift that keeps on giving to the vast majority of the world's population: a typical wage in the U.S. today buys two and a half times as much in the way of durable goods as it did 22 years ago (i.e., 1.69/.6 = 2.5), and there is no sign that this won't continue. Wow.

Memo to Trump: slapping a huge tariff on Chinese imports would only serve to make durable goods more expensive, to the detriment on all consumers, in a misguided attempt to attract some manufacturing jobs back here from China. You don't make the U.S. economy stronger by making durable goods more expensive. If we want more jobs in the U.S., all we need to do is make the U.S. more attractive to capital, and we can do that by drastically reducing the taxes on capital. That's the win-win solution. Increase the after-tax returns to capital invested in the U.S., and you will see more capital invested, and with more capital, perforce come more jobs.

I should add that monetary policy has had little if anything to do with durable goods deflation. It's all about China opening up its billions of people to the global marketplace, the blossoming of international trade, and the technological wonders released by the combination of ever-more-powerful computer chips and incredible software technology.

This is not something to fear, this is something to celebrate.

Sunday, March 27, 2016

Profits are down; is that bad for stocks?

The recent release of the final estimate of Q4/15 GDP stats revealed that growth was stronger than had been previously estimated (1.4% now vs. 0.7% in the first estimate). It also brought us our first look at corporate profits for the quarter. After-tax profits were unquestionably weak, down 8% or so from the prior quarter, and down 12% from year-ago levels, after adjusting for inventory valuation and capital consumption allowances. (Without adjustments, after-tax corporate profits were down 8% for the quarter and 3.6% for the year.) As a percent of GDP, however, after-tax profits were still substantially above their long term average.

So, good news and bad news. Growth has slowed but the economy is not collapsing; profits are no longer growing and they are down on the margin. However, profits are still unusually strong relative to GDP. It is likely, of course, that profits have been depressed of late because of distress in the oil patch, but this doesn't change the more sobering fact that profits have not been growing much, if at all, for several years.

PE ratios today are somewhat above their long-term average, so considering that profits are flat to down would suggest that equity valuations today are unattractive. (Contrast this to a similar post I made in May, 2013, in which I argued that valuations were quite attractive.) But there are other considerations worth noting (see below), and on balance I think that, for long-term investors willing to overlook the current weakness, equities are still attractive.

The chart above compares the two measures of corporate profits that I am referring to in this post; one as calculated in the National Income and Products Accounts, and the other as reported by S&P 500 companies according to GAAP standards. A few years ago I discussed the difference between the two measures of profits here, concluding that of the two, the NIPA measure is probably the better one. Regardless, both have been flat to down of late.

The chart above shows the conventional PE ratio of the S&P 500 index as calculated by Bloomberg. Today's PE of 18.5 is about 10% above its long-term average of 16.7. Based on this simple fact, one could conclude that equities are somewhat unattractive, yet not nearly as unattractive as they were in the late 1990s.

The chart above calculates the PE ratio of the S&P 500 using corporate profits as calculated in the GDP stats as the "E", and normalizing the result to match the average of the conventional PE ratio. (It also assumes that the S&P 500 index is a decent proxy for the price of all corporate equities, which is quite defensible.) This arguably has several advantages relative to the conventional method of calculating PE ratios. Instead of using 12-month trailing earnings as in a conventional analysis, this method uses the annualized profits of the most recent quarter, thus giving us a more contemporaneous measure of multiples. Furthermore, NIPA profits are based on actual profits as reported to the IRS, which are quite unlikely to be overstated or otherwise distorted by accounting methods, or by equity buybacks. Interestingly, this method gives us a similar conclusion: PE ratios are somewhat higher today than their long-term average. In recent years this method has yielded PE ratios that were below average. Clearly, equities are no longer "cheap," but neither are they grossly overvalued.

The chart above compares NIPA corporate profits to nominal GDP. Both y-axes have a similar ratio scale, and are plotted in log fashion so that increases and decreases are representative of changes of similar magnitude.

The chart above shows the ratio of corporate profits to nominal GDP, using the data from the previous chart. Here we see how profits have been much higher relative to GDP in the past decade or so than they were in prior decades, and they remain substantially above their long-term average. This has led many skeptics to argue that profits will eventually mean-revert to a much lower level of GDP.

I've argued in a prior post that the unusually strong growth of profits in recent decades is most likely due to globalization, which has had the effect of significantly expanding the market for U.S. corporations. Apple can sell iPhones to billions of customers today, whereas that would have been impossible just a few decades ago. I would also note that when the after tax profits of U.S. corporations are compared to global GDP, they don't appear to be unusually high at all. That further suggests that profits relative to U.S. GDP needn't be mean-reverting. It could well be that profits have a higher floor, relative to GDP, than in the past, and that downside risks from here are not significant, so long as the global economy does not collapse.

The chart above shows the difference between the earnings yield (the inverse of the PE ratio) on the S&P 500 and the yield on 10-yr Treasuries. This represents the premium that investors demand in order to accept the risk of equities versus the security of Treasuries. The premium has not often been as high as it is today, and that's especially noteworthy. Consider: investors today are willing to pay more than $50 for a dollar's worth of 10-yr Treasury coupons, but only $18 or so for a dollar's worth of corporate earnings. That huge difference is symptomatic, I would argue, of a deep-seated risk aversion on the part of the world's investors.

Considering that the upside potential of equities is likely much greater than the upside potential of Treasuries (given the very low level of Treasury yields), it's interesting that the world's capital markets are apparently indifferent to earning less than 2% on bonds at a time when the earnings yield on equities (currently 5.4%) is considerably higher. This is another way of saying that the market has priced in very pessimistic assumptions for future growth and profits. All it takes to be bullish these days is to hold a less pessimistic view of the future than the market holds.

The chart above compares the level of the S&P 500 index to the ratio of the Vix Index to the 10-yr Treasury yield, the latter being a proxy for the market's level of fear, uncertainty, and doubt. For the past two years, rising levels of fear and uncertainty have corresponded reliably to declining equity values, and vice versa. This again confirms my view that equity prices currently are depressed because the market is still worried about the future.

The chart above illustrates the "Rule of 20," a valuation tool that is based on the belief that stocks are fairly valued if the trailing 12-month PE ratio on stocks equals 20 minus inflation. (The idea being that PE ratios should move inversely to levels of inflation; rising inflation drives interest rates and discount rates higher, thus depressing the present value of future earnings.) The Core Personal Consumption Deflator is currently about 1.7, which suggests a "fair value" PE ratio of 18.3, which is almost exactly equal to the current PE ratio of the S&P 500. Stocks by this measure appear fairly valued.

Conclusion:Stocks may be somewhat overvalued based on the level of PE ratios, but corporate profits remain robust and equities hold the promise of delivering substantially higher returns than risk-free alternatives. For investors that are willing to take the long view—that the U.S. economy is likely to continue to grow, albeit slowly—stocks are still attractive. 

Thursday, March 24, 2016

Lousy economy, but great job security

The economy is still in the midst of its weakest recovery ever. But the news is not all bad: the chances of a worker being fired today are lower than at any time in the past 50 years.

As the chart above shows, the 4-week moving average of initial claims for unemployment has fallen to its lowest level since 1973.

As a percent of the workforce, initial claims are the lowest they have been since records were first kept in 1967. In the past 4 weeks, initial claims dipped to a mere 0.18% of the 143.6 million people working.

Wednesday, March 16, 2016

Inflation is alive and well

I suspect a good many people would be surprised to learn that, if you abstract from volatile energy prices, consumer price inflation in the U.S. has been running at an annualized rate of 2.0% for the past 10 and 20 years. In fact, the CPI ex-energy is up 2.1% in the 12 months ended February and it has even risen at a 2.3% annualized rate over the past six months and 2.5% over the past three months. Inflation is far from dead, and the deflation concerns you've heard about in recent years are all the by-product of collapsing energy prices, which, by the way, are now a thing of the past.

The FOMC undoubtedly will take note of this fact in their deliberations today, and it will encourage them to move—albeit slowly—to raise short-term interest rates to a higher level. This should not be surprising nor scary. On the contrary, it would be scary if they ignored the behavior of core inflation.

The chart above shows the year over year change in the CPI (total) and the CPI ex-energy. Note how much more volatile the total is compared to the ex-energy version. Note also how the most recent period, during which oil prices have collapsed—is similar to the 1986-87 period, when oil prices fell about as much in percentage terms as they have in the past 22 months. In both periods, the total CPI suffered a significant decline followed by a significant rebound, while the ex-energy version was relatively unchanged. There is every reason to believe that the headline (total) CPI will register 2% year over year growth (if not more) within the foreseeable future, since oil prices are no longer declining and have even rebounded some 40% in the past month or so.

The Fed's preferred measure of inflation, the Core Personal Consumption Deflator rose 1.7% in the 12 months ended January, and it is likely to post a slightly higher rate of growth in February. This is entirely consistent with the behavior of the CPI, since the PCE deflator tends to register about 30-40 bps less than the CPI. What this means is that the Fed's preferred inflation gauge will soon be very close to the top end of its 1-2% target range.

Memo to FOMC: Raising short-term interest rates to 0.75% in the next few months—thus leaving real short-term rates still deep in negative territory—would not only be fully justified, it might even be too little too late.

Friday, March 11, 2016

The deflation/recession threat recedes

Exactly one month ago, many thought the world was about to tumble into a deflationary abyss.

Oil prices had collapsed to $26/bbl, high-yield spreads had soared to almost 900 bps, HY energy spreads were within inches of hitting 2000 bps, 5-yr inflation expectations had fallen to 1.0%, the Vix index was approaching 30, 10-yr Treasury yields had plunged to 1.66%, and the S&P 500 was down 15% from its all-time high.

What a difference a month can make. Today, all of these key indicators have reversed significantly. Oil is up 45% and approaching $40/bbl, high-yield spreads are down and approaching 650 bps, 5-yr inflation expectations are back up to 1.5%, the Vix index is down to 17, 10-yr Treasury yields are just shy of 2%, and the S&P 500 is only down 5% from its all-time high.

I note that one key indicator hasn't changed at all in the past month: 2-yr swap spreads remain very low (5-6 bps). As I've said numerous times in recent years, swap spreads are excellent coincident and leading indicators of financial market health. Very low swap spreads tell us that liquidity is abundant and systemic risk is low. Low swap spreads mean the underlying mechanisms of the financial markets are working just fine, allowing the market to spread risk from those who cannot bear it to those who can. Liquid, functioning financial markets are key to a healthy economy, just as are free-market prices. Price signals (e.g., cheap oil) have persuaded producers to bring their production more in line with demand. Markets have short-circuited a deflationary collapse.

We're fortunate that governments haven't stepped in to try and "fix" things that weren't broken to begin with (unlike what happened in the latter half of 2008).

I also note that one month ago there were signs that indicated we weren't headed for the end of the world as we know it. Industrial commodity prices were beginning to turn up. The CRB Metals index is now almost 20% above its January lows (see chart above).

It's tempting to say that yesterday's ECB announcement (i.e., more QE) made all the difference, but I'm not convinced. The turn for the better has been underway for the past month, and maybe the ECB announcement provided an additional nudge. For what it's worth, here is a recap of what's been going on in chart form:

Above: oil prices have rebounded sharply from their Feb. 11 lows. The fact that the active rig count in the U.S. has collapsed by 75% in the past 15 months is an excellent sign that producers have cut back production. Meanwhile, oil demand is up around the world.

High-yield Credit Default Swap spreads have tumbled, as higher commodity prices reduce the risk of corporate debt defaults.

The 5-yr expected rate of inflation embedded in the prices of 5-yr TIPS and 5-yr Treasuries has surged from 1.0% a month ago to almost 1.5% today, as higher oil prices mean that the headline CPI is likely to be much higher than the market feared. 

One more installment in the Walls of Worry chart that I've been featuring periodically. Fears are receding, and the prices of risk assets are rising. It's the same pattern we've seen repeated numerous times in recent years.

Good as all this has been, we're not out of the woods yet. As the chart above shows, the prices of gold and 5-yr TIPS are still relatively high, which means the market is still willing to pay up for the protection these unique assets offer. Gold rose to almost $1250/oz on Feb. 11, and today it is a bit higher at $1260. The real yield on 5-yr TIPS fell to 0.1% on Feb. 11, and today they are a bit lower still (the chart uses the inverse of real yields as a proxy for TIPS prices). You might not see it in the headlines, but elevated gold and TIPS prices tell us that the market is worried about the future direction of inflation being up instead of down. With a strong bounce in commodity markets occurring at the same time that major central banks have their policy pedals to the metal, it's not impossible that we could see inflation rising above target before too long.

The U.S. is richer than ever

Yesterday the Fed released its estimate of the balance sheet of U.S. households as of the end of last year. Collectively, our net worth reached a new high in nominal, real, and per capita terms. We can complain all day about the fact that we are living in the weakest recovery ever, and things could and should be a lot better, but it is still the case that today we are better off than ever before. (The stock market has recovered virtually all of its losses year to date, so the significance of the numbers you see here hasn't changed.)

As of Dec. 31, 2015, the net worth of U.S. households (including that of Non-Profit Organizations, which presumably exist for the benefit of all) reached a staggering $86.7 trillion. To put that in perspective, it's about one-third more than the value of all global equity markets, which were worth $64.6 trillion at the end of last year according to Bloomberg.

On a real, per capita basis, the net worth of the average person living in the U.S. reached a record $270,000. This measure of wealth has been rising, on average, about 2.4% per year since records were first kept beginning in 1951. There's nothing unusual going on: life in the U.S. has been getting better and better for generations. If you're hungry for more details of the steady march of progress, check out Human Progress, a worthwhile project of Cato, my favorite think-tank.

And even if it were the case that the entirety of the value of stocks, bonds, deposits and real estate included in these statistics were owned by a handful of people, we all enjoy their benefits. These assets are what provide jobs and the wherewithal to run and maintain our economy.

This ongoing accumulation of wealth is not a house of cards built on a bulging debt bubble either, regardless of what you might hear from the scaremongers. On the contrary, the typical household has undergone a significant deleveraging since the onset of the Great Recession in 2008. Household liabilities today are the same as they were in early 2008 (about $14.5 trillion), but financial assets have increased by one-third, thanks to significant gains in savings deposits, bonds, and equities. Since early 2008, the value of households' real estate holdings has increased by a relatively modest 8%.

Friday, March 4, 2016

Stronger commodity prices trump stable jobs growth

The February jobs report was good (beating expectations plus upward revisions to prior months), but it only marked a continuation of the moderate 2 - 2½% growth trend that has been in place for the past 6-7 years. More impressive, however, is the emerging rally in the commodity markets and, by extension, the emerging market economies. It's looking more and more like the the threat posed by the China slowdown, plunging oil prices and soaring credit spreads is fading away. In its place global growth is likely stabilizing as commodity prices firm up. Against this backdrop, central banks, the majority of which are still deathly afraid of recession and deflation, seem out of step. I think that's why gold has done so well of late: markets are sensing that monetary policy may now be too easy and therefore inflation is more likely to rise than fall. Think of gold as an early-warning indicator of the direction of future inflation. Not always right, of course, but worth paying attention to.

Private sector jobs, the ones that count, have been growing at a fairly steady pace of 2 to 2½% for just over 5 years. This, added to weak productivity of less than 1% per year, is going to give us something in the neighborhood of 2.5% real growth this year. All the monetary "stimulus" in the world is not going to change the fact that this remains the weakest recovery ever. What needs to change is fiscal policy, and that won't change meaningfully until next year, provided we have a new president who understands that the private sector needs better incentives if it is to work and invest more. 

One thing does appear to be changing, however. Labor force growth has been tepid since 2008; the number of people either working or willing to work has been growing at an annualized rate of only 0.4% for the past seven years, until recently. Over the past six months, the labor force grew at an annualized rate of 2.3%. This equates to some stirrings of life in an otherwise sleepy economy. 

As a result, the labor force participation rate looks to have bottomed. It's too early to get excited, however, since new entrants to the labor force don't appear to be fighting for top-paying jobs. But it is an important change on the margin which bodes well for the future, and that's a good reason to remain optimistic.

What's changing today is the outlook for commodity prices. After falling from 2011 through the end of last year, they are turning up. Gold prices are up 20% in just over two months. Industrial scrap metal prices are up 10% since mid-January.

And one of the most important commodities (crude oil, see chart above) is up 37% in just under one month. What this means at the very least is that market forces—prices—have brought commodity supplies back into line with commodity demand. And it's not too hard to imagine that as supplies have been reduced, demand has picked up. Rising commodity prices probably signify that the fundamentals of the global economy are improving on the margin, and that is very good news.

One example: vehicle miles driven last year were up 5% from mid-2014, which is when oil prices started to plunge (see chart above).

After falling 80% from early 2011 through January of this year, Brazil's stock market is up a staggering 45% in dollar terms, thanks to the confluence of stronger commodity prices and promises of a badly-needed change in government. Mexico's stock market is up 15%, and Australia's stock market is up 14% over the same period.

In this last chart we see that gold has shrugged off its 4-year losing streak, jumping 20% since mid-December. TIPS prices have jumped too, as have 5-yr breakeven spreads, which are up from 1.0% a month ago to 1.45% today.

Deflation? That's yesterday's news. Today markets are beginning to worry that inflation might be on the rise while central banks still have their policy pedals to the metal.

Thursday, March 3, 2016

Progress report on climbing

The main concern that markets are grappling with these days is the possibility that weakness in China and in the oil patch, coupled with escalating debt defaults, could conspire to produce another recession in the U.S. I've argued that these fears are probably overblown, that the U.S. economy is inherently resilient, that most of the damage so far has been contained to the oil patch, that financial markets are fundamentally healthy, and that therefore all it takes to alleviate the market's concerns is the absence of recession, which is the most likely outcome in any event. I don't expect strong growth, merely a continuation of the modest 2 - 2½% growth we've seen for the past 6-7 years. Here are a few charts which document the progress towards climbing the latest wall of worry:

As the chart above shows, the price of oil has jumped by one-third in the past three weeks. This takes a lot of pressure off the oil patch.

Higher oil prices have helped spreads on HY energy debt to narrow by almost 500 bps! This is a clear sign that panic is receding. 

A major contributing factor to the bounce in oil prices is the huge drop in the number of active drilling rigs in the U.S., which has plunged by 75% in the past 14 months. The cure for low oil prices is low oil prices, which have sent the message to producers to shut down production and exploration.

This same dynamic (supply and demand coming into balance) is playing out in the metals markets. The CRB Metals index (see above chart) is up 10% in the past two months. This suggests that the Chinese and global economies are not going down a black hole. Producers are cutting back and consumers are ramping up demand in response to lower prices. Markets work!

The service sector is also not going down a black hole. Although the readings from the ISM surveys show the service sector is relatively weak, it is still growing. The Business Activity index, shown above, bounced quite a bit from its January low, which suggests that sentiment (e.g., everyone's worried these days, but the worry index is going down of late) could be playing a role in the relatively weak readings. It's also the case that most of the weakness can be traced to the energy sector, which contributed an additional 25K layoffs last month, according to the Challenger survey of announced corporate layoffs.

Weekly claims for unemployment have probably fallen as much as they are going to. The recent uptick is minor, and likely reflects a final round of energy-sector layoffs. 

The ADP estimate of February private sector payrolls (blue line in the chart above) suggests that jobs growth continues at the rate which has prevailed for the past several years. No deterioration, no improvement. Steady as she goes may be boring, but it is good news when the market is worried about a recession.

 With the news coming in better than feared, the market has managed to rally.

But as the chart above suggests, there is still a lot of concern out there. Gold and TIPS prices have jumped as the world worries that central banks will try once more to goose their economies with more QE and negative interest rates.

With the bounce in oil prices, we've also seen a bounce in inflation expectations. Breakeven spreads on 5-yr TIPS have jumped almost 45 bps in the past three weeks. Now at 1.44%, they are a bit below their long-term average of 1.9%, but not seriously below. In essence, the threat of deflation has almost gone up in smoke, according to the bond market.