Published on 05-07-2014

Yellen cites housing, geo-political risk to U.S. economy.

Federal Reserve Chair Janet Yellen said the central bank will continue to provide a high degree of monetary policy accommodation, and cited geo-political turmoil and weak housing data as risks to the U.S. economy. Yellen, speaking to the congressional Joint Economic Committee today, also indicated concerns over investors exerting risky behaviour given the extended period of low interest rates. “Some reach-for-yield behaviour may be evident,” Yellen said in her prepared testimony, pointing to the lower-rated corporate debt markets as an example. Yellen added that issuance of syndicated leverage loans and high-yield bonds has expanded, while underwriting standards loosened, though she said that these increases appear modest – particularly at large banks and life insurers. The Fed chief repeated the view of the Federal Open Market Committee that despite the expected U.S. economic growth, considerable slack in the labour markets and low inflation warrants a “high degree of monetary accommodation.”

Why oil and gasoline prices could plunge.

A big boost in domestic oil production during the past two years hasn’t led to big energy savings for Americans. But that may be about to change. Oil prices may plunge by the end of the year, according to Zach Schreiber, CEO of hedge fund PointState Capital, who made that call recently at the annual Sohn Investment Conference in New York. “We believe crude is going lower — much lower,” Shreiber said at the conference. “The oversupply of North American crude has not been felt yet.” Schreiber declined to provide numbers, but his presentation suggests West Texas Intermediate, or WTI — the type of high-quality oil typically extracted in the United States — could fall from about $100 per barrel now to $85 or less by the end of the year. That’s the level at which drillers might curtail production, as falling prices hurt their profitability. “Production won’t slow meaningfully until at least $80 to $85 per barrel,” Schreiber said.

A minority view:

Oil prices are notoriously difficult to predict, and Schreiber’s is a minority view. Citibank’s top oil analyst agrees with him, saying oil prices will fall to around $75 during the next couple of years. But Chevron is planning for oil at $110. OPEC, the Middle East oil cartel, predicts rising demand will push prices up. And the U.S. government predicts WTI prices will end the year at about $96 per barrel, then fall to about $90 by the end of 2015. Schreiber believes WTI is overpriced because technical and temporary factors are making an oversupply of oil seem like a shortage. Oil inventories in Cushing, Oklahoma — a key transshipment point — are low, suggesting scarcity. But more oil than usual is piling up near Gulf Coast refineries, which are operating at maximum capacity. “The market is fixated on Cushing,” Shreiber says, “which is a temporary island of scarcity in the middle of a sea of crude.” For all the talk of a U.S. oil boom, new drilling techniques such as hydrofracking have only begun to push up domestic production. U.S. crude production fell consistently from 1985 to 2008, then ticked up for a few years. The first real spike in production didn’t occur until 2012, as the following chart shows:

That increase in U.S. production occurred at the same time output fell in Libya and Iran, keeping global supplies more or less in balance, and prices stable in the ballpark of $100. Gasoline prices track oil prices closely, as the next chart shows, and with oil fairly steady, U.S. gas prices ranged between $3.30 and $3.70 per gallon for most of the past two years. If oil fell to $85 or lower, that would probably push gas prices down toward $3, an obvious boon for consumers. Other factors affect pump prices — especially refining capacity — but it also helps that Americans are driving less and cars are increasingly efficient, keeping demand for gas softer than it might otherwise be. International factors seem to favor lower prices as well. Iran and Libya are both bringing more oil to market just as U.S. production is kicking into high gear. That oil isn’t quite the same as WTI, but it has a similar effect on markets and prices. China’s demand for oil has a big impact on price — and the Chinese economy may be slowing to the lowest growth rate since the 1980s, which will likely reduce its demand for oil. There’s also talk of ending the ban on U.S. oil exports, which would ease the glut of oil awaiting a spin through U.S. refineries. But that wouldn’t necessarily push prices up, since new overseas markets would give drillers more incentive to produce. If oil prices do fall, it would aid U.S. consumers and businesses while trapping speculators gambling on prices going the other way. But if prices fall too far, it will no longer be profitable to drill for the costliest oil, which will put a floor under prices. The real question is how low the floor can go.

Gold likely to reach four-year low in 2014.

Gold prices have probably peaked this year and could sink to their lowest since 2010 at $1,100 an ounce as the U.S. economic recovery gathers pace, consultancy Metals Focus said today. Weakness is likely to set in after an impressive start to the year, it said, when gold rallied to six-month highs. But a replay of last year’s 28 percent plunge, triggered by the U.S. Federal Reserve’s tapering of extraordinary stimulus measures, is not on the cards. The consultancy also forecast that an eventual easing of tensions in Ukraine would add to a bearish trajectory for the market. “In the short term, the U.S. recovery regaining momentum (thanks to improving weather conditions) and the eventual de-escalation in Ukraine are likely catalysts for lower prices,” it said in its Gold and Silver Mining Focus 2014. “Meanwhile, the Fed’s ongoing reduction in its bond purchases, easing concerns about fiscal situations on both sides of the Atlantic and low inflation are all headwinds for the yellow metal for the rest of 2014.” Robust demand from the major physical gold markets in Asia should help offset Western investors’ lingering caution in gold futures, derivatives and exchange-traded funds.

Chinese demand, which surged last year as prices fell, will remain strong, it said, though below the 2013 level. That, along with strength in retail demand in Western markets, helped drive a 35 percent surge in physical investment last year to 47.1 million ounces. Jewellery consumption also rose 22 percent to 81.7 million ounces, while the volume of scrap gold returned to the market fell 26 percent to 39.3 million ounces. That helped offset a 5 percent rise in output from gold mines to 96.7 million ounces, resulting in a 21.8 tonne structural deficit in the market last year, Metals Focus said. That does not include outflows from bullion-backed exchange-traded funds (ETFs), however, which according to Reuters data totalled 26.354 million ounces last year. The strength of ETF outflows was a major weight on prices in 2013. “Given plenty of above-ground inventory, other than a temporary shortage of kilobars in Q2, the gold market remained well supplied last year,” Metals Focus said. “Moreover, it is of note that ‘Western’ investors tend to set the price, while physical markets react to it.” The consultancy expects silver prices to average just under $20 an ounce this year, not far from current levels but well below last year’s average of around $23.80 an ounce, as its fundamentals weaken. “Global supply is expected to rise by around 2 percent, compared with a 4 percent drop in world silver demand,” it said. “The most significant change … is expected in physical investment, which is forecast to drop 11 percent.”

Productivity of U.S. Workers Decreased in the First Quarter.

American workers were less productive in the first quarter as harsh winter weather prevented some from getting to their jobs, causing the economy to stall. The measure of employee output per hour dropped at a 1.7 percent annualized rate, the weakest reading in a year, after rising at a 2.3 percent pace in the last three months of 2013, a Labor Department report showed today in Washington. The median forecast in a Bloomberg survey of 59 economists called for a 1.2 percent drop. Unit labor costs climbed at a 4.2 percent rate, more than estimated. The pullback in productivity came as snow and unusually cold weather covered much of the U.S., depressing economic activity as consumers stayed indoors and companies put off investment plans. As growth recovers in the months ahead, some companies may be induced to either take on more workers or invest in equipment to keep up with demand. “The quarterly figures can be volatile and lower productivity in the first quarter just reflects the fact that overall economic activity was disrupted by a variety of temporary factors, including the severe winter weather,” Ryan Wang, an economist at HSBC Securities USA Inc. in New York, said in an interview before the report. “GDP growth and productivity should make up for some of that weakness in the second quarter.” Economists’ estimates for productivity ranged from a 1.8 percent decline to a gain of 0.3 percent. The prior quarter’s reading was previously reported as an increase of 1.8 percent.

Year to Year:

Over the past year, productivity increased 1.4 percent, the same as in the 12 months ended in December. Last quarter’s increase in expenses per worker, which are adjusted for efficiency gains, was the biggest since the last three months of 2012. Costs were forecast to rise 2.8 percent last quarter, according to the Bloomberg survey median. Unit labor costs were up 0.9 percent compared with the first quarter of 2013. Adjusted for inflation, hourly earnings increased at a 0.5 percent rate in the first quarter after rising at a 0.6 percent pace the previous period. Output rose at a 0.3 percent rate, following a 3.8 percent jump in the fourth quarter. Hours worked climbed at a 2 percent pace after a 1.4 percent increase in the prior period. Compensation for each hour worked climbed at a 2.4 percent annual pace. Manufacturers fared better than the economy as a whole, with worker productivity increasing at a 3.3 percent rate.

Growth Stalled:

U.S. economic growth nearly ground to a halt in the first quarter as harsh winter weather chilled business investment, exports dropped and inventories climbed at a slower pace. Gross domestic product grew at a 0.1 percent annualized rate from January through March, compared with a 2.6 percent gain in the prior quarter, figures from the Commerce Department showed last week. Growth may rebound in the coming months as demand strengthens, supported by the most widespread advance in payroll gains in two years. The 288,000 increase in employment followed a 203,000 rise the prior month, according to last week’s Labor Department report. An index measuring the share of industries hiring climbed to 67, the highest level since January 2012. Central bankers after a meeting last week said the economy is showing signs of picking up and the job market is improving. The Federal Reserve’s Open Market Committee pared its monthly asset-buying to $45 billion, its fourth straight $10 billion cut, and said further reductions in “measured steps” are likely.

Growth Potential:

Productivity is important because it helps determine the pace at which an economy can grow without stoking inflation, which economists term its speed limit. That reflects the rate of growth of the labor force plus how much each worker can produce. Smaller gains in productivity therefore mean advances in gross domestic product will also be restrained. Aside from the quarter-to-quarter wiggles, productivity gains have been slowing companies have been slow to boost spending on more sophisticated machinery and time-saving devices such as faster computers that help boost output. From 1995 through 2000, worker output per hour rose 2.8 percent a year on average, according to figures from the Labor Department. It rose 0.5 percent in 2013. “Productivity has been low for the last several years and that’s been reflected in a moderate pace of overall economic growth,” HSBC Securities USA’s Wang said before the report. “Despite quarterly fluctuations, so far it still looks as if productivity growth is remaining slower than in prior economic expansions.”

Treasury Long-Term Debt Is Top Performer Before Yellen Speaks.

Treasury long-term notes and bonds were the world’s best-performing government securities over the past month before Federal Reserve Chair Janet Yellen testifies to Congress today. The Fed said April 30 it will keep the benchmark interest-rate target at almost zero for a “considerable time” after its bond-buying program ends. Yellen is scheduled to testify before the congressional Joint Economic Committee today and the Senate Budget Committee tomorrow. Unrest in Ukraine is supporting demand for the safest assets. The U.S. plans to auction $24 billion of 10-year notes today and $16 billion of 30-year bonds tomorrow, following a $29 billion three-year sale yesterday. “It’s too early to change the Fed’s view and Yellen won’t signal rate hikes are in the offing any time soon,” said Nick Stamenkovic, a fixed-income strategist at broker RIA Capital Markets Ltd. in Edinburgh. “Treasuries are also benefiting from safe-haven status. Technically, the market looks vulnerable and we could see 2.50 percent being tested in the near term on the 10-year yield.” Benchmark 10-year yields rose two basis points, or 0.02 percentage point, to 2.61 percent in New York, based on Bloomberg Bond Trader data. The price of the 2.75 percent note due in February 2024 declined 5/32, or $1.56 per $1,000 face amount, to 101 6/32. The yield fell to 2.57 percent on May 5, a level not seen since Feb. 3. U.S. government securities due in 10 years and more returned 3.5 percent in the month ended yesterday, the most of 144 debt indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies.

Fed Tapering:

The Fed reduced its monthly debt purchases to $45 billion on April 30, its fourth straight $10 billion cut, and said further reductions are likely in “measured steps” if the economy continues to improve. The difference between yields on 10-year notes and similar-maturity Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the debt, was 2.17 percentage points. The average for the past decade is 2.21. Russia called on Ukraine to postpone a May 25 presidential election and draft a new constitution first, as the government in Kiev pursued a military offensive against separatists in the country’s east and south. The decline in 10-year yields may damp demand at today’s auction given signs of improvement in the economy, said John Gorman at Nomura Holdings Inc. in Singapore. The company is a one of the 22 primary dealers that underwrite the U.S. debt.

Jobs Report:

The U.S. added 288,000 jobs in April, the Labor Department said this month, the most since January 2012. Separate data have shown gains in consumption, manufacturing and service industries. “The yield level is entirely too low,” said Gorman, who is the head of dollar-denominated interest-rate products for Asia. “The data continue to come in stronger. The payroll number was extremely solid.” The 10-year notes scheduled to be sold today yielded 2.645 percent in pre-auction trading, versus 2.72 percent at a previous auction on April 9. Investors submitted bids for 2.76 times the amount of 10-year debt for sale last month, compared with 2.92 at a previous auction in March. This week’s note and bond sales will raise $9.7 billion of new cash, as maturing securities held by the public total $59.3 billion, according to the U.S. Treasury.

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