Over My Shoulder | Mauldin Economics

Over My Shoulder

Chris Whalen: Outlook 2015: Deflation Remains the Dominant Theme

December 16, 2014

Chris Whalen is one of the smarter investing guys I know and one of the true experts on credit and banking. He is “go to” when I have questions. He is now managing director of Kroll Bond Rating Agency, a new rating agency formed in 2010 in an effort to bring some credibility to bond ratings.
Chris offers his forecast for 2015 through the lens of his perspective on the credit markets. Short for the typical forecast (3.5 pages) but very pithy:

“We suspect that investors are not going to regain confidence and be willing to take on new risk positions until the extent of the damage caused by rapid downward moves in commodity prices are known. Once we see the spread between high yield and Treasury debt start to close again, then we will know that the markets are regaining composure. Until then, deflation and the attendant risks caused by a sudden revelation about hidden debts will remain the chief concern for investors and policy makers in 2015.”

Download - KBRA_Macro-Market_Research_Outlook_2015_Deflation_Remains_the_Dominant_Theme.pdf

“Former governor says Fed may have to be aggressive once it starts hiking”

December 12, 2014

This is a news story about a former Fed governor saying that the Fed may have to raise rates faster than anyone thinks, once they get started. Given that there is a whole board-full of former Fed governors, you can usually find someone who will say any given thing. But this is not just any old former Fed governor; this is Frederic Mishkin, who was one of the chief economists at the Fed prior to becoming a governor, and who authored the study the Fed did correlating the yield curve and recessions, along with numerous other important Fed papers. I've talked with them over the years, and he is very bright.

Interestingly, I had lunch yesterday with Harvey Rosenblum, former chief economist of the Dallas Fed (he recently resigned). We have been friends and fishing buddies for years. He is wondering whether the Fed might not raise rates at a slower pace, maybe even by 1/8 increments (which is a possibility he suggested in his research many years ago), but start earlier in the spring rather than waiting for the June meeting. Reading other Fed economists and talking with serious Fed watchers and former governors, I think about the only thing we can safely conclude is that the FOMC really doesn't know what it's going to do yet. At a minimum, they're going to have to remove the words for a considerable period of time from the statement that is issued after each Fed meeting. Harvey doesn't think they will do it next week, but I don't see how you can wait very long to remove that statement. I mean, removing it at one meeting and starting to raise rates the very next meeting is not exactly in keeping with the spirit of the meaning of the words a considerable period of time. Just saying.

Download - Former_governor_says_Fed_may_have_to_be_aggressive_once_it_starts_hiking_-_MarketWatch.pdf

Council on Foreign Relations: Risks to Mexico and the US from Falling Oil Prices

December 12, 2014

The Mexican economy has diversified away from oil, but Nieto’s government still depends on oil exports. Over 1/3 of its budget is currently funded by PEMEX, the state-owned oil company. With oil prices falling, the Mexican government needs to raise revenues or cut spending immediately. Contrary to the CFR paper attached here, I don’t think more debt is a viable strategy in the new era of volatile FX flows.

Even the IMF is worried about capital outflows from Mexico in the near future: http://www.imf.org/external/pubs/cat/longres.aspx?sk=42444.0

The baseline growth projection [for Mexico] is predicated on a smooth process of U.S. monetary policy normalization, accompanied by strengthening activity in the United States. However, a resurgence of financial market volatility cannot be ruled out. Potential triggers include an earlier or sharper-than-expected rise in U.S. interest rates (for example due to an unexpected rise in inflation or a rapid decompression of U.S. term premia), increasing geopolitical risks, or investors’ reassessment of sovereign risks more generally. A materialization of this risk could lead to capital flow reversals from emerging markets (including Mexico), reduction of market access, and a sharp increase in the volatility of asset prices. A protracted period of financial market instability could also affect the confidence of long-term investors, lead to lower-than-expected FDI inflows, and slow the implementation of structural reforms.

All this pressure – from (1) falling oil prices, eroding government revenues, and (2) serious warnings of possible capital flight – gives Nieto lots of ammunition to push for speedy economic and structural reforms… which will also depend on a major corruption crackdown to re-win the support of Mexican voters.

While it may be too late to avoid an FX shock from the USD rally & imminent reversal in capital flows, Mexico may find itself in a very competitive position in the post-shock emerging markets beauty contest, alongside Modi & Rajan’s India… but only if it pushes ahead with Nieto’s proposed reform agenda.

I’m optimistic. 

KKR’s Henry McVey wrote a solid report on Mexico’s prospects in May 2014 that may help readers get a grip on the basic outlook. The situation has continued to evolve, obviously, but this is a good place to start: http://www.kkr.com/global-perspectives/publications/mexico-different-investment-lens-required

Download - Spillovers_From_Falling_Oil_Prices.pdf

Boston Fed: The Emerging Market Economies in Times of Taper-Talk and Actual Tapering

December 12, 2014

The Federal Reserve continues to dismiss the emerging-market contagion risk of a rising US dollar.

Either they are oblivious to the risk of policy divergence (Harvey Rosenblum said the FOMC does not actively monitor the size of the carry trade in its policy decisions) or they are intentionally downplaying those risks as Yellen, Fischer, et al. knowingly push on for a ZIRP exit.

Here's the latest paper from the Boston Fed.

Download - cpp1406.pdf