Leveling the Playing Field

October 21, 2013

_______________________________________________________________________ Took my kids to the pumpkin patch and corn maze this weekend. My youngest one is not quite six, so he qualified for a $2 discount. Meanwhile, my 13 year old daughter was standing next to us sighing audibly. She is simply too cool for all of this now. I asked the cashier for the Angsty Teenager discount, but she didnt get it. She must not have a teenage daughter because I promise you, mine did not get her moneys worth. Do you think Bernanke was saying told you so over the last two weeks? Despite the government shutting down for a few weeks and Congress taking the debt ceiling debate right up to the final hour, markets were relatively stable. No doubt some of that is attributable to the fact that no one really expected the US to default. But much of it is attributable to the Bernanke put. By taking ta pering off the table, investors didnt feel the sense of panic that would have come with a normal US federal government default. Hey, if Ben is going to keep printing money, then I am not that concerned. Forecasting tapering is more an art than a science, but one of the most critical data points is the labor data due out the first Friday of each month. With the shutdown, there was no release this month. We will instead get those reports on Tuesday (22nd), and with the default temporarily avoided, markets will turn their eyes back to tapering as the primary driver for rates. Keep in mind that all the data was gathered prior to the shutdown, so those effects wont be known until at least next month. Economists we trust expect a modest 170k gain in payrolls and for the UR to hold steady at 7.3%. Dont be surprised if the White House massages the numbers to paint a certain political picture. We were on track before the Republicans messed it all up! Its hard to believe, but the Fed embarked on QE4E VA more than a year ago and at that time the UR was 8.1%. If we held the participation rate constant over the last 14 months, the UR today would be about 7.7% - still an improvement but not the same as the official 7.3% UR from last month. Bernanke did indicate after the last FOMC meeting that tapering would be driven by growth in labor markets rather than declining participation rate. He had to do this since the 7.0% benchmark the Fed had been using was clearly within range only because of job seekers becoming so discouraged they simply stopped looking for work. At that press conference, Bernanke also conceded that markets interpreted tapering as tightening. If markets get jittery over the Fed buying just $65B per month instead of $85B, imagine what could have happened if the US defaulted on its obligations? This

recent Congressional debacle gives the Fed even more cover fire to delay tapering into the spring. Chicago Fed President Evans suggested the likely outcome is for the Fed to take a couple of meetings to assess data before adjusting asset purchases. Evans went on to say for me to be confident that we in fact have achieved substantial, sustainable improvement in labor conditions, I would need to see the lower unemployment rate accompanied by cyclical improvement in the participation rate. And I also would need to see more steady, solid growth in gross domestic product (GDP) to be confident that the labor market gains would not be undone by a drop in businesses demand for labor. Tapering could be put off even longer, particularly if GDP takes a hit. On Thursday, BofA cut Q1 2014 GDP forecasts from 3.3% to 2.8%. Dallas Fed President on Wednesday said Im beginning to see signs not just in my district but across the country that we are entering once again a housing bubble. Its clear the Fed cant rely simply on UR to measure improvement in labor markets. We expect them to begin to focus more on the details of the reports, like unemployment duration and the employment/population ratio. We also believe the U6 will begin to take on increased significance. Were also going to be keeping an eye on wage growth, because weakness here indicates workers have no leverage, an absence of inflationary pressure, and is a good leading indicator for hiring patterns. Interest Rate Outlook Theres a lid on interest rates for the time being and we expect long term rates to be range-bound, quite possibly through year end if we dont get any surprise news. On the 10yr, were close to the 2.50% resistance level, but well need something more negative to break through that barrier. This Week Tuesdays labor reports are the headliners this week. With the default delayed for several months, the focus will turn back to the data. Weve been cautioning that the Feds datadependence will result in increased significance for economic releases as investors try to read the tea leaves; however, with tapering essentially off the table we think markets will settle a bit.

Economic Calendar
Day Monday Tuesday Time 10:00AM 8:30AM 8:30AM 8:30AM 8:30AM 8:30AM 10:00AM Wednesday 7:00AM 8:30AM 8:30AM 9:00AM Thursday 8:30AM 8:30AM 10:00AM 11:00AM Friday 8:30AM 8:30AM 9:55AM Report Existing Home Sales (MoM) Change in Nonfarm Payrolls Change in Private Payrolls Unemployment Rate Underemployment Rate (U6) Avg Weekly Hours All Employees Richmond Fed Manufacturing Index MBA Mortgage Applications Import Price Index (MoM) Import Price Index (YoY) House Price Index (MoM) Initial Jobless Claims Continuing Claims New Home Sales (MoM) Kansas City Fed Manufacturing Activity Durable Goods Orders Durables ex Transportation University of Michigan Confidence 0.2% -1.0% 0.8% 340k 2865k 1.0% 2 2.0% 0.5% 75.0 34.5 0 Forecast -3.3% 180k 180k 7.3% Previous 1.7% 169k 152k 7.3% 13.7% 34.5 0 0.3% 0.0% -0.4% 1.0% 358k 2859k 7.9% 2 0.1% -0.1% 75.2

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