Naughty, not nice

Dollar-based investors won’t find many goodies in Santa’s sack

CHRISTMAS tends to be the season of goodwill and investor optimism. A poll of fund managers by Bank of America Merrill Lynch (BAML) in December 2014 found that most expected stronger economic growth and low inflation in 2015. Investors were enthusiastic about equities (particularly in Europe) but negative on government bonds.

The consensus is often wrong and this was no exception. Not every bet soured, but most predictions went in the wrong direction. Global economic growth has disappointed once again, although largely thanks to a poor performance by emerging, rather than developed, economies. Forecasts have been steadily revised lower. The OECD’s latest estimate for global growth in 2015 is 2.9%, well below the average rate over the past 30 years, of 3.6%.

When it came to predicting the best-performing asset class of 2015, investors had little doubt. Two-thirds of managers picked equities and just 4% government bonds. Alas, in dollar terms, equity investors have lost money (see chart). As of December 15th the total return from shares in the developed world (in dollar terms) was -1.4%. Government-bond markets have also suffered a small loss, roughly on a par with that suffered by equities. Those who put their money into the benchmark ten-year Treasury bond actually eked out a small gain.

Investors who opted for more exotic assets generally did badly. Emerging-market equities did terribly, with a negative return of 17.3% (including a calamitous 32% drop in Latin America).

Those who bought high-yield bonds also lost money. To be fair, fund managers were pessimistic about commodities a year ago and, boy, were they right: gold fell by 10% on the year and the Bloomberg commodity index dropped by 26%.

European and Japanese investors had a better time of it than their American counterparts.

Euro-zone stockmarkets were up in local currency terms, as were shares in Tokyo. The decline of both the euro and the yen against the greenback means that these markets performed badly in dollar terms. But it also means that the international portfolios of European and Japanese investors look more profitable in local-currency terms (less so, of course, for those who hedged their currency exposure).

For dollar-based investors, this has been a disappointing year. Even the good news—a sharp fall in the oil price—has not been as helpful as might have been expected. Lower petrol prices have acted as a tax cut for Western consumers, spurring developed economies. But they are hardly booming. And the weakness of energy prices has put a dampener on investment (commodity producers were responsible for 39% of global capital-expenditure growth in 2014), and caused some wobbles in the corporate-bond market.

Corporate profits have also been affected. According to Société Générale, a French bank, fourth-quarter profits at S&P 500 companies are likely to have fallen by 3.6% year on year; even without financial and energy stocks, profits would be up by just 0.1%. In the absence of higher profits, stockmarkets need higher valuations if they are to generate positive returns. But Wall Street started 2015 on a cyclically-adjusted price-earnings ratio of 26.8, compared with the historical average of 16.6; it ends the year, according to Professor Robert Shiller of Yale University, on 26.6.

Investor sentiment has taken such a dent that, so far, December has failed to produce the traditional “Santa Claus” rally that drives up shares in the final weeks of the year. Perhaps the Grinch has stolen it. The much-anticipated tightening of monetary policy by the Federal Reserve, expected after The Economist went to press, may also have induced caution.

The latest BAML survey suggests investors are not quite so upbeat about 2016 as they were about 2015. More still think the global economy will strengthen than weaken and only 7% foresee a global recession. But China’s economy is a big cause for concern, with a net 43% of fund managers expecting weaker growth there. Forecasts for profits growth are at their weakest since July 2012.

Despite those worries, investors are pretty much making the same bets. They are heavily overweight in equities (particularly European ones) and underweight in government bonds and commodities.

That is not a completely coherent position. If commodities collapse further, that should help keep inflation low, which ought to be good for government bonds. And the big bet on equities may be a sign of desperation, not confidence: the prospects of every other asset class look dismal by comparison.

lunes, diciembre 21, 2015



The Great Greek Bank Robbery

Yanis Varoufakis

Greek euro coin and European Union pin
ATHENS – Since 2008, bank bailouts have entailed a significant transfer of private losses to taxpayers in Europe and the United States. The latest Greek bank bailout constitutes a cautionary tale about how politics – in this case, Europe’s – is geared toward maximizing public losses for questionable private benefits.
In 2012, the insolvent Greek state borrowed €41 billion ($45 billion, or 22% of Greece’s shrinking national income) from European taxpayers to recapitalize the country’s insolvent commercial banks.
For an economy in the clutches of unsustainable debt, and the associated debt-deflation spiral, the new loan and the stringent austerity on which it was conditioned were a ball and chain. At least, Greeks were promised, this bailout would secure the country’s banks once and for all.
In 2013, once that tranche of funds had been transferred by the European Financial Stability Facility (EFSF), the eurozone’s bailout fund, to its Greek franchise, the Hellenic Financial Stability Facility, the HFSF pumped approximately €40 billion into the four “systemic” banks in exchange for non-voting shares.
A few months later, in the autumn of 2013, a second recapitalization was orchestrated, with a new share issue. To make the new shares attractive to private investors, Greece’s “troika” of official creditors (the International Monetary Fund, European Central Bank, and the European Commission) approved offering them at a remarkable 80% discount on the prices that the HFSF, on behalf of European taxpayers, had paid a few months earlier. Crucially, the HFSF was prevented from participating, imposing upon taxpayers a massive dilution of their equity stake.
Sensing potential gains at taxpayers’ expense, foreign hedge funds rushed in to take advantage.

As if to prove that it understood the impropriety involved, the Troika compelled Greece’s government to immunize the HFSF board members from criminal prosecution for not participating in the new share offer and for the resulting disappearance of half of the taxpayers’ €41 billion capital injection.
The Troika celebrated the hedge funds’ interest as evidence that its bank bailout had inspired private-sector confidence. But the absence of long-term investors revealed that the capital inflow was purely speculative. Serious investors understood that the banks remained in serious trouble, despite the large injection of public funds. After all, Greece’s Great Depression had caused the share of non-performing loans (NPLs) to rise to 40%.
In February 2014, months after the second recapitalization, the asset management company Blackrock reported that the burgeoning volume of NPLs necessitated a substantial third recapitalization. By June 2014, the IMF was leaking reports that more than €15 billion was needed to restore the banks’ capital – a great deal more money than was left in Greece’s second bailout package.
By the end of 2014, with Greece’s second bailout running out of time and cash, and the government nursing another €22 billion of unfunded debt repayments for 2015, Troika officials were in no doubt.
To maintain the pretense that the Greek “program” was on track, a third bailout was required.
The problem with pushing through a third bailout was twofold. First, the Troika-friendly Greek government had staked its political survival on the pledge that the country’s second bailout would be completed by December 2014 and would be its last. Several eurozone governments had secured their parliaments’ agreement by making the same pledge. The fallout was that the government collapsed and, in January 2015, our Syriza government was elected with a mandate to challenge the very logic of these “bailouts.”
As the new government’s finance minister, I was determined that any new bank recapitalization should avoid the pitfalls of the first two. New loans should be secured only after Greece’s debt had been rendered viable, and no new public funds should be injected into the commercial banks unless and until a special-purpose institution – a “bad bank” – was established to deal with their NPLs.
Unfortunately, the Troika was not interested in a rational solution. Its aim was to crush a government that dared challenge it. And crush us it did by engineering a six-month-long bank run, shutting down the Greek banks in June, and causing Prime Minister Alexis Tsipras’s capitulation to the Troika’s third bailout loan in July.
The first significant move was a third recapitalization of the banks in November. Taxpayers contributed another €6 billion, through the HFSF, but were again prevented from purchasing the shares offered to private investors.
As a result, despite capital injections of approximately €47 billion (€41 billion in 2013 and another €6 billion in 2015), the taxpayer’s equity share dropped from more than 65% to less than 26%, while hedge funds and foreign investors (for example, John Paulson, Brookfield, Fairfax, Wellington, and Highfields) grabbed 74% of the banks’ equity for a mere €5.1 billion investment. Although hedge funds had lost money since 2013, the opportunity to taking over Greece’s entire banking system for such a paltry sum proved irresistibly tempting.
The result is a banking system still awash in NPLs and buffeted by continuing recession. And with the latest round of recapitalization, the cost of the Troika’s determination to stick to the practice of extend-and-pretend bailout loans just got higher. Never before have taxpayers contributed so much to so few for so little.

Fed rate rise — now comes the hard part

Robin Wigglesworth, US Markets Editor

A momentous era in monetary history is finally over: the Federal Reserve has voted to raise interest rates for the first time since 2006. But actually implementing the decision may not be quite so straightforward.
The legacy of the US central bank’s efforts to combat the 2008-09 crisis is a financial system soaked with the Fed’s money, which has in the process neutralised its traditional interest rate tools and necessitated a radical new approach.
The Fed’s New York branch will on Friday begin to push and pull on its new monetary levers in an attempt to get its main interest rate up by roughly a quarter of a percentage point. While analysts mostly expect it to go smoothly, the experimental nature of this monetary tightening cycle means it could be a bumpy ride.
“Now comes the hard part,” Credit Suisse analysts Zoltan Pozsar and James Sweeney said in a note on Wednesday. “The financial system has completely changed since the last hiking cycle.”
First, some background. When economists talk about the Fed’s official borrowing rate, they refer to the Fed funds rate, which since late 2008 has been confined to a corridor between zero and 0.25 per cent.
Here is a chart that shows the overnight Fed funds rate over the past decade. There were some loopy moves around the financial crisis, but generally the central bank has kept control of the rate.

The Fed funds rate sets a benchmark for the cost of credit that ripples through markets and guides borrowing costs for everyone in the US (and much further afield). But the Fed’s crisis-fighting has stymied the old-fashioned way of lifting interest rates.
Historically, the Fed has set interest rates by controlling how much money there is sloshing around in the Fed funds market. If it wanted to lift rates the Fed sucked funds out of the system by selling some of the Treasuries it had in storage, and charging the banks’ accounts at the Fed.

When it lowered interest rates it pushed money into the market by buying Treasuries and debiting money to banks.

Yet quantitative easing by the Fed entailed buying massive amounts of bonds from banks and crediting their accounts at the Fed with new money — so the financial system is now awash with surplus Fed funds.

Here’s a chart that shows how the excess reserves have exploded in recent years. That little dimple in 2001 is when the Fed pumped extra money into the system following the 9/11 terrorist attacks.

Chart: Excess reserves held at Federal Reserve

The US central bank has maintained the effective Fed funds rate as its primary interest rate target, but has introduced some new tools to keep it within its new interest rate corridor. The first will act as a ceiling — or in reality a magnet — pulling the Fed funds rate upwards, while the second will in theory serve as a floor.

The first is called “interest on excess reserves”, or IOER. This lets the Fed pay interest on money held at the central bank. On Wednesday policymakers voted to lift the IOER rate from 0.25 per cent to 0.5 per cent.
In theory, this should drag the effective Fed funds rate up to this level, as banks should not be willing to lend to other financial institutions at a rate lower than what the central bank pays.

But only actual banks have access to the IOER, and there are many other lenders in the Fed funds market that in practice have dragged the effective rate well below where the IOER is set.

Here’s a chart that shows that in action.

So the Fed has therefore since 2013 been testing out another, more powerful tool to help it manage the process of lifting rates. The overnight reverse repo programme, or Overnight RRP, is primarily aimed at money market funds, and is expected to do much of the heavy lifting when the Fed actually lifts rates.
In a typical RRP the Fed’s market desk sells a Treasury bond from its portfolio to a money-market fund and agrees to buy it back the next day at a certain price, a process known as “repo”, short for repurchase. In practice, the central bank’s balance sheet does not shrink, but this sets a benchmark for cash interest rates paid by the Fed itself. These RRP operations will happen every business day between 12.45pm and 1.15pm in New York.

Here is a chart that shows how the Fed has been testing the impact of the RRP on the effective funds rate. It has occasionally been lifted or lowered to see the impact on the Fed funds market.
The training wheels are now coming off. The Fed voted on Wednesday to increase the RRP rate from 0.05 per cent to 0.25 per cent. To ensure that the programme has enough torque to get the Fed funds rate above that level the central bank also crucially suspended an overall ceiling on the programme.
This could lift the programme’s size to almost $2tn if every one of the 65 approved counterparties maxes out its $30bn cap. The Fed has already announced a total cap of $300bn on longer-term repos, which is separate from overnight repo.

Fed officials have been concerned about letting the RRP programme get too big, given that this could distort the money markets, but in the short term the absolute priority is clearly for the central bank to show that is has full control over the Fed funds rate.

As Megan Greene, chief economist at Manulife says, “If the Fed cannot effectively manage the Fed funds rate then its credibility will be severely undermined”. By in practice lifting size limits on the RRP, analysts expect it to manage this feat. While it may not be an instantaneous lift-off, Fed officials have been confident that the Fed funds rate will gravitate to within the new range.
Still, even if the Fed manages to get the effective Fed funds rate up to roughly the midpoint in its new corridor, the question remains whether the rest of the fixed income market will respond.

Typically, other important market rates would rise alongside the Fed funds, as banks and fund managers take advantage of any opportunities to “arbitrage” away anomalies. But regulations have severely curtailed the ability of banks to lubricate these arbitrage trades, leading to a series of anomalies in money markets.

For example, the GCF bank repo rate — essentially the cost for banks to borrow from each other when they proffer collateral like Treasuries — is now higher than Libor, the unsecured bank funding rate.

Some economists argue that the Fed should look for a new mechanism to set US interest rates, since the Fed funds market is so small and thinly traded nowadays. There used to be close to $350bn a day that changed hands before the crisis, but daily volumes are now roughly $50bn a day. Some are therefore urging a radical rethink.
Even Simon Potter, head of the New York Fed’s markets division — and thus the man who will have to implement the central bank’s decision — hinted that this may be needed.
“We should, of course, consider the traditional parts of an operating framework, for example, possible interest rate targets and the mechanisms used to achieve the target,” he said in a recent speech at the Bank of England. “But recent experience strongly suggests that we need to consider options beyond just a classic interest rate targeting regime that’s based on a scarcity of reserve balances.”
But for now, the focus is squarely on ensuring a smooth interest rate lift-off with its new experimental toolkit.

The Stock Market Is Lying to You

Justin Spittler

Are we in a bull market, or not?

Nearly seven years ago, the U.S. stock market began a historic rally. After bottoming out in March 2009, the S&P 500 gained 204% through December 2014.

But this year, the rally has fizzled out. The S&P 500 has lost 1% since January. As you can see in the chart below, stocks have gone nowhere in 2015.

Last week, the S&P 500 dropped 3.8%. It was the worst week for U.S. stocks since late August.

• Although stocks have failed to go up in 2015…

They haven’t gone down much, either. The S&P 500 is currently just 3.2% below its all-time high. But beneath the surface, the stock market is weakening…

The average stock in the S&P 500 is down 4.4% this year…and is 19.2% below its 52-week high. On Monday, just four stocks on the New York Stock Exchange hit new 52-week highs…while an incredible 365 stocks hit new 52-week lows.

A handful of giant stocks have kept the S&P 500 from falling…

The S&P 500 is weighted by company size. Bigger companies comprise more of the index than smaller companies.

For example, Apple (AAPL), the largest company, makes up 3.7% of the S&P 500. While Chipotle Mexican Grill (CMG), the 256th-largest, makes up just 0.1%.

These giant stocks are propping up the S&P 500. For example, Google (GOOGL), the second-biggest company in the S&P 500, is up 44% on the year. Microsoft (MSFT), the third-biggest, is up 19% this year. Amazon (AMZN), the sixth-biggest, is up 112%. Facebook (FB), the eighth-biggest, is up 34%.

• E.B. Tucker, editor of The Casey Report, called the end of the bull market months ago…

The title of his September issue of The Casey Report was, “R.I.P. 2009 -2015 Bull Market.”

E.B’s call has been dead-on. None of the major U.S. markets have set new highs since the summer. Most stocks are actually falling.

Here’s E.B.:

The S&P 500 is basically flat on the year. The headlines read, "Everything's fine." But everything is not fine. If you take a close look at market, you will see it’s tired, out of shape, and teetering on collapse.

Google, Amazon, and Facebook are part of a small group of stocks that propel the S&P 500.

This is possible because these are massive companies. Amazon, for example, is worth $309 billion. It’s nine times larger the average stock in the S&P 500.

Plus, these giant stocks that are propping the market up are extremely expensive. E.B. explains:

The average stock in the S&P 500 index has a price to earnings (P/E) ratio of just over 19.

Google has a P/E ratio of 36. Facebook has a P/E ratio of 105. Amazon has an off-the-charts P/E ratio of 955.

These sky-high valuations aren’t scaring away investors. They keep buying these stocks because they think these companies will give them safety during a downturn. That’s why these stocks are flying high while hundreds of other stocks are plumbing new lows.

We’ve seen this happen before. It never ends well.

• Natural gas just hit a 16-year low…

Yesterday the price of natural gas fell 5.0%. It’s now down 38% on this year and trading at its lowest level since 1999. Natural gas heats about one-half of U.S. homes.

Falling gas prices have hit major gas producers hard…

Chesapeake Energy (CHK), the second-largest U.S. gas producer, has plunged 81% this year. It’s trading at its lowest since 2000.

Anadarko (APC), the third-largest U.S. gas producer, has dropped 41%. It’s trading at its lowest since 2010.

• Natural gas is one of many commodities in a brutal bear market right now…

The Bloomberg Commodity Index, which tracks 22 different commodities, has declined 26% this year. It’s at its lowest level since 1999.

Yesterday, The Wall Street Journal explained why natural gas prices are crashing.

The natural-gas market is oversupplied due to weak demand and continued robust production.

Stockpiles stood at 3.88 trillion cubic feet as of Dec. 4, near the record high reached last month and 6.5% above average levels for this time of year. Some traders and analysts say the industry could run out of storage space for gas by mid-2016.

The warm winter has also hurt gas prices.

Weather forecasts released Tuesday showed warmer temperatures in the next two weeks than previously forecast.

Analysts say that even if a bout of cold weather arrives, there is ample gas in storage to meet any spike in consumption.

• Switching gears, U.S. companies are getting more “creative” with their accounting…

On Monday, The Wall Street Journal reported:

A financial obfuscation of the dot-com era is making a comeback: Hundreds of U.S. companies are trumpeting adjusted net income, adjusted sales, and “adjusted Ebitda.”

About one in 10 major securities filings this year used the term adjusted Ebidta – or adjusted earnings before interest, taxes, depreciation and amortization – up from one in 40 a decade ago.

About a quarter of earnings-related filings this year included figures that don’t comply with generally accepted accounting principles, or GAAP, as well as more standard measures…

The Wall Street Journal continues…

Scana Corp., a utility holding company, strips weather from its results to smooth out the effects of unusual warm and cold spells…

Restaurant chains like Potbelly Corp., burger joint Shake Shack Inc. and chicken-and-biscuits seller Bojangles Inc. exclude much of the costs of opening new stores. Telecom companies like AT&T and Sprint Corp. omit the multibillion-dollar depreciation bills that reflect the cost of upgrading their networks.

Of course, the companies claim these “adjusted” measures give a more realistic picture of their financial results. That’s true in some cases. However, management typically has a strong incentive to “fudge” earnings numbers. High earnings can cause a company’s share price to rise...which can cause management bonuses to rise.

• Companies are using accounting tricks to seem more profitable…

Officially, earnings for companies in the S&P 500 fell 0.1% during the third quarter. However, if all companies used standard reporting, earnings would have fallen by 13%, according to The Wall Street Journal.

• This is why Nick Giambruno, editor of Crisis Speculator, recommends using dividends to measure a company’s financial health…

Here’s Nick:

Dividends are the most reliable and simple indicator of true value. You can believe in the cash payments landing in your pocket.

Reported earnings aren’t as reliable: it’s too easy for a company’s management to pump them up by choosing the right accounting formalities…

Also, accounting and reporting standards vary widely across the world. Dividends, on the other hand, are actual cash payments. They are real, and nothing is easier to measure or harder to fake.

Nick uses dividends in the “Value Radar,” his proprietary tool for finding companies that pay big income streams and are trading for pennies on the dollar. In the last couple months, the Value Radar has helped Nick identify two undervalued companies that pay 14%+ dividends.

Nick rates both companies as Buys today. You can learn about them by taking a risk-free trial of Crisis Speculator.

Chart of the Day

Dispatch readers know oil is in a brutal bear market…

The price of oil has plunged 67% since peaking at just over $106 a barrel last summer. On Friday, oil hit its lowest level since 2008.

Low oil prices have slammed major energy companies. The Energy Select Sector SPDR ETF (XLE), which tracks the performance of major U.S. oil and gas companies, has fallen 39% since oil peaked last summer.

However, by one measure, U.S. energy stocks are still the most expensive they’ve been in 16 years…
Today’s chart shows XLE as a ratio of the price of oil. The higher the ratio, the more expensive U.S. stocks are relative to the price of oil.

As you can see, this ratio is at its highest level since 1999. U.S. energy stocks are 83% more expensive than their historic average, according to this ratio.

Op-Ed Contributors

Fixing Fannie and Freddie for Good


 Credit Michael Reynolds/European Pressphoto Agency       

IN the longstanding debate about what should be done to overhaul Fannie Mae and Freddie Mac, the mortgage behemoths that taxpayers rescued at the height of the financial crisis, a growing number of groups, including several hedge funds and other investors, as well as civil rights groups and consumer advocates, are offering a surprising answer: Go back to the very system we just bailed out.

In September 2008, after the two institutions had racked up tens of billions in losses that had wiped out their capital, and amid fears about what their insolvency might mean for the American housing market and the wider economy, the then newly created Federal Housing Finance Agency stepped in to place Fannie and Freddie in conservatorship. Taxpayers have backstopped the two institutions and their mortgage securities ever since.
Yet, hard as it is to imagine, given the colossal scale of this bailout and the dramatic effect that their failure had on the broader economy, many are arguing that we should now resurrect Fannie and Freddie as the privately owned but taxpayer-backed oligopoly whose collapse contributed mightily to the financial turmoil and resulting Great Recession.
More surprising still, one of the primary reasons offered by many proponents of this view is that we cannot end their stranglehold without decreasing competition in the mortgage market.
This view isn’t merely counterintuitive; it’s wrong.
Fannie Mae and Freddie Mac are among the largest financial institutions in the world, currently purchasing roughly one-half of the mortgages issued by lenders in the United States.
They package and create securities out of these loans, and provide guarantees to the investors that they will be paid their principal and interest under any economic scenario. They thus act as critical gatekeepers in determining what kinds of mortgage loans lenders can make, and who gets a loan and under what terms.
The concern is that any move to reform Fannie and Freddie by diminishing their dominance of the housing finance system will inevitably mean that the nation’s biggest banks will swoop in to take over their gatekeeping role. If they do, then these banks will use that power to their advantage, squeezing out smaller competitors.
This would indeed be a bad outcome. We would simply be swapping one dysfunctional system dependent on too-big-to-fail institutions for another with the same problem.
If this were what reforming Fannie and Freddie was all about, then the critics of reform would be right. But it’s not.
The point of the kind of reform that we support is to end the system’s dependence on too-big-to-fail institutions. It is critical to ensure that no institution central to the system has an incentive to take on excessive risk, knowing that taxpayers will bail them out if things go wrong, as happened with Fannie and Freddie and could happen in a system overly dominated by other too-big-to-fail institutions.
One of us, Mark Zandi, is on the board of a mortgage insurer; the other, Jim Parrott, advises several financial institutions in the housing finance industry. Some of these institutions could benefit from Fannie and Freddie reform, while others may suffer. But our focus is not the interests of these institutions, any more than it is those of the big banks or the shareholders of Fannie and Freddie. The aim of reform should be to create a healthier housing finance system, which means, among other things, one with greater competition.
In winding down Fannie and Freddie’s duopoly, Congress could and, we have long argued, should explicitly prohibit institutions that make mortgage loans from also playing the role of gatekeeper to the secondary market of mortgage-backed securities. Congress could also cap the market share of any single gatekeeper at a low enough level to preclude market concentration, or it could even create new gatekeepers to ensure that smaller lenders never are locked out of making mortgage loans.
Legislative reform could be a long time coming, however, given the complex politics of the issue. In the meantime, the F.H.F.A. should work to ease the mortgage giants’ unhealthy hold on the market.
The agency has already taken two steps that hold great promise: requiring that Fannie and Freddie share the risk they take when guaranteeing mortgage securities with a broad range of private financial institutions, and that they develop a common platform for offering securities on mortgage loans.
Done right, these steps could eventually open up the market to greater competition, reducing the dominance of Fannie and Freddie without enabling other too-big-to-fail institutions to take their place.
It is simply not true that we are forced to choose between one system dominated by Fannie Mae and Freddie Mac and another dominated by a few huge banks. The argument is at best ill considered, and at worst a red herring that will undermine any attempt to achieve significant reform.
There is no reason we can’t create a dynamic mortgage market with plenty of competition, free of an unhealthy dependence on institutions we cannot afford to let fail. As we consider reforming the role of Fannie Mae and Freddie Mac, we should settle for nothing less.
Jim Parrott is a senior fellow at the Urban Institute and the owner of Falling Creek Advisors, a financial consulting firm. Mark Zandi is the chief economist at Moody’s Analytics.

Jeremy Siegel On The Fed Rate Hike And What It Means For 2016

- On Wednesday afternoon, the Federal Reserve (Fed) raised rates by 25 basis points (bps), effectively raising its target band for the Federal Funds Rate to 25-50 bps.
- A widely anticipated move, it is an important and positive development for risk markets such as equities in that it removes a level of uncertainty.
- Following that decision, Fed chairman Janet Yellen's statement was generally dovish, placing a large emphasis on "gradual" rate hikes in the upcoming months.
- In my opinion, it is extremely unlikely that the Fed will raise rates at its first meeting in January 2016.
While many ponder the unintended consequences of the Fed keeping rates low over the past seven years, academic research has shown that market forces have largely contributed to these low rates, namely outsized demand for "safe" liquid assets.

By Jeremy J. Siegel, Senior Investment Strategy Advisor

On Wednesday afternoon, the Federal Reserve (Fed) raised rates by 25 basis points (bps), effectively raising its target band for the Federal Funds Rate to 25-50 bps. A widely anticipated move, it is an important and positive development for risk markets such as equities in that it removes a level of uncertainty.

Dovish Fed - Dot Plots Revised Downward

Following that decision, Fed chairman Janet Yellen's statement was generally dovish, placing a large emphasis on "gradual" rate hikes in the upcoming months. The dot plots that reflect projections from members of the Fed committee suggest that median estimates for Fed fund rates in 2016 lie between 1.25% and 1.50%. This implies there will likely be four rate hikes in 2016.

There are two important factors that put this in context. First, although median forecasts of the dot plots imply four rate hikes, only three participants estimated that rates might actually be higher than the median, while seven members thought that rates would not get to that level.
In contrast, at the September meeting, eight members thought the Fed would increase rates in excess of the median forecasts, indicating there has been a dovish tilt to these dots since then.
Furthermore, these Fed forecasts of the Funds rate have been notoriously too hawkish - the Fed has systematically over-predicted the level for interest rates, and that may still be the case, given current market expectations.

Timing of Second Rate Hike

In my opinion, it is extremely unlikely that the Fed will raise rates at its first meeting in January 2016. Unless something extraordinary occurs, it will probably pass on this meeting and have a lively discussion at the March meeting, where a second rate hike is more likely.

Inflation - or Lack Thereof

West Texas Intermediate (WTI), which is used as a benchmark in oil pricing, fell to an 11-year low on Wednesday. Although core inflation, which the Fed monitors, excludes food and energy, a dramatic price drop for goods and services in the manufacturing and services sector - resulting from lower oil prices - can ultimately put a lid on core inflation.

Will the Fed Turn Hawkish in 2016?

Wednesday's meeting ended with its committee members being in broad agreement of the decision - which is somewhat historic by itself, given that dissent has been a regular occurrence over the year.

Many are expecting the Fed to tilt towards the hawkish end of the spectrum, what with one of its most dovish members, Narayana Kocherlakota, departing.

I believe the Fed will be more balanced in its approach and will likely engage in a lively debate.

We are nowhere close to having known hawks such as former Philadelphia Fed president Plosser or former Dallas Fed president Fisher as voting members next year.

Fed Funds Futures to Underestimate Rate Hikes

The Fed Funds futures market implies only two hikes in 2016. This likely underestimates where rates may end up, given the negative beta of these futures prices to the general market. This is because if growth collapses, the Fed will not hike rates - and these futures contracts will rise in price, working as a hedge against that event. As a result, these futures are often priced somewhat above their expected value, and, therefore, rates somewhat below their expected value. While the Fed dot plot has provided median guidance of four rate hikes for 2016, the Fed Funds market implies only two hikes.

Given the negative bias, I think we'll likely see between two and three hikes instead of just two.

What Does It Mean to Target a 0.25%-0.50% Band?

When the Fed targeted a 0%-0.25% band, the midpoint was effectively 0.125%. With the new target band of 0.25%-0.50% (which implies a midpoint of 0.375%), the Fed will likely target the lower end of the range to maintain full control over the Fed Funds Rate. Yellen herself mentioned at the press conference that the reverse repo facility will peg a rate of 25 bps, close to the floor of the new range.

The New Neutral: 2%

At the October Fed meeting, the Fed staff projected that the appropriate Fed Funds Rate level during a neutral period would be about a 0% real rate. With a target inflation rate of 1.5%-2%, the nominal Fed Funds Rate may get up to 1.5%-2%. This is largely in line with Bill Gross's concept of a new neutral of 2% for the Fed Funds Rate that I also support.

I furthermore foresee that the interest curve will flatten somewhat, with 10-year rates increasing by half as much as shorter-term rates. It is likely that the 10-year may creep up from its current level of 2.30% to 2.50%-2.75% by the end of 2016. TIPS yields may increase to 90-100 bps from their current level of 80 bps.

Fed not Fully Responsible for Ultra-Low Rates

While many ponder the unintended consequences of the Fed keeping rates low over the past seven years, academic research has shown that market forces have largely contributed to these low rates, namely outsized demand for "safe" liquid assets. To add fuel to the fire, record-low inflation, low economic growth, high risk aversion and an aging investor class are also partly responsible for this risk aversion. It was a combination of risk aversion and low growth that have kept rates this low for this long.

Swiss Bank Hid Assets for Jews in Wartime, Then Tax Evaders
Dreyfus Sons & Co. has operated for two centuries as a private Swiss bank, catering to Jewish clients who wanted to hide assets from the Nazis during the 1930s and World War II.

More recently, it helped U.S. clients hide assets from the Internal Revenue Service by concealing their true ownership with offshore entities and by storing gold and cash in a segregated area of its vaults, according to a non-prosecution agreement, released Tuesday, that the bank reached with the Justice Department.

Dreyfus avoided U.S. prosecution by agreeing to pay $24.2 million and admitting it “did not implement strict enough controls” to ensure that its American clients paid their taxes, the agreement says.

George Clarke, a lawyer for Dreyfus, declined to comment on the accord.
The U.S. announced two other pacts Tuesday, with Credit Agricole SA’s Swiss unit, which agreed to pay $99.2 million, and Baumann & Cie., which is to pay $7.7 million.

Gold Rush
In all, 64 Swiss banks have agreed to pay almost $742 million in penalties this year. While many of the other accords spell out classic Swiss tactics, like numbered accounts and off-the-shelf corporations to help clients cheat the IRS, none detail the use of gold storage like the Dreyfus pact.

Two decades ago, Dreyfus agreed to serve as a custodian for gold and cash held by a Swiss-based British Virgin Islands entity -- 315 accounts valued at $440 million, in all. Some of those accounts should have been disclosed to the IRS and weren’t, until clients came forward to tell the tax agency about them to avoid prosecution, according to the bank’s statement of facts in the agreement.

“Although some of the gold and cash client base maintained their accounts because of fears related to the collapse of the banking system,” others “show strong indicia of the concealment of assets,” the agreement says.

The British Virgin Islands entity had an account at the bank, with U.S. customers holding sub-accounts, according to the pact. The sub-accounts were often held in the names of offshore trusts, foundations or corporations.

Jewish Assets

Dreyfus was founded in 1813 in Basel by a Jewish immigrant from France. It grew to 7,000 accounts valued at 18 billion Swiss francs ($18.2 billion) in 2013, the accord says. Of those, 855 were U.S. accounts valued at $1.76 billion.

Some of those accounts were held in the name of Panamanian corporations, a practice that began after World War II because Jewish clients wanted to “protect their assets for reasons of personal safety” while also hiding them from governments, according to the pact. Of the U.S. accounts, 33 were held in the name of Panamanian entities, with bank employees serving as directors for most.

One such account disguised weekly checks ranging from $3,900 to $4,100 to a U.S. woman or her relatives from 1998 to 2013. From another account, opened with $1 million, $925,000 worth of weekly checks were sent to a U.S. man and his three sons, according to the agreement. Other clients used 34 offshore entities in Liechtenstein, the Isle of Man, Liberia, the Bahamas, Nevis and Mauritius.

‘Lack of Candor’

After 2008, when the U.S. began a criminal investigation of UBS Group AG, Switzerland’s largest bank, other Swiss firms began shutting down U.S. accounts because of the risk of being implicated in clients’ tax evasion. 

The Dreyfus exit process “languished” until 2012, when a U.S.-born manager was appointed to oversee the operation.

Dreyfus showed a “deliberate lack of candor” by failing to tell the Justice Department that the manager had five accounts valued at $1 million that he didn’t declare to the IRS, according to the agreement. Dreyfus didn’t tell the Justice Department until the manager voluntarily disclosed his accounts to the IRS, giving him a chance to “discreetly regularize his U.S. tax matters.”

The bank tried to use his disclosure, among others, to lower its penalty. When the Justice Department balked, it withdrew its request.

Credit Agricole’s payment was the second-largest of the year after BSI SA, which agreed to pay $211 million in March. Alexandre Barat, a spokesman for Credit Agricole, declined to comment on its pact. Keith Krakaur, a lawyer for Baumann, didn’t immediately return a call.

The Top 7 Reasons Why You Need a Second Passport

by Nick Giambruno

Before World War I, you didn’t need a passport for international travel.

People simply went wherever they wanted. In many cases, they didn’t need any kind of permission from a government agency.

Obviously, that’s not how it works today.

Today, governments use passports to document and control their citizens. In my view, the world would be better off without them.

Of course, passports are not going away. You will continue to need one to travel. This is why you’re better having more than one.

A second passport keeps the government from locking you in. Without it, the government in your home country can effectively place you under house arrest by taking back your passport.

Among other things, having a second passport allows you to invest, bank, travel, live, and do business in places you wouldn’t otherwise be able to.

Obtaining a second passport is a fundamental step toward freeing yourself from absolute dependence on any one country. Once you have that freedom, it’s much harder for any government to control your destiny.

No matter where you live, you can benefit from the political diversification that comes with a second passport.

Here are the top seven reasons why everyone needs a second Passport.

Reason #1: More Financial Options

A second passport unlocks the door to international financial services. This is especially true for Americans. U.S. regulators have a long reach. This is why many, but not yet all, foreign financial institutions now turn away anyone who presents a U.S. passport. To be a welcome customer, you need a passport from a different country.

Reason #2: Avoid Foreign Policy Blowback

Say your home government has a bad habit of sticking its nose in other nations’ internal affairs. This could make you a target if you happen to be in the wrong place at the wrong time, like the next time ISIS radicals decide to attack a public area.

There are, of course, passports with minimal risk of foreign policy blowback. When was the last time you heard of anyone targeting Swiss passport holders or rounding up Uruguayans?

Reason #3: More Visa-Free Travel

Applying for a visa before a trip is a real hassle. It can be frustrating, time-consuming, and expensive.

A good second passport gives you visa-free access to more countries than you had before.

Take Paraguay, for example. It’s one of the easiest countries in the world to obtain a second passport from. A passport from Paraguay lets you travel visa-free to 123 countries, including most of Latin American and much of Europe.

Reason #4: Preempt People Controls

A second passport can also come in handy when your home government starts restricting where its citizens can go. For example, after Castro came to power in Cuba, the government used to make its citizens apply for an exit visa to leave the island. It did not grant them easily.

Preventing people from leaving has always been the hallmark of an authoritarian regime.

Unfortunately, the practice is growing in so-called liberal democracies for ever more trivial offenses.

In the U.S., for example, the government can cancel your passport if they accuse you of a felony.

They don’t even need to convict you.

Many people think felonies only consist of major crimes like robbery and murder.

But that isn’t true.

The ever-expanding mountain of laws and regulations has criminalized even the most mundane activities. It’s not as hard to commit a felony as you might think. Many victimless “crimes” are felonies.

A study by civil liberty lawyer Harvey Silverglate found that the average American inadvertently commits three felonies a day.

So, if the U.S. government really wants to cancel your U.S. passport, it can find some technicality for doing so…for anyone. That, of course, is not unique to the U.S. government. Any government can revoke or cancel the passport of its citizens for any reason it sees fit.

Having a second passport dilutes this power.

Reason #5: You Don't Have to Live Like a Refugee

A second passport is mobility insurance for you and your family. Regardless of how bad the economic or political situation might get in your home country, a second passport gives you the legal right to live and work elsewhere. It guarantees that once you get out of Dodge, you won't have to live like a refugee.

Reason #6: Renunciation

In all likelihood, you will need a second passport if you decide to take the drastic step of renouncing your citizenship. This could give you huge tax and regulatory benefits if your home country burdens its citizens with suffocating and inescapable taxes…as the U.S. does.

Reason #7: Generational Benefits

Once you obtain a second passport, the political diversification benefits will last for generations. You will be able to pass on multiple citizenships to your future children and grandchildren.

Not Easy, but Necessary

Unfortunately, no path to a legitimate second passport is at the same time fast, easy, and inexpensive.

However this does not make a second passport any less crucial.

Today, the government is the biggest threat to your personal freedom and financial security.

And the risks it poses are only growing amid skyrocketing government debt. At some point, politicians will inevitably try to further restrict the movement of citizens in a desperate attempt to squeeze them for every penny.

You may have noticed there’s a lot of misinformation out there about second passports.

Following bad advice can create significant problems and limit your options. Your goal should be the opposite: Minimizing problems and expanding your options.

In these shark-infested waters, it’s essential to have a trusted resource with reliable information. That’s where International Man comes in. We can show you how to get started.