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“If we had 8% unemployment, Keynes would be back.  We must remember that economists are not necessarily the creatures of great thought but of circumstance.  Keynes would not have written ‘The General Theory’ except in the Great Depression.”

-John Kenneth Galbraith, 1999


Today’s quote of the day is typical of Galbraith; he expressed his views with a masterful economy of language.   Ten years after Galbraith made his prediction that Keynes would be back in vogue if unemployment reached 8%, his prophecy came true.  Robert Skidelsky began writing “Keynes: Return of the Master” – on January 1st, 1999 – as unemployment was just under 8% and trending higher.  The Wall Street Journal also devoted a full-page spread to Keynes a week after Skidelsky put pen to paper. 


It’s difficult to understand the motivations of academic economists.  The measure of success for an economist, some might argue, is whether or not one’s theory stands the test of time and remains part of future policy debates.  The difficulty with this, as Skidelsky highlights, is that circumstances may permit your ideas to be heard outside of academia but they will almost certainly demand that theories will, as policies, be applied in a vulgarized form.  The discrediting of economists in recent times has prompted many public figures to disavow all ties with the profession; Tim Geithner is just one example.


Despite the provocative title of his aforementioned book, Skidelsky is realistic and honest about the role of circumstance in the ascension of Keynes and others to the throne of economics that some would place them on, stating that “just as Keynes succeeded politically because unemployment was the problem of the 1930s, Friedman succeeded politically because inflation was the problem of the 1970s.”  The rise of Barrack Obama and, perhaps, the ever-perseverant Mitt Romney are also permitted more by the fickle preferences of their time than the genius of their ideas.  Thankfully, politicians and the policies they implement are answerable to voters.  One long term positive emerging in the United States is what could be called the bottoming process of political participation in this country.  Obama’s engagement of the youth vote through social media was a political revelation of a scale not seen since Reagan went public with his appeal for voters to contact their state representatives to support Federal Tax Reduction Legislation in July 1981.  The Great Communicator understood the value of engendering a feeling of inclusivity among the electorate and he warned Congress of the importance of public opinion, also in 1981, by quoting Teddy Roosevelt’s message to Congress 80 years prior, “The American people are slow to wrath but when their wrath is once kindled, it burns like a consuming flame.”  The aftermath of the Great Recession has bred a new strain of voter: young, confused and dissatisfied with their vision of the future.  The internet is greasing the wheel of mobilization as circumstance drives voters to wonder what factors are behind the country’s predicaments and how they can be changed.


A Gallup poll conducted in July 2011 posed the following question to Americans: What do you think is the most important problem facing this country today?  The top three responses were “economy in general”, “jobs”, and “federal debt/deficit”, making up 31%, 27%, and 16% of the responses, respectively.  While Obama has recorded some significant coups in terms of the War on Terror and has taken pride in health care legislation passed on his watch, what the vast majority of Americans want is the economy to be back on track.  The longer the “Jobless Recovery” continues, the less relevant other topics become.


We believe that a strong dollar is the first step to rejuvenating American confidence. 71% of GDP is consumption and a stronger dollar increases purchasing power.  GDP growth has strengthened sequentially as the greenback appreciated and we expect that to continue.  Politicians in Washington need to recognize the strong dollar and the impact it has had on the economy recently.  The short term impact for jobs has been unmistakably positive.


Our Chart of the Day highlights this point clearly.  The two meaningful positive moves in the US Dollar Index since 2009 have coincided with improvements in employment growth.  One of the many positives of democracy is that, in the end, the mandate is made clear.  The People’s directive to Washington, D.C. is to create jobs.  Economists that debate the optimal method by which to achieve this end are not incentivized to compromise.  There are neither direct consequences of their words nor any clock hurrying them through their thought processes.  Politicians are not being afforded such shelter from scrutiny.  To compromise is the most human of actions and, whether they like it or not, many political figures in Washington are going to be forced to do just that from now on.  The circumstances – and the People – demand it.


Have a great weekend,

Rory Green





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Initial Claims Rise

The headline initial claims number rose 27k WoW to 399k (up 24k after a 3k upward revision to last week’s data).  Rolling claims rose 7.75k to 382k. On a non-seasonally-adjusted basis, reported claims rose 102k WoW to 642k.


We've pointed out that there are two very important relationships to be cognizant of when looking at claims. The first stems from the observation that claims tend to begin falling from week 36 through year-end and then reverse in the first 1-2 months of the new year. This morning's print is consistent with that trend as this was the first print of 2012. The second relationship to watch is the relationship between the the S&P and claims, as shown in our chart below. Over the last two years we've noted that these two series move in tandem and that any divergence between the two is short lived.


Full mean reversion from the claims side implies a level around 410k. Conversely, should claims stay flat and the S&P revert, our model implies that the index would need to go to ~1350 to close the gap.











2-10 Spread

The 2-10 spread tightened 4 bps versus last week to 168 bps as of yesterday.  The ten-year bond yield decreased 7 bps to 191 bps.






Financial Subsector Performance

The table below shows the stock performance of each Financial subsector over four durations. 


INITIAL CLAIMS RISE IN THE EARLY INNINGS OF 2012  - Subsector performance 2


Joshua Steiner, CFA


Allison Kaptur


Robert Belsky


Having trouble viewing the charts in this email?  Please click the link at the bottom of the note to view in your browser. 

The Resiliency of Oil

Conclusion:  Despite a strengthening U.S. dollar, the price of oil has not corrected.  This is a function of heightened geo-political risk, maxed-out Saudi Arabian production, and the U.S. insistence on using oil as a foreign policy tool against Iran.

Many of our key investment themes, and really macro asset allocations, over the past couple of years have been related to the direction of the U.S. dollar.  Specific to commodities, dollar up has consistently meant commodities down.  Recently, that correlation has weakened with oil.  In fact, both Brent crude and the U.S. dollar have broken into Bullish Formations on our quantitative models.


Given the recent rhetoric from Iran related to the Strait of Hormuz, the strength in the price of oil is not totally surprising.  In December, Iran threatened to shut the Strait of Hormuz if sanctions were imposed on its oil exports.  Subsequent to that announcement, Iran held a series of naval maneuvers over a period of ten days, ending on January 3rd, just east of the strait. 


Today, the latest gauntlet was thrown down over Iranian oil.  After meetings with U.S. Treasury Secretary Tim Geithner, the Japanese indicated that they intend to reduce their imports of Iranian oil, which stand at roughly 10% of their total imports.  Behind China at 20%, Japan is the second largest importer of Iranian oil at approximately 17% of total Iranian exports.  China, on the other hand, has been reluctant to cut its use of Iranian oil, though Premier Wen Jiabao is making his first trip to Saudi Arabia this weekend, which can be seen as an affront to Iran.


The strategic relevance of the Strait of Hormuz is that more than one-fifth of the world’s oil is transported through the strait, which is 34 miles wide at its narrowest.  As oil is transported out of the Persian Gulf it passes through the Strait of Hormuz before crossing in the Arabian Sea.  Every day, about 14 tankers carrying 15.5 million barrels of crude oil pass through the strait.


The Resiliency of Oil - hormuz pic


On “Face the Nation” this past Sunday, Joint Chiefs of Staff Chairman General Martin Dempsey was very specific in stating that the U.S. was prepared to act aggressively should Iran attempt to block the strait.  General Dempsey stated:


“They’ve invested in capabilities that could, in fact, for a period of time block the Strait of Hormuz.  We’ve invested in capabilities that ensure if that happens, we can defeat that.”  


Defense Secretary Leon Panetta echoed these comments and also indicated that efforts by Iran to build a nuclear weapon would also constitute a “red line”, which implies potential the need for U.S. retaliation.


On the subject of nuclear weapons, according to the Iranian newspaper, Kayhan, Iran has started to enrich uranium at its Fordo production facility.  The Fordo plant is built into the side of a mountain near Qom, a Muslim holy city, which is located just south of Tehran.  (Ironically, the Fordo location is also believed to be the site of the largest number of fatalities in the Iran-Iraq war.)  This site was disclosed in 2009 and has been at the epicenter of the debate over whether Iran is on the path to nuclear weapons, or merely using this enrichment for energy purposes.  We’ve posted a satellite image of the site below.


The Resiliency of Oil - 2


Coincident with the strong language voice this weekend on “Meet the Press” by the Secretary of Defense and the Chairman of the Joint Chiefs of Staff, the Council on Foreign Relations publication, “Foreign Affairs”, featured an article by former Pentagon defense planner Matthew Kroenig titled, “Time to Attack Iran”.  According to the article:


“But skeptics of military action fail to appreciate the true danger that a nuclear-armed Iran would pose to U.S. interests in the Middle East and beyond.  And their grim forecasts assume that the cure would be worse than the disease -- that is, that the consequences of a U.S. assault on Iran would be as bad as or worse than those of Iran achieving its nuclear ambitions.  But that is a faulty assumption.  The truth is that a military strike intended to destroy Iran’s nuclear program, if managed carefully, could spare the region and the world a very real threat and dramatically improve the long-term national security of the United States.”


His conclusion is simply that the U.S. has little choice but to attack, and the time to do so is now.


Obviously, Kroenig’s view is more aggressive than the administration’s in terms of how to deal with Iran, and his essay shouldn’t be construed as carrying water for the administration, despite being a former advisor to the Secretary of Defense.  Regardless, if the resilience of the price of oil, strong actions by the Iranians, and strong language by the Americans are telling us anything, it is that the Iranian issue is not going away in the short-term. 


In the scenario that military action is taken against Iran, the risk management question to ponder is: what will the impact on the price of oil be?  As a proxy, in the two charts below, we evaluated how the price of Brent reacted in the six months leading to Gulf Wars I and II and the six months preceding.   In Gulf War I, the price of oil ran up into the event and then almost doubled as the invasion ensued, but six months later was lower than the price at the start of the war.  In Gulf War II, which was slightly different given the long anticipatory period, the price of Brent actually sold off on the news and six months later was basically at the same price.


The Resiliency of Oil - brent.gwi


The Resiliency of Oil - brent.gwii



Currently, at least based on mainstream reports, an invasion of Iran is not being seriously contemplated, but rather the likely action, if any, would be a strategic strike, so it is perhaps somewhat inaccurate to compare the Gulf Wars to a potential action in Iran.  Conversely, though, Iran is a much more critical player in the world oil supply.  Specifically, after Saudi Arabia and Canada, Iran has the third most reserves globally, about 10% of the world’s total.  As well, Iran is the third largest oil exporter after Russia and Saudi Arabia.


The heightened rhetoric relating to Iran comes at a time when Saudi Arabia is reportedly pumping close to capacity at 10 million barrels per day.  This means that there is very little spare capacity in the event of either the Iranians closing, even if for a period of time, the Strait of Hormuz, or a strategic strike against Iran that shutters some of their production.  Thus, we shouldn’t be surprised by the resiliency in the price of oil, particularly Brent.


Daryl G. Jones

Director of Research

ECB Press Conference Notes: Draghi Stands Strong Behind LTRO

The ECB’s governing council decided to keep main interest rates unchanged today, following 25bp cuts on 11/3 and 12/8 of last year. The council iterated that the economic outlook remains subject o high uncertainty and substantial downside risks, inflation should moderate to below the 2% target after a number of months above 2%, and the pace of monetary expansion remains moderate.  


For more specifics, see this ECB press release:



However, more interesting than Mario Draghi’s prepared comments were his responses in the Q&A session. In particular, Draghi was quick to defend the workings of the LTRO to prevent credit contraction. While banks may be parking record amounts at the ECB’s overnight deposit, Draghi stated there’s initial evidence that money is circulating, especially as the banks that borrowed from the LTRO are not [all] the same banks re-depositing with the ECB. Mario Draghi’s (MD) responses are below:


Top 3 Q&A Responses:

How much of an uptick in the LTRO is coming up? Collateral changes were issued in the last meeting but, when do they come into effect?  –MD:  expect substantial demand in the second LTRO. Work is underway to make changes to collateral effective at the next LTRO, so in February [29th].


How successful is the LTRO? There are fears that money is just being parked at the ECB?  –MD: as more time passes we see that it is more and more successful. The decision (for the LTRO) that was given to all banks was an insurance against being without liquidity. It gave banks time to manage liquidity and assets and liabilities in a more effective way. We see some unsecured bank markets now open, which were previously closed. Also, 200B EUR in debt due is coming due in Q1.


Interest rates are declining across the yield curve, first on short end, now (today) more on long. So, there’s evidence that money isn’t just parked at the facility (ECB), it’s circulating. Initial signs of flowing include bids and behavior in accessing the LTRO depended on amount of bonds coming due for each institution in Q1. And by in large, banks borrowing were not [all] the same banks that are re-depositing with the ECB. Aware that more liquidity we inject, the larger the liabilities are for the ECB. What about the credit part?  Hard to judge, and there’s a lag in seeing money used to extend credit, but having said that, ECB thinks LTRO prevents credit contraction. The LTRO has come at the appropriate time to avoid credit contraction. 


Given the success of the LTRO, can the ECB lessen SMP purchases? – MD:  the rational of SMP is to unclog channels. The interbank market is still not functioning. Some opening is happening, but we’re really at the beginning of the process.


Additional Q&A:

Was today’s decision unanimous?  –MD:  yes, unanimous.


Thoughts on the ECB playing a larger role for the EFSF? –MB:  no comment.  Some of the stressed countries are taking serious measure for fiscal consolidation. Markets are showing some appreciation of this.  If one only limits itself for fiscal consolidation, one will have fiscal contraction over the short term.  One must understand this fiscal consolidation is unavoidable. Goal is to improve competitiveness, job growth, and confidence. And confidence comes from steady competition.  Therefore, the fiscal compact is key, and hopefully is signed this month rather than in March.


ECB will act as an agent for EFSF. Much progress has happened. We’re close to signing an agency agreement with EFSF. But the EFSF has a different task than the ECB. The ECB is responsible for price stability. The EFSF’s objective is completely different. But the ECB is prepared to put ‘technostructure’ (in the words of Trichet) at the disposal of the EFSF.


How confident are you that the economy is stabilizing?  -MD:  we see a weakening of economic activity in the Eurozone, see significant downside risk and a high level of uncertainty. Some data suggest stability at low levels, however it’s hard to be confident in initial positives.


Greece is looking towards higher haircuts, thoughts? – MD:  on PSI, one says more is needed… one needs to have in mind there is a debt sustainability assessment. There are a variety of factors. One thing is clear, Greece must bring back fiscal actions on track to complete fiscal reforms. The ECB is not part of the negotiations, just part of Troika.


It was previously communicated that main interest rate has a 1% floor, is that fair?  -MD:  we never pre-commit. In this situation of high uncertainty, we look at all factors and monitor all developments, then decide.


Could what happened to Philipp Hildebrand at the SNB happen at the ECB? – MD:  we all regret the developments that lead to his resignation. We’ll miss a very good CB governor. But we must say, the ethical code at ECB, which is public, prevents any such happenings.  [Draghi reads out statement on ethics code].


Did the governing council consider cutting deposit rate to prevent banks parking funds? –MD:  not discussed.


On Hungary, the ECB is critical of its CB legislation, what must Hungary do to address these concerns? –MD:  frankly, we’re very concerned because the ECB is extremely careful about pressures being put on NCBs. These pressures are inconsistent with EU treaties.


Besides PSI, would the ECB be prepared for a 100% write-down of Greek holdings, opinion? – MD:  the ECB is not in direct negotiations with Greece, so we hold our judgment. But there is no amount of sufficient relief if you don’t have fiscal consolidation and structural reforms. We [the public] focus on the relief side, but we must focus on the progress of fiscal reforms. ECB VP Victor Constancio:  stance is the same as before. PSI is private sector, so ECB is not involved in those negotiations. 


Is there the ability to combine the EFSF and ESM facilities together for a 1T EUR, opinion?  -MD:  I think anything governments can do to increase firepower is supported by ECB.


Stress tests revealed capital needs of banks, is there extreme stress across the system?  -MD:  well when the EBA survey was conducted, the EFSF wasn’t in place, so the survey is misleading. There’s no probability that the same exercise will be repeated in future. In the U.S., the banks had capital in place before the stress tests were issued.


Risk to ECB balance sheet, opinion? – MD:  there’s no doubt that expanding collateral rules also expands potential risks, but our risk management is very careful. Our system of potential haircuts and pricing is very developed. We’re very confident that we can manage the risks.


ECB’s position remains no PSI involvement on Greek bonds, but is it willing to accept losses on Greek holdings?  – Draghi calls Greece a unique case and has no direct answer to accepting losses.


Italy has done its “homework”, but debt is still very high, and market conditions are uncertain, opinion?  –MD:  the market appreciates what the country is doing, see yields falling today. Job creation should be first focus across countries.




Matthew Hedrick


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