Macro and Credit - Iconic Memory

"There are things known and there are things unknown, and in between are the doors of perception." - Aldous Huxley

Looking at the significant acceleration in the melt-up in the equities space in early 2018 on the back of decent macro data and earnings, with credit spreads going towards the 11 level on the credit amplifier in true Spinal Tap fashion, when it comes to selecting our first title analogy for the new year we decided to go for "Iconic memory". The development of iconic memory begins at birth and continues as development of the primary and secondary visual system occurs.  A small decrease in visual persistence occurs with age. Iconic memory is the visual sensory memory (SM) register pertaining to the visual domain and a fast-decaying store of visual information. It is a component of visual memory and is described as a very brief:

1. The duration of visible persistence is inversely related to stimulus duration. This means that the longer the physical stimulus is presented for, (QE 1, 2 and 3) the faster the visual image decays in memory.
2. The duration of visible persistence is inversely related to stimulus luminance. When the luminance, or brightness of a stimulus is increased, the duration of visible persistence decreases. Due to the involvement of the neural system, visible persistence is highly dependent on the physiology of the photoreceptors and activation of different cell types in the visual cortex. This visible representation is subject to masking effects whereby the presentation of interfering stimulus during, or immediately after stimulus offset interferes with one's ability to remember the stimulus

Information persistence represents the information about a stimulus that persists after its physical offset (Tapering). It is visual in nature, but not visible. The brief representation in iconic memory is thought to play a key role in the ability to detect change in a visual scene such as the continuation of the Fed's reduction of its balance sheet and its impact which has yet to be fully assimilated by many investors due to their "Iconic memory" we think. In similar fashion the "Iconic memory" of the Great Financial Crisis (GFC) has led many retail investors including the US middle-class to continue to be scared out of the stock market and leading the top 10% of American households to now own 84% of all stocks. 

In this week's conversation, we would like to look at what allocations could benefit 2018 in the on-going "goldilocks" environment thanks to a very muted volatility overall but, the most important question, we think will be once again the direction of the US dollar. In terms of "allocation" we gave a small Christmas present in our last musing on the 17th of December when we hinted that we liked gold miners again because they had "cheapened" a lot. We continue to like the sector for 2018. 

Synopsis:

• Macro and Credit - The US Dollar New Year's hangover
• Final charts - Credit Conditions in early 2018? Take it "easy"

• Macro and Credit - The US Dollar New Year's hangover

While in early January last year we indicated our contrarian view to the long USD investing crowd and we also indicated that in the context of a weaker US Dollar one should rather be overweight Emerging Markets (EM) equities versus US equities. The US dollar index fell by around 10% in 2017 which does indeed validates our early contrarian stance of 2017 as per our conversation "The Woozle effect":

"It appears that from a "Mack the Knife" perspective, it will be rather binary, either we are right and the consensus is wrong thanks to the Woozle effect, or we are wrong and then there is much more acute pain coming for Emerging Markets, should the US dollar continue its stratospheric run. From a contrarian perspective we are willing to play on the outlier." - source Macronomics, January 2017

And as indicated from the table below from the blog "The Capitalist Spectator", playing the outlier namely being overweight EM versus Equities has rewarded the "contrarian crowd" handsomely in 2017:

- source The Capitalist Spectator

Could 2018 play out differently than 2017 when it comes to the US Dollar? We do not think so, yet no doubt we could see in the early stage of 2018 a technical bounce of the US dollar. But, for us, from our "Iconic memory" perspective, we still see a weakening of the US dollar from a medium term perspective. On that note we agree with Barclays take from their note from their Thought for the Week Ahead note from the 7th of January entitled "The perils of following the consensus":

"USD: Holiday hangover

The USD has lost ground versus practically all major G10 and EM currencies (except for the JPY and MXN) since mid-December. Price action suggests that FX markets had largely anticipated the announced tax bill. Our economists have taken a closer look at the final details and recently updated their forecasts (see US Economics Research: 2018-19 US Outlook: Tax cut-induced bounce in activity, 4 January 2018). The tax plan is likely to boost near-term growth prospects by about 0.5pp and push out any slowing in the economy into 2019. Above-trend growth and a tightening labor market imply an increase in inflation toward the Fed’s target, and we now look for four Fed hikes in 2018 and three in 2019, taking the target fed funds rate to 3.00-3.25%.

That said, we do not see a lasting effect of the tax plan in pushing potential growth and, hence, long-term rates higher. The expected temporary boost to growth would be driven, largely, by a one-time improvement in disposable income. With many of the changes to personal taxation expected to be phased out of the bill, we do not expect it to have a permanent effect. In addition, it is likely to have heterogeneous effects for consumers based on household situations and the type of income earned. On the investment side, business spending has tended to have low elasticity with respect to changes in the required rate of return on capital, and as such, we are skeptical that it can deliver a substantial increase, particularly given the maturity of the business cycle. Finally, the discussion of restrictive immigration and trade policies that are also on the administration’s agenda may work against delivering lasting productivity improvements.

We remain USD bears over the medium term on account of an overvalued exchange rate (13% versus BEER), compression in risk premium in the US as symbolized by a bear-flattening yield curve, and a global backdrop that remains positive both in terms of cyclical prospects (the US cycle looking more mature) and from a valuation perspective. We believe the market’s focus will shift from tax policy to other policy priorities in Washington. These include approving the budget, immigration (DACA, the border wall, etc.), healthcare (renewal of CHIP, paying for Obamacare subsidies, etc.), and trade policy (NAFTA, alongside Korea and China). The 19 January government shutdown deadline and the seventh round of NAFTA negotiations on 23-28 January should be on investors’ radar." - source Barclays

As per our final conversation for 2017, either you think we are in a bull flattening case or in a bear flattening case:

"In a Bear Flattener case thanks to the Fed's Rician fading, it is still TINA playing out for the Japanese investor crowd" - source Macronomics December 2017.

We argued in our previous conversation that Japanese investors (and global credit and overall allocation wise these guys matter a lot) tends to be dip buyers ensuring in effect a bear flattening of the US yield curve. In 2018 we will watch again very closely what "Bondzilla" the NIRP monster "Made in Japan" will do in terms of "allocation". It is a major support to US credit markets as well. We think monitoring what the Bank of Japan (BOJ) does in 2018 will be paramount. On that note we agree with Deutsche Bank's take from their Japan Fixed Income Weekly note from the 5th of January entitled "BOJ normalization could pose a tail risk to domestic and overseas rates":

"Global investors focusing on the BOJ?

We expect the BOJ to be a major focus of attention among global investors in 2018. We say this because any change in the BOJ's monetary policy stance could have significant ramifications for how Japanese investors approach foreign bonds.

For example, the January 2016 launch of BOJ NIRP and September 2016 institution of YCC each had an important impact on international bond investment flows. Japanese banks were net sellers of foreign bonds to the tune of around JPY1 trillion and life insurers were big net buyers (+JPY4.8 trillion) over the 34- month period between the April 2013 launch of QQE and the January 2016 launch of NIRP, but the subsequent eight-month period up until the September 2016 launch of YCC saw net purchases of JPY5.2 trillion by banks and JPY9.3 trillion by lifers. The obvious conclusion is that the introduction of BOJ NIRP played a major role in the decline in the 10y UST yield from above 1.9% to below 1.4% that was observed between January and July 2016.

Conversely, the eight-month period following the launch of BOJ YCC (October 2016~) saw banks sell off foreign bonds to the tune of JPY9 trillion while lifers cut back their net purchases to just JPY1.3 trillion. We attribute this to bear-steepening of the JGB curve under YCC leaving domestic players with less of  an incentive to invest in foreign bonds, with life insurers in particular probably becoming more willing to wait for overseas interest rates to move higher once they perceived that the risk of the JGB curve bull-flattening had diminished.

Banks began FY2017 by selling off foreign bonds to the tune of JPY5.6 trillion in April (the biggest monthly selloff on record), rebuilt their holdings somewhat through July, and then shifted back into selling mode, meaning that they have now sold more than they have bought since April 2013. Lifers have also remained slow to add to their positions. We attribute this to a flattening of the UST curve —with the 10y yield having ranged between 2.00% and 2.60% even as the Fed has proceeded with multiple rate hikes—reducing the relative appeal of USTs. The flipside is that we see ample potential for Japanese investors to shift into dip-buying mode in the event of overseas yield curves starting to face bear-steepening pressure.

The key question among overseas investors is whether BOJ easing will continue to serve as an anchor for global interest rates. Under the current easing framework, demand from yield-starved Japanese investors should help to prevent overseas long-term interest rates from rising more than modestly. Conversely, if domestic long-term interest rates rise as a consequence of the BOJ commencing "normalization" efforts, then overseas interest rates could rise sharply due to Japanese players seeing less of an incentive to invest abroad. The trajectory of overseas interest rates in 2018 and beyond could therefore depend in significant part on what the BOJ decides and does.

It would not be at all surprising for short- to medium-term JGB yields to move significantly higher if BOJ normalization starts to be seen as a realistic possibility given that (1) foreigners have been by far the most active traders in negative yield short- to medium-term JGBs and (2) BOJ normalization is liable to reduce the FX "hedge premium" available to foreigners (and hence the attractiveness of short- to medium-term JGBs) by causing (negative) USD/JPY basis swap spreads to tighten.

Foreigners' cumulative net purchases have totaled JPY23 trillion for Japanese long-term debt securities and JPY14 trillion for short-term debt securities since the April 2013 launch of QQE, with medium-term JGBs likely to have accounted for much of the former if purchases were indeed funded mostly via the basis swap  market. Up until 2016 net purchases tended to increase when basis swap spreads widened, with this positive correlation reflecting the ability of foreign investors to earn positive spreads over USD LIBOR. However, we would expect foreigners to start reducing their Japanese bond holdings if and when the BOJ commences normalization, in which case short- to medium-term JGB yields might face some quite strong upward pressure until the YCC framework (which will presumably remain in place at least initially) begins to exert its influence once again.

Much will ultimately depend on inflation, but we are wary of bear-steepening risk under the YCC framework

Our US economics team expects US inflation to quicken in 2018, supporting a total of four further Fed rate hikes and a rise in the 10y UST yield to around 3%. The JGB yield curve is liable to face at least some bear-steepening pressure under such a scenario. However, we do not expect Japanese inflation to establish a firm foothold at or above +1% and thus see little prospect of the BOJ actually commencing normalization this year. As such, we will be looking for Japanese investors to step up their purchases of foreign bonds if interest rates move higher, thereby acting as a counterbalance. Irrespective of how many times the Fed hikes, upside for JPY rates is likely to be limited so long as Japanese inflation remains sluggish, leaving foreign bonds as the best means of generating carry. We expect the JGB curve to face a certain amount of bear-steepening pressure in 1H 2018 if overseas interest rates do indeed rise, but bull-flattening pressure may then start to dominate if the Japanese economy loses momentum, domestic CPI inflation peaks out, and the BOJ persists with its YCC framework.

The most obvious risk scenario is that of the BOJ shifting into normalization mode, in which case interest rates could rise quite sharply both at home and abroad. Attention in the first quarter of 2018 is thus likely to be focusing largely on (1) whether domestic and overseas inflation accelerates and (2) whether the Fed hikes once again in March." - source Deutsche Bank

As we pointed out it is still TINA (There Is No Alternative) for the Japanese investing crowd therefore we believe the bear-flattening of the US yield curve will continue its "Iconic memory" movement in 2018.

But moving back to the US dollar and the New Year's hangover, we read with interest Nomura's take in their FX Insights note from the 4th of January entitled "Two factors hurting the dollar":

"As is often the case, markets move when it is least convenient. The dollar has tumbled since mid-December until now – a period when investors were more likely to be embroiled in family dramas and over-eating than to be trading FX markets. Dollar weakness has come despite the passing of US tax cuts, an associated upgrade to US growth expectations and a hawkish Fed. There are many medium-term factors that we think are weighing on the dollar, but in terms of short-term factors, two stand out:

1. The dollar typically falls after a hike. Markets are all about expectations and it was likely the expectation of the December Fed hike that was helping the dollar. The actual hike, then, would naturally reset those expectations and would lead to a “buy the rumour, sell the fact” dynamic in the dollar. Indeed, the dollar has followed a pattern of trading relatively well into Fed hikes, but selling off after (Figure 1).

This time appears to be no different.

2. Rising US inflation expectations could be hurting the dollar. Wednesday’s ISM report showed the prices paid component bouncing back from an earlier dip. Oil prices are marching higher. Importantly, US inflation expectations as priced by US rates markets have consistently risen since early December. The 10yr breakeven from the TIPS market breached 2% in recent days – the first time since early 2017, and the 5y5y inflation swap inflation breakeven has gone above 2.35%. The dollar does not always move with inflation expectations (notably during the” Trumpflation” phase), but typically it does (Figure 2).

Some of this co-movement could be the dollar influencing inflation expectations, but some could be inflation affecting the dollar (through PPP, real yields or “credibility”). Either way, inflation could be returning as a market factor.

Of course, the start of the year is a period when market liquidity is poor. Therefore, we need to be cautious in extrapolating too much from price action, but these two factors do warrant some attention." - source Nomura

It isn't a surprised to see inflation returning as a market factor. A surge in inflation expectations would indeed mark a return of volatility and would be negative for bond yields. If inflation expectations are rising, then again it would continue to be headwind we think on the US dollar. Morgan Stanley in an interesting FX Pulse note from the 4th of January 2018 entitled "New USD Lows in Store" make as well the case for a lower US dollar:

"The case for USD weakness. The USD has come back under selling pressure and the DXY is set to break its early September low. This renewed weakness has occurred despite continued positive US economic surprises (Exhibit 2).

However, we note that the strength of US performance should be taken in the context of the global economy. Global synchronized growth, which should eat into global capacity reserves, will in turn clear the way for a pick-up in investment. Investment requires funding, which augurs poorly for funding currencies.

USD is the world's dominant reserve and funding currency. In order for a currency to be considered a funding currency, it should meet two important criteria: expected funding costs should stay below anticipated returns on investment; and the availability of capital must be ample.

In other words, there needs to be a substantial supply of the currency to be lent out and institutions or individuals willing to lend it. By definition, a dominant reserve currency meets this criterion.

As the world's primary reserve currency, then, it is no surprise that the USD makes up the majority of cross-border foreign-currency lending (Exhibit 5).

Other currencies may temporarily fall into the funding currency category, such as JPY, EUR, and CHF, which have seen periods of significant outflows.

Funding qualifications. The use of QE by global central banks has altered the funding environment, with central banks absorbing outstanding sovereign bonds in exchange for base money. In the case of QE programs from the ECB and Riksbank, EUR- and SEK denominated sovereign bonds held by foreigners declined as a proportion of total bonds outstanding (Exhibit 6).

In comparison, the proportion of foreign holdings of US Treasuries held relatively stable despite the Fed conducting its QE operations.

However, the relative stability of foreign Treasury holdings masks an important underlying shift. While foreign private accounts reduced their Treasury holdings, the ownership by foreign central banks increased. Two factors explain this. First, the Fed's QE operations took place in a period when global currency reserves were rising (2009- 2013), so demand for Treasuries from reserve managers rose in tandem. Second, debt issuance by the US government during this period also increased, so as demand for Treasuries grew with the Fed entering the market, supply also expanded simultaneously.

US assets for sale. Importantly, US agency debt and higher-yielding corporate bonds did experience a significant uptick in foreign holdings. Unlike in Europe and Japan, where private fixed income assets are in relatively limited supply, the US bond market offers a high yielding alternative to sovereigns. This in part explains the increase in the US' net foreign liability position (Exhibit 7).

Private foreign investors selling their Treasury holdings to the Fed reinvested those funds into higher-yielding USD-denominated bonds.

Our key point here is that foreign holdings of USD-denominated debt have increased, while foreign holdings of European debt instruments have declined. A similar dynamic has taken place for equities, where foreign ownership of US equities has more than doubled, which contrasts with trends in the foreign ownership of European equities. An important implication is that, should US assets lose their relative attractiveness (e.g., widening credit spreads, declining equities), then there could be a substantial amount of foreign-held USD-denominated assets for sale. In comparison, the relatively smaller share of foreign-owned assets in Europe renders it more immune to a pullback in foreign sentiment. This is why an environment of rising global bond yields may see the USD lose further ground.

The increase in the US's net foreign liability position comes at a time of relative stability in the US current account, with the deficit fluctuating around 2.5% of GDP since 2009 (Exhibit 8).

However, inward US net foreign direct investment (as provided by the World Bank) has turned negative for the first time since 2006. The composition of US inflows has become narrower, which renders the USD more vulnerable to selling once US equity and credit markets turn lower.

The case for JPY strength. One could argue that foreign ownership within the JGB market has increased, too. The BoJ's QE operations resulted in a significant absorption of JGBs held by the Japanese banking system, which reached the lowest level since 2007 and is now lower than that held by foreign investors (Exhibit 9). 

Importantly, many of these foreign JGBs have been currency hedged - with the FX hedge offering additional income, as opposed to a cost. Indeed, with the widening of the USDJPY basis, the returns offered for asset swaps into Japanese fixed income have increased. These foreign purchases have helped keep JGB yields low, particularly as the majority of the currency-hedged return comes not from the yield on the JGB itself, but from the currency hedge, which renders these foreign investors fairly price-insensitive.
The cross-currency basis represents the cost difference between domestic and offshore FX. A wider basis, all else equal, suggests tight offshore liquidity conditions, while a narrower basis indicates that offshore liquidity is relatively more ample. At this point, the 1 year USDJPY cross-currency basis is trading at its tightest since the summer of 2017, reducing the relative attractiveness of foreign accounts holding FX-hedged JGB exposures (Exhibit 10).

The reduction in this exposure may have no initial FX impact given the FX-hedged nature of the investments. The second order effects, though, are important, as reduced exposures could lead to a potential steepening of the JGB curve. A steeper JGB curve raises the incentive for Japan-based investors to keep funds at home, instead of investing in higher yielding foreign securities. For more detail on our JPY framework and why we no longer view the JPY as a funding currency, see: JPY: Impact of Bank Lending.

The neutral rate matters. Despite the Fed hiking rates 5 times since 2015, the USD will remain the globe's best funding currency. Buoyant financial conditions suggest that the Fed's gradual pace of rate hikes has not yet overtaken the market's perceived neutral rate of interest. The continued easing of financial conditions and the strong growth environment, it can be argued, suggest that the Fed may be behind the curve. Moreover, with soon-to-be Chair Powell taking the reins of the Fed in February, President Dudley planning to retire in mid-2018, and the three vacancies on the Board, markets may begin to question whether the FOMC's reaction function is set to change.

Forget the textbook. Textbook analysis would suggest that the estimated $1.5 trillion deficit expansion as part of the recently-passed tax reform bill, coupled with the limited degree of economic slack, should lead to higher US rates and a stronger USD. However, real yields remain at low levels by historical standards.

One way to explain this dynamic is that markets believe that there has been a structural shift in the mix between growth and inflation. However, another explanation could be a perceived shift in the Fed's reaction function, justifying real yields staying low.

Accommodative Fedspeak. FOMC participants have generally eschewed aggressive policy tightening, remaining instead in favor of a gradual normalization which keeps financial conditions from tightening prematurely. Indeed, despite the 5 rate hikes so far this cycle, financial conditions are at their loosest level since 2014 (Exhibit 13).

The most recent FOMC minutes support this thesis. However, some have also supported a looser regulation approach, most notably soon-to-be Chair Powell, whose comments during his testimony suggested an openness to regulatory reform.

Combining easy monetary policy with financial deregulation suggests that the velocity of money is poised to rise, which bodes well for USD liquidity conditions remaining ample. Other major central banks such as the ECB and the BoJ are also likely to gradually normalize their policy stances. This speaks in favor of the EUR and JPY against the USD as these areas remain investment destinations.

Explaining real yields. What drives real yields? Traditional academic research has suggested that factors such as demand deficiency, demography and aging societies, inequality, and poor total factor productivity are important, and these may explain the current low real yield environment within the DM world.

A recent BIS study has enriched this debate by claiming that the above factors may explain the evolution of DM real yields over the past 30 years, but they fail to explain real yield behaviors in eras preceding the 1980s. Instead, they argue, changes in central bank regimes may have had a bigger impact on the broader evolution of real yields. The current low real yield environment began in the early 1980s when DM central banks began adopting inflation-targeting regimes.

The effects of inflation targeting. Inflation targeting has been successful by maintaining price stability and providing stable funding conditions in the DM and EM alike, which has been an important foundation for EMs to develop income and wealth. Another implication, though, may have been an increase in liquidity preference (increased demand for cash and cash-like instruments) within DM economies which may also explain demand deficiency and, implicity, weak DM investment. This is because low and stable inflation reduces the costs of saving - compared to higher and less stable inflation, which may incentivize consumers to invest in other financial assets or consume.

Creating higher inflation expectations may reduce this liquidity preference, pushing these funds into circulation within the economy. The combination of Fed policy accommodation and financial deregulation may be sufficient to do so. A weaker USD in the FX market would be the side effect.

Bringing China into the equation. Prices tend to fall when supply exceeds demand. DM investment-to-GDP ratios have come down within the post-Lehman environment. However, what investors often miss is that the global investment-to-GDP ratio has been rising since the early 1990s, driven in large part by China (which currently has a 40% investment-to-GDP ratio). Exhibit 17 shows the relationship between the US 10-year yield with the global investment-to-GDP ratio. Yields declined as investment rose relative to GDP.

The fact that much of the investment took place in China, which has closed and regulated capital and financial accounts, may have helped global bond yields to stay low via two key channels. First, China's investment boom had largely been funded by local savings, meaning that little foreign capital was needed (which would have drawn capital away from DM bond markets). High household savings and an accommodative PBoC provided the sufficient liquidity. Second, the emphasis on investment provided a source of latent deflationary pressure, pushing inflation risk premia lower. This, in turn, bolstered the demand for liquidity, as inflation risks were low and stable, and in turn supported subsequent demand weakness.

In general, it is fairly unusual within a historical context to see a domestic investment boom without foreign funding contributing to it. Typically, investment booms and current account deficits (where investment exceeds domestic savings) should go hand in hand. When this is not the case, then funding costs tend to decline. Another example has been Japan's investment boom in the 1980s, which turned Japan into a country of low inflation even before the 1990s and beyond.

The concentration of investment in China, where local liquidity was sufficient to finance it, meant that global demand for capital did not rise, which allowed yields to stay low. Should China's investment boom be replaced by investment in other jurisdictions with open capital accounts, prices may still face disinflationary headwinds, but funding pressures would rise. The Fed, then, has an incentive to counter these disinflationary headwinds by keeping policy accommodative.

Still bullish on EM: The bearish USD story has been seen across the emerging market spectrum too. As risk appetite remains strong, investors will likely focus on vol-adjusted carry again to capture excess return. As seen in Exhibit 18, most of the high-yielding EMFX offers such value and we are bullish on most of these currencies.

We believe that rising global growth momentum, improving EM fundamentals and reasonable valuation in EMFX will prompt new inflows into EM in 2018." - source Morgan Stanley

Whereas Morgan Stanley believes a steeper JGB curve raises the incentive for Japan-based investors to keep funds at home, instead of investing in higher yielding foreign securities, we do not think Japanese investors have much alternative at the moment so the TINA trade will still make them buyers of the dip as mentioned above in our conversation. While we do expect some short term pull-back and US dollar strength in the near term, we do think that from our Iconic memory perspective more weakness lies ahead for the US dollar and given the positive macro momentum, equities wise, we would continue chasing EM over US equities from an allocation perspective. When it comes to credit, it is still "carry on" as we move again towards that famous 11 on the credit amplifier in true Spinal Tap fashion, basically more of the same, though as we pointed out we expect debt-fueled M&A to be a big theme in 2018 which will no doubt deliver some "sucker punches" along the way to the Investment Grade investing crowd, so, as we repeated in various conversations, dust up your LBO screener in 2018.

Yes 2018 has started with a bang with relentless tightening and equities indices racing even higher, the goldilocks environment is still alive and kicking, even if there are some genuine geopolitical concerns on the background. It is still pretty much "carry on". In our final chart below, for those still rooting for US High Yield, financial conditions in early 2018 still remain plentiful. Apart from a surge in inflation expectations that would warrant a faster tightening by the Fed in 2018, we do not see at the moment the catalyst for a sell-off unless of course our Iconic memory is playing with our thought process but we ramble again...

• Final charts - Credit Conditions in early 2018? Take it "easy"

As we pointed out, the goldilocks environment continues to be supportive thanks to low volatility in various asset classes. Credit conditions remain a key support for sensitive credit such as US High Yield, yet we do think after the significant rally of low beta in 2017 including the CCC bucket, one should start switching from quantity (yield) towards quality (up the rating spectrum). After all the US yield curve continues to bear flatten thanks as well to its Japanese support. Our final charts come from CITI Monday Morning Musings from the 5th of January entitled "Five Charts to Start 2018" and display comforting credit conditions:

"Comforting Credit Conditions

Commercial & Industrial (C&I) lending standards are the key reasons for being comfortable with the upcoming trend in business activity. Figure 9, which is key, illustrates the long-term relationship between the two and Figure 10 provides additional underlying detail. Essentially, easy money lowers the cost of capital and allows corporations to fund hiring plans, capex and working capital needs with C&I credit conditions providing a nine-month lead getting us well into 4Q18. As we have shown in the past, industrial production is very closely correlated with changes in net income.

- source CITI

While the US dollar has started 2018 with a hangover, we do expect a short term rebound in the near future though we remain bearish in the medium term. Meanwhile, no doubt to us, the central banking narrative is changing and it isn't only the Fed which has been retreating from QE, the ECB and even the BOJ are paring as well. Though your Iconic memory might be still playing tricks, you have been warned, the level of the strike on the central banking put is fading we think.

"There is no truth. There is only perception." -  Gustave Flaubert

Stay tuned !

Credit - The Golden Mean

"Extreme positions are not succeeded by moderate ones, but by contrary extreme positions." - Friedrich Nietzsche

Looking at the much vaunted 288 K NFP print in conjunction with the 6.1% and the continuation of the rally in risky asset prices, it means of course that the "hunt for yield" will intensify in true "Cantillon Effects" fashion. We were expecting the 5 year European CDS index for Investment Grade, the Itraxx Main to close around 50 bps at the end of June, with the index at 57 bps today, we were not that far off, rest assured the "japonification" process in the credit space will continue further.  For us"Cantillon effects" describe increasing asset prices (asset bubbles) coinciding with "exogenous" liquidity induced central bank money supply. 

When it comes to choosing this week's title, we were inspired by Gavyn Davies' take on the diverging views between Janet Yellen at the Fed and the BIS take in his post "Keynesian Yellen versus Wicksellian BIS" which we read with great interest:

"Let us start with a few similarities between them. There is agreement that financial crashes that trigger “balance sheet recessions” lead to deeper and longer recessions than occur in a normal business cycle. There is also agreement that inflation is not likely to re-appear any time soon, and that the current recovery should be used to strengthen the balance sheets of the financial sector through regulatory and macro-prudential policy. That, however, is where the agreement ends.

The roots of disagreement can be traced back to the causes of the GFC. The BIS views the crash as the culmination of successive economic cycles during which the central banks adopted an asymmetric policy stance, easing monetary policy substantially during downturns, while tightening only modestly during recoveries (ie the Greenspan and Bernanke “puts”).

On this view, monetary policy has been too easy on average, leading to a long term upward trend in debt and risky financial investments. The financial cycle, which extends over much longer periods than the usual business cycle in output and inflation, eventually peaked in 2008. But, even now, the BIS says that the central banks are attempting to validate the long term rise in debt and leverage, instead of allowing it to correct itself. Excessive debt, it contends, is preventing the rise in capital investment needed for a healthy recovery. Financial and household balance sheets need to be repaired (ie debt needs to be reduced) before this can take place.

In contrast, the mainstream central bank view denies that monetary policy has been biased towards accommodation over the long term. Ms Yellen’s speech claims that higher interest rates in the mid 2000s would have done little to prevent the housing and financial bubble from developing. She certainly admits that mistakes were made, but they were in the regulatory sphere, where there was insufficient understanding of the new financial instruments that would eventually exacerbate the effects of the housing crash. Higher interest rates, she says, would have led to much worse unemployment, without doing much to reduce leverage and dangerous financial innovation." - source FT - Gavyn Davies

Our chosen title the Golden Mean reflects the great Aristotelian philosophical difference between both the Fed and the BIS given that, in philosophy, the 'golden mean' is the desirable middle between two extremes, one of excess and the other of deficiency. Whereas the Keynesian Fed is arguably one of excess (liquidity and ZIRP triggering "Cantillon Effects" aka bubbles), the other, the BIS, could be argued as one of deficiency (lack of sound financial regulation in the first place) but we ramble again.

A good illustration of this philosophical argument and Janet Yellen's perspective comes from Bank of America Merrill Lynch's Thundering Word note from the 2nd of July entitled "I'm so bullish, I'm bearish":

"Is the Fed Losing the Dot?

The Fed’s “print & regulate” mantra has boosted Wall St not Main St (Chart 1); the longer it takes for growth and rates to normalize, the greater the risk of speculative credit excesses (and a policy response to curb speculation). Our base case remains higher growth/yields/$. Bank lending; small business confidence hint at H2 macro; rate normalization. If so, expect an autumn correction in risk assets (hence “I’m so bullish, I’m bearish”). Either way, volatility will rise." - source Bank of America Merrill Lynch

What is truly interesting, we think, is the analogy that can be made from a financial markets perspective with the Eastern philosophy's take on the "Golden Mean". Thiruvalluvar, the celebrated Tamil poet and philosopher wrote in his Tirukkural of the Sangnam period of Tamizhagam about the "middle state" (the Golden Mean) which is to preserve equity. He emphasises this principle and suggests that the two ways of preserving equity is to be impartial and avoid excess.

Credit bubbles generated by ZIRP will not preserve equity, rest assured.

From our Wicksellian penchant, we would therefore argue that when it comes to the Fed's record, the Fed has repeatedly failed in being "impartial" and in "avoiding excesses" which led to one the biggest equity wipe-out in 2008 the world has ever known. We will therefore discuss in this conversation the slack in the unemployment since the great "reflation" trade and the materialisation of our past concerns justifying the tapering stance of the Fed.

Like the preeminent medieval Spanish, Sephardic Jewish philosopher Maimonides said:

"If a man finds that his nature tends or is disposed to one of these extremes..., he should turn back and improve, so as to walk in the way of good people, which is the right way. The right way is the mean in each group of dispositions common to humanity; namely, that disposition which is equally distant from the two extremes in its class, not being nearer to the one than to the other."

Of course given the rising "inequalities" given the "extreme" reflating policies followed by the Fed, no wonder that the "Golden Mean" has been broken favoring Wall-Street in the Process versus Main Street. Using Maimonides "philosophical take, the Fed has indeed been nearer a "class" rather than equally distant we think, with Wall Street and the owners of capital booming while Main Street and the workers struggling:

- source Bank of America Merrill Lynch, June 2014 - The Thundering Word.

Another illustration of the divergence between Wall Street and Main Street and how broken the "Golden Mean" is can be seen in the significant fall in the US Labor Participation rate compared to previous "recoveries" following US recessions as per the below Bloomberg graph:

We have long argued that the Fed is continuing on a "wrong" path and ignoring basic relationship such as Okun's law and the prolonged negative effects of ZIRP on the labor force (capital being mis-priced, it is mis-allocated to speculative purposes rather than productive purposes):

"In economics, Okun's law (named after Arthur Melvin Okun, who proposed the relationship in 1962.is an empirically observed relationship relating unemployment to losses in a country's production. The "gap version" states that for every 1% increase in the unemployment rate, a country's GDP will be roughly an additional 2% lower than its potential GDP." - source Wikipedia

In our conversation "The Last refuge of a scoundrel" back in September 2013 we argued the following:

"To that effect we wanted to illustrate more clearly this week the "Cantillon effect" of Bullard's effective way to conduct monetary "stabilization" policy, so, we plotted on Bloomberg not only the rise of the Fed's Balance sheet, but also the rise of the S&P 500, buybacks and of course the fall in the US labor participation rate (inversely plotted) - source Bloomberg (chart updated as of 7th of July 2014):

In red: the Fed's balance sheet

In dark blue: the S&P 500
In light blue: S&P 500 buybacks
In purple: NYSE Margin debt
In green: inverse US labor participation rate.

We think this graph clearly illustrates the Fed's conundrum in the sense that with the Fed's dual mandate of promoting "maximum employment" since 1978, it cannot promote both employment and sustain the "wealth effect" through capital growth with ZIRP. The Fed tried to increase jobs by lowering interest rates, weakening the dollar in the process, boosting exports but exporting inflation on a global scale, as well as lifting stock prices, playing on the wealth effect game.

Something will have to give.

ZIRP, we think is the main culprit."

We also added at the time:

"If capital cannot be re-allocated to "productive" endeavors, enabling companies to focus their resources on their core business, how can labor thrive in such a ZIRP environment? Please feel free to explain us how."

Of course companies have been focusing more on the wealth effect game leading to record stock prices and record buybacks as one can see from the performance of stock prices from companies which have boosted their stock prices through buybacks - graph source Bloomberg:

The performance of the US stock market has been artificially "boosted" by "de-equitization", namely the reduction of the number of shares courtesy of buybacks thanks to increase leverage, leading the "Golden Mean" to be even further damaged by the Fed's extreme reflating policy. 

When it comes to US unemployment figure at 6.1% and the latest NFP of 288 K we would like to re-iterate what we said in our conversation "Goodhart's law" in June 2013:

"When a measure becomes a target, it ceases to be a good measure." - Charles Goodhart

Conducing monetary policy based on an unemployment target is, no doubt, an application of the aforementioned Goodhart law. Therefore, when unemployment becomes a target for the Fed, we could argue that it ceases to be a good measure. - Macronomics

In the same conversation, we argued:

"We think that QE is not the core issue but ZIRP, which is in effect preventing creative destruction in a Schumpeter fashion and delaying much needed adjustments such as the ones needed from the European banking sector."

No wonder investing in European banks shares have been less profitable than investing in financial bonds from the European sector. In the deleveraging and credit "japonification", we expected financial credit to outperform. While the ECB has so far delayed deploying a QE buying spree in true Japanese fashion, no wonder investors have been more skeptical about the industry and its share prices as described by Bloomberg:

"European bank valuations show investors’ are skeptical about the industry.

Lenders in the Stoxx Europe 600 Index are trading near their lowest valuation in a year versus banks in developed economies worldwide, as the CHART OF THE DAY highlights. After reaching a seven-month high in January, the European group’s price-to-earnings ratio lost 5 percent to 47.55, compared with a 2 percent increase for lenders in the MSCI World Index.

While the European Central Bank introduced a negative deposit rate and announced targeted loans to stimulate lending last month, it held off on a securities-purchasing program. For European banks to rally, investors need to see the ECB buying assets, which it probably won’t do until after giving current policies more time, said Ian Richards of Exane BNP Paribas.

“It’s too early to be buying aggressively on the prospect of a euro-zone recovery,” Richards, the head of equity strategy in London, said by phone. “The prospect of supporting material credit growth and better earnings revisions in the banking sector is further down the line than the market had hoped.” U.S. regulatory probes and penalties that have slammed some European lenders are adding to concerns. Barclays Plc tumbled 14 percent in June, the most since May 2012, as New York’s attorney general said the bank lied to customers and masked how much high-frequency traders were buying and selling in its LX dark pool. BNP Paribas SA and Credit Suisse Group AG posted their worst quarterly performances in two years after being fined for U.S. sanctions violations and to help Americans evade taxes, respectively. “These one-offs in conduct issues keep on coming back and haunting the sector,” Richards said." - source Bloomberg

For us a bank is a second derivative of an economy. No growth, no stock performance.

When it comes to our contrarian take on US yields since early January 2014 we argued the following in our conversation "Supervaluationism" back in May this year:

"We recently pointed out the strength of the performance of US long bonds as well as the "Great Rotation" from Institutional Investors to Private Clients". As posited by Cam Hui on his blog "Humble Student of the Markets", the "great rotation" has indeed been triggered somewhat by defined benefit pension funds locking in their profits. One of the chief reason therefore behind this rotation has been coming from US Corporate pensions, as indicated by Gertrude Chavez-Dreyfuss and Richard Leong in Reuters in their article from the 24th of April entitled "US Corporate pensions bet on bonds even as prices seen falling":

"Major U.S. companies including Clorox and Kraft are favoring more bonds in the mix for their employees' defined benefit pension plans, even amid signs the three-decade bull run in bonds is on its last legs.

The $2.5 trillion U.S. corporate pension market enjoyed a robust recovery in 2013, paced by stocks, as the Standard & Poor's 500 Index rose the most since 1997. That helped pension funds close a funding hole that opened after the global credit crisis of 2008, so that the average corporate pension was funded at about 95 percent at the end of 2013, compared with 75 percent at the end of 2012, Mercer Investments data show.

Now that they're more confident that they have the money to meet their pension obligations, corporate pension managers are pulling back from the perceived risk of the stock market and buying U.S. government and corporate bonds, even though many expect bond prices to fall in coming years.

"Even if interest rates rise more than the market predicts, you do get the income component that offsets the price loss of those bonds," said Gary Veerman, managing director of U.S. Client Solutions Group at BlackRock in New York, which has $4.4 trillion under management, of which two-thirds are retirement-related assets. Veerman's group advises corporate treasurers how to manage their pensions.

The allocation to bonds by the top 100 publicly-listed U.S. companies in their defined benefit pension plans increased to a median of 39.6 percent in 2013 from 35.9 percent in 2010. Stock allocation in the plans fell to 40.9 percent in 2013 from 44.6 percent in 2010, according to global consulting firm Milliman." 

"Now they're in a position to say: 'I don't need all those equities because my funding status is in the mid- to low-90s,'" said Dan Tremblay, director of institutional fixed-income solutions at Fidelity unit Pyramis in Merrimack, New Hampshire, which manages more than $200 billion.

To further illustrate the "pension fund" effect and the increase in duration risk with the "great rotation" in 2014 from equities to bonds please find below the iBoxx U.S. Pension Index up 11% YTD which "validates" our previous take on the subject - graph source Bloomberg:

The chart tracks the iBoxx U.S. Pension Index, designed to mirror the performance of a typical plan with defined benefits.

What our "wealth effect" planners at the Fed should take into account is that rising stock prices may do relatively little to bolster the finances of corporate pension funds. Bonds matter because increases in projected distributions put even more pressure on yield hunting leading to an increase in duration risk exposure and high yield exposure. Volatility in funds’ asset value and relatively low interest rates have made managing pensions increasingly difficult for corporate managers, one of the solution they have found is shifting into bonds and away from stocks. Of course if the "magicians" at the Fed had respected the "Golden Mean" and prevented past and present excesses, funding gaps and overall pension pressures would have been avoided in the first place, but we are ranting again...

As a reminder from our conversation "Goodhart's law" in June 2013:

As indicated by CreditSights in their 29th of May 2013 Asset Allocation Trends - 2012 Pension Review:

"Key among the prevailing market realities in the post-financial crisis environment has been the extended period Quantitative Easing and the continuation of the Fed's prevailing zero interest rate policy and in the latest year's plan asset allocation data there was evidence of the effect this was having. As noted above, historically low interest rates have not only inflated the calculated liabilities of pension plans via the downward pressure on interest rates, they have also deflated assumed plan asset return rates as fixed income has increased as a percentage of plan assets." - source CreditSights.

So much for the great rotation, given, as indicated in the same report from CreditSights:

"One of the notable observations from our data analysis was that there was very little change in the allocation across the plans vs. the prior year. The median allocation to equity fell only marginally (from 50.8% to 50.0%) and the allocation to fixed income, rather than increasing, fell from 37.0% to 36.4%. This suggests that the trend towards Liability Driven Investment has slowed. While this, at least in part, likely reflects that the shifts made over the last seven years have better aligned many plans with their desired allocations, it also is undoubtedly influenced by the interest rate environment. Historically low interest rates across the full maturity spectrum make it an inopportune time to be increasing the allocation to fixed income assets (or to be increasing the duration of those assets in the portfolio!) " - source CreditSights.

Hence the reason of our Wicksellian stance relating to the distortion created by ZIRP, because of the increasing duration risk which has to be taken by players such as pension funds!

Moving on to the justification of the tapering of the Fed, we reminder ourselves of some of our previous observations:

First observation from our good credit friend in 2013 from our conversation "Simpson's paradox" as the Fed tries to re-establish somewhat the "Golden Mean":

"There have been a lot of talks recently about the FED decision to possibly reduce its liquidity injection at the end of the summer. Some market participants still think the FED will not taper as the economy is not yet on a very strong footing, and because the various thresholds announced by B. Bernanke (unemployment level, inflation,…) are still far from being reached. These arguments are undeniably right and strong, but one must consider other information prior to declare the “tapper” off.

First of all, B. Bernanke has explicitly announced that the FED will not look at economic data over the next few months, but rather at the trend which has developed.

Second, and more importantly, the FED currently owns about 33% of the outstanding US Federal debt. As funding needs of the US Treasury are diminishing following the sequester, there is less issuance and the FED ownership of bonds in percentage is rising quicker. Should the Central Bank continue buying the same amounts of bonds, it will own 40% of the outstanding in 2014, then north of 50% in 2015. The subsequent volatility on the interest rate market will increase drastically as the liquidity of the bond market disappears, and the currency could debase very quickly, creating a new crisis.

Third, and also a cause of concern, the bond market repo activity is facing an increasing number of failures (fails to deliver are on the rise exponentially) due to the large FED holding, which has ripple effect on the overall bond market activity. 

Fourth, and finally, economic growth in a society based on consumption requires credit. In order for credit to grow, or in other words banks to lend, collateral must be available. Since the 2007-2008 financial crisis, high quality collateral has slowly but surely become less available. If Central Banks continue to buy various government bonds (and US Treasuries are among those bonds), the available collateral will trend lower and the economy will stall, or worst spiral down as a credit crunch will occur at some point. So the FED has no other choice than to slow and even stop its QE if it wants the game to go on.

To resume, the FED may have more incentive to tapper and even stop its QE over time than to continue it, even if the economy slows down and some asset prices move lower. Apparently, it is the price to pay if one wants to avoid bigger problems in the future. The only remaining question is the following : “Is it the right time to do the tapper, or did the CB already crossed an invisible dangerous line?”  The way asset prices will behave and re-price in the coming weeks/months will give us the answer (nice retreat or collapse)."

One of the most important point validating our good credit friend's take on the tapering necessity and repo can be ascertained from Liza Capo McCormick article in Bloomberg on the 7th of July entitled "Bond Anxiety in $1.6 Trillion Repo Market as Failures Soar":

"In the relative calm that is the market for U.S. Treasuries, a sense of unease over a vital cog in the financial system’s plumbing is beginning to rise.

The Federal Reserve’s bond purchases combined with demand from banks to meet tightened regulatory requirements is making it harder for traders to easily borrow and lend certain desired securities in the $1.6 trillion-a-day market for repurchase agreements. That’s causing such trades to go uncompleted at some of the highest rates since the financial crisis.

Disruptions in so-called repos, which Wall Street’s biggest banks rely on for their day-to-day financing needs, are another unintended consequence of extraordinary central-bank policies that pulled the economy out of the worst financial crisis since the Great Depression. They also belie the stability projected by bond yields at about record lows.

“You have a little bit of a perfect storm here,” said Stanley Sun, a New York-based interest-rate strategist at Nomura Holdings Inc., one of the 22 primary dealers that bid at Treasury auctions, in a telephone interview June 30.

A smoothly functioning repo market is vital to the health of markets. The fall of Bear Stearns Cos., which was taken over by JPMorgan Chase & Co. in 2008 after an emergency bailout orchestrated by the Fed, and collapse of Lehman Brothers Holdings Inc., whose bankruptcy in September of that year plunged markets into a crisis, was hastened after they lost access to such financing." - source Bloomberg

Remember financial crisis are always triggered by liquidity crisis. From the same article:

"Liquidity Issues

“The effect of all the collateral issues we see now is an indication of not so much how things are, but how bad things will be when you really need liquidity,” said Jeffrey Snider, chief investment strategist at West Palm Beach, Florida-based Alhambra Investment Partners LLC, in a telephone interview June 30. “That’s when you get into potentially dire situations.”

The conditions for repo stress were on display last month. The 2.5 percent note due in May 2024 reached negative 3 percentage points in repo in the days preceding a June 11 Treasury auction of $21 billion in notes to finance government operations.

Dealer Constraints

Repo rates have been most prone to go negative, a situation known as specials in the market, in the days preceding an auction as traders who previously sold the debt seek to buy the securities to cover those positions.

In this week’s note and bond sales, the U.S. plans to auction $27 billion of three-year Treasuries tomorrow, $21 billion of 10-year debt on July 9 and $13 billion of 30-year securities July 10.

Signs of dysfunction are coming at a sensitive time for markets. The Fed is paring its stimulus and futures show traders expect the central bank may start raising interest rates in the middle of next year.

The concern is that dealers, which have pared inventories to meet more-stringent capital requirements required by the 2010 Dodd-Frank Act mandated by the Volcker Rule and Basel III, won’t have as much capacity to handle any surge in volumes or volatility.

Securities Industry and Financial Markets Association data show the average daily trading volume in Treasuries has fallen to $504 billion this year from $570 billion in 2007, even though the amount outstanding has risen to more than $12 trillion from $4.34 trillion.

Available Securities

Bank of America Merrill Lynch’s MOVE Index, a measure of expectations for swings in bond yields based on volatility in over-the-counter options on Treasuries maturing in two to 30 years, reached 52.7 percent on June 30, almost a record low.

The Fed is partly to blame. Through its policy of quantitative easing, it now owns about 20 percent of all Treasuries, or $2.39 trillion. Banks hold $547 billion of Treasury and agency-related debt.

In addition, the Fed’s holdings have shifted in ways that leave fewer central-bank-owned Treasuries available to be borrowed. The shifts were caused by Operation Twist during the November 2011 to December 2012 period when the Fed sold shorter-dated Treasuries and bought more bonds, plus self-imposed central-bank restrictions on holdings of specific maturities.

Stimulus Withdrawal

The Fed’s lack of certain holdings “appears to be driving the surge in fails, which has been concentrated in the on-the-run five- and 10-year notes,” Joe Abate, a money-market strategist in New York at primary dealer Barclays Plc, wrote in a note to clients on June 27. On-the-run refers to the most recently issued Treasuries of a specific maturity.

While the Fed has sought to cut risk in the repo market since the crisis, it still sees the chance that rapid sales of securities, known as fire sales, could disrupt the financial system. Fails reached a record $2.7 trillion in October 2008.

Repos are also important to the Fed because it has been testing a program in the market that is seen as a potential tool to withdraw some of its unprecedented monetary stimulus.

Eric Pajonk, a spokesman at the New York Fed, decline to comment on the Fed’s reaction to the movements in recent weeks in the repo market.

The amount of securities financed daily in the tri-party repo market has declined 18 percent an average $1.60 trillion May, from $1.96 trillion in December 2012, data compiled by the Fed show. In a tri-party agreement, one of two clearing banks functions as the agent for the transaction and holds the security as collateral. JPMorgan Chase & Co. and Bank of New York Mellon Corp. serve as the industry’s clearing banks.

 Supply Falls

Another difficulty in the repo market has been the decline in Treasury bill supply, with the U.S. having sold $264 billion fewer short-term bills in the April-through-June period than those that matured, according to John Canavan, a fixed-income strategist at Stone & McCarthy Research Associates in Princeton, New Jersey.

“The repo market itself provides lubricant to the entire Treasury market,” Canavan said in a July 3 telephone interview. “Bills are a key lubricant to the repo market, and the supply of bills has fallen sharply. If this situation were to continue longer-term, it would be a more substantial problem.”"  - source Bloomberg.

Second observation from our 2012 conversation "Zemblanity" (The inexorable discovery of what we don't want to know"): 

"In similar fashion to the current Japanese plight, the Fed will eventually discover soon that company debt sales will counter its bond buying plan"

As a reminder, back in January 2012 in our conversation "Bayesian thoughts" we quoted Dr. Constantin Gurdgiev, from his post entitled "Great Moderation or Great Delusion":

"when investors "infer the persistence of low volatility from empirical evidence" (in other words when knowledge is imperfect and there is a probabilistic scenario under which the moderation can be permanent, then "Bayesian learning can deliver a strong rise in asset prices by up to 80%. Moreover, the end of the low volatility period leads to a strong and sudden crash in prices."

So enjoy the final melt-up because if the Fed had indeed respected the "Golden Mean" there would not be greater risk of overshooting mean reversion on the way down. Of course timing is everything, but it looks to us we are indeed in the final innings of the great reflation trade.

On a final note in our previous conversation we voiced our concerns on the impact of the velocity of rising oil prices and their ability in triggering recessions, seeing US gasoline in at a 6 year high on Iraq, is,  requires close monitoring we think as it is a cause for concern - graph source Bloomberg:

"U.S. drivers will pay the most for gasoline over the July 4 holiday weekend in six years after the conflict in Iraq boosted crude oil last month, preventing the typical June decline in pump prices.

The CHART OF THE DAY shows how gasoline at $3.67 a gallon is the highest for this time of year since 2008. Retail prices rose 0.3 cent in June, compared with an average drop of 20.8 cents during the month in the past three years. While prices have slipped in the past five days, they probably won’t fall much more before the weekend as almost 35 million people hit the road, according to AAA.

“I’m not expecting any big changes,” Michael Green, a spokesman for Heathrow, Florida-based AAA, the biggest U.S. motoring organization, said by telephone from Washington. “We might see a drop of a few tenths of a cent.”

Regular gasoline in the U.S. costs 19.2 cents a gallon more than a year ago, dragged up by oil prices that jumped last month as fighting in Iraq threatened to cut off supplies from OPEC’s second-largest producer. International benchmark Brent crude rose $2.95 a barrel in June, and settled at $111.24 a barrel

on the 3rd of July.

The increase came just as the most people since 2007 made plans to travel over the July 4 holiday. About 34.8 million people will drive 50 miles or more from home during the five days ending July 6, up from 34.1 million last year, AAA estimates.

“Last year, prices peaked around March, and now they’ve peaked basically in June,” Sean Hill, petroleum economist for the Energy Information Administration, the Energy Department’s statistical arm, said by telephone from Washington. “This is all a function of what crude oil has done because of the Middle

East.”" - source Bloomberg

"The extreme limit of wisdom, that's what the public calls madness." - Jean Cocteau

Stay tuned!