And you thought JP Morgan was aggressive. Goldman just threw out the last trump card in its current sell-side arsenal by increasing Q4 GDP estimates from 4% to a paroxysmal attack inducing 5.8%. While Zero Hedge long ago gave up discussing corporate fundamentals due to our long-held tenet that currently the only relevant pieces of financial information are contained in the Fed's H.4.1, H.3 statements, and, when Ron Paul's attempt at Fed deobfuscation is finally successful, the Fed's daily Sources and Uses of Funds statement, it would appear even macro economic data now is essentially one big joke. We are confident that JPM and Goldman are right on the money, and that the government will present the economy as having grown by nearly 6% in Q4. What is troubling is that after having taken over the housing and treasury market, and according to some others, the equity market as well, the Treserve (thank you Marla) has also singlehandedly added several log scale orders of magnitude of volatility to the general economy itself. Too bad GETCO does not have some predatory algo floating around, and overextending GDP momentum in any one general direction, as at this rate we would not be in the least surprised if Obama's Disinformation Czar (TBD) were to announce that the US is now competing for 10% GDP growth with China. As the two countries' centrally-planned economic systems now differ, well, not at all, it is only a matter of time before the race to the bottom in currency devaluation is enjoined by a competition as to who can fabricate, manipulate, inflate, stimulate and other "-ates", the fastest.
Back to Goldman and Jan Hatzius' latest "Q&A on Housing Policies in 2010." As housing will be the wildcard that determines the outlook of the economy in the next 12 months, we read this particular report with great interest to get the reverse psychological recommendations that Goldman's prop desk will not be pursuing.
First, Goldman discusses the most pertinent topic currently of whether the Fed will indeed end MBS Q.E. on schedule. The conclusion is a definite maybe.
Q: Will the Fed end its asset purchases on schedule? It seems likely that the Fed will end its program to purchase $1.25 trillion in agency MBS on schedule at the end of March. However, there is clearly some uncertainty, related to three issues: first, the minutes of the last two FOMC meetings indicate that several committee members support extending the MBS purchase program. Second, our expectation is that growth will weaken again over the course of 2010. Renewed growth concerns could add support for an extension. Third, the Fed will accumulate interest income and is likely to see significant prepayments on its MBS holdings. The latter implies that some additional purchases would be necessary simply to maintain the level of assets on the Fed?s balance sheet. The issue of whether to reinvest the proceeds is likely to be on the agenda in upcoming FOMC meetings.
A logical corollary, and a topic that is troubling Goldman's competitor Morgan Stanley (whose analysis about the need to "unearth" a massive incremental buyer of fixed income securities in 2010 is precisely what this Goldman piece is a response to) much more than it seems to concern Mr. Hatzius, is what happens to conforming MBS spreads. Amusingly, Goldman also takes a stab at Sprott, and the mysterious "household" buyer category of securities. However, unlike Sprott who looks at "households" from the perspective of a securities' buyer, Goldman analyzes them from the supply side.
Q: What will happen to the conforming mortgage spread if asset purchases end? It seems likely to widen, but not that substantially. Along with Treasury and the GSEs, the Fed?s purchases absorbed a net average of $100 billion per month in 2009 (Exhibit 1). By the time the program ends in March, combined MBS purchases will have taken $1.55 trillion of MBS out of the market. Broker dealers, ?households? (this includes hedge funds and other nonspecific entities), and foreign holders were the main sellers.
Over the same period, total agency MBS outstanding, including GNMA securities, increased by only $600 billion. The result is a $1 trillion decline in agency MBS in private hands, along with a $200 billion decline in outstanding non-agency mortgage debt. There is no reason to expect any greater supply of agency MBS in 2010; it is more likely to be lower, given what was probably peak refinancing volume in the first half of 2009, a potential decrease in first time homebuyers, and increasing foreclosures.
As for the conforming mortgage spread, which as the chart below demonstrates is at what is likely an all time tight, Goldman says don't worry about that either. Some widening is expected by nothing that should keep you awake at night.
In October we estimated that Fed purchases may have narrowed the conforming mortgage spread by 30 bps. This still looks accurate, but the spread has tightened even further since then despite the upcoming end to purchases (Exhibit 2). The most recent move was probably driven in part by the strengthened financial support for the GSEs, discussed below.
So if indeed the Fed is stuck without an option to extend Q.E. directly, and the ability to funnel money straight from Bernanke's printer to purchase a low mortgage yield (not as difficult as it sounds), who will be the next artificial buyer of GSE MBS to continue the game of extend and pretend? Well, courtesy of the administration's recent move to basically let the GSE's do whatever they want as everyone now realizes they will be the next AIG-like financial black hole sooner or later, regardless of regulatory intervention, it appears that the GSEs themselves will soon be primed.
Q: What can the GSEs do to keep rates down? The most obvious approach would be for the agencies to add to the $1.5 trillion in mortgages and mortgage-backed securities that they collectively hold in their portfolios. As shown in Exhibit 1 above, the GSEs have not been large buyers of MBS over the last year, accumulating roughly $100 billion. This is largely because when the Treasury put the GSEs under conservatorship, it required them to reduce their portfolios by roughly $150 billion below year-end 2009 levels by the end of 2010.
In December, the Treasury amended this agreement, effectively raising the portfolio cap to $110 billion above current levels, or $260 billion above where it otherwise would have been (Exhibit 4). This is a relatively small amount, equivalent to roughly one month?s worth of Fed/Treasury purchases in 2009. It is also worth noting that the last time the portfolio limit was increased, it had little effect. In May of 2009, the Treasury increased the cap on the GSE portfolios by a combined $100 billion, but this resulted in little GSE net buying. In fact, the agencies? retained portfolios began to shrink soon after.
That said, the agencies will still have some flexibility to influence rates. The cap on portfolio size applies only at year end. During the year, the GSEs are limited only by the cap on outstanding debt, which is set at 120% of their portfolio cap, or roughly $2 trillion in 2010. However, this expansion would necessarily be temporary, since the agreement requires that the retained portfolio be reduced to $1.6 trillion by calendar year end.
And another sleight of hand the government can pull to put some more lipstick on a rapidly amortizing pig:
In light of substantial federal support, regulators could also reduce the risk weighting on agency debt and MBS, from 20% to 10%, thereby reducing the capital banks must hold against agency securities versus other assets. This was proposed in late 2008 but never finalized. If the conforming spread widens significantly in response to the end of Fed purchases, this proposal might be revived as a means of increasing demand for MBS. Indeed, the linkage between the Treasury and the GSEs is much stronger now than it was when this was last contemplated.
As for end-demand, it looks like the March cliff is really going to hurt, as Goldman envisions no new stimulus in the form of homebuyer tax credit:
Q. What will become of the homebuyer credit? The homebuyer tax credit appears to have had a stronger effect on home sales than we previously estimated, due to a revision in survey data from the National Association of Realtors (NAR), and may have added as much as 400,000 units of first time demand in 2009. However, now that the credit has been extended through April, there is little discussion of a further extension.3 Given the debate over additional stimulus, as well as the upcoming election, we can?t entirely rule out another extension, but even the provision?s most ardent supporters for now concede it is likely to end on schedule.
Yet the main observations in the piece revolve around the projected Q4 GDP boost, the ongoing increase in the unemployment rate (if Goldman is right and unemployment indeed trickles down without a "green shoot" moment before 2011, the Democrats can kiss the mid-term elections goodbye), inflation (fear not, all shall be well there), and whether or not Treasury rates will do what Morgan Stanley expects them to do (hit 5.5%) - Goldman firmly believes this is not the case, precisely for the same reason why Japan's rates are where they are.
On the GDP front, the problem as even Goldman acknowledges, is all stimulus driven. Look for more stimulus-hyperventilation out of Krugman soon.
1. Recovery in 2010 is apt to be slow after a large, inventory-driven, fourth-quarter surge. The 5.8% annualized increase we now estimate for real GDP in the fourth quarter would boost the average growth rate for the second half of 2009 to 4%. We reckon that fiscal stimulus (including its multiplier effects) and inventory stabilization accounted for all of this growth, on balance; by the second half of 2010 these supports will have dissipated. Meanwhile, the US economy faces several structural headwinds. Among them: (a) efforts by households to boost saving out of current income, aggravated by (b) weakness in labor income, reflecting the impact of high unemployment on wages and employers? reluctance to rehire aggressively, (c) fiscal drag from the state and local sector, (d) large overhangs of vacant homes and unused industrial capacity, which limit the potential for major improvements in private-sector investment, and (e) limited credit availability from a financial sector that is still on the mend. As a result, we expect growth to slow gradually to an annual rate of 1½% in the second half of 2010 before reaccelerating in 2011.
A sugar high indeed. And a high that is about to slam into a wall of governmental denial. Rosenberg could not be more correct. Yet who says the government can not print in perpetuity? So far buyers for hundreds of billions have materialized - what would change this. This is indeed the $64k question.
This will be aggravated by the ongoing "jobless recovery." Then again if Jim Cramer is correct, the more unemployment, the better for the economy and stocks, so buy, buy, buy... Geodon indeed.
2. The unemployment rate should continue to drift up, to about 10¾% by early 2011. We think the ?jobless recovery? pattern of the 1991-92 and 2001-03 recoveries provides a better template for corporate hiring decisions over the next year or two than the more robust payroll rebounds of earlier cycles, and so far the payroll data support this judgment. If this pattern continues, then net hiring will not absorb all of the influx into the labor force that is apt to occur over the next year and a half, in which case the cyclical peak in unemployment will again lag far behind the
mid-2009 bottom in real GDP.
On the inflation front, even with hyperinflation in the marijuana market due to supply-side problems in Cali, Goldman is convinced all is good, gold bugs be damned.
3. Inflation is not a significant threat, at least for the next few years. Although highly expansionary fiscal and monetary policies have caused many market participants to worry about inflation, these concerns miss the point that the policies have been undertaken to combat a large and growing gap between actual and potential output. Under any reasonable economic scenario, the aggregate US output gap is huge?- currently about 8% of GDP-?and thus will require years of above-trend growth to eliminate. Given this prospect, we expect inflation in the core consumer price indexes to trend down further from their year-end levels (1.8% in December for the CPI, 1.3% in November for the PCE index).
And with low inflation comes little risk of near-term tightening. This we agree with - look for Fed Fund futures to increasingly get reacquainted with gravity.
4. Monetary tightening is highly unlikely before the end of 2010, and we do not expect it in 2011 either. The outlook for Fed policy hinges on how strong the incipient recovery will be, and what the strength of that recovery means for inflation. We think most members of the Federal Open Market Committee (FOMC) will be reluctant to raise the funds rate target-?even from its near-zero current setting?-until they have some confidence that the unemployment rate has reached its cyclical peak or will do so shortly. This is especially true if our outlook for further disinflation is right. Accordingly, we see the FOMC?s strong commitment to low interest rates as reiterated in its most recent policy statement and in officials? speeches as consistent with our outlook for stability in the funds rate through year-end 2011.
And the best for last: Goldman sees the 10 Year going back down to 3% in the next few months, diametrically opposite of where Morgan Stanley's duo of Cashin and Caron expect the curve hump to go. We believe Goldman's primary assumption that the increasing household savings rate will be sufficient to boost demand is flawed, for the same reasons which Dylan Grice highlighted will precipitate a demographic shock and force the transition in Japanese internal demand from a secular end-buyer to a net seller of JGBs. To expect the ageing US population and the ever-older babyboomers to continue to gobble up USTs with the same fervor with which they used to buy equities is near-sighted. Increasingly more educated babyboomers (all the free time they have courtesy of unemployment is presumably spent reading various increasingly more skeptical media outlets) are all too aware that buying a 10 Year at 3% or a 30 Year at 4.5% will certainly be a disastrous proposition in the mid- to long-run. Goldman's bet on the stupidity of America's population may finally backfire.
5. Treasury yields should come down. The Treasury curve still builds in too much Fed tightening next year. We expect 10-year note yields to slide back toward 3% over the next few months as final demand remains sluggish and disinflation continues. We also remain convinced that the increase in Treasury supply is less important for bond yields than many investors believe, for two reasons. First, increased saving by households and businesses creates a potential demand for Treasury securities as well as less competition for lenders? funds; flow of funds data and bank balance sheet reports confirm that the domestic private sector is increasing its allocation to Treasury securities. Second, the Treasury?s auction schedule for coupon securities is now more than adequate to meet funding needs over the next few years; as this becomes evident, concerns about further increases in auction sizes should abate.
As always, readers are cautioned to accept Goldman's interpretation of the economy with a mountain of salt. If there is one entity that benefits more than anyone from continuing cruising along the status quo, it is Goldman Sachs. Which is why this report could have as easily been titled "Why nothing will change." Alas, we think that on this assumption Goldman is wrong. There are market aspects Goldman's massive economy of scale can push simply by its involvement; however, there are those which even it falls short. The inexorable demographic shift, the increasingly weary upper middle class, the skepticism with which the population perceives attempts to fix the economy which only end up benefit the likes of Goldman, and an overall belief that AAA-rated Uncle Sam-issued pieces of paper are the traditional store of value are just some of these.