Introduction

Every week I try to take noteworthy events and provide accessible commentary regarding the potential impacts of these events and my own personal interpretation. These comments are not necessarily the viewpoint of Newfound Research and solely represent my own personal perspective.

Week Ending: May 3rd, 2013

One market phenomenon certainly worth keeping an eye on is investor expectations of inflation. Since the initial announcement of Quantitative Easing in 2008, one of the main criticisms has been the resulting high inflation that would ensue from the injections of liquidity into the market. However, a brief glance at the chart below and it's clear that inflationary expectations, even for the long term, are pretty subdued.

Inflation Expectations-01

The chart also effectively illustrates that persistent declines in inflationary expectations have been followed by Federal Reserve promises for massive asset purchases, to avoid a deflationary spiral. Seeing as this indicator has continued to decline for several months, it should come as no surprise that the Fed is keeping their options open through all encompassing statements to "either increase or decrease purchases." (see 2nd bullet point below).

Noteworthy Reads / Events of the Week

  • Euro area unemployment increased from 12% to 12.1% The increased unemployment is exacerbated by still worse youth unemployment statistics, which climbed to 24% for the region.
  • On Wednesday, the Federal Reserve promised to continue buying $40BB in MBS and $45BB in U.S. Treasuries. Of note was an additional statement of willingness added to the FOMC minutes (emphasis mine) "to increase or reduce the pace of its purchases to maintain appropriate policy accommodation." Translation: "At some point we need to drop a meteor into a kiddie pool without making any ripples… now keep calm and carry on."
  • On Thursday the European Central Bank cut interest rates 0.75 to 0.5%. This was the first rate cut since July of 2012. Unfortunately, there is little chance the rate cut will aid the constricted lending situation in southern EU countries, it will likely however, help exporters by driving down the value of the Euro.
  • The Economist did an op ed piece distinguishing the Fed's response and the ECBs response to the financial crisis, and the comparative unemployment that has resulted because of the different responses.
  • If you were wondering how Cypriotic banks had so much Greek Debt on their balance sheets -- which ultimately caused a $1.8BB loss from sanctioned write-down of 80% of the debt and the eventual collapse of the Cypriotic financial system -- there is apparently a thumb drive that had those answers… until it was erased.
  • Unemployment (finally) surprised to the upside and past months were revised upward.  Unfortunately, the increase in non-farm payroll is just enough to keep pace with population growth and isn't really indicative of a labor market mending quickly.
  • Great read by VOX.eu regarding the impact of insurance companies reaching for yield on lower credit debt. In fact, they argue that:
    1. Insurance companies impact credit spread compressions much moreso than banks and pension funds as economic conditions improve and credit spreads narrow.
    2. Insurance companies therefore have greater systematic risk exposure as preferred issuance is provided to undeserving companies
    3. (Most interestingly) Because institutional arrangements and regulation of banks, insurance and asset management industry greatly impact credit cycles, one could argue that extreme yield compressions are hardwired into the process of financial intermediation, rather than animal spirits.

Benjamin is a Managing Director in Newfound’s Product Development and Quantitative Strategies group, where he is responsible for the ongoing research and development of new intellectual property and strategies. Specifically, Benjamin’s focus is in the area of exploring model applications to fundamental, economic and systemic market variables. Drawing on his years of experience in the financial services industry, he helps to ensure that Newfound’s products and messaging effectively meet the needs of investors and portfolio managers. He also plays a critical role in developing new business and client relationships.