SEMI-MONTHLY FISCAL/MONETARY UPDATE – GDP GROWTH SLUGGISH, FED BALANCE SHEET COMES DOWN-BUT BEHIND SCHEDULE, GOLD PRICE READY FOR UPSIDE BREAKOUT?

THE ECONOMY

It now seems clear that Q1’18 will not demonstrate a pickup in the economy. After 2.9% real GDP growth in Q4’17, lagging the much heralded 3% plus in Q2 and Q3’17 (Q3 aided by reconstruction activities after the storms), it now seems clear that Q1’18 will be closer to 2% than 3%. Recall that Q4 consumer spending, which included the best Christmas season in at least five years, included record high consumer credit card debt (with an increasing incidence of default) and a reduction of the consumer savings rate down to about 3% of household income, not the healthiest combination for longer term spending expectations. Sure enough, the first quarter of ’18 seems to be characterized by slightly higher consumer savings, as the public is still burdened with high health care, rent, and education costs. We saw a chart recently that indicates that about 33% of 25-29 year olds are living with parents or grandparents, up from about 26% in 2010. No doubt many of these Millennials are coping with the burden of student loans. Surveys indicate that many consumers are going to apply savings from the new tax bill against debts, rather than increase spending. Economic spokespersons (i.e.Kudlow, Mnuchin, etc.etc.) continue to predict that the tax bill will stimulate faster GDP growth and much higher tax revenues, in time reducing the federal debt burden. Time will tell, obviously, but the jury is still out, and the signs are not convincing so far.

FEDERAL RESERVE NORMALIZATION PROGRAM

The US Federal Reserve continues to “normalize” the bloated balance sheet, but is running behind schedule. Recall that the plan called for $10B/month reduction in Q4, $20B/month in Q1, $30B/month in Q2, $40B in Q3, $50B in Q4’18, and that’s as far as described. The plan fell behind schedule by $23B in Q4, fell another $4-10B behind plan in Q1 (depending on whether you use 3/28 or 4/4), so was $27-33B behind schedule as of 3/31, a significant percentage against the $90B that was scheduled. In the first week of Q2, ending 4/11, the Fed’s balance sheet was essentially unchanged. The rubber meets the road now with a reduction of  $30B monthly. Since the Fed’s activities affect short term interest rates rather than longer term, it could be instructive to look at what the bellwether ten year treasury note has done over the last six months. During Q4, as the Fed got $23B behind their $30B objective, the ten year traded between at 2.35% to 2.45%. The Fed stepped up their selling in Q1, meeting their quarterly objective (though not catching  up) and the ten year moved dramatically, from just above 2.40% to as high as 2.95% and closed Q1 at about 2.75%. So far in Q2, the ten year has traded back up to 2.85% as this is written.  The more volatile two year treasury, which bottomed around 1.3% in midSeptember, has moved in a straight line to 1.9% at 12/31, 2.27% at 3/31, and 2.38% today. These are very dramatic moves, and the pace of “normalization” continues to quicken. Time will tell what affect $30B/month of Fed “runoff” has on interest rates, but the possibility exists that rates could spike higher, especially if the Fed tries to catch up with the shortfall to date of about $30B. If interest rates spike upward in Q2, as they did in Q1, it could  be unsettling to capital markets that are already showing volatility that we have not seen in years

GOLD UPDATE

Gold has been “consolidating”, around $1350/oz., up 3-4% for the year, fairly firm day to day, seemingly threatening to break out on the upside. No doubt the increasing visibility of federal debt accelerating to over $1 trillion annually as far as the eye can see, is contributing to the interest, as well as the possibility of increased inflation. Since Central Banks, worldwide, are trying to stimulate inflation, it stands to reason that they would be continuing to purchase gold bullion, which they are. Market technicians, chartists, point to $1,375 and $1,400 per ounce as “breakout” levels on the upside. After a 4-5 year consolidation, some observers think gold bullion could make a move to new all time highs, above $2,000/oz. From our standpoint, the gold miners seem to be the most advantageous way to participate, since the gold mining stocks are even more depressed in price than the metal itself. The last time gold bullion was around $1,350/oz., in mid 2016, the gold mining stocks were about 35% higher. If the price of gold breaks out on the upside, the gold mining stocks should do even better.

Roger Lipton