Bernanke’s Testimony
Posted by Eddy Elfenbein on July 17th, 2012 at 10:22 am

Here’s Ben’s speech today:

Chairman Johnson, Ranking Member Shelby, and other members of the Committee, I am pleased to present the Federal Reserve’s semiannual Monetary Policy Report to the Congress. I will begin with a discussion of current economic conditions and the outlook before turning to monetary policy.

The Economic Outlook

The U.S. economy has continued to recover, but economic activity appears to have decelerated somewhat during the first half of this year. After rising at an annual rate of 2-1/2 percent in the second half of 2011, real gross domestic product (GDP) increased at a 2 percent pace in the first quarter of 2012, and available indicators point to a still-smaller gain in the second quarter.

Conditions in the labor market improved during the latter part of 2011 and early this year, with the unemployment rate falling about a percentage point over that period. However, after running at nearly 200,000 per month during the fourth and first quarters, the average increase in payroll employment shrank to 75,000 per month during the second quarter. Issues related to seasonal adjustment and the unusually warm weather this past winter can account for a part, but only a part, of this loss of momentum in job creation. At the same time, the jobless rate has recently leveled out at just over 8 percent.

Household spending has continued to advance, but recent data indicate a somewhat slower rate of growth in the second quarter. Although declines in energy prices are now providing some support to consumers’ purchasing power, households remain concerned about their employment and income prospects and their overall level of confidence remains relatively low.

We have seen modest signs of improvement in housing. In part because of historically low mortgage rates, both new and existing home sales have been gradually trending upward since last summer, and some measures of house prices have turned up in recent months. Construction has increased, especially in the multifamily sector. Still, a number of factors continue to impede progress in the housing market. On the demand side, many would-be buyers are deterred by worries about their own finances or about the economy more generally. Other prospective homebuyers cannot obtain mortgages due to tight lending standards, impaired creditworthiness, or because their current mortgages are underwater–that is, they owe more than their homes are worth. On the supply side, the large number of vacant homes, boosted by the ongoing inflow of foreclosed properties, continues to divert demand from new construction.

After posting strong gains over the second half of 2011 and into the first quarter of 2012, manufacturing production has slowed in recent months. Similarly, the rise in real business spending on equipment and software appears to have decelerated from the double-digit pace seen over the second half of 2011 to a more moderate rate of growth over the first part of this year. Forward-looking indicators of investment demand–such as surveys of business conditions and capital spending plans–suggest further weakness ahead. In part, slowing growth in production and capital investment appears to reflect economic stresses in Europe, which, together with some cooling in the economies of other trading partners, is restraining the demand for U.S. exports.

At the time of the June meeting of the Federal Open Market Committee (FOMC), my colleagues and I projected that, under the assumption of appropriate monetary policy, economic growth will likely continue at a moderate pace over coming quarters and then pick up very gradually. Specifically, our projections for growth in real GDP prepared for the meeting had a central tendency of 1.9 to 2.4 percent for this year and 2.2 to 2.8 percent for 2013. These forecasts are lower than those we made in January, reflecting the generally disappointing tone of the recent incoming data. In addition, financial strains associated with the crisis in Europe have increased since earlier in the year, which–as I already noted–are weighing on both global and domestic economic activity. The recovery in the United States continues to be held back by a number of other headwinds, including still-tight borrowing conditions for some businesses and households, and–as I will discuss in more detail shortly–the restraining effects of fiscal policy and fiscal uncertainty. Moreover, although the housing market has shown improvement, the contribution of this sector to the recovery is less than has been typical of previous recoveries. These headwinds should fade over time, allowing the economy to grow somewhat more rapidly and the unemployment rate to decline toward a more normal level. However, given that growth is projected to be not much above the rate needed to absorb new entrants to the labor force, the reduction in the unemployment rate seems likely to be frustratingly slow. Indeed, the central tendency of participants’ forecasts now has the unemployment rate at 7 percent or higher at the end of 2014.

The Committee made comparatively small changes in June to its projections for inflation. Over the first three months of 2012, the price index for personal consumption expenditures (PCE) rose about 3-1/2 percent at an annual rate, boosted by a large increase in retail energy prices that in turn reflected the higher cost of crude oil. However, the sharp drop in crude oil prices in the past few months has brought inflation down. In all, the PCE price index rose at an annual rate of 1-1/2 percent over the first five months of this year, compared with a 2-1/2 percent rise over 2011 as a whole. The central tendency of the Committee’s projections is that inflation will be 1.2 to 1.7 percent this year, and at or below the 2 percent level that the Committee judges to be consistent with its statutory mandate in 2013 and 2014.

Risks to the Outlook

Participants at the June FOMC meeting indicated that they see a higher degree of uncertainty about their forecasts than normal and that the risks to economic growth have increased. I would like to highlight two main sources of risk: The first is the euro-area fiscal and banking crisis; the second is the U.S. fiscal situation.

Earlier this year, financial strains in the euro area moderated in response to a number of constructive steps by the European authorities, including the provision of three-year bank financing by the European Central Bank. However, tensions in euro-area financial markets intensified again more recently, reflecting political uncertainties in Greece and news of losses at Spanish banks, which in turn raised questions about Spain’s fiscal position and the resilience of the euro-area banking system more broadly. Euro-area authorities have responded by announcing a number of measures, including funding for the recapitalization of Spain’s troubled banks, greater flexibility in the use of the European financial backstops (including, potentially, the flexibility to recapitalize banks directly rather than through loans to sovereigns), and movement toward unified supervision of euro-area banks. Even with these announcements, however, Europe’s financial markets and economy remain under significant stress, with spillover effects on financial and economic conditions in the rest of the world, including the United States. Moreover, the possibility that the situation in Europe will worsen further remains a significant risk to the outlook.

The Federal Reserve remains in close communication with our European counterparts. Although the politics are complex, we believe that the European authorities have both strong incentives and sufficient resources to resolve the crisis. At the same time, we have been focusing on improving the resilience of our financial system to severe shocks, including those that might emanate from Europe. The capital and liquidity positions of U.S. banking institutions have improved substantially in recent years, and we have been working with U.S. financial firms to ensure they are taking steps to manage the risks associated with their exposures to Europe. That said, European developments that resulted in a significant disruption in global financial markets would inevitably pose significant challenges for our financial system and our economy.

The second important risk to our recovery, as I mentioned, is the domestic fiscal situation. As is well known, U.S. fiscal policies are on an unsustainable path, and the development of a credible medium-term plan for controlling deficits should be a high priority. At the same time, fiscal decisions should take into account the fragility of the recovery. That recovery could be endangered by the confluence of tax increases and spending reductions that will take effect early next year if no legislative action is taken. The Congressional Budget Office has estimated that, if the full range of tax increases and spending cuts were allowed to take effect–a scenario widely referred to as the fiscal cliff–a shallow recession would occur early next year and about 1-1/4 million fewer jobs would be created in 2013. These estimates do not incorporate the additional negative effects likely to result from public uncertainty about how these matters will be resolved. As you recall, market volatility spiked and confidence fell last summer, in part as a result of the protracted debate about the necessary increase in the debt ceiling. Similar effects could ensue as the debt ceiling and other difficult fiscal issues come into clearer view toward the end of this year.

The most effective way that the Congress could help to support the economy right now would be to work to address the nation’s fiscal challenges in a way that takes into account both the need for long-run sustainability and the fragility of the recovery. Doing so earlier rather than later would help reduce uncertainty and boost household and business confidence.

Monetary Policy

In view of the weaker economic outlook, subdued projected path for inflation, and significant downside risks to economic growth, the FOMC decided to ease monetary policy at its June meeting by continuing its maturity extension program (or MEP) through the end of this year. The MEP combines sales of short-term Treasury securities with an equivalent amount of purchases of longer-term Treasury securities. As a result, it decreases the supply of longer-term Treasury securities available to the public, putting upward pressure on the prices of those securities and downward pressure on their yields, without affecting the overall size of the Federal Reserve’s balance sheet. By removing additional longer-term Treasury securities from the market, the Fed’s asset purchases also induce private investors to acquire other longer-term assets, such as corporate bonds and mortgage backed-securities, helping to raise their prices and lower their yields and thereby making broader financial conditions more accommodative.

Economic growth is also being supported by the exceptionally low level of the target range for the federal funds rate of 0 to 1/4 percent and the Committee’s forward guidance regarding the anticipated path of the funds rate. As I reported in my February testimony, the FOMC extended its forward guidance at its January meeting, noting that it expects that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014. The Committee has maintained this conditional forward guidance at its subsequent meetings. Reflecting its concerns about the slow pace of progress in reducing unemployment and the downside risks to the economic outlook, the Committee made clear at its June meeting that it is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.

Thank you. I would be pleased to take your questions.

Industrial Production Rises 0.4% in June
Posted by Eddy Elfenbein on July 17th, 2012 at 10:09 am

I like to keep an eye on the monthly report on Industrial Production because it has a good record of aligning well with recessions and expansions (although it’s not a leading indicator). Check out how well the drops in the line match up with recessions (the gray area).

There’s been some talk that the U.S. is either in or about to enter a recession. I prefer to let the data speak for itself. This morning’s industrial production report showed a seasonally adjusted increase of 0.4% for June.

As a general rule, Industrial Production needs to fall by at least 6% for NBER (the official recession dating committee) declares a recession. The number for June is the highest number in four years.

I still don’t see any conclusive evidence that the U.S. economy is currently in a recession.

CPI Unchanged Last Month
Posted by Eddy Elfenbein on July 17th, 2012 at 9:54 am

Some folks are convinced that we’re in an era of hyperinflation. The data, however, seems to disagree. The CPI for June showed no increase last month. The core rate, which excludes food and energy prices, rose by 0.2% for the fourth month in a row.

We’ll learn more of Bernanke’s views later today when he testifies before Congress. But we do know that inflation is trending below the Fed’s target rate of 2%.

J&J Is Another Victim of the Dollar
Posted by Eddy Elfenbein on July 17th, 2012 at 9:22 am

Johnson & Johnson ($JNJ) reported adjusted second-quarter earnings of $1.30 per share this morning which was one penny better than expectations. Sales for the quarter fell by 0.7% to $16.48 billion which was $0.21 billion below Wall Street’s forecast.

While J&J has introduced some promising new drugs recently, sales have been pressured by the loss of patent protection for older drugs, including attention deficit/hyperactivity disorder treatment Concerta.

The health-care giant also recently completed its $19.7 billion acquisition of orthopedic products maker Synthes Inc., which it plans to integrate with its DePuy business. In the latest quarter, Synthes contributed 1.2 percentage points to global sales growth.

The bad news is that Johnson & Johnson is getting squeezed by the strong dollar. The company lowered its full-year forecast today from $5.07 – $5.17 per share to $5.00 – $5.07 per share. In last week’s CWS Market Review I said I think the company has a shot of earnings $5.21 per share this year. I was clearly too optimistic.

The silver lining is that the lower guidance isn’t due to problems with operations but rather due to the foreign exchange rate. I’m not as worried by that since foreign exchange issues come and go. If it’s a problem with the business itself, that’s something much more worrying.

I still like Johnson & Johnson and the stock has performed well in the past month. Going by this morning’s price, the shares yield 3.6%.

Morning News: July 17, 2012
Posted by Eddy Elfenbein on July 17th, 2012 at 7:12 am

Spanish Borrowing Costs Drop as Economy Minister Warns on Debt

Bank of England’s King Testifies To Parliament Committee

ZEW Investor Confidence Declines to Lowest Since January

Cuba Hits Walls in 2-Year Effort at Privatization

Gold Climbs Towards $1,600/Oz Ahead Of Bernanke

Oil Near Seven-Week High on Iran Tension, Fed Speculation

Fed Shifts Focus to Jobs as Unemployment Stalls Above 8%

U.S. Tightens Security for Economic Data

U.S. Drought Worsens Crop Damage, Raising World Food, Fuel Worry

A Yahoo Search Calls Up a Chief From Google

Three Lessons From GlaxoSmithKline’s Purchase Of Human Genome Sciences

Hokuriku Bank Linked To HSBC Money-Laundering Probe

Visa Among U.S. Firms Seen Helped by WTO Ruling on China

Mattel’s Profit Tops Estimates On Lower Costs

Jeff Carter: The Fallacy of Government Spending

Cullen Roche: Is The Wall Street Casino Closing?

Be sure to follow me on Twitter.

The Complete Interview
Posted by Eddy Elfenbein on July 16th, 2012 at 12:38 pm

Here’s the entire interview I did with Brian Richards of the Motley Fool.

10-Year Yield Hits All-Time Low
Posted by Eddy Elfenbein on July 16th, 2012 at 11:59 am

The stock market dropped early on in today’s trading, but we regrouped and have made back everything we lost. Right now, the S&P 500 is holding on to a small gain.

Both Johnson & Johnson ($JNJ) and Reynolds American ($RAI) got to new 52-week highs this morning. Tomorrow we’re going to receive earnings reports from JNJ and Stryker ($SYK). It will be interesting to hear what they have to say.

The yield on the 10-year Treasury dropped to an all-time low today. The yield got to 1.442%.

The S&P 500 and Earnings
Posted by Eddy Elfenbein on July 16th, 2012 at 10:44 am

Here’s a look at the S&P 500 (black line, left scale) along with its earnings (yellow line, right scale). The two lines are scaled at a ratio of 16-to-1 which means that whenever the lines cross, the market’s P/E Ratio is exactly 16.

We’re at a crossroads right now in the market. Earnings are going to be flat this earnings season but they’re expected to be flat. Wall Street currently expects earnings and the economy to reaccelerate later this year (note the upturn in the yellow line). The market, however, is a doubter. Actually, right about now is the trough in earnings growth.

If analysts are right and earnings start growing again, the market right now is very cheap. Under a reacceleration scenario, I think the S&P 500 could easily hit 1,500.

But if traders are picking up something not yet seen in the data, and the economy drops sharply, stocks could drop even further.

Morning News: July 16, 2012
Posted by Eddy Elfenbein on July 16th, 2012 at 6:59 am

Merkel Gives No Ground on Demands for Oversight in Crisis

Euro-Area Inflation Held Steady in June, Imports Fell in May

Focus Shifts to Regulators in British Inquiry on Rate-Fixing

London Self-Regulatory System Proves Illusory in Libor Scandal

China’s Cabinet Meets as Wen Warns on Economy

India Inflation Eases; Monsoon Holds Key To Rate Cut

Crude Oil Futures Drop From One-Week High

Consumer Bureau Poised to Unleash Rules

JPMorgan Blaming Marks on Traders Baffles Ex-Employees

Surveys Give Big Investors an Early View From Analysts

Buffett Empowers Deputies by Raising Funds to $8 Billion

Microsoft and NBC Complete Web Divorce

BASF To Take On Asia’s Battery Chemicals Makers

Howard Lindzon: Instagram (Facebook) Trumps Twitter

Jeff Miller: Weighing the Week Ahead: A Summertime Three-Ring Circus

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JPMorgan Chase Earns $1.21 Per Share
Posted by Eddy Elfenbein on July 13th, 2012 at 7:05 am

JPMorgan just released their earnings report. For the second quarter, the bank earned $1.21 per share. They said that the botched trade in London lost $5.8 billion including $4.4 billion during the second quarter. They said that the trader was misleading them so they’ll have to restate Q1 earnings. Their income for Q1 will be $459 million less than originally reported.

Here’s the earnings report:

JPMorgan Chase & Co. (NYSE: JPM) today reported second-quarter 2012 net income of $5.0 billion, compared with net income of $5.4 billion in the second quarter of 2011. Earnings per share were $1.21, compared with $1.27 in the second quarter of 2011. The Firm’s return on tangible common equity for the second quarter of 2012 was 15%, compared with 17% in the prior year.

Jamie Dimon, Chairman and Chief Executive Officer, commented on financial results: “Importantly, all of our client-driven businesses had solid performance. However, there were several significant items that affected the quarter’s results – some positively; some negatively. These included $4.4 billion of losses on CIO’s synthetic credit portfolio, $1.0 billion of securities gains in CIO and a $545 million gain on a Bear Stearns-related first-loss note, for which the Firm now expects full recovery. The Firm’s results also included $755 million of DVA gains, reflecting adjustments for the widening of the Firm’s credit spreads which, as we have consistently said, do not reflect the underlying operations of the Firm. The Firm also reduced loan loss reserves by $2.1 billion, mostly for the mortgage and credit card portfolios. These reductions in reserves are based on the same methodologies we have used in the past – the good news is that these reductions reflected meaningful improvements in delinquencies and estimated losses in these portfolios. We continue to maintain strong reserves.”

Dimon continued: “Since the end of the first quarter, we have significantly reduced the total synthetic credit risk in CIO – whether measured by notional amounts, stress testing or other statistical methods. The reduction in risk has brought the portfolio to a scale that allowed us to transfer substantially all remaining synthetic credit positions to the Investment Bank . The Investment Bank has the expertise, capacity, trading platforms and market franchise to effectively manage these positions and maximize economic value going forward. As a result of the transfer, the Investment Bank’s Value-at-Risk and Risk Weighted Assets will increase, but we believe they will come down over time. Importantly, we have put most of this problem behind us and we can now focus our full energy on what we do best – serving our clients and communities around the world.”

Commenting further on CIO, Dimon said: “CIO will no longer trade a synthetic credit portfolio and will focus on its core mandate of conservatively investing excess deposits to earn a fair return. CIO’s $323 billion available-for-sale portfolio had $7.9 billion of net unrealized gains at the end of the quarter. This portfolio has an average rating of AA+, has a current yield of approximately 2.6%, and is positioned to help to protect the Firm against rapidly rising interest rates. In addition to CIO, we have $175 billion in cash and deposits, primarily invested at central banks.”

“The Firm has been conducting an extensive review of what happened in CIO and we will be sharing our observations today. We have already completely overhauled CIO management and enhanced the governance standards within CIO. We believe these events to be isolated to CIO, but have taken the opportunity to apply lessons learned across the Firm. The Board of Directors is independently overseeing and guiding the Company’s review, including any additional corrective actions. While our review continues, it is important to note that no client was impacted.”

Commenting on the balance sheet, Dimon said: “Our fortress balance sheet remained strong, ending the second quarter with a strong Basel I Tier 1 common ratio of 10.3%. We estimate that our Basel III Tier 1 common ratio was approximately 7.9% at the end of the second quarter, after the effect of the final Basel 2.5 rules and the Federal Reserve’s recent Notice of Proposed Rulemaking.”

Dimon concluded: “Through the depth of the financial crisis and through recent events, we have never stopped fulfilling our mission: to serve clients – consumers and companies – and communities around the globe. During the first half of 2012, we provided $130 billion of credit to consumers. Over the same period we provided nearly $10 billion of credit to small businesses, the engine of growth for our economy, up 35% compared with the same period last year. For America’s largest companies, we raised or lent over $720 billion of capital in the first six months to help them build and expand around the world. Even in this difficult economy, we have added thousands of new employees across the country – over 62,000 since January 2008. In 2011, we founded the “100,000 Jobs Mission” – a partnership with 54 other companies to hire 100,000 U.S. veterans by the year 2020. We have hired more than 4,000 veterans since the beginning of 2011, in addition to the thousands of veterans who already worked at our Firm. I am proud of JPMorgan Chase and what all of our employees do every day to serve our clients and communities in a first-class way.”

Excluding all adjustments, the bank earned 67 cents per share last quarter.