Posts Tagged ‘QE3’

QE3 A Boon to CMBS

Tuesday, November 13th, 2012

If history repeats itself, QE3 will be good for commercial mortgage-backed securities (CMBS). The Fed’s third round of quantitative easing – which is purchasing $40 billion of residential mortgage-backed securities (RMBS) each month from Fannie Mae and Freddie Mac – will free up money for the commercial real estate market and lure investors away from other vehicles in their hunt for maximum yield.  QE3 is expected to last at least until 2015.

“The primary difference between 2012 and 2010 is that commercial property prices in healthy markets are stronger than they were just two years ago.  At its peak, CMBS constituted 40 percent of all commercial real estate loans,” said John O’Callahan of CoStar.  O’Callahan notes that “Investment returns of 40 percent or more for riskier assets during QE1 were largely a result of a bounce-back from the lows caused by investor panic in late 2008 through early 2009.  The overall impact of QE becomes clearer upon examining QE2.  Prices of equities and high-yield bonds, including CMBS, gained a respectable 12 to 15 percent.”

Low interest rates mean that returns will narrow to as little as 150 basis points, forcing investors to look elsewhere for respectable yields.  Currently, B-piece CMBS investors are achieving 20 percent and higher yields.  By contrast, the Dow Jones Industrial Average’s yield has remained below three percent each of the last 20 years.

CMBS has “been a boon for us,” said Kenneth Cohen, head of CMBS at UBS Securities.  “You’ve seen a fairly good size increase in loan pipelines.  Our pipeline has increased probably 50 percent over the last six weeks.”  Borrowers also are cashing in on the favorable loan terms.  According to Fitch Ratings, loans in 2012 are averaging 95.7 percent of a stressed property’s estimated value; that’s up from 91.6 percent in 2011.

Despite the good news, industry experts don’t expect the resurgent CMBS market to resolve all financing woes.  For example, the encouraging loan terms are of minimal help to commercial real estate owners who are under water, nor will new issuance be adequate to refinance the $54 billion in CMBS loans coming due this year.  Additionally, some ratings firms warn that the credit quality of CMBS loans could increase risk for some investors.  In response, Moody’s Investor Services’ now requires that senior bonds have expensive credit protection.

Bernanke: No QE3

Wednesday, October 5th, 2011

Federal Reserve Chairman Ben Bernanke, in a long-awaited speech in Jackson Hole, WY, announced no new steps the Fed will take to prop up the shaky U.S. economy.  Rather, he expressed optimism that the economy will continue to recover, based on its inherent strength and from assistance provided by the central bank.  Bernanke restated the Fed’s determination to keep the federal funds rate “exceptionally low” for a minimum of two years.  He did not say what many had been hoping to hear: that the Fed would begin another round of quantitative easing – usually referred to as QE3.

 Bernanke said that he expected inflation to remain at or below two percent.  Additionally, he acknowledged that the recent downgrade of the nation’s AAA credit rating had undermined both “household and business confidence.”  He implied that there was only so much more the Fed can do to stimulate the economy, and that the time has come for Congress and the Obama administration to create “policies that support robust economic growth in the long term,” to reform the nation’s tax structure and to control spending.

“In addition to refining our forward guidance, the Federal Reserve has a range of tools that could be used to provide additional monetary stimulus.  We discussed the relative merits and costs of such tools at our August meeting.  We will continue to consider those and other pertinent issues, including, of course, economic and financial developments, at our meeting in September,” Bernanke said.  He went on to clarify the Fed’s guidance about how long interest rates will remain exceptionally low.  “In what the committee judges to be the most likely scenarios for resource utilization and inflation in the medium term, the target for the federal funds rate would be held at its current low levels for at least two more years.”

As Bernanke delivered his remarks, the government cut its estimated 2nd quarter GDP growth to a paltry rate of one percent, a revision from the 1.3 percent previously reported.  The revision was expected and primarily due to weaker exports.  In more positive news, private spending and investment in April through June were slightly higher than initially estimated.  The GDP grew by an annual rate of just 0.4 percent in the 1st quarter.  The 2nd half of 2011 is expected to be somewhat stronger, but a major driver of the economy — consumer spending — remains weak amid slow hiring and sluggish income gains.

“This economic healing will take a while, and there may be setbacks along the way,” Bernanke said.  “Although the issue of fiscal sustainability must urgently be addressed, fiscal policymakers should not, as a consequence, disregard the fragility of the current economic recovery.  Although important problems certainly exist,  the growth fundamentals of the United States do not appear to have been permanently altered by the shocks of the past four years,” Bernanke said. “It may take some time, but we can reasonably expect to see a return to growth rates and employment levels consistent with those underlying fundamentals.”

“Economic performance is clearly subpar, and from that standpoint the case for some sort of further economic-policy assistance is just being made by the poor performance,” said Keith Hembre, chief economist and investment strategist in Minneapolis at Nuveen Asset Management.  Although Bernanke said the Fed has stimulus tools left, “the threshold to utilizing them is going to require fairly different conditions than what we have today,” such as lower inflation or a return of financial instability, Hembre said.

Bernanke also used the occasion to scold Congress for its tardiness in resolving the deficit debate. “The country would be well served by a better process for making fiscal decisions,” Bernanke said at the Federal Reserve Bank of Kansas City’s annual economic symposium.  “The negotiations that took place over the summer disrupted financial markets and probably the economy, as well, and similar events in the future could, over time, seriously jeopardize the willingness of investors around the world to hold U.S. financial assets or to make direct investments in job-creating U.S. businesses.”  Bernanke implied that a return to economic prosperity is at stake.  “I do not expect the long-run growth potential of the U.S. economy to be materially affected by the crisis and the recession if — and I stress if — our country takes the necessary steps to secure that outcome,” he said.  The budget process, according to Bernanke, would be more effective if negotiators set “clear and transparent budget goals” and established “the credibility of those goals.” 

Bernanke reassured investors that United States prospects for growth are sound over the long term and that the Fed has tools to aid the recovery if needed, even though he is not planning another stimulus at this time.  “What no action will do is give confidence to investors that things are not as bad as many people perceive, otherwise he would’ve acted,” Keith Springer, president of Springer Financial Advisors in Sacramento, CA, said.  “Investors will eventually see the positives.”

Stagflation Rears Its Ugly Head

Wednesday, September 21st, 2011

The Consumer Price Index (CPI) climbed by 0.5 percent in July, according to a Labor Department report.  That came after a decrease of 0.2 percent the previous month.  Rising inflation cuts consumers’ buying power.  Average pay, when adjusted for inflation, fell in July and has declined by 1.3 percent in the last year.  Over the last 12 months, prices have gone up 3.6 percent.  Core prices over the last year have risen 1.8 percent — the largest increase since December of 2009. 

“Once again, the consumer was pushed to the wall by rising retail costs,” said Joel Naroff, chief economist at Naroff Economic Advisors.  “It’s bad enough that workers are not getting any pay increases but the surge in retail prices is cutting into spendable income.”  Although many economists and the Federal Reserve expect that higher food and energy prices will prove short lived, that offers little good news to Americans who must find the money to pay for food and gas.  “This is not welcome news for Fed officials who are trying to justify QE3,” First Trust analysts said.

The news also raises the specter of stagflation, a circumstance when the inflation rate is high and the economic growth rate is slow.  Writing for CBS Money Watch, Dan Burrows says that “Prices are growing rapidly but the economy is not.  Sound familiar?  It’s called stagflation — something we haven’t had in three decades — and markets are getting more jittery about its possibility with each passing data point.  A stagnant economy plus inflation equals stagflation, and it could actually be worse for American households this time around, should it come to pass.  Yes, inflation rates of three percent to four percent are nothing compared to the double-digit inflation Americans lived with in the 1970s and early 1980s.  But then households were in much better shape back then because they carried much less debt, be it through mortgages, home equity loans, credit cards or student loans.”

The Hill’s Vicki Needham writes that “The energy index has risen 19 percent over the past year.  Overall, food prices increased 0.4 percent in July, with larger increases in dairy and fruit prices.  The cost of meat, coffee and vegetables all increased.  The core index, excluding volatile food and energy, was up 0.2 percent, slightly below the 0.3 percent increase in each of the previous two months.  Prices are up 3.6 percent from a year ago, the same amount as in May and June.  Core prices are 1.8 percent higher than they were a year earlier, the largest increase in two years, with rent and the rising cost of hotels pushing up housing prices by the most in three years.  Although prices are up, the index of core prices, used by the Federal Reserve to gauge inflation, is within the target range of 1.5 and two percent.  Core consumer inflation is expected to remain between 1.5 and 1.8 percent this year, the Fed has said.  The cost of apparel increased sharply last month, as clothing prices were up 1.2 percent, the third consecutive month of increases.  Clothing costs have increased 3.1 percent during the past 12 months, the largest yearly increase since July 1992.”

With an economy sluggish, and many calling a recession inevitable, the latest CPI number fits with recently released Producer Price Indexes (PPI) which showed prices rising throughout different levels of production.  While recessions are usually deflationary, rising measures of inflation have sparked fears of stagflation.

Surprisingly, the Chicago area was relatively immune to July’s inflationary numbers.  Consumer prices in metropolitan Chicago declined 0.4 percent in July from June as energy prices fell, according to the Labor Department.  With the exception of food and energy, prices were also down 0.4 percent.  Compared with last year, prices rose 3.2 percent and there was a 17.8 percent spike in energy costs.  When food and energy are taken out of the equation, prices rose 1.6 percent compared with last year.  Food prices remained the same as June, but rose 3.5 percent from July 2010.  Energy prices declined one percent from June as gasoline prices dropped 4.2 percent.  Gas prices were 37.3 percent higher than in 2010.  The biggest price declines were in education and communication, down 3.8 percent; clothing was down 2.6 percent; and transportation was down 1.7 percent.  Housing costs rose 0.5 percent.

Is QE3 On the Horizon?

Tuesday, June 21st, 2011

Now that QE2 (quantitative easing 2) is winding down – and with the economy sputtering – will Federal Reserve chairman Ben Bernanke call for a new round of stimulus in the form of QE3? The answer likely is “no”, although it’s doubtful that the Fed will tighten monetary policy until the economy is stronger.  The central bank’s strategy has been to buy Treasury bonds to increase the money supply and foster growth.  The second round of such purchases, worth $600 billion, ends June 30.

Writing in the Washington Post, Neil Irwin says that “The lousy unemployment report comes on the heels of other disappointing economic data, but Fed officials view the current situation as different from the conditions that led to last year’s bond buying.  The recent round of data is neither alarming enough nor definitive enough to make them reconsider the unconventional monetary policy.  For one, much of the economic slowdown in the first half of the year was likely driven by temporary factors.  The Japanese earthquake and tsunami appear to have disrupted the supply chain at U.S. factories more than initial forecasts, contributing to the drop in manufacturing activity and May’s sluggish employment report.  And although oil prices spiked earlier in the year, they have ebbed downward since late April.”

Mohamed A. El-Erian, CEO and Co-CIO of Pimco, agrees, noting that “Notwithstanding the historical parallel, I suspect that it is very unlikely that there will be a QE3.  This view is based on an assessment of economic, political and international factors.  As Chairman Bernanke noted in his August Jackson Hole speech, and reiterated in his first press conference, policy measures should be judged in terms of the expected balance of benefits, costs and risks.  I suspect that there is now broad agreement that, in the case of QE3, this balance has shifted: lowering the potential gains and increasing the probability of collateral damage and adverse unintended consequences.  It is also clear that, in its attempt to deliver ‘good’ asset price inflation (e.g., higher equity prices), the Fed also got ‘bad’ inflation.  The latter, which essentially took the form of higher commodity prices, is stagflationary in that it imposes an inflationary tax on both production and consumption — thus countering the objective of QE2.”

There’s also the point that QE2 has had mixed results.  According to Bernanke, “Yields on 5- to 10-year nominal Treasury securities initially declined markedly as markets priced in prospective Fed purchases; these yields subsequently rose, however, as investors became more optimistic about economic growth and as traders scaled back their expectations of future securities purchases.  Equity prices have risen significantly, volatility in the equity market has fallen, corporate bond spreads have narrowed, and inflation compensation…has risen to historically more normal levels.”

Philadelphia Fed President Charles Plosser warns that QE2 provides excessive stimulus: The central bank has “a trillion-plus excess reserves,” he noted, which could be “the fuel for inflation.”  Anticipated inflation could explain the sudden increase in long-term yields that began last November.  But the rate for 10-year Treasury Inflation Protected Securities (TIPS), rose at the same time, which contradicts that interpretation.  At the same time, the five-year TIP rate didn’t rise.  Had that rate increased, there would have been a sign of a stronger economy in the next five years.


UBS thinks that QE2 failed and is strongly opposed to another round of stimulus.  Maury N. Harris, UBS’ Managing Director and Chief Economist for the Americas, says that “The evidence that QE2 boosted economic activity is lacking.  Yields moved higher and equity markets did as well, although the latter was justified by rising corporate earnings.  They importantly reflected better volumes, which probably cannot be traced to any believable instantaneous response to policy that works with a lag.  Despite the recent weakness in the data, we continue to view the recent slowing as insufficient to prompt further QE from the Federal Reserve.  Relative to conditions in August 2010, when QE2 was floated by Chairman Bernanke, labor market conditions are better.  Additionally, the threat of disinflation last fall has given way to a somewhat more disturbing build-up in inflation pressures as core inflation continues to accelerate.”

Where’s Our Recovery? Job Growth and Productivity Falter

Monday, June 13th, 2011

Sluggish job growth in May could be a sign that the economic recovery is losing momentum.According to the ADP May Employment Report, a mere 38,000 jobs were added in the private sector on a seasonally adjusted basis.  That was well below consensus estimates of 170,000 new jobs.  The report also revised downwards the estimated change from March to April from 179,000 to 177,000. “A deceleration in employment, while disappointing, is not entirely surprising,” the report said.  “In the 1st quarter, GDP grew at only a 1.8 percent rate and only about 2¼ percent over the last four quarters.  This is below most economists’ estimate of the economy’s potential growth rate and normally would be associated with very weak growth of employment.”

Patrick O’Keefe, director of economic research at J.H. Cohn, said that although some seasonal factors may have been at work in the recent claims data and in the ADP estimates, the report still disappointed.  “We can put away our balloons and party hats today,” he said.  “We expected a pull back in the rate of acceleration, instead we got deceleration.  It appears that the general expansion has lost a bit of momentum and employment numbers, which were already lethargic, are slowing further.”

“This only adds fuel to the argument that the slowdown story is here in the U.S.,” said Tom Porcelli, chief economist at RBC Capital Markets.  “I am fairly confident that people are going to be scaling back their estimates for nonfarm payrolls.  While it is a good thing that small and medium-sized companies are adding payrolls, there is no doubt that the pace has slowed.  This is exactly what we do not want when other significant data shows things are slowing down as well.  Having said that, I still do not believe the Fed will initiate QE3.”

Writing in the National Journal, Jim Tankersley takes a more optimistic viewpoint. According to Tankersley, “Reality is a little more positive and a lot more complicated than that.  Wall Street analysts are fairly united in their view that the recovery has entered a “soft patch,” just like it did last year, and that sooner or later, growth and job-creation are on track to pick up again.  Several analysts and columnists have been reminding Americans that recoveries from financial crises can often feel like stop-and-go traffic on the freeway.  For now, the economic brakes seem to be pumping.  The 2010 slowdown flowed from worries over Europe’s sovereign debt crisis.  This one is likely a combination of several factors.  The spike in oil and food prices has spooked confidence — though consumers are still spending apace, dipping into their savings to keep up — and may be driving businesses to scale back hiring.”

On the MarketWatch website, Rex Nutting says that “If you recall that government employment is declining by almost that much every month, the ADP report implies only a very small increase in total employment.  This is no way to get the unemployment rate down from nine percent.  The economy has been buffeted by both natural and man-made forces.  Extremely bad weather earlier in the year depressed activity, as did the surge in commodity prices, especially for energy and food.  Then the Japanese earthquake and tsunami knocked out vital supply chains.  Global economic growth, which had given a big boost to U.S. exporters, is slowing. Europe is dead in the water, so is Japan.  The fast-growing developing nations such as China, India and Brazil are downshifting to avoid overheating.  The strongest sector of the U.S. economy — manufacturing — is still growing, but the momentum is fading.  The Institute for Supply Management’s closely watched diffusion index (Defined by Investopedia as “A measure of the breadth of a move in any of the Conference Boards Business Cycle Indicators (BCI), showing how many of an indicators components are moving together with the overall indicator index) plunged by 6.9 points to 53.5 percent in May, the largest one-month decline since 1984.

Companies may need to start hiring again as a new report from the Department of Labor is showing that the productivity of American workers slowed in the 1st quarter and labor costs rose as companies boosted employment to meet rising demand.  The measure of employee output per hour increased at a 1.8 percent annual rate after a 2.9 percent gain in the prior three months, revised figures from the Labor Department showed today in Washington, D.C.  Employee expenses climbed at a 0.7 percent rate after dropping 2.8 percent the prior quarter.

Productivity measures the amount of output per hour of work.  A slowdown in growth is bad for the economy if it persists.  But it can be good in the short term when unemployment is high because it can mean that companies are reaching the limits on how much extra output they can get from their existing work forces.  Output grew 3.9 percent in 2010, the biggest increase since 2002.  But many economists believe it will slow to 50 percent of that rate this year.  The expectation is that companies will hire new workers to further boost output.