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Ben Emons, Chief Economist

Ben Emons is Chief Economist/Head of Credit Portfolio Management for Intellectus. Prior to Intellectus, he was a Senior Vice President and Portfolio Manager at Pacific Investment Company (PIMCO).

Los Angeles

20 posts

Somewhat Rich Valuations

In her sit down discussion in London, Federal Reserve Chair Yellen presented a milder version of what Alan Greenspan once dubbed 20-years earlier as “irrational exuberance” to describe the state of the stock market. Fed Chair Yellen said valuations appear to be “somewhat rich” when measured on traditional models. The model she referred to is the “Fed model” of stock valuations, introduced by Alan Greenspan at the Humprey Hawkins testimony in 1997. The model uses the 1-year forward earnings yield of the S&P 500 and compares that to the 10-year Treasury yield. When these two are equal, the stock and bond market are in “equilibrium.” In Figure 1, the historical series is shown and it shows there is a wide gap between the S&

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Is the U.S. experiencing shadow deflation?

The latest Consumer Price Index release was the third consecutive inflation report that came out on the soft side. The economy has been moderately growing at 2 percent average with wages around 2.5 percent and unemployment around 4.3 percent. An economist who advocates the “Phillips Curve” (the relationship between unemployment rate and inflation) would argue the U.S. economy is on the brink of a burst in inflation. And yet, the actual inflation is benign and even shows ingrained deflationary trends across a variety of core goods categories. Such are new and used cars, cellular plans and retail goods. Figure 1 shows the long term trend in some of these categories. They have been in decline for some time. What is going here exactly?

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Where are 10-year yields going?

Yields are falling despite the Fed, the Bank of Canada and the Bank of England, want to hike interest rates. The long end of the yield curve responds with natural defense because soft inflation and hikes means the Fed will not meet the inflation target. Indeed, the Treasury Inflation Protected Securities (TIPS) curve discounts a below target inflation for the next 30-years. This expectation has been in place since late 2014 since QE3 ended. Since that time, the 10-year has been in a downtrend with occasional sell offs (like during Trump election). The chart below shows the 10-year since the end of QE3 (October '14) until today, compared to the 10-year during 2001-2006 period. Figure 1 Source: Bloomberg It is interesting to note the 10-year is

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The Benefit of Post U.K. Election Uncertainty

Once again, British polls turned out to be unreliable, and the political fallout may linger for some time. While Brexit negotiations are about to get under way, the Conservatives position in the House of Commons has weakened on May’s mandate backed by a slim majority. This is the uncertainty the Pound Sterling reflected on Friday by falling 1.5 percent against major currencies. A currency that expresses political risk may serve as a reflation backdrop because it can loosen global financial conditions. For example as Figure 1 shows, U.K. financial conditions are the easiest globally despite political uncertainty is perhaps the highest in Britain. Figure 1 Source: Bloomberg For financial markets this is good news because uncertainty begets low volatility when capital remains opportunistically

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A Different Take on the Recent Payrolls Report

Last Friday's (May 5) payrolls report was a steady as you go report. The consistent strength in payroll growth suggests "slack" is gradually removed. If there was an acceleration in reduction of slack however, not only wages may rise faster, but productivity would go up too. This hasn't been the case so far with the recent productivity report showing a meager 0.6% annualized increase. The labor market is therefore currently tightening in a moderate fashion and this coincides with a slow deterioration in the labor market conditions index published by the Federal Reserve. The graph below compares a measure of slack (part time employment for economic reasons) and the labor market conditions index. The positive change in the labor market conditions index has historically peaked

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A Level Playing Field for the Trump Trade

Over the past week, financial markets revisited the “Trump Trade” as a portfolio consisting out of 3 variables. The first variable is the dollar. The green buck resumed strength because of a more favorable stance by President Trump in trade discussions with Japan and China. Japanese Prime Minister Abe praised Trump for his business qualities with a trade deal potentially away from the Trans-Pacific Partnership (“TPP”). The conference call with Chinese President Xi Jinping resulted in a policy shift by Trump when he formally confirmed to uphold the “China One Policy.” The diplomatic nature of these discussions with Japan and China critically refrained from “currency manipulation” and was rather translated as a “level playing field” on currency valuation. The dollar index re-priced to moderately above 100,

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The FOMC Stalemate

The Federal Reserve’s FOMC Statement may have had the look of a stalemate but the language was crafted such that there are two important implications. The first is both sides of the dual mandate (inflation & unemployment) are in the Fed’s view now at target. The outlook for inflation was changed from “expected” to “will rise to 2 percent.” The Federal Reserve has high conviction inflation will be at target by removing from the Statement “transitory effects of declines in energy and import prices dissipate.” The other part of the mandate, the unemployment rate, was described as “stayed near its recent low” rather than declining. The assessment of the mandate coming into balance, suggests the Fed is getting ready for the next phase of

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An End to the American Carnage

As Donald Trump was sworn in as the 45th President of the United States, there were two notable points in his inaugural speech. The first point is President Trump took a firm stance against the political establishment. His message was conveyed such there will be a power transfer from government back to the private sector. By ending state control, “carnage” as President Trump described it, would end effectively. That may imply government intervention in private markets is now something of the past. One may argue President Trump took to heart the ideologies of the late economist Paul Samuelson. He argued maximizing welfare for the public results in an economy operating at optimal efficiency. The speech focus on “buy American, hire American” is adage to Samuelson by

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Credit Contagion

Credit risk premiums recently narrowed to their tightest levels since late 2007. There are a few risks emerging at the horizon that may alter valuation of corporate bonds. These risks can be put into three categories: 1) macro risks, 2) cross border holdings and 3) non-repatriated earnings and corporate tax reform. In the Minutes of the Federal Reserve released this week, there was a discussion how to respond when the economy with an already tight labor market could face additional fiscal stimulus. Many FOMC members saw a quicker tightening as the appropriate response. This tightening would be through 2 to 3 rate hikes in 2017, possibly followed by a reduction of the size of the Fed's balance sheet. These tightening measures may come at a time

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A Message From The Yield Curve

The slope of the yield curve informs about the future state of the economy. Post the great recession, the yield curve hasn’t tracked always the “normal” cycle shown in Figure 1. There are two reasons why this is the case and what it means for core fixed income investing. Figure 1: U.S. Treasury and Japanese Yield Curve Compared Source: Bloomberg, monthly data. T-= years before the cycle peak of economic growth, T+ = years post peak and into recession. The first reason is to compare the slope of the U.S. yield curve to Japan. The Japanese curve followed the normal cycle but deviated when deflation took hold (T+2 to T+4, Figure 1). Notably, the U.S. yield curve (orange line) follows the

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The Great Unwind

One possible effect stemming from the Brexit and U.S. elections outcome could have significant consequences: central banks relinquish their independence. There are academic proposals that call for central banks to maintain “operational independence” but give up political independence. There has been rhetoric during and post campaigns that argue for a change of central bank influence, different board and Chairman appointments and even a call to return to the gold standard. Politically motivated changes of a central bank have been associated with periods of high inflation. However, removal of central bank independence could also play out differently, for example by way of market forces. There are three ways how that may happen: 1.Loss of control over long maturity interest rates 2.Loss of control over

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The Effects of a Dollar Surge

Since the U.S. elections, the dollar has surged by 5 percent while emerging market currencies fell by double. When the value of the dollar spikes, global GDP on average has contracted by 2 percentage points in the past, and eventually dip into recession territory (see Figure 1). Currently, markets are in the “first inning” of a periods of rising rates, surging dollar and contracting global GDP. This combination could have two profound effects: dollar shortage and Fed balance sheet contraction. Figure 1: Dollar and Global GDP Source: Bloomberg, quarterly data, 1980-2016 Since the middle of 1990s, global debt denominated in dollars has expanded by an average of $1.5 trillion a year, to a cumulative of $50 trillion today according the Bank of International Settlements.

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Risk in Europe

Youth unemployment, debt burdens, current account imbalances and deflation remain at the heart of a struggling Eurozone economy. These factors may again play a role as Europe enters 2017 with elections in the Netherlands (March), France (April) and Germany (September) stacked up like a domino. The European political system, where decisions are made by unelected officials, may spark confidence votes in national parliaments or referendums in individual countries. The linkage between sovereign risk and banks has increased through the European Central Bank’s QE program. And a rise in populism may cause snap elections and minority coalitions. These factors in the wake of Trump’s win are widening European sovereign spreads and resemble the early period before the European debt crisis erupted (see Figure 1, red

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Trump the Domino

The stunning victory by President elect Donald Trump may be out of the playbook of the “democratic domino theory.” Empirical research (Leeson/Dean) found across 130 countries between 1850 and 2000 that “democratic dominoes” catch around 11 percent of their average geographic neighbors’ changes in democracy. In the context of the outcome of Brexit and the Trump win, political movements in rural areas most prone to global trade, emulate each other’s victories by a substantial voter turnout. Currency markets respond with significant dislocations (see Figure 1) in response to a political regime shift. This happened to the Pound during EMS crisis in 1992 and the Mexican Peso crisis in 1994. In reaction to those crises, the CNY devalued and U.S. interest rates saw a

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From Data Dependent to High Pressure

When quantitative easing (“QE”) ended 2014, the Fed adopted “data dependent.” When market volatility rose, the Fed used “data dependent” in communications. By lowering the probability of a hike, volatility and fears moderated (see Figure 1). The result of data dependent was the Fed needs a full year worth of data to justify one hike. Now data dependency has been two years in effect, how can investors anticipate a new policy by the Fed? Figure 1: Historical Probability of a Hike by December and VIX Index Source: Bloomberg. December probability implied from Fed Funds Futures. Probability = 100*(Dec Futures-Sep Futures)/0.125). The answer may be found in the return of a portfolio consisting out of S&P, Barclays Aggregate, Commodity and Currency indices. Figure

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