Independent, Fee-Only Financial Advisor

Independent, Fee-Only Financial Advisor

Monday, June 29, 2020

Wrangling The Curve

Everyone's favorite conspiracy theories got a little kick recently. In their latest meeting, the Federal Reserve's Open Markets Committee noted that they had discussed "Yield Curve Control." As the Federal Reserve is the center of all of the best conspiracy theories, hearing them say "control" sounds exciting. What does it mean?

Jay Powell wrangling interest rates


The Federal Open Markets Committee is the part of the Federal Reserve that handles monetary policy. When you hear about the Federal Reserve raising rates, lowering rates, buying bonds, or launching another program of quantitative easing, this is the group in charge. They meet regularly throughout the year and look deeply at economic data. From that data they decide if money needs to be easier or harder to get, to either slow down or step up the economy.

Generally they target the shortest term interest rates: overnight rates. Large banks fund their operations by borrowing what they need on an overnight basis, so it is a quick way to influence banks and get money into, or take money out of the economy. On the other hand, consumers, businesses and the Federal Government borrow money for generally longer terms. If you have a mortgage, for instance, it's probably a 15 or 30 year loan. Lowering short term rates is great for the bank, and encourages them to lend to you, but it doesn't directly make your 30 year loan cheaper.

Interest rates are the cost of borrowing. High interest rates mean it is expensive for people to borrow money and low interest rates mean it is cheap to borrow. Since the interest payment is often fixed, interest rates have an inverse relationship with the price of the bond or loan. That is, as the price of a bond goes up, the payment stays the same, therefore the interest rate on it goes down.

If the Federal Reserve wants to make it cheaper for consumers, businesses or the government to borrow, it needs to lower longer term interest rates. Since they don't lend to you directly, they have to operate in the open market. With the ability to create or destroy practically infinite amounts of money, the Federal Reserve can be a large player in any market, and their presence can move prices. To lower longer term interest rates, the Federal Reserve buys longer term bonds. These are huge markets, so they need to bring a lot of money to the table. The Quantitative Easing programs of the last ten years were just that: huge purchases of longer dated bonds designed to bring down interest rates for everyone.

Now the Federal Reserve is talking about controlling the yield curve even more. This means that they would be targeting specific interest rates for different loans by maturity or borrower. While traditionally they have only bought Treasury bonds issued by the Federal Government, in QE they stepped out to buying government agency bonds and they have now started buying corporate bonds. In short, they are directly lowering borrowing costs for everyone!

What do lower interest rates mean? Lower interest rates mean it is cheaper to borrow the money used to buy homes, build factories, invest in infrastructure or fund government spending. Those are all big ticket expenses that support the economy through current spending and investment for the future. On the other hand, the cheaper it is to borrow, the more money is chasing the same goods. While money is an important part of the equation, the other side needs to be addressed too. We still need more houses and more people working and more raw materials to make those investments.

The Federal Reserve has a strong hand on an important lever, but the economy is much more complicated that just that.

Friday, June 26, 2020

The Walking Dead

I have a friend who convinced me to stream The Walking Dead. I tried, but all those zombies were a bit much for my taste. But my ears perked up when I listened to conversations about the rise of zombie firms. Zombie firms are those that are still operating and generating revenue but not enough to service their debt. In a normal, healthy economy, those firms would die a natural death. But we’re not in a normal, healthy economy.

The Federal Reserve is throwing everything at this crisis. They are pushing interest rates down, making debt more appealing. They are buying corporate bonds to prevent defaults. They are pumping up liquidity in any way possible to get us through this pandemic. And that is exactly what they should be doing, but it’s creating more zombie firms.

Creative destruction is an economics term that describes the dynamic process in a capitalistic system. Old ways, old ideas, old companies are constantly being shed or destroyed. New, more efficient ways arise from the ashes. Innovation comes about when outdated firms are allowed to die a natural death.

Right now, we’re in a Walking Dead type of economy. The Federal Reserve is propping up a lot of zombie firms, but that is exactly what needs to happen… for now. First, we need to get through the pandemic and its economic damage. Then those firms who are no longer viable can die. And many will, all at once. So for all the headlines about bankruptcies and doors closing, there are many more zombies out there waiting to take their last breath. When this is all over, expect a lot of destruction, but that will be followed by a burst of innovation and creativity. Watch for the live ones!

Thursday, April 30, 2020

Taking Our Temperatures

Gross Domestic Product (GDP) data is like taking the temperature of the economy. It is measured quarterly, with annual numbers calculated from the quarterly data. Revisions are common. First quarters are typically anemic, since it’s after Christmas and things have slowed down. Usually, we pick back up by the second quarter. 

Common measures of a recession are “two quarters of negative GDP,” but economists use broader measures to make this determination. Often, we don’t know if we’re in recession until much later, and we certainly don’t know if we’ve turned a corner till even later.

The Great Recession knocked a hole in GDP, with the last quarter of 2008 logging nearly a 9% decline. Despite this, the annual GDP number was only -0.1%. The next year (2009) gave us a -2.5%, but it’s been in positive mode ever since. While most of Americans struggled to get through the Great Recession, GDP numbers show us turning positive fairly quickly, with a GDP rate of 2.6% in 2010, just over one year into the crisis.

Since then, there have been complaints about the slow pace of growth. Why weren’t we growing at 4-5% rates like we did in previous expansions? Meanwhile, Fed economists tamped down these expectations with long-term projections in the 2-2.5% range. What is holding us back?

Well, we are a mature economy. Once an economy reaches a certain size, it’s difficult to maintain higher percentage growth to get EVEN bigger. It’s just math. Plus, our citizens are reaching a certain maturity. We’re getting older, and population growth is slowing. In order to fuel growth, we need a young and growing population. 

While we are better off than Europe and Japan, we are slowing. Yes, we are still reproducing ourselves, with about 2.2 children per family, but that’s less than previous decades. Young families buy more things, and young workers are needed for the labor force. Improvements in production through technology help but can’t bridge all gaps.

Which brings us to today’s numbers. What I wouldn’t give for a 2% GDP growth rate! Instead, the coronavirus has knocked another hole in the economy. While we suspected we were already in recession, the most recent data prove it. The first quarter of 2020 yielded a negative GDP of 4.8%. Whoa!

But that’s not the worst of it! We only got the wind knocked out of us in the last few weeks of the quarter. January and February were good. That means a full second quarter of an economy in lockdown will be much worse. How much worse? Economists are projecting negative rates in the 30-40% range!

I don’t think we need a bunch of economists to tell us we’re in deep you know what! 30 million people are unemployed. Savings increased to 13%. Consumption declined 7.6% last month, putting the driving force in our economy into reverse. What did we stop spending on? Autos and healthcare. Healthcare, you say!?! What’s up with that?

While we are looking to the healthcare profession to save us from the virus, we are stopping all kinds of other health procedures. Of course, we are ramping up spending on groceries. When this is all over, we may need to head back to the doctors to help us with the damage we’ve done with our comfort eating!

When does this all end? Going forward, we hoped for a V shaped recovery. That’s a big drop, with an immediate climb back up to the top. Because of the nature of the illness and our response, we are now expecting a U shape. Yes, by the third quarter, things will be improving but expect to hang around at the bottom of that U until sometime in 2021.

At that point, what will be our biggest worry? Inflation! Pent-up demand may push prices. Combine this with high levels of debt and—yikes! Well, we’ll worry about that one tomorrow. For now, 2% GDP looks pretty good to me, if only we can get back to those days.

Wednesday, April 22, 2020

Free Oil!

"They're going to be giving this stuff away soon" I mumbled to myself
as I shook change out of a fifteen dollar bill to fill my tank.

When I drive by a gas station with low prices, I remark "they're going to be giving it away soon." It's my inside joke that gets a guaranteed eye roll from whoever else is in the car. Sometimes that is just me. Recently, some gas stations have come close to giving gas away, one near my house sold gas for $1 and gave free sandwiches and water away with a fill up recently. Costco was selling gas $1.17/gallon.

But yesterday - they really were giving it away for free.

To be precise, the price of oil went below $0. People were PAYING to get rid of oil. What's up with that?


First, a primer. If you're trading oil for financial purposes (speculation, hedging, fun or profit, etc) you don't go out and secure a few barrels of the stuff, you trade contracts on a bunch of it. These standardized futures contracts state what type of oil, how much ($10,000 barrels, generally), what type (West Texas Intermediate, in this case) and when it will be delivered (there is a monthly schedule). If you hold the contract when it expires, congratulations, you own the oil! You just need to go to Cushing, OK to pick it up. This is all very standard stuff, and it's right there in the contract:

Delivery shall be made free-on-board ("F.O.B.") at any pipeline or storage facility in Cushing, Oklahoma with pipeline access to Enterprise, Cushing storage or Enbridge, Cushing storage. Delivery shall be made in accordance with all applicable Federal executive orders and all applicable Federal, State and local laws and regulations.

At buyer's option, delivery shall be made by any of the following methods: (1) by interfacility transfer ("pumpover") into a designated pipeline or storage facility with access to seller's incoming pipeline or storage facility; (2) by in-line (or in-system) transfer, or book-out of title to the buyer; or (3) if the seller agrees to such transfer and if the facility used by the seller allows for such transfer, without physical movement of product, by in-tank transfer of title to the buyer.

If you don't want to own the oil, easy, just sell the contract and pick up the next month. Generally, this works pretty smoothly. Again, oil is a widely used commodity and if you don't want it, someone else probably does.

But lately, oil prices haven't been working the same way they generally do. With heavy travel restrictions and everyone working from home, demand for oil in the form of gasoline and jet fuel has declined precipitously. On top of that Saudi Arabia and Russia decided start a price war, pumping as fast as they could and pushing the price down even further. American producers, indebted since the last oil price shock in 2016, kept their rigs pumping even though they starting losing money on every barrel. Having a little money and a lot of bills is better than having no money, and still a lot of bills, they figured.

So oil prices kept dropping, but how did they get negative?

If you're pumping oil, but nobody wants it, you've got to store it. People with storage space, in huge above ground tanks, massive ships or a salt dome in their back yard, charge for storage. That storage was filling up fast. When storage is full, and nobody will buy from you, the price will plummet more. Eventually, you've got to pay someone to take it from you.

A particular problem emerges when people holding contracts for oil realize that they can't store the oil either. If you're just holding the contracts in your brokerage account, or a fund like USO you can't take physical delivery of oil. You have to get rid of those contracts at any price - even if it means paying someone to take them.

That is what happened Monday. Nobody had storage space for oil and nobody wanted to hold their contract as it expired. Brokerages dumped the shares as fast as they could, which meant in some cases they were paying to get rid of them. The price of oil to be delivered in May dropped as low as -$40 at one point!

Could this happen again?

It is not impossible for oil prices to go below zero, but this has been a lesson learned for a lot of market participants. Brokers don't want to be on the hook for closing out customers positions at such a large loss (these are traded using money borrowed from the brokerage, if the value goes negative again, and you can't pay the broker back, that is the broker's problem!). Many will likely update their policies and procedures to keep that from happening again. Plenty of investors will continue to buy oil futures or funds though and storage will continue to fill up. The price action may not be as dramatic next time, but there certainly can be a next time.


Tuesday, April 07, 2020

Unemployment in Mississippi

Today's radio topic was unemployment in Mississippi. We were joined by Jackie Turner, Executive Director and Timothy Rush, Director of Unemployment Insurance, of the Mississippi Department of Employment Security.

Here are the highlights:

  • Unemployment insurance applications, amounts and rules are determined by states. The Federal government is providing an additional $600/week on top of what states provide.
  • Self employed and other 1099 employees are generally not eligible for unemployment benefits. The $600/week Federal benefit will be available to self employed and other 1099 employees.
  • Systems are heavily bogged down with claimants right now!
  • The eligibility requirements for the Federal benefit are new: Mississippi is updating their programs to accept these claims.
  • If you think you are eligible for unemployment, go ahead and start a claim. Even if it is rejected initially, they anticipate being able to accept more claims under the Pandemic Unemployment Assistance program soon.
  • If you are already receiving benefits, the $600 is coming soon, and you don't have to do anything else to receive it.


There have been numerous ways that the Federal Government is getting money out to people and business affected by the Covid-19 related shut downs, and unemployment payments will be a much needed benefit for the record number of people who have found themselves unemployed, furloughed or otherwise very restricted income lately. As part of the CARES Act, there is an additional $600/week benefit to those claiming unemployment.

A few rules have been waived with filings. An order from the Governor waived the initial week wait that was required and you are no longer required to be searching for other employment while receiving benefits. This makes a ton of sense as everyone has been let off for the same reason - their jobs are simply not feasible now.

The unprecedented volume of sign ups has created some issues. Their call center has 900 lines and they are working on adding more. MDES has recently started using employees of the WIN Job centers to receive calls as well. There are a host of other logistical issues too - with many new requirements and regulations on the federal funds, MDES is working overtime to get their systems programmed to accept applicants and get funds out to them.

One huge difference is in how Self-Employed, Sole Proprietors or people paid on a 1099 are able to apply. Previously, if you were self employed, you generally were not eligible for unemployment benefits. The CARES Act does say they should be covered, but the state system is not set up to allow them yet. New guidance which they received over the weekend is helping them accept those workers. This particular program is called Pandemic Unemployment Assistance, Jackie and Timothy strongly recommended that people follow their press releases via social media to see when those applicants would be accepted.

If you were a self employed or 1099 employee, you are encouraged to go ahead and apply. Your initial claim will likely be rejected. Jackie estimates that within a week, they will be going back through rejected claims to see if any are eligible under the new requirements. There will be some more application effort and reporting, but you should be able to receive the benefits.

A truck driver passing through asked about his wife, she had only been employed for a few weeks before being laid off, would she receive any benefits? While the Mississippi Department of Employment Security couldn't speak for Arizona, they stated that her situation would be covered under the new Pandemic Unemployment Assistance rules. Notably, the unemployment system generally looks at the last four quarters of employment to see what your wages were, someone only recently employed would not have any wages there. The new rules should accept them.

A caller asked about a friend who was cut to 30% of his previous salary. Timothy explained that while he would have to report that he was employed and receiving wages, reduced income and forced part time work was still eligible for benefits. The state benefit would likely be very reduced, but the $600/week federal benefit would be on top of the state calculation.

A caller asked when the $600 benefit would start to come. Jackie explained that there was nothing additional that you needed to do to get the $600/weekly benefit. They hoped to have the funds to send out, alongside the state benefit, within a week. The $600/week benefit will continue through July 31st.