Macro Roundup

“…As with any simplified model, the analysis is silent about some potentially important issues - such as the effect of the corporate tax on savings, growth and other dynamics - that may also have important effects on corporate tax incidence..."Assumptions (these are the big two) 1. “…The application starts with an assumption that capital is perfectly mobile internationally…” 2. “…also assumes initially that the degree of international output substitutability does not matter because the corporate tradable sectors have equal output capital intensities…”NOTE both of the above assumptions are “relaxed later in the application”3. “…The world consists of two countries. In an initial equilibrium, both economies are identical except for size. For each economy, production is divided into five sectors that each produce goods or services using labor, capital and (for agriculture) land. All production technologies are characterized by constant returns to scale; production functions are twice-differentiable and concave; competition is perfect at the level of the producer. The first three sectors are corporate. Sector one produces internationally tradable outputs for which the foreign and domestic products are perfect demand substitutes. The output from that sector is the numeraire. Sector two produces internationally tradable outputs for which the foreign and domestic products are not perfect demand substitutes. Sector three produces non-internationally tradable outputs for which consumption must occur in the same country as production; examples include utilities and transportation services. Sectors four and five are noncorporate sectors. Sector four produces internationally tradeable agricultural products. Sector five produces outputs that are not internationally tradeable, such as residential housing and retail services..." 4. “…Labor is homogeneous and perfectly mobile within each country, but cannot move between countries. Thus, the wage rate is the same for every sector within a country, but can differ between countries. Individuals do not vary their amount of labor supplied to the market…” 5. “…The worldwide supply of capital is fixed but perfectly mobile between countries in that the geographic location of investment does not matter to a marginal investor…” 6. “…The marginal return to investment is the same everywhere in equilibrium, excluding producer-level taxes on capital income…” 7. “…Capital owners can own capital in either country, but cannot themselves relocate abroad. Each owns a fixed share of the world capital stock…” 8. “…Consumers have identical homothetic preferences and must consume where they live. They can choose from among the five types of outputs produced in their own country (or imported from the other country in the case of outputs from sectors one and four) and imports of the unique output from sector two of the other country. Initial consumer expenditures on the six types of goods and services are proportional to the initial shares of worldwide production…” 9. “…The domestic government collects taxes and makes lump-sum distributions. In order to isolate the effects of the corporate income tax, the government’s other policies are assumed to affect neither economic efficiency nor the distribution of income. With any available tax revenues, the domestic government purchases the six available varieties of consumer goods according to the same expenditure shares as domestic consumers. The government redistributes that bundle of commodities to domestic residents in proportion to their incomes. The foreign government does not respond to any tax policies chosen by the domestic government…” 10. "...assuming that the input substitution elasticities are identical in all sectors and countries...." 11. "...assumed here that the domestic country does not produce enough to affect the world price of output in that sector..." 12. "...The model can be applied based on very few assumptions about the economy. Share assumptions (Table 1) apply for the United States and are taken from Gravelle and Smetters (2006).21 The capital intensities of sectors one and two are initially equated for simplicity. When those capital intensities are equal, the incidence results are the same as if the first two sectors are combined into one sector for which the foreign and domestic outputs are perfect substitutes. In other words, the fact that sector two produces foreign and domestic outputs that are not perfect substitutes does not affect the incidence results when the first two sectors have the same capital intensities. A later part of the application examines how incidence changes when those capital intensities are different. The domestic economy accounts for 30 percent of world output. In addition, domestic residents are assumed to own 30 percent of world output, so the country is neither a net international lender nor a net international borrower. That assumption is also relaxed later in this study..." 13. "...The tax burden is not exported or imported in the aggregate because the initial domestic and foreign per capital wealth endowments are assumed to be equal, and because the corporate tax has no tariff-like effects when the first two sectors have the same capital intensities..." 14. "...The excess burden, measured as a share of revenue, is largest when the domestic economy is smallest. That excess arises because the corporate tax causes capital to be allocated inefficiently away from the domestic corporate sector and out of the domestic economy. Both sources of inefficiency become smaller relative to domestic revenue as the domestic economy is assumed to be relatively larger..." 15. "...the marginal investor is still assumed to be indifferent between domestic and foreign investments that pay the same rate of return, but only for investments in some of the countries - perhaps between the highly industrialized countries...." 16. "...However, the capital intensities and output shares can be specified in a way that is consistent with Harberger’s (1995) assumptions: that labor employed in the first two sectors accounts for one-fourth of the domestic labor force; that capital used in the first two sectors accounts for one-half of all capital used in the corporate sectors; and that domestic capital accounts for three-eighths of the world’s capital stock. Otherwise, the parameter values (Table A1) have been completed with share assumptions. Alternatively, the first three sectors can be assumed to have the same relative capital intensities as in Table 1, but the capital intensity of sector five must be much lower for the Harberger (1995) assumptions to be satisfied. Either way, those assumptions do not appear to be reasonable for the U.S. economy. Sector three includes utilities and transportation, both of which are more capital-intensive than the manufacturing in sectors one and two. Sector five includes housing and retail services, for which production is much more capital intensive than manufacturing. Under the assumptions in Table A1, the domestic consumer’s burden is -95.8 percent of the revenue, while the foreign consumer’s burden is -0.04 percent of the revenue made by Gravelle and Smetters (2006), most critical of which is the assumption that labor receives about 70 percent of the value of total output. Compared to the base case in this study (Table 1), the capital intensity is assumed to be higher in the first two sectors (manufacturing). Also, in contrast to the base case, sector three (utilities) is assumed to be less capital intensive than the first two sectors...." Randolph, William, “International Burdens of the Corporate Income Tax,” Congressional Budget Office, August 2006. Available at:http://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/75xx/doc7503/2006-09.pdf

From the article the annualized numbers are roughly:

$1.4 T (= 995 x 12/8) total
$600 B share buy back
$ 60 B capex
$500 B repay debt
$150 B mergers

Very little is used for investment. Half is refinacing to get a lower rate and half is share buy back. Acquisition are just refinancing and share buybacks (of other companies). Given the size of the share buy backs there doesn't appear to be much net cash on corp balance sheets. Yes, companies build up cash to avoid repatriation taxes but then they borrow against that cash and buy back shares which is economically equivalent to paying dividends.

"U.S. corporate-bond issuance is hurtling toward a record for the third consecutive year...Companies around the globe have sold about $994.9 billion of bonds in the U.S. this year as of Thursday morning....up more than 4% from a year ago, with sales on pace to cross the $1 trillion mark at the fastest clip on record. A $4.5 billion sale Thursday from Bank of America Corp. put the total closer to that milestone....Acquisitions have about doubled in the U.S. from last year to a recent $1.1 trillion, and U.S. bond sales earmarked for capital spending—purchases or upgrades of long-lived assets such as plant and equipment—have risen 90% from a year earlier to $40 billion...Capital expenditures fell by 1% globally in real terms in 2013, according to Standard & Poor's.About $315 billion of corporate bonds have been sold in the U.S. to repay or refinance existing debt, an approximately 35% increase over last year."U.S. Bond Issuance Nears $1 Trillion Companies Take Advantage of Low Interest Rates to Issue Bonds By MIKE CHERNEY Updated Aug. 21, 2014 7:59 p.m. ET

Cherney, Mike, "U.S. Bond Issuance Nears $1 Trillion," Wall Street Journal, August 21, 2014. Available at:http://online.wsj.com/articles/u-s-bond-issuance-nears-1-trillion-1408651952

Monsanto didn't immediately respond to a request for comment.

MonsantoCo. this summer sold $4.5 billion of bonds to help pay for a $6 billion share buyback plan. Bond analysts often take a negative view on such so-called leveraged buybacks, because they potentially reward shareholders with higher stock prices at the expense of bondholders, who face higher debt-service costs on the same revenue base and could lead to a downgrade.

Share buybacks have been another popular use of bond proceeds. S&P 500 companies bought back about $158.4 billion in the first quarter, the third-largest quarterly amount since 2005, according to FactSet.

"Management teams are looking to increase shareholder value in a slow-growth environment," said Jim Keenan, head of credit atBlackRockInc.

According to Dealogic, about $109 billion in bonds has been sold globally this year that identified mergers as a use of proceeds, up from $84 billion at this time last year.

This year's Numericable bond deal was the largest junk-rated offering on record, and was sold to help finance the company's acquisition ofVivendiSA 's telecom unit SFR.

AppleInc. sold $12 billion in April, the largest corporate deal this year. French cable operatorNumericable Groupsold $10.88 billion, also in April, andOracleCorp. sold $10 billion in June, according to Dealogic. Last year, Verizon CommunicationsInc. sold a whopping $49 billion, in what remains the largest corporate deal on record.

"I can't think of an environment where people have been more on the wrong side of the boat from where they think rates are going to go," said Tom Murphy, senior portfolio manager at Columbia Management, which has been buying some 30-year corporate bonds recently.

Investors have been lapping up the new debt offerings. Bankers on some deals say they received many more investor orders than bonds available, as portfolio managers seek out securities that offer more yield than Treasurys and bet that the improving economy will ultimately be good for American companies.

Instead, rates have fallen, with the 10-year U.S. Treasury yield recently hitting a 14-month low at 2.3%. Analysts said the decline reflects the uneven domestic growth outlook, geopolitical unrest in Ukraine, Israel and Iraq and fears that Europe is facing a new economic slowdown.

The flurry of bond deals has caught many Wall Street analysts off guard. Market experts broadly expected benchmark U.S. Treasury rates to tick up from 3% at the end of 2013 as the economy grew and the Federal Reserve prepared to end its monthly stimulus, developments that were expected to hit the prices of bonds and trim demand for new debt issues.

At Continental Resources, Mr. Hart said May's bond sale also helped the company reduce costs by refinancing existing, higher-rate bonds.

"We looked at the markets, and we wanted to take advantage of the compelling opportunity that we saw in lower interest rates," said Linda Sullivan, senior vice president and chief financial officer at American Water.

American Water WorksCo., the largest publicly traded U.S. water utility, sold $500 million in 11-year and 28-year bonds earlier this month, with rates of 3.4% and 4.3%, respectively. Some of the proceeds went to pay off existing long-term debt that carried rates of between 4.9% and about 6%.

"There is still a level of uncertainty in the executive suite," said Dan Heckman, senior fixed-income strategist at U.S. Bank Wealth Management, which oversees $124 billion.

The sums raised to refinance debt, bolster corporate cash and pay shareholders underscore the difficulty of finding high-returning investments five years after the financial crisis, amid uneven U.S. growth and low interest rates. Central-bank officials are gathering this week in Jackson Hole, Wyo., to discuss the economic outlook and the pace of potential Federal Reserve rate increases among other issues.

While bond sales tabbed to capital spending have risen, they remain below their pace about a decade ago, Dealogic said. Capital expenditures fell by 1% globally in real terms in 2013, according to Standard & Poor's.About $315 billion of corporate bonds have been sold in the U.S. to repay or refinance existing debt, an approximately 35% increase over last year, according to Dealogic.

At the same time, much of the cash is being used to refinance existing debt, being sent back to shareholders as dividend payments and share buybacks, or banked in the corporate treasury as executives consider how to potentially deploy funds as the economy expands.

Also in May, a subsidiary ofCheniere Energy PartnersLP sold 10-year bonds to help pay for an expansion at a natural-gas facility in Louisiana. The company initially intended to sell $1.5 billion but was able to increase the size of its offering to $2 billion.

Without the favorable bond-market environment, "potentially, our capex would be less," Mr. Hart said.

Mr. Hart said the company tapped the debt markets this year because "we've viewed them as an attractive source of financing." He added, "It has certainly been a very attractive market for us."

Continental ResourcesInc. sold $1.7 billion of debt with 10- and 30-year terms in May, with some of the money helping to fund the Oklahoma City, Okla., company's oil-drilling and development operations in North Dakota and Oklahoma, said John Hart, chief financial officer.

Investors and analysts say companies are raising funds partly with an eye to investing in fresh projects as the U.S. economy gains pace, a move that can further help along economic growth. Acquisitions have about doubled in the U.S. from last year to a recent $1.1 trillion, and U.S. bond sales earmarked for capital spending—purchases or upgrades of long-lived assets such as plant and equipment—have risen 90% from a year earlier to $40 billion, Dealogic said.

Companies around the globe have sold about $994.9 billion of bonds in the U.S. this year as of Thursday morning, according to data provider Dealogic, which has figures dating back to 1995. That is up more than 4% from a year ago, with sales on pace to cross the $1 trillion mark at the fastest clip on record. A $4.5 billion sale Thursday fromBank of AmericaCorp. put the total closer to that milestone.

U.S. corporate-bond issuance is hurtling toward a record for the third consecutive year, as companies take advantage of a surprising interest-rate decline to stock up on cash.

on inflationary expectations. had to read this closely, I don't really"believe" in a natural rate of interest (if that makes sense) but I get it "...Over 2007 to mid-2010, a constant 6-10 year expected rate+term premium of 2.3%/year (save for the height of the financial crisis itself, with the yield spike from fears of TIP illiquidity). Ms Market appears confident that whatever happens, by 6-10 years out the ocean will be calm and flat again at the global savings glut Wicksellian real natural rate of 2.3%/year. And over 2007 to 2010 we have (a) the steep fall in the 5-Year TIPS yield as Ms Market expects aggressive monetary policy over a five-year horizon, (b) the step rise in the yield as Ms Market thinks something very bad might and then is happening to TIPS liquidity, (c) the return to normal slow-recovery views of the 5-Year TIPS yield like these previously seen over 2003 to mid-2005, and (d) the further collapse of the 5-Year TIPS yield to zero as Ms Market recognizes that this is not your normal slow recovery, that there are few if any of Tim Geithner’s “green shoots”, and that it will be a long slog...Over mid-2010 to mid-2013, the collapse in the 5-Yr TIPS yield to -1.4%/year and the collapse in the 6-10 year expected rate+term premium to 0%/year as Ms Market recognizes that this time-with QE∞, permanent underemployment, and secular stagnation-really is different... Since late 2013, a belief by Ms Market that the Federal Reserve is still planning to start serious normalization-but with a start date that seems to be pushed out an extra week for every week that passes-coupled with a dawning recognition that we are unlikely to be anywhere close to normal in years 6-10, hence the late-2013 belief that you should bet on the economy being at a semi-normal Wicksellian real natural interest rate in 2020 was probably wrong...If I were an inflation hawk I would say that right now Ms Market expects us to get the economy in five years to a place where it is then doing its normal thing that it does when we target 2%/year inflation-and that is a powerful sign that our current taper policy is on the right track.But when I look at the sub-zero 5-Year TIP and at the 0.6%/year 6-10 Year TIP I read that as Ms Market decoupling its inflation expectations from its real growth and real interest rate expectations, and not in a good way..." Does the New Bond Market Conundrum Tell Us Anything? If So, What?: Tuesday Focus for September 2, 2014 byBrad DeLongPosted on September 2, 2014 at 12:26 pm

We are very far away from anything I would like to call “social science” or even “forecasting” here-“haruspicy”, or perhaps“plastromancy”captures it better…

With that caveat, I have been struck for a while by what we see when we break up the 10-Year TIPS rate into its 5-Year TIPS and its 6-10-Year Forward TIPS components:

If you read this graph as showing the expectations of Ms Market over the next five and the subsequent five years, we get the following for the market’s ideas about the real interest rate:

1) Over 2003 to mid-2005, a constant 0-5 year rate and a 6-10 year expected rate+term premium that falls from 3%/year to 2.3%/year, presumably as Ms Market adjusts to the idea that there might actually be a global savings glut and hence a lower Wicksellian real natural interest rate in the long run:

2) Over mid-2005 to 2006, a rise in the 0-5 year rate to 2.3%/year or so and a 6-10 year expected rate+term premium that remains steady, presumably as Ms Market now expects more of a full-employment economy and a stronger demand for funds to finance real investment than had seemed likely before mid-2005:

3) Over 2007 to mid-2010, a constant 6-10 year expected rate+term premium of 2.3%/year (save for the height of the financial crisis itself, with the yield spike from fears of TIP illiquidity). Ms Market appears confident that whatever happens, by 6-10 years out the ocean will be calm and flat again at the global savings glut Wicksellian real natural rate of 2.3%/year. And over 2007 to 2010 we have (a) the steep fall in the 5-Year TIPS yield as Ms Market expects aggressive monetary policy over a five-year horizon, (b) the step rise in the yield as Ms Market thinks something very bad might and then is happening to TIPS liquidity, (c) the return to normal slow-recovery views of the 5-Year TIPS yield like these previously seen over 2003 to mid-2005, and (d) the further collapse of the 5-Year TIPS yield to zero as Ms Market recognizes that this is not your normal slow recovery, that there are few if any of Tim Geithner’s “green shoots”, and that it will be a long slog:

4) Over mid-2010 to mid-2013, the collapse in the 5-Yr TIPS yield to -1.4%/year and the collapse in the 6-10 year expected rate+term premium to 0%/year as Ms Market recognizes that this time-with QE∞, permanent underemployment, and secular stagnation-really is different:

4) In 2013, taper-talk: Bernanke’s announcements interpreted as signaling that the FOMC thinks the question is not whether but when to normalize, and the consequent rapid semi-normalization of the 6-10 year expected rate+term premium and rapid rise of the 5-Year TIPS to near 0%/year:

5) Since late 2013, a belief by Ms Market that the Federal Reserve is still planning to start serious normalization-but with a start date that seems to be pushed out an extra week for every week that passes-coupled with a dawning recognition that we are unlikely to be anywhere close to normal in years 6-10, hence the late-2013 belief that you should bet on the economy being at a semi-normal Wicksellian real natural interest rate in 2020 was probably wrong:

Is there actually an intelligent entity-some kind of distributed anthology intelligence suffering from some sort of aphasia-that we call Ms Market that actually has expectations and whose expectations we can read off of bond yields? And if there is such an entity, is there any reason we should pay any attention to her expectations either as guides to some central tendency of investor sentiment or as forecasts that are in their own right worth incorporating into our own information sets, and hence into our own forecasts? Who knows? I don’t.

What I do know is that if we are willing to divine some market-sentiment-macro-expectations factor out of TIPS and other yields, the past eight months or so have seen Ms Market become much more pessimistic about the state of the real economy and thus of real interest rates six to ten years hence.

The one thing casting doubt on this interpretation is the failure of the 6-10 year inflation break-even to decline. It has been hanging out there at 2.5%/year (with notably rare exceptions) since 2004:

If I were an inflation hawk I would say that right now Ms Market expects us to get the economy in five years to a place where it is then doing its normal thing that it does when we target 2%/year inflation-and that is a powerful sign that our current taper policy is on the right track. But when I look at the sub-zero 5-Year TIP and at the 0.6%/year 6-10 Year TIP I read that as Ms Market decoupling its inflation expectations from its real growth and real interest rate expectations, and not in a good way.

The new bond market conundrum is thus yet another reason for the sun to appear dark in my eyes…

David Beckworth uses a decomposition of the long term interest rate into an average expected real short-term interest rate, average expected inflation, and a term premium to argue that it’s the term premium has been steadily falling…. James Hamilton writes that… while the… 10-year Treasury has been falling… the 5-year yield has held fairly steady…. Something happened this year to persuade people that rates in the future (for 5 to 10 years from now) were going to be lower than they had been expecting. Robin Harding and Michael Mackenzie write that this is unprecedented…. James Hamilton writes that it’s hard to attribute it to changing perceptions about the Fed… DeLong, Brad, "Does the New Bond Market Conundrum Tell Us Anything? If So, What?" Washington Center for Equitable Growth, September 2, 2014. Available at:http://equitablegrowth.org/2014/09/02/new-bond-market-conundrum-tell-us-anything-tuesday-focus-september-2-2014/

Jeff Sommer… David Beckworth… Marc to Market…. James Hamilton writes that as the U.S. economy returns to healthier growth, many of us expected long-term interest rates to return to more normal historical levels. But the general trend has been down…. In… 2005… Greenspan noted that long-term interest rates trended lower in recent months even as the Federal Reserve raised the level of the target federal funds rate by 150 basis points… to the expectations theory of interest rates were long rates are the geometric average of expected future short rates plus a risk premium that would usually increase with duration of the instrument….

Jérémie Cohen-Setton:Blogs review: The bond market conundrum redux:“Are we seeing a new version of the Greenspan 2005 conundrum?… Fed tapering was widely expected to push up US yields. Instead, US yields have fallen since the beginning of the year…. A successful explanation of this new conundrum cannot just rely on a flight to safety… it also needs to rationalize why 5-year… and 10-year yield have diverged….

The extremely-sharpJérémie Cohen-Settonhas a roundup:

"...is that the amount of variation within metro areas was often as big as, if not greater than, the variation between them....These variations affect who ended up cutting their debt loads the most. Debt reduction since 2007 has been heavily concentrated in extremely indebted neighborhoods, also according to the Cleveland Fed. Many of these ultra-borrowers did not reduce their debt burdens solely out of their income. According to a study from the New York Fed published at the end of last year, foreclosures (red) reduced mortgage balances more than paydowns (green)..."Where are Americans’ debts?Matthew C Klein | Sep 03 18:10 |

Klein, Matt, "Where are Americans’ debts?" FT Alphaville, September 3, 2014. Available at:http://ftalphaville.ft.com/2014/09/03/1954961/where-are-americans-debts/

The concentration of extreme indebtedness among a relatively small subset of the US population may help explain why politicians had relatively little interest in doing anything to mitigate the damage caused byforeclosures. Hopefully the research produced in the aftermath of the crisis will help limit a repeat performance.

Many of these ultra-borrowers did not reduce their debt burdens solely out of their income. According to a study from the New York Fed published at the end of last year, foreclosures (red) reduced mortgage balancesmore than paydowns (green):

These variations affect who ended up cutting their debt loads the most. Debt reduction since 2007 has been heavily concentrated in extremely indebted neighborhoods, also according to the Cleveland Fed.

Even parts of Las Vegas, which gorged itself on widely available credit during the go-go years, were relatively free of debt during the peak of the bubble:

Consider Columbus, Ohio, which is about average in terms of household indebtedness. The chart below looks at debt-to-income ratios by census tract for the city and its suburbs. As you can see, some parts of the city carry very little debt, while other areas — both in the suburban periphery and in the core — borrow a lot relative to what they earn:

What’s striking to us, from aResearch notepublished by the Federal Reserve Bank of Cleveland, is that the amount of variationwithinmetro areas was often as big as, if not greater than, the variation between them.

During the peak of the bubble, the average Nevadan carried about two-and-a-half times as much mortgage and consumer debt as the average Texan, according to theFederal Reserve Bank of New York:

Excessive US household borrowing of the 2000s was not evenly distributed.