Financial Market Affects September 7, 2015

In a holiday-shortened week, the stock market moved modestly higher while the bond market saw a minor price decline with yields moving slightly higher.  Tuesday, global stock markets moved higher on expectations the Chinese government will employ additional monetary stimulus measures and on news that China’s exports fell less than expected.

China also stimulated their stock market by eliminating personal income taxes on dividends for shareholders who hold stocks for more than a year and by cutting taxes in half on dividends for those shareholders holding positions between a month and a year.  Bond prices retreated when investors left safe-haven assets in favor of riskier stock market investments.

On Wednesday, the JOLTS Job Openings report for July caught investor attention by showing an increase of 430,000 job openings to 5.753 million, a record high.  This was a rise of 3.9% from the 5.249 million openings reported in June.  However, the hiring rate fell to 3.5% from 3.7% in June.  The quits rate remained at 1.9%.  The slower rate of hiring suggests employers could be having difficulties finding qualified workers and this in turn could eventually lift wages.  Also, there was a substantial drop in the number of unemployed job seekers per open job to a record low ratio of 1.44 from 1.56 in June.  Bottom line, the data in this JOLTS report could draw the attention of the Federal Reserve’s FOMC members during their monetary policy meeting this coming week.

In mortgage news, the Mortgage Bankers Association released their Mortgage Application Data for the week ended August 28.  Overall the Index fell 6.2%.  The Refinance Index dropped 10.0% from the prior week, while the seasonally adjusted Purchase Index fell decreased by 1.0% from a week earlier.  However, Purchases on a year-over-year basis are 41% higher.  Overall, the refinance portion of mortgage activity decreased to 56.9% from 58.7% of total applications the previous week.  The adjustable-rate mortgage segment of activity decreased to 6.9% of total applications from 7.5% in the prior week.  The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balance increased to 4.10% from 4.08%.

Thursday was characterized by some choppy trading when both stocks and bonds opened lower.  However, after struggling to find direction in the early going, stocks gained strength and firmed up heading into afternoon trading while bond prices continued to pull back.  The day’s economic data was mostly seen as a positive for the economy.

The Labor Department reported weekly Initial Jobless Claims fell to a seasonally adjusted 275,000 last week to match the consensus forecast.  Jobless Claims have now remained below 300,000, the level typically associated with a strengthening labor market, for more than six months.  Continuing Jobless Claims edged higher to 2,260,000 during the week ended August 29 from 2,259,000 in the prior week.  The consensus estimate was for 2,257,000 continuing claims.

Further, U.S. Import Prices excluding oil declined by 0.4% percent in August, indicating persistent downward inflation pressure that may have an effect on the Fed’s decision to lift interest rates.  Export Prices excluding agriculture fell 1.3% during August.

On Friday, the stock market opened to the downside then slowly strengthened to end up in positive territory at the close of trading while bond prices opened slightly higher and then improved on economic news.  Traders received a couple of noteworthy economic reports.  First, the Producer Price Index (PPI) for August was reported unchanged after rising 0.2% in July.  This was slightly higher than the consensus forecast of -0.1%.

When excluding volatile food and energy prices, the Core PPI increased 0.3% month-over-month after a similar rise in July.  This exceeded the consensus forecast of 0.1% and was attributed to widening profit margins at clothing retailers.  Year-over-year the PPI is -0.8% while the Core PPI is +0.9%.  The data suggests there is benign inflation pressure that could influence the Federal Reserve’s decision on monetary policy during this coming week’s FOMC meeting.

Further, the University of Michigan’s preliminary Consumer Sentiment Index for September was reported at 85.7, below consensus expectations for 91.5 and down from the August reading of 91.9.  This is the lowest recording of the Consumer Sentiment Index since it reached 84.6 in September 2014.  The overall decline in the Consumer Sentiment Index is a likely outcome from the sharp decline in stock prices that began at the end of August.

Overall, investors have seemed to reduce their expectations the Fed will raise interest rates due to stock market turmoil originating from concerns over slowing Chinese and global economic growth.  If Fed officials do not raise rates on Thursday, they could still suggest a rate increase remains on the table for its October or December FOMC meetings.

For the week, the FNMA 3.5% coupon bond lost 35.9 basis points to end at $103.63 while the 10-year Treasury yield gained 5.5 basis points to end at 2.19%.  Stocks ended the week with the NASDAQ Composite gaining 138.42 points to close at 4,822.34.  The Dow Jones Industrial Average rose 330.71 points to end at 16,433.09, and the S&P 500 added 39.83 points to close at 1,961.05.

Year to date, and exclusive of any dividends, the NASDAQ Composite has gained 1.79%, the Dow Jones Industrial Average has dropped 8.46%, and the S&P 500 has fallen 4.99%.  The national average 30-year mortgage rate moved to 3.99% from 3.97% while the 15-year mortgage rate increased to 3.25% from 3.24%.  The 5/1 ARM mortgage rate increased to 2.99% from 2.98%.  FHA 30-year rates increased to 3.75% from 3.70% while Jumbo 30-year rates increased to 3.81% from 3.79%.

Mortgage Rate Forecast with Chart

For the week, the FNMA 30-year 3.5% coupon bond ($103.63, -35.9 bp) traded within a 53 basis point range between a weekly intraday high of 104.00 and a weekly intraday low of $103.47 before closing at $103.63 on Friday.  Mortgage Bonds had their monthly coupon rollover Thursday evening after market close and the effect of this rollover was -32 basis points.  The candlestick formed on the technical chart for Thursday due to this reset has to be discounted.  Due to the coupon rollover reset, our technical support and resistance levels are reassigned as follows:  primary support is defined by the 100-day moving average at $103.60 while resistance becomes the 25-day moving average at $103.76.

The bond slipped lower during a holiday-shortened week to trade around technical support levels as traders employed a cautious approach ahead of the weekend and the Federal Reserve’s pending FOMC meeting that takes place on Wednesday and Thursday.  We should expect to see the financial markets continue to trade in a very restrained manner until the rate decision and accompanying commentary is released next Thursday afternoon.  This coming week the technical picture for bonds will take a back seat to the FOMC meeting.  If the bond market responds favorably to the FOMC meeting, we should see mortgage rates improve while a negative reaction could result in worsening mortgage rates.

Chart:  FNMA 30-Year 3.5% Coupon Bond

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Economic Calendar – for the Week of September 14

The economic calendar increases in importance this week with several potential market-moving reports and events.  The Consumer Price Index (CPI) and Core CPI on Wednesday will take on added significance as these will be the last inflation measures before Thursday’s FOMC interest rate decision.  Economic reports having the greatest potential impact on the financial markets this coming week are highlighted in bold.

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Road Signs – Want worker wages to rise? End the corporate income tax

By Laurence J Kotlikoff, Professor of Economics at Boston University

Workers’ wages have stagnated, even as the unemployment rate has plunged to a seven-year low and the economy is bounding ahead.  Some people propose raising the federal minimum wage and bolstering labor unions to address slow growth in wages.

One great way to lift pay that is not discussed often enough would be to end the corporate income tax.  Not just cut it, kill it, but not in a way that’s a sop to the rich.

Sound extreme?  Here’s why it’s a smart and progressive idea that would raise wages, lower employment, boost investment and give the economy enough vim so that the Federal Reserve’s Janet Yellen can increase interest rates without restless nights.  And it would eliminate the incentive for companies to move their tax homes abroad (such as by doing corporate inversions) and encourage more businesses to establish their headquarters here.

Time is ripe

First off, the timing is good.  Corporate tax reform is one of the few areas where we might see some legislation supported by the Republican Congress and the Democratic president.  The latter may not be quite ready to go for the elimination of corporate taxes, but he should think about it.

Second, the US may have the highest marginal rates of any developed country, ranging from 23% to 35% depending on who you ask.

The actual average or effective rate companies pay on their profits, however, is about 13%, because so much of it is sitting overseas and untaxed – in addition to the many loopholes and deductions that employ small armies of accountants and lawyers.  In 2013, the tax produced revenue equal to only 1.8% of GDP, a pittance compared with 8.1% for personal federal income taxes.

Where the corporate tax ax falls hardest

One of the problems in reforming corporate taxes is that in the popular imagination it is a levy on companies and their owners.  But many economists, going back to David Bradford in 1978 and including myself, have concluded that the tax may actually fall hardest on workers – not the owners of corporations, which, truth be told, includes workers via their holdings of stock in their 401(k)s.

That’s primarily because while workers are relatively immobile and are unlikely to travel far for a job, capital is not and is generally free to roam far and wide in search of a better home – that is, one with less regulation and with less tax.  When the capital flees, workers lose their jobs, and wages decline.  Ireland was a beneficiary of this during the so-called Irish Miracle in the late 1980s when a 75% cut in its corporate tax rate led to a massive inflow of capital, the establishment of more than 1,000 corporate headquarters, and dramatic increases in workers’ wages.

The same thing would happen here

I’ve been working with colleagues through the Fiscal Analysis Center to create a large-scale computer simulation model of the United States economy to show how it interacts over time with other nations’ economies.  We then used the model to see how it reacts to eliminating the US corporate income tax in conjunction with raising personal income taxes.  The findings make a strong, worker-based case for reform.

The model shows that ending the corporate income tax creates rapid and dramatic increases in investment, GDP and real wages, which help self-finance the lost revenue. The rest of the money the US Treasury would lose could be replaced with higher personal income tax rates, leading to a huge short-run inflow of capital.  US capital stock – machines and buildings – would increase 23%, output would climb 8% and wages would go up 12%.

Benefits also accrue if the tax is just trimmed, down to 9%, and loopholes eliminated – a revenue-neutral corporate tax base broadening.  In that case, the capital stock would increase 17%, output would grow 6% and wages would rise 8%.

A boon for the future

Both policies, eliminating and trimming, create gains in welfare for all Americans, but especially for today’s youth and future workers.  If other countries followed the US lead and cut their rates as well, the benefits would be smaller, but still significant.

Another way to eliminate the corporate income tax, which I’ve previously proposed, would be to force shareholders to pay income taxes on their companies’ profits as they accrue.  This gives companies no tax-related reason to leave the US, while ensuring shareholders rather than workers make up for any revenue losses.

Either way, getting rid of the tax may be a difficult political pill to swallow.  It sounds like a giveaway to corporate interests, but nothing could be further from the truth.  Rather, doing so would give the economy and workers a tremendous boost, just what it needs to achieve escape velocity.

Laurence J Kotlikoff is president of Economic Security Planning, Inc. and director of The Fiscal Analysis Center.