Look To TIPS, Not Fed Forecasts, For Inflation Trends

When the Federal Reserve announces its stance on interest rates Wednesday afternoon, it will likely cite stable longer-term inflation expectations as one reason to keep rates low.

But one key measure watched by the Fed suggests that investors aren’t convinced the central bank will successfully reverse its massive infusion of money into markets without sparking inflation.

Treasury inflation-protected securities, or TIPS, indicate investors’ inflation expectations practically in real time.

By some measures, TIPS show a tame inflation outlook. Using the difference between yields on regular Treasurys and TIPS — known as a “breakeven” rate — five-year TIPS are priced for the consumer-price index to rise just 1.8% a year until 2015, and 10-year TIPS are priced for inflation to run at a 2.3% annual rate, below the long-term average for CPI.

But swings in food and energy prices can distort inflation readings short term, while a 10-year average can smooth out meaningful inflation signals.

A better reading can come from the “5yr5yr breakeven,” which uses implied inflation rates on five-year and 10-year TIPS to calculate inflation expectations in the period five to 10 years down the road.

There are different ways to calculate the 5yr5yr breakeven, but according to a version published by the Fed, inflation is expected to exceed 3% per year.

That figure has been stable for several months. However, it also is at levels last regularly seen in 2003 and 2004, when many say the Fed helped inflate the housing bubble.

Barclays Capital’s 5yr5yr measure now reads 2.9%, also on a par with levels in late 2003. Then, “these measures increased because the Fed was keeping rates low” as it’s doing now, says Michael Pond, inflation market strategist at Barclays.

What’s causing this? Not expectations of rapid economic growth.

“Investors appear to be concerned that the Fed may not have the right tools to put quantitative easing into reverse or get the timing right,” says Jeffrey Schoenfeld, co-head of fixed income at Brown Brothers Harriman.

From these levels, when the Fed eventually unveils its exit strategy, a rise in the 5yr5yr could be a signal saying that it isn’t going well.

Credit: By Tom Lauricella

Verizon To Cut 13,000 Jobs–”Economy Not Helping”

Verizon Communications Inc. posted a fourth-quarter loss, said it would cut roughly another 13,000 jobs this year and struck a downbeat note on the economic recovery, even as its wireless arm continued to show growth.

The results underscore the New York telecommunications giant’s dependence on its wireless business, particularly users of smart phones like Motorola Inc.’s Droid, whose increased spending on data services is slowing a slide in the monthly revenue it collects from users.

Verizon took a charge of $3 billion to cover the cost of layoffs in its fixed-line telephone business, which is under pressure as customers give up residential lines and the sluggish economy cuts into business use. The company said business spending has been surprisingly slow to pick up.

“The economy won’t help us as much as we thought,” Chief Executive Ivan Seidenberg said, adding he doesn’t see significant improvement until year’s end. The company has shed roughly 13,000 jobs in each of the past two years and said Tuesday it would make similar cuts this year, representing 5.8% of its total work force of 222,927.

Verizon swung to a fourth-quarter loss of $653 million, or 23 cents a share, compared with a year-earlier profit of $1.23 billion, or 43 cents a share. Revenue jumped 9.9% to $27.09 billion, reflecting the acquisition of wireless provider Alltel.

Verizon Wireless, a joint venture with Vodafone Group PLC, remained the growth engine for the company. Wireless revenue jumped 23% to $15.73 billion. It added 2.2 million total customers, including 1.2 million retail customers who sign long-term contracts, taking its total customer base to 91.2 million.

Carriers have been trying to recoup falling rates for voice calls by tapping the boom in data traffic. Earlier this month, Verizon revamped its wireless-rate plans, lowering the cost of voice plans but requiring more users to buy data packages.

Over the past few months, the company has exploited the perception that its wireless network is superior to AT&T Inc.’s through advertising, trying to blunt the appeal of Apple Inc.’s iPhone, carried exclusively by AT&T. Apple executives Monday reiterated their confidence in AT&T and the carrier’s plans to upgrade its network.

Chief Financial Officer John Killian declined to comment on speculation that Verizon Wireless would get to offer either the anticipated Apple tablet or the next iteration of the iPhone. “It’s their call,” Mr. Killian said about Apple.

Helping the wireless business this quarter was the Droid, which saw moderate success with its holiday launch. The company declined to comment on the phone’s sales, which Verizon backed with a $100 million marketing campaign.

The fixed-line business remained a drag, with revenue falling 3.9% to $11.5 billion. Meanwhile, the company added 153,000 customers to both FiOS Internet and FiOS TV services, driving a 12.6% increase in its average revenue per user. FiOS TV growth, however, was down 50% from a year earlier, and results were considered a disappointment.

“Today’s results were eye-opening, if only because of the magnitude of the divergence,” said Craig Moffett, an analyst at Sanford C. Bernstein & Co. “Wireline results were at least as weak as wireless was strong.”

Hiring, Business Investment and Other Big Variables That Will Drive 2010 Economy

The consensus of economic forecasters expects 2010 to be a year of modest economic growth — almost 3% — much better than the previous two years. But that’s not good enough to bring unemployment — the greatest continuing threat to the economy — close to pre-recession levels.

The consensus is almost always wrong in some respect; the question is in which respects the economy will surprise us. A lot rides on how much hiring employers do. Here are three of the other big variables.

Business investment is primed to rebound. Will it?

The pullback from consumers spooked by an economic downturn spurred an even sharper withdrawal by businesses. Capital spending tumbled during the recession more than it had at any time since the Great Depression. That means it has plenty of room to recover, if businesses can grow more confident.

Business balance sheets overall look promising. Corporate profits are up, the cost of capital is down and productivity is strong.

Firms have plenty of funds to finance investments, from machinery to software. The corporate financing gap, a reflection of how much firms must raise externally, hit a negative $189 billion in the third quarter from a negative $153 billion in the April-June period, according to Federal Reserve data. A negative financing gap means companies have the funds in house to support their capital expenditures.

“Unlike the household sector, the corporate sector is in excellent fiscal condition,” says Robert Barbera, chief economist at Investment Technology Group Inc., a brokerage and financial technology firm. Businesses are “wildly generating more money than they’re using to invest.”

A sustained rebound in capital expenditures can’t occur without a modest improvement in consumer spending. But pent-up demand by businesses, after slashing expenditures sharply in the past year, could prove critical in giving the economy the velocity it needs to recover.

Economists are on counting on some improvement in capital spending. On this front, we could see an upside surprise in 2010.

Will housing heal?

Trouble throughout the housing sector clearly is abating. But homeowners, lenders and builders have a long way to go before regaining confidence.

Sharp home-price declines can lead consumers to spend less and banks, hit by loan losses, to lend less. While the worst of the price drops appear to be over, home values nationwide are expected to show tiny gains — if any — throughout 2010.

The biggest reason: the troubling spike in home foreclosures is nowhere near its end. At the end of the third quarter, 4.5% of loans were in the foreclosure process, up from 3% a year earlier, according to the Mortgage Bankers Association. On top of that, 9.6% of all loans had at least one past-due payment. Until the unemployment rate recovers substantially, improvement will be elusive.

All of that means more homes coming on the market, pushing values lower. “There still is a huge, huge excess of homes,” says Jim O’Sullivan, chief economist at MF Global. Due to better home affordability “you’re going to eat into that glut over time, but nonetheless there’s still a huge excess.”

Much of the recent improvement in sales is due to low mortgage rates, spurred by the Federal Reserve’s purchase of mortgage securities, and a federal tax credit for home buyers. Both are set to expire by the middle of next year. When they do, sales activity will take a hit.

One area of housing could show some hope. Residential investment fell so sharply during the economic downturn that it has little room to decline further.

Sales of new homes in November stood 74% below the July 2005 peak and are unlikely to reach that level again for many years. But inventories have been whittled down to the lowest level since 1971, so construction is likely to rise and contribute to overall growth in the economy.

After two years of turmoil, forecasters’ consensus view is for minor improvement in housing in 2010. For home prices, the risk is clearly to the downside given mounting foreclosures. But home construction, starting from its depressed levels, has a good shot at being a positive surprise for 2010.

Will the economy withstand loss of public-sector support?

The government put the U.S. economy on an artificial heart pump for much of 2009. If the life support comes off as scheduled in 2010, we can expect a few bruising setbacks.

The $787 billion mix of tax cuts and spending deserves credit for helping to spur growth in the economy — and improve confidence — in the second half of this year. Goldman Sachs economists expect fiscal stimulus will continue to boost annualized growth by two percentage points in the first half of 2010. In the second half, the boost is gone.

Outside the labor market, the biggest question mark hanging over the economy is how consumers and businesses respond when the government support fades. Many consumers picked up lower-priced houses and cars in 2009 thanks to government aid. Businesses found construction contracts and cheaper loans thanks to taxpayer support.

Congress and the White House, in an election year plagued by high unemployment, are planning more programs to boost hiring by businesses, support local governments and increase infrastructure spending.

But they’ll face the risk that doing more will create other problems through a rising deficit. “You are getting to the point now where the worries about fiscal sustainability really are intensifying,” J.P. Morgan Chase economist Michael Feroli says. “Slowing down the drag does come with a cost.”

The story of 2010 could be how the economy fared when the government spigots turned off. The consensus expects the private sector to pick up the baton, but the downside risks to the economy as federal aid fades are substantial.