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The US Economy is Strengthening and the Risks from Both China and Greece are Waning.

As expected, FRB Chair Yellen’s remarks were a market nonevent.  Her comments were widely as expected and similar to those made last week reiterating the Central Bank’s intentions to raise interest rates sometime this year, emphasizing the timing of the first rate rise is less important than the subsequent path of increases, which she said would be gradual. Yellen remarked the US economy is strengthening and the risks from both China and Greece are waning.

Yesterday the Fed Beige Book or the statistical compilation utilized at the upcoming Fed meeting was released. The statistics largely supported Yellen’s testimony but I found two details of potential significance.

The first is the comment about possible wage pressures given the recent increases in minimum wage that is creating some competition for some workers. Are wage gains finally gravitating to the lowest rung of the job market’s latter?   The Beige Book reiterated “ongoing tightness for high skilled and specialized workers.”

The second comment is bank lending stating lending “is up a across the board” for the first time since 2007.  Is monetary velocity or the turnover of monies finally accelerating?  As evidenced by second quarter earnings releases from the large financials, loan portfolios are “pristine.”   Banks will not and cannot increase lending if non-performing assets are rising.  I will ardently argue these “pristine” portfolios are a major catalyst for the increased lending “across the board.”

Oil fell yesterday and is down about $8 barrel or about 14% from June 30.  The negative oil narrative is intense, perhaps eclipsing March’s crescendo.   Several times I have commented that Iran’s production will not have an immediate impact, a view that Goldman echoed suggesting that it will be at least 12 months before the infrastructure is created to export more than 500,000 barrels a day.

Moreover yesterday was the first time I read that other firms are questioning the economic viability of many Middle Eastern countries with crude at these levels, commenting that these economies are also subject to the rules of economics.

For example, Saudi Arabia. Saudi Arabia requires $80 oil to meet its budget obligations.  Data will be released shortly about its second quarter budget shortfalls.   At the end of the first quarter, Saudi Arabia projected 2015 state revenues to decline by 33.7% to $186 billion while public spending, spending required to placate its largely unemployed youth, is expected to remain unchanged at $290.9 billion.

To meet this shortfall, Saudi Arabia intends to utilize its large foreign currency reserves and the international debt market.  First quarter data indicated its foreign reserve balances dropped by the largest amount on record…about 5% of its total.

I must further write Saudi Arabia’s first quarter deficits were considerably higher than those projected at the beginning of the year.

The report suggested Saudi Arabia cannot infinitely continue generating these large deficits and at some juncture must reduce production to raise prices, a view that I have held for about five months. .  [Note: Saudi Arabia is approximately 50% of OPEC’s oil production and 25% of global production]

Is this a radical thought?  If I wrote 12 months ago of budding formal military alliance between the Sunni nations and Israel because of American foreign policy, most would think such thoughts as ludicrous.

What will happen today?  Earning season continues.  Yesterday I read a report supporting a long held view that analysts’ estimates are on the verge of becoming meaningless given how results have consistently exceeded expectations.  The Bloomberg report further states market reaction to positive surprises is virtually nonexistent but the response to negative surprises have increased considerably.

Yellen’s Congressional testimony continues today.   While most expect her testimony to be a non-event, anytime any Fed official speaks could be of significance.

Last night the foreign markets were up. London was up 1.60%, Paris up 1.63% and Frankfurt up 1.44%.  Japan was up 0.67% and Hang Sang up 0.43%.

The Dow should open nominally higher on the belief that central banks will do what is needed, including weakening their currencies via very accommodative monetary policy to bolster their economies.  Moreover and as expected, Greece approved the latest austerity measures.  The 10-year is off 8/32 to yield 2.38%.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.