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Halloween candy

Halloween is upon us─the only time children are encouraged to receive candy from total strangers. And it feels like this ritual is becoming more important every year, which might put pressure on the market for candy. FRED does not have data about candy sales, but it does have a price index for it. If we compare that index with the general consumer price index, maybe we can unearth something about our hypothesis.

It turns out this is a ghostly idea: There’s literally nothing to see. Candy price data start in December 1997; so, after setting both series to 100 at that date, the current numbers are virtually indistinguishable. This may be due to uncanny luck, as candy prices were at times as much as 10% below general prices, including at the end of the last economic boom. So maybe this shadowy idea about candy price pressure applies only to the time since the Great Recession. Or perhaps our hypothesis simply has no bearing on the price of candy because candy supply can easily accommodate fluctuations in demand. All in all, nothing scary to report.

How this graph was created: Search for “candy” and the candy price index should be your first choice. Then add the CPI  series. Modify the latter’s units to show 100 in 1997-12-01.

Suggested by Christian Zimmermann

View on FRED, series used in this post: CPIAUCSL, CUUR0000SEFR02

The changing composition of U.S. trade

Over the past 30 years, the composition of U.S. trade among its partners has changed dramatically. New economic powers, trade agreements, technological advancements, and changes in policy preferences are all contributing factors. The four graphs in this post examine the evolution of imports, exports, and trade balances between the U.S. and four of its largest trading partners: China, Canada, Mexico, and Japan. The graph above shows trade patterns between the U.S. and China from 1985 to 2015. Both imports and exports have dramatically increased, but imports have outpaced exports, resulting in a large trade deficit. (See the green line, which corresponds to the right y-axis: Points below zero indicate a trade deficit.) This pattern is not the same for all trading partners, however. In the graphs below, imports and exports have increased for both Canada and Mexico as well, but they have remained relatively flat for Japan. Similarly, although the U.S. trade deficit has increased with Canada and with Mexico, it has done so at a much slower pace than it has with China. After the latest recession, trade deficits have moderated, which is most noticeable for U.S. trade with Canada, which has become almost balanced.

How these graphs were created: Search FRED as follows: For imports, search for the “U.S. imports of goods from [country x] customs basis.” For exports, use the “Add Data Series” option to search for and add “f.a.s. basis series for [country x].” Use the “Create your own data transformation” option (under the “Edit Data Series” section) to transform both series to natural logarithms (logs). For the third series, use the “Add Data Series” option to re-add the imports series as a new series; then, use “Add Data Series” option again to add the export series, but under the “Modify existing series” option for Data Series 3; finally, under the data transformation option, type “b-a” into the transformation field and set this third series to appear on the right y-axis.

Suggested by Maxmiliano Dvorkin and Hannah Shell.

View on FRED, series used in this post: EXPCA, EXPCH, EXPJP, EXPMX, IMPCA, IMPCH, IMPJP, IMPMX

Illiquidity in the bond market

An asset is said to be “liquid” if traders can convert it quickly to cash without materially affecting its market price. The market for large cap stocks is liquid because equity claims are relatively homogeneous and there are normally large numbers of buyers and sellers trading on centralized exchanges. Most bond markets are highly illiquid, primarily because bonds are highly idiosyncratic. Even bonds issued by the same entity normally differ along several dimensions, including maturity, coupon rate, and covenants. Because this is so, bonds typically trade over-the-counter (OTC)—that is, in a decentralized trading environment where idiosyncratic bonds must be matched with willing buyers. These markets are typically very thin, and most bonds do not even trade on secondary markets. The bonds issued by sovereigns and large corporations are an exception. But even these bonds trade largely in decentralized OTC markets.

There has been a growing concern as of late that liquidity conditions in even relatively liquid bond markets have deteriorated in recent years. If this is so, then even modest events may trigger an unexpected and undesirable disruption in financial markets. In the summer of 2013, for example, when Fed chair Ben Bernanke hinted at a possible slowdown in the pace of Fed bond purchases, the bond market reacted violently in what was described as a “taper tantrum.” Another example is the Oct. 15, 2014, “flash rally” in which the 10-year on-the-run U.S. Treasury experienced an incredible 40 basis point movement in a single day for no apparent reason. According to a report released by the U.S. Treasury Department, it seems that for a brief period of time there were far more trades to buy Treasuries than trades to sell. That this happened in the most liquid of all bond markets raises a concern with other less-liquid bond markets. Might a modest increase in the Fed policy rate induce a “rush to the exits,” forcing a fire sale of bonds into an illiquid market to meet redemption payments?

It is, in fact, very difficult to know whether liquidity conditions are deteriorating in bond markets. Standard measures, such as bid-ask spreads, are of little help because historically narrow bid-ask spreads can widen suddenly in a liquidity event. Some commentators have pointed to the post-financial-crisis behavior of the 22 primary dealers, who play an important role as market makers for bonds. In fact, primary dealer inventories in corporate bonds have declined from over $250 billion in 2007 to about $50 billion in 2015. Since 2007, the supply of U.S. corporate bonds has increased from about $3.2 trillion to almost $5.0 trillion (see graph above), so that the dealer inventory relative to outstanding debt has dropped precipitously. Moreover, prior to 2007, dealers were net long in corporate bonds and net short in U.S. Treasuries. Dealers are now net long in Treasuries. This, together with their reduced holdings of corporate securities, suggests that dealers’ willingness and/or ability to take on risk has diminished greatly since 2008. Many commentators blame the Volcker rule, which was designed to curtail the proprietary trading activities of dealer banks.

Whether these behaviors contribute to reduce bond market liquidity is difficult to judge. In fact, one could make the case that the dealer banks are in much better position than they were in 2007 to absorb a liquidity event, for example, by absorbing a sell-off in corporate bonds with sales of Treasuries. Much of the bond supply is intermediated through money market mutual funds. Historically, these funds have sought to maintain fixed exchange rate regimes subject to speculative attack. The vulnerability of these funds to mass redemption events, however, may be curtailed with the passing of Rule 2a-7 by the U.S. Securities and Exchange Commission. This new rule requires that funds adopt a floating exchange rate regime (floating net asset value) and permits the imposition of liquidity fees and redemption gates at the discretion of the funds’ board of directors. These rules are consistent with the ones prescribed in Diamond and Dybvig (1983) for the prevention of bank runs.

It is important to understand, however, that such measures are not a guarantee against price volatility. They are simply measures to mitigate the “excess” price volatility that accompanies thinly traded markets. If everyone wants to sell bonds, their price will decline even in the most liquid of bond markets.

How this graph was created: Search for the (quarterly) series shown above and add it to the graph. Restrict the sample period to start in 2001.

Suggested by David Andolfatto

View on FRED, series used in this post: NCBDBIQ027S

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