Gasoline demand

this doesn’t look like the stuff of recession:

FUNDAMENTALS TO SUPPORT

Barclays Capital said gasoline demand indications from the U.S., the world’s largest consumer, have been robust.

“Gasoline is showing the strongest year-on-year growth in demand for January-to-date,” it said in a research note.

“In each of the past six years, February has marked the start of a run of six months of consecutive month-on-month gasoline demand increases, and we have no reason to expect 2008 to break that pattern.”


Fed cuts increasing demand and lowering the dollar support crude prices

Oil futures jump back above $90 a barrel

by John Wilen

Oil futures jumped back above $90 a barrel Friday, adding to the previous session’s sharp gains on a view that the recession worries that pulled prices lower in recent weeks may have been overblown.

So markets are now linking rising oil prices to a stronger economy? This is a change in rhetoric from the previous talk that high oil prices were slowing demand, to the current talk that high demand is driving up oil prices.

This would signal to the Fed that markets are saying the economy is now strong enough to cause further inflation.

Energy investors were heartened by recent moves by the Federal Reserve and Congress to shore up the economy, which could prevent oil demand from slowing as much as many had feared.

The Fed doesn’t want this to happen – markets seeing their moves as supportive of higher inflation.

“This week’s emergency interest rate cut by the Fed and the economic stimulus plan proffered by Congress appear to have, for now, stemmed fears of a looming recession in the U.S.,” said Addison Armstrong, director of exchange traded markets at TFS Energy Futures LLC, of Stamford, Conn., in a research note.

Word that Chinese oil demand grew by 6.4 percent in December, the highest rate in months, contributed to oil’s advance.

Concerns that demand from the booming Chinese and Indian economies is outstripping global oil supplies helped push oil to records above $100 earlier this month.

Rising oil prices are also signaling that India and China continue to grow quickly enough to drive up prices.

Light, sweet crude for March delivery rose $1.30 to settle at $90.71 on the New York Mercantile Exchange after rising as high as $91.38. Oil futures last closed above $90 last Friday.

While investors believe the government’s $150 billion stimulus plan and the Fed’s rate cuts will stave off a serious economic slowdown, rate cuts also tend to weaken the dollar, giving investors another reason to buy oil futures. Crude futures offer a hedge against a falling dollar, and oil futures bought and sold in dollars are more attractive to foreign investors when the greenback is falling.

And the Fed’s cuts have weakened the dollar and also contributed to the higher oil prices.

In other words, the article is stating that the rate cuts caused both strong demand and a weak dollar, both driving up inflation.

The financial media is beginning to look past recession fears and to inflation.

Look for article about how the Fed is falling behind the inflation curve.

“When (investors in foreign) countries go to buy oil, they’re buying it on sale,” said James Cordier, president of Liberty Trading Corp., in Tampa, Fla.

Many analysts believe the weakening dollar helped draw speculative investors into oil markets this fall and winter, driving oil prices
above the $100 mark.

Other energy futures also rose Friday. February heating oil futures jumped 4.28 cents to settle at $2.5191 a gallon on the Nymex while February gasoline futures added 3.54 cents to settle at $2.3182 a gallon. Heating oil and gasoline prices were supported by news that Valero Energy Corp.’s 255,000 barrel a day refinery in Aruba was shut down due to a fire.

February natural gas futures rose 18.1 cents to settle at $7.983 per 1,000 cubic feet.

In London, March Brent crude rose $1.83 to settle at $90.90 a barrel Friday on the ICE Futures exchange.


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Tax cuts, oil prices, and gasoline consumption

Oil prices jump after Bush, Congress reach agreement on economic stimulus plan

by John Wilen

Oil futures jumped more than $2 a barrel Thursday after the Bush administration and Congressional leaders agreed to an economic stimulus plan that will give most Americans tax rebates of $600 to $1,200, or even more if they have kids.

With Bernanke’s blessings and with the mainstream seeing demand already strong enough to be driving prices well above the Fed’s comfort zone, the response is no surprise. Gold shot up as well as other commodities, and the $ fell.

Prices were already higher after the government reported a drop in heating oil supplies and as investors anticipated a stimulus plan. But futures took off, posting their largest gains in over three weeks, on word that an agreement had been reached.

“What’s boosting us up today is a little economic optimism because people are going to get a little free money,” said Phil Flynn, an analyst at Alaron Trading Corp., in Chicago.

Yes, and a turnaround in housing probably is underway as well.

Light, sweet crude for March delivery rose $2.42 to settle at $89.41 a barrel on the New York Mercantile Exchange.

(SNIP)

The high prices may be having an impact on consumer behavior. Demand for gasoline fell last week by 152,000 barrels, though demand over the past four weeks _ which included the busy holiday travel period _ rose by 1.1 percent over the same period last year.

Real demand up for the month year over year.

Looking forward to see how a ‘nimble’ Fed responds.


Re: Will the cure be worse than the disease?

(an interoffice email)

> the only problem i have with Meltzer is that is the consensus view now,
> that inflation is a foregone conclusion-i think long term that may be
> right (long term paper currency devaluation) but you could easily
> correct commodity and energy prices if you have a reduction of
> speculator and investor demand (ie see 1970s chart of gold and crude
> oil-there years in which the price of those commodities corrected
> viciously in a long term up trend). Specs of today in a mark to market
> world i dont believe are immune from short term negative commodity
> marks…

Agreed.

Two things (as Reagan would say):

  1. Crude probably stays high as Saudis are selling 9 million bpd at current prices. no reason to cut price unless demand fall off and forces them to hit bids rather than getting offers lifted. And world inventories are relatively low so it would be hard to get a sell off from physical inventory liquidation. More likely for other commodities to underperform crude in a spec sell off. Might even be happening now. (And biofuels like crude and food costs.)
  1. Even if crude/food/import and export prices level off or even go down some, they are so far ahead of core CPI increases that core can continue to go up for several quarters to close the gap. And the Fed thinks that can dislodge expectations so can’t afford to let it happen.
  1. world employment/income seems to be holding up, so actual nominal demand for consumption of resources shouldn’t collapse without some major positive supplied side shock.

Meltzer is wrong as IMHO not much is a function of interest rates; so, he’s ‘blaming’ the wrong entity for ‘inflation’. But his story is the mainstream story; so, i expect a lot more of same.


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Will the cure be worse than the disease?

Will the cure be worse than the disease?

Right, the financial press will chop the Fed to ribbons if inflation continues higher, as I expect it will.

But Bernanke is setting the stage for an even bigger recession down the road. Just as the ultra-low rates of the early 2000s created many of the problems we’re experiencing today, pumping money into the system would probably stoke inflation, forcing the Fed to hike rates sharply in the near future. “It’s better to take a small recession and kill inflation immediately instead of facing high inflation and a really big recession later,” says Carnegie Mellon economist Allan Meltzer.

That’s the orthodox mainstream view. They are already starting to turn on Bernanke and his reinvention of monetary policy.

Meltzer, who is finishing the second volume of his history of the Federal Reserve, warns that Bernanke is risking a disastrous replay of the 1970s, when high oil prices fueled double-digit inflation. Every time the Fed started to tighten and unemployment jumped, chairmen G. William Miller and Arthur Burns lost their nerve. They lowered rates to boost job growth, and inflation inevitably revived, causing a vicious price spiral. The Fed let the disease rage for so long that it took draconian action by chairman Paul Volcker in the early 1980s to finally defeat inflation. The price was a deep recession, with unemployment hitting 11% in 1982. “The mentality is the same as in the 1970s,” says Meltzer. “‘As soon as we get rid of the risk of recession, we’ll do something about inflation.’ But that comes too late.”

Yes, that’s the mainstream story (not mine, of course) and likely to get a lot louder, and if inflation picks up, it could cost Bernanke his job.

Indeed, while the economy is sending mixed messages about growth, the signs of increasing inflation are flashing bright red. For 2007 the consumer price index rose 4.1%, the biggest annual increase in 17 years. Gold, historically a reliable harbinger of inflation, set an all-time high of more than $900 an ounce. The dollar is languishing at a record low against the euro and a weighted basket of international currencies. “Flooding the market with liquidity is a disaster for the purchasing power of the dollar,” says David Gitlitz, chief economist for Trend Macrolytics.

And the Fed knows this. And they know they are ‘way out of bounds’ of mainstream theory with current policy, including encouraging a fiscal package.

The Fed’s supporters tend to downplay those dangers. They contend that the inflation surge is being driven largely by energy costs. Since oil isn’t likely to rise from its near-$100 level, inflation is likely to tail off in 2008. “That argument is wrong,” says Brian Wesbury, chief economist with First Trust Portfolios, an asset-management firm. “As people spend less to drive to the golf course, they will spend the extra money on golf clubs or other products. The Fed wants to reflate the economy, so the money that went into higher oil prices will drive up the prices of other goods.”

That’s the mainstream story, and it’s lose/lose for the Fed.

Fed supporters also point out that the yield on ten-year Treasury bonds stands at just 3.8%, a figure that implies that investors expect inflation to be around 2% in future years. So if inflation is really expected to rage, why aren’t interest rates far higher? The explanation is twofold. First, government bonds are hardly a foolproof forecaster. For example, five years ago Treasury yields were predicting 2% inflation over the next five years, and the actual figure was 3%, or 50% higher.

Another point the mainstream will make: Fed foolishly relied on its forecasting models and ignored the obvious signs of inflation.

Second, investors are so skittish about most stocks and corporate bonds that they’re paying a huge premium for safe investments, chiefly U.S. Treasuries. “It’s all about a flight to safety,” says Meltzer. Stand by for a major rise in yields as the reality of looming inflation sinks in.

So what is the right course for the Fed? Bernanke should hold the Fed funds rate exactly where it is now, at 4.25%. Standing pat might well push the economy into a recession. But the Fed’s newfound vigilance on inflation would boost the dollar, effectively lowering the prices of oil and other imports. America would suffer a short downturn and restore price stability, paving the way to a strong recovery in 2010 or 2011.

Sadly, the Fed has already chosen sides. It’s likely to lower rates every time growth slows or joblessness rises. As a result, it will never tame inflation until it becomes a clawing, bellowing threat. Then we’ll have to suffer a real recession, the kind we suffered in the aftermath of a time we should study and shouldn’t forget – the 1970s.

Says it all.

Hard to say why the Fed hasn’t played it that way, but they haven’t and will pay the price if inflation keeps rising.


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Meltdown?, continued..

Weakness:

  • Equity markets still heading down.
  • Commodity markets anticipate slowing demand.
  • Credit markets anticipate additional rate cuts.

First, a word on the bond insurers:

A Fed rate cut won’t address the risk that an insurer failure could trigger panic selling by bond holders that require AAA ratings to hold their bonds.

The Fed could offer to provide supplemental insurance to investors holding the bonds for a fee (maybe a point), and discount the strike of the put a few points as well. The insurer would continue in first loss position. This would allow investors to ‘pay the price’ to the Fed if they want to keep the AAA rating. Additionally the Fed would take measures to make sure this doesn’t happen again.

Second, commodity markets:

Story today that OPEC still sees demand increasing 1.3 million bpd, even with a slowdown. Not good. Means they retain pricing power.

The unknown is whether they agreed to cut prices in response to the Bush visit.

Third, equities:

Dupont earnings way above expectations on world demand, and price increases on their cost side were more than passed through.

And bank earnings off but all still in positive territory for Q4, indicating losses during what is likely the largest quarter for writeoffs were less than earnings. I’ve seen worse…

Equity markets relatively flat from yesterday, earning look good, particularly ex financial writedowns, as core earnings of the financials look OK as well.

One of the problems with equities continues to be shareholder vulnerability to converts and other dilutions as corporate structure/law rewards management for this kind of recapitalization. This shifts wealth from existing shareholder to new shareholders.

Initial claims estimated at 325,000 for Thursday. If so, I still don’t see much damage to the real economy. Q4 may sink or swim on December export numbers that will be released in February.

The jobless recovery ends with a full employment recession?
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2008-01-21 Update

Major themes intact:

  • weak economy
  • higher prices

Weakness:

US demand soft but supported by exports.

US export strength resulting from non resident ‘desires’ to reduce the rate of accumulation of $US net financial assets. This driving force is ideologically entrenched and not likely to reverse in the next several months.

In previous posts, I suggested the world is ‘leveraged’ to the US demand for $700 billion per year in net imports, as determined by the non resident desire to accumulate 700 billion in $US net financial assets.

US net imports were something over 2% of rest of world GDP, and the investment to support that demand as it grew was probably worth another 1% or more of world GDP.

The shift from an increasing to decreasing US trade deficit is a negative demand shock to rest of world economies.

This comes at a time when most nations have decreasing government budget deficits as a percent of their GDP, also reducing demand.

The shift away from the rest of world accumulation of $US financial assets should continue. Much of it came from foreign CB’s. And now, with Tsy Sec Paulson threatening to call any CB that buys $US a ‘currency manipulator’, it is unlikely the desire to accumulate $US financial assets will reverse sufficiently to stop the increase in US exports. I’m sure, for example, Japan would already have bought $US in substantial size if not for the US ‘weak dollar’ policy.

All else equal, increasing exports is a decrease in the standard of living (exports are a real cost, imports a benefit), so Americans will be continuing to work but consuming less, as higher prices slow incomes, and output goes to non residents.

I also expect a quick fiscal package that will add about 1% to US GDP for a few quarters, further supporting a ‘muddling through’ of US GDP.

Additional fiscal proposals will be coming forward and likely to be passed by Congress. It’s an election year and Congress doesn’t connect fiscal policy with inflation, and the Fed probably doesn’t either, as they consider it strictly a monetary phenomena as a point of rhetoric.

Higher Prices:

Higher prices world wide are coming from both increased competition for resources and imperfect competition in the production and distribution of crude oil. In particular, the Saudis, and maybe the Russians as well, are acting as swing producer. They simply set price and let output adjust to demand conditions.

So the question is how high they will set price. President Bush recently visited the Saudis asking for lower prices, and perhaps the recent drop in prices can be attributed to those meetings. But the current dip in prices may also be speculators reducing positions, which creates short term dips in price, which the Saudis slowly follow down with their posted prices to disguise the fact they are price setters, before resuming their price hikes.

At current prices, Saudi production has actually been slowly increasing, indicating demand is firm at current prices and the Saudis are free to continue raising them as long as desired.

The current US fiscal proposals are designed to help people pay the higher energy prices, further supporting demand for Saudi oil.

They may also be realizing that if they spend their increased income on US goods and services, US GDP is sustained and real terms of trade shift towards the oil producers.

Conclusion:

  • The real economy muddling through
  • Inflation pressures continuing

A word on the financial sector’s continuing interruptions:

With floating exchange rates and countercyclical tax structures we won’t see the old fixed exchange rate types of real sector collapses.

The Eurozone banking sector is the exception, and remains vulnerable to systemic failure, as they don’t have credible deposit insurance in place, and, in fact, the one institution that can readily ‘write the check’ (the ECB) is specifically prohibited by treaty from doing so.

Today, in most major economies, fiscal balances move to substantial, demand supporting deficits with an increase in unemployment of only a few percentage points. Note the US is already proactively adding 1% to the budget deficit with unemployment rising only 0.3% at the last initial observation in December. In fact, fiscal relaxation is being undertaken to relieve financial sector stress, and not stress in the real economy.

Food and energy have had near triple digit increases over the last year or so. Even if they level off, or fall modestly, the cost pressures will continue to move through the economy for several quarters, and can keep core inflation prices above Fed comfort zones for a considerable period of time.

Fiscal measures to support GDP will add to the perception of inflationary pressures.

The popular press is starting to discuss how inflation is hurting working people. For example, I just saw Glen Beck note that with inflation at 4.1% for 07 real wages fell for the first time in a long time, and he proclaimed inflation the bigger fundamental threat than the weakening economy.

I also discussed the mortgage market with a small but national mortgage banker. He’s down 50% year over year, but said the absolute declines leveled off in October, including California. He also pointed out one of my old trade ideas is back – when discounts on pools become excessive to current market rates, buy discounted pools of mortgages and then pay mortgage bankers enough of that discount to be able refinance the individual loans at below market rates.


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Why I expect US exports to continue to be very strong..

The desire to accumulate $US financial assets has been diminished for at least the following reasons:

  1. Treasury policy – Paulson is actively pushing both a strong yuan and threatening any other CB that buys $US with the label of ‘currency manipulator.’ CB’s had been perhaps the largest source of $US financial assets accumulation and are now limited to compounding of interest.
  2. US foreign policy is probably driving CB’s in less than friendly nations to diversify their reserves away from $US financial assets.
  3. Fed policy has the appearance of a ‘beggar thy neighbor’/’inflate your way out of debt’ policy, as the Fed aggressively cuts rates in the face of inflation not seen in 25 years.

This all sets in motion a downward pricing of the $US as non residents sell them to each other at lower and lower prices in this effort to lower their rate of accumulation of $US financial assets. But these financial assets can only ‘go away’ when they get spent or invested in the US, when US prices are low enough to cause this to happen. The rapid rise in exports and accelerated non resident buying of US real estate and other assets is anecdotal evidence this is taking place as theory predicts.

This is a very large cyclical force that should continue to drive rapidly rising exports for perhaps a year or more. Weak foreign economies should have little effect on this process, as that weakness doesn’t reduce the desire of portfolio managers to shift out of $US financial assets.

This is also highly inflationary for the US. This buying by non residents both drives down the $US and drives up the prices of US exports, now rising at a 7% clip last I checked.

The desired shift is probably well over $1 trillion which means exports will increase by a good part of that to facilitate this transfer.

This can sustain US GDP in the face of falling domestic demand, which will stay relatively low until housing picks up. Employment will remain reasonably good, but standards of living fall as we produce as much, but export more and consume less. We get paid to work but can buy less due to high prices, with our remaining production exported to those wishing to reduce their accumulated $US financial assets.

We’ve been talking about this possibility about a long time, but seems our trade negotiators have finally got their wish.

Meanwhile, Saudis continue to act the swing producer. In fact, they told Bush today they have 2 million bpd capacity in reserve, and that markets are well supplied. At their price, of course.

Probably have been some year end allocations out of crude by pension funds as with the price hikes they would need to sell some to keep the same ‘weight’ in their portfolios. That should be ending soon.

And I agree with Karim, the Fed is not likely to act on inflation until core starts to rise or their measures of inflation expectations start to rise, despite the fact that mainstream theory clearly says if any of that happens it’s too late. Seems to me the senior FOMC members are putting their jobs on the line by taking that kind of systemic risk, which their own theory tells them is far higher than the risk of any lost output from a .


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ECB Mersch on inflation

ECB’s Mersch Says Oil Must Not Boost Other Prices

by Simone Meier

(Bloomberg) European Central Bank council member Yves Mersch said a surge in oil prices must not be allowed to lead to permanently faster inflation, Luxembourg’s Wort newspaper reported, citing an interview.

Yes, that is the mainstream view – don’t turn a relative value story into an inflation story.

“Of course we can do something against” faster inflation, Mersch, who is also governor of Luxembourg’s central bank, said in the interview, according to Wort. “We have to prevent temporary price increases, as we see with oil, from permanently impacting on the overall level of prices.”

It already has started to do this via biofuels and increased costs of production. Food prices are up, and other prices are facing upward pressure.

Rising oil prices are “like a tax,” Mersch told the newspaper. “If someone is taxing us, we all become poorer. If we refuse to become poorer, we’re not creating any purchasing power but only inflation,” the newspaper quoted him as saying.

Yes by keeping it a relative value story by limiting demand, real terms of trade deteriorate making the nation ‘poorer’.

“We have to watch out that other sectors and services don’t become infected” by rising prices, Mersch said, according to Wort.

Demand has to be kept low enough to not let a relative value story become an inflation story.