Now versus the 1970s

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Looks very much like the 1970’s to me.

Yes, the labor situation was different then – strong unions due to strong businesses with imperfect competition, umbrella pricing power and the like.

But it was my take then that inflation was due to energy prices, and not wage pressures. Inflation went up with oil leading throughout the 1970’s and the rate of inflation came down only when oil broke in the early 1980’s, due to a sufficiently large supply response. It was cost push all the way, and even the -2% growth of 1980 didn’t do the trick. Nor did 20%+ interest rates. Inflation came down only after Saudi Arabia, acting then as now as swing producer, watched its output fall to levels where it couldn’t cut production any more without capping wells, and was forced to hit bids in the crude spot market. Prices fell from a high of maybe $40 per barrel to the $10-15 range for the next two decades, and inflation followed oil down. And when demand for Saudi production recovered a few years ago they quickly re-assumed the role of swing producer and quietly began moving prices higher even as they denied and continue to deny they are acting as ‘price setter’ with inflation again following.

And both then and now everything is ultimately ‘made out of food and energy’ and hikes in those costs work through to everything else over time.

There are differences between then and now. A new contributor to inflation this time around are our own pension funds, who have been allocating funds to a passive commodity strategies as an ‘asset class.’ This both drives up costs and inflation directly, and adds to aggregate demand (also previously discussed at length).

Also different is that today we’ve outsourced a lot of the labor content of our gdp, so I suggest looking to import prices of high labor content goods and services as a proxy for real wages. And even prices from China, for example, have gone from falling to rising, indicating an inflation bias that corresponds to the wage increases of the 70’s.

Costs of production have been going up as indicated anecdotally by corporate data and by indicators such as the PPI and its components. These costs at first may have resulted in some margin compression, but recent earnings releases seem to confirm pricing power is back and costs are pushing up final prices, even as the US GDP growth slows.

US policies (discussed in previous posts) have contributed to a reduced desire for non residents to accumulate $US financial assets. This plays out via market forces with a $US weak enough to entice foreigners to buy US goods and services, as evidenced by double digit growth in US exports and a falling trade gap. This ‘external demand’ is providing the incremental demand that helps support US gdp, and corporate margins via rapidly rising export prices.

World demand is high enough today to support $100 crude, and push US cpi towards 5%, even with US GDP running near zero.
As long as this persists the cost push price pressures will continue.

Meanwhile, markets are pricing continued ff rate cuts as they assume the Fed will continue to put inflation on the back burner until the economy turns. While this is not a precise parallel with the 1970’s, the era’s were somewhat similar, with Chairman Miller ultimately considered too soft on inflation during economic weakness. He was replaced by Chairman Volcker who immediately hiked rates to attack the inflation issue, even as GDP went negative.

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2008-02-21 US Economic Releases

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2008-02-21 Initial Jobless Claims

Initial Jobless Claims (Feb 16)

Survey 349K
Actual 349K
Prior 348K
Revised 358K

Down a bit but lost a day in California. Chart looks like it’s drifted to a bit higher levels.

Still not recession type numbers yet, however.

2008-02-21 Continuing Claims

Continuing Claims (Feb 9)

Survey 2760K
Actual 2784
Prior 2761K
Revised 2736

Also looking like it’s moved up to higher levels, but still far from typical recession levels.

2008-02-21 Philadelphia Fed.

Philadelphia Fed. (Feb)

Survey -10.0
Actual -24.0
Prior -20.9
Revised n/a

Looks serious!  Strange that employment was up 2.5, however, and, of course, prices on the rise.

2008-02-21 Leading Indicators

Leading Indicators (Jan)

Survey -0.1%
Actual -0.1%
Prior -0.2%
Revised -0.1%

Still drifting lower, but no collapse.

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Bloomberg: Trichet may not cut rates in 2008

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Trichet May Not Cut Rates in 2008, Say Merrill, ABN

by Simon Kennedy
(SNIP)
(Bloomberg)Erik Nielsen, Goldman Sachs’s chief European economist, disagrees. He said the ECB’s primary mandate is to preserve price stability, so it has no room to follow the Federal Reserve and the Bank of England, even as economic growth weakens. The Fed slashed its main rate by 1.25 percentage points last month, and the Bank of England cut its benchmark by a quarter point Feb. 7 for the second time in three months.

‘Hurdle’
“Inflation and expectations for it are a hurdle for a cut,” Nielsen said. “Inflation is very stubborn” in Europe.

The annual pace of consumer-price increases in the euro region accelerated to a 14-year high of 3.2 percent in January, pushed above the ECB’s 2 percent limit for a fifth month by food and energy costs. Inflation in France, the euro-area’s second largest economy, accelerated in January to the fastest pace in at least 12 years, according to data released today.

US CPI is up nearly 4.5% year over year with no let up in sight, and core measures are above FOMC comfort zones and picking up steam as well.

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2008-02-20 US Economic Releases

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2008-02-20 MBAVPRCH Index

MBAVPRCH Index (Feb 15)

Survey n/a
Actual 357.6
Prior 403.9
Revised n/a

2008-02-20 MBAVREFI Index

MBAVREFI Index (Feb 15)

Survey n/a
Actual 3533.8
Prior 4901.5
Revised n/a

These look very weak.

Banks are not included, so there’s a chance the banks could be taking market share from the mortgage bankers.

2008-02-20 Consumer Price Index MoM

Consumer Price Index MoM (Jan)

Survey 0.3%
Actual 0.4%
Prior 0.3%
Revised 0.4%

2008-02-20 CPI Ex Food & Energy MoM

CPI Ex Food & Energy MoM (Jan)

Survey 0.2%
Actual 0.3%
Prior 0.2%
Revised n/a

2008-02-20 Consumer Price Index YoY

Consumer Price Index YoY (Jan)

Survey 4.2%
Actual 4.3%
Prior 4.1%
Revised n/a

2008-02-20 CPI Ex Food & Energy YoY

CPI Ex Food & Energy YoY (Jan)

Survey 2.4%
Actual 2.5%
Prior 2.4%
Revised n/a

Today’s CPI report shows inflation is moving up sharply. If it was above Yellen the dove’s comfort zone last week it even further above it now. Same with Mishkin, who more than once said the FOMC had to be prepared to reverse course as needed.

Stocks are sensing they may be ‘on their own’ if the Fed is constrained by inflation.

Yes, the economy is weak, growth near 0 (see housing below), but demand is high enough to keep pushing food, crude, and import/export prices ever higher.

The Fed seeks an output gap/GDP growth consistent with inflation within their comfort zone.

Stronger growth will increase their inflation forecasts, while weaker growth is expected to bring inflation down.

Higher prices for food and crude are also presumed to bring out supply side responses, thereby bringing prices down.

But they also believe this has to happen before inflation expectations elevate, otherwise the higher prices get ‘monetized’ and a relative value story turns into an inflation story.

The data is now showing that is starting to happen, and for most FOMC time has probably run out. They may now feel they have used up all the past ‘credibility’ that has kept inflation expectations ‘well anchored’ trying to ‘forestall’ a financial collapse.

2008-02-20 Housing Starts

Housing Starts (Jan)

Survey 1010K
Actual 1012K
Prior 1006K
Revised 1004K

A glimmer of hope, but not much, but still winter numbers. Better picture will emerge by March.

2008-02-20 Building Permits

Building Permits (Jan)

Survey 1050K
Actual 1048K
Prior 1068K
Revised 1080K

No sign of a turn here.

From Karim:

Core up 0.311%; with headline spurred by food and energy (each up 0.7%). Y/Y up to 2.5% from 2.4%

OER up another 0.3% and medical up 0.5%

Some items unlikely to repeat next month are lodging away from home, which was up 1.1%.

Also, apparel (which was up 0.4%) has now risen 5 straight months. This series usually chops around and like lodging away from home, has seasonal adjustment issues. Tobacco up 1.1% after 0.8% prior month. Expect all of these to reverse over next 1-2 months.

Maybe, maybe not. With import prices and local costs rising, cost-push-inflation can keep things moving up until all catches up with food/energy numbers.

Also, many wage agreements, including government, and other contracts have CPI escalators, which sustain demand for the ever higher prices.

Housing starts tick up 0.8% from downwardly revised December number; single family starts down another 3% to lowest since 1/91

Building permits down another 3% (typically leads starts)

Bottom line is Fed is likely to believe that the pattern of growth and inflation of the past two easing cycles will repeat itself (chart attached); that is inflation typically peaks about 2-3 years after the peak in growth. Fed Member Stern (voter) referred to this yesterday where he said he expected core to come down over the next several years but not anytime soon, and that recent rate cuts were ‘wholly appropriate’.

Agreed, they may believe that, but they also believe that if inflation expectations elevate, the higher prices get ‘monetized’ and don’t revert.

That’s why they are so focused on the inflation expectation indicators, which they also know are difficult to read and not considered completely reliable.

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2008-02-20 EU Highlights

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Should the Fed turn it’s attention to inflation, it will find itself way behind that curve.

The US cpi is about 100 bp higher than the eurozone cpi’s, including the UK where rates are north of 5%.

With US inflation where it is, the mainstream calculation for the appropriate ff rate is probably north of 7%.

The way the mainstream now sees it, the more the Fed cuts to get ahead of the ‘economy curve’ (whatever that is), the further it gets behind the inflation curve.

At this point if may not take much in the way of economic ‘improvement’ to redirect the Fed’s attention. A sign of a housing turn might be sufficient.

And with a general inflation underway, housing prices will go up as well, regardless of weakness, due to cost pressures, much like the late 70’s.

Highlights:

European Government Bonds Fall as German Producer Prices Surge
ECB’s Garganas Says There’s `Intense Concern’ About Inflation
Spain’s Exports Grew as Economy Accelerated in Fourth Quarter
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Lukoil cuts German oil exports by pipeline on pricing

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Russia exercising it’s pricing power as a swing producer as well.

Lukoil Cuts German Oil Exports by Pipeline on Pricing (Update1)

by Torrey Clark and Thom Rose

(Bloomberg) OAO Lukoil, Russia’s largest independent oil producer, may cut March shipments of crude oil to Germany by pipeline, continuing the halt ordered yesterday because of a pricing dispute.

Lukoil stopped February exports through the Druzhba pipeline and will consider cutting March sales while demanding higher prices from traders in Germany, spokesman Dmitry Dolgov said by phone today. The Moscow-based oil producer has reserved space in the pipeline for next month, he said.

“Why should we sell oil cheap?” Dolgov said. “We have found alternatives.”

German refineries tapped fuel from alternative sources last year to supply their customers when Druzhba shipments fell as Lukoil and Sunimex Handels-GmbH, the dominant oil trader, clashed over prices in July and August. PCK Raffinerie GmbH in Schwedt said the disputes haven’t affected output.

“We haven’t had any problems or production cuts,” PCK Schwedt spokesman Karl-Heinz Schwelnus said today by telephone.

Lukoil will renew attempts to sell oil directly to the refineries, Dolgov said. The company isn’t breaking any contracts by cutting shipments and the refineries are unlikely to run short of crude, he said.

“German drivers have nothing to worry about,” Dolgov said.

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Re: energy and the dollar

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(an email)

> On Feb 19, 2008 10:03 AM, Mike wrote:

> Warren, note spec comments and dollar issues, a big hurdle to overcome
> if they go the other way …
> Mike

Hi Mike,

Agreed the dollar may have bottomed. Seems to have reached a level where exports are now growing at about 13% which maybe is the right number to accommodate the pressure from the non resident sector to slow it’s accumulation of $US financial assets.
However I continue to conclude the price of crude is being set by the Saudi’s/Russians acting as swing producer, and that there is sufficient demand to keep them in the driver’s seat. Quantity pumped keeps creeping up at current prices, with Saudis last reporting 9.2 million bpd output.

Crude at 98.70 now. Note crude goes up on news a refinery is down, when refineries are the only buyers of crude, so in fact it’s going up for other reasons (price setting by the swing producer?). Also, WTI is now ahead of Brent, indicating whatever was causing the sag in WTI vs Brent is over. WTI would ordinarily trade higher than Brent due to shipping charges.

Warren

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Bank of France says Fed overreacted to market decline

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Interesting they would take a shot like that at the Fed. Probably concerned about Euro strength and the US gaining export share.

Bank of France Says Fed Overreacted to Market Decline

By Francois de Beaupuy

(Bloomberg) The Bank of France said the U.S. Federal Reserve may have cut interest rates too much and too quickly in response to financial-market declines.

An unsigned article in the Paris-based bank’s monthly bulletin, published today, said new financial products have amplified asset price swings.

That may lead to “stronger monetary reactions than what would otherwise be necessary, as shown by the recent decision of the Federal Reserve,” the article said.

The unusual criticism by one central bank of another may reflect the European Central Bank’s reluctance to follow its U.S. and U.K. counterparts in cutting rates to cushion against an economic slowdown. The ECB left its benchmark rate at 4 percent this month even as growth prospects deteriorate.

“The Bank of France is simply going along the ECB line, trying to manage expectations away from any response similar to the Fed,” said Gareth Claase, an economist at Royal Bank of Scotland Plc in London. “The Fed moved quickly and far. The ECB is likely to move slowly and little.”

The Fed has lowered its benchmark rate by 2.25 percentage points since September to 3 percent — including a three-quarter point emergency cut on Jan 22 — and traders expect another reduction next month.

‘Unusually High’
German Finance Minister Peer Steinbrueck said Feb. 12 he didn’t see ECB Bank President Jean-Claude Trichet shifting to a neutral stance, which might be a prelude to cutting rates. At a press conference last week, Trichet said uncertainty about growth prospects is “unusually high,” prompting traders to raise bets on a rate cut.

“Pressure on the ECB increased after the massive Fed rate cuts,” said Michael Schubert, an economist at Commerzbank AG in Frankfurt. “The ECB has said that it won’t act anytime soon. It doesn’t want to be driven by the Fed.”

German investor confidence unexpectedly increased this month, a sign the European economy can weather the U.S. slowdown.

“It’s unusual for central banks to criticize the actions of others,” said Dominic Bryant, an economist at BNP Paribas in London. “The U.S. is in recession, so it’s somewhat difficult to say the Fed overreacted.”

♥

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