Tag Archives: Oil

Re: Bernanke/data

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(an interoffice email)

Yes, and he reaffirmed that he’s using the futures prices to predict where prices are going.  He pointed to crude being at $95 in the back months and stated that translates to a forecast for prices to come down from current levels.

Also indicated the lower dollar is useful for bringing down the trade deficit.  This ‘works’ for as long as US labor costs are ‘well anchored’.  Congress didn’t grasp this part, as it no doubt would have evoked quite an outcry if they had understood it.

Bernanke plainly stated he considered export growth a desired outcome versus domestic consumption.

Initial claims telling today.  Other numbers point to surprises on the upside.  This could be partially tempered by Q4 GDP being revised up.

FF futures already discounting cuts to below 2% over the next six months.

While crude inventories are up, markets are saying it’s ‘desired’ inventory as the term structure is still backwardated and WTI is still higher than Brent.

On Wed, Feb 27, 2008 at 12:32 PM, Karim wrote:
All you need to know about BB’s testimony courtesy of the Xinhua news agency:

WASHINGTON, Feb 27, 2008 (Xinhua via COMTEX) — Federal Reserve Chairman Ben

Bernanke told Congress on Wednesday the central bank will again lower interest

rates to boost U.S. economy.

 

Other highlights:

 

Commenting on new Fed forecasts from last week:

The risks to this outlook remain to the downside.  The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further.

 

… financial markets continue to be under considerable stress

 

Important comment on the time frame over which policy should aim to attain objective inflation rates

The inflation projections submitted by FOMC participants for 2010–which ranged from 1.5 percent to 2.0 percent for overall PCE inflation–were importantly influenced by participants’ judgments about the measured rates of inflation consistent with the Federal Reserve’s dual mandate and about the time frame over which policy should aim to attain those rates.

 

Concluding comments highlight downside risks to growth and inflation pressures but when addressing ACTION, only mentions supporting growth and providing insurance against downside risks.

A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability in an environment of downside risks to growth, stressed financial conditions, and inflation pressures.  In particular, the FOMC will need to judge whether the policy actions taken thus far are having their intended effects.  Monetary policy works with a lag.  Therefore, our policy stance must be determined in light of the medium-term forecast for real activity and inflation as well as the risks to that forecast.  Although the FOMC participants’ economic projections envision an improving economic picture, it is important to recognize that downside risks to growth remain.  The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.

 

Data-wise, more of the same:

  • Durable goods orders down 5.3% after 4.4% rise last month. Core component down 1.4% after 5.2% rise. Capex too small a part of economy and potential rates of change too little to have much bearing on end growth at this stage.
  • New home sales down another 2.8% in January and mths supply makes a new high, rising from 9.5 to 9.9; Y/Y median price drops to -15.1% from -7.8%
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Additions to yesterday’s review

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Forgot to include the influence of the 8,000 lb gorilla I’ve been advancing for the last few years!

Supporting GDP

  1. Pension funds adding to allocations for passive commodity strategies

Sources of inflation

  1. Pension funds adding to allocations for passive commodity strategies
  2. Pension funds contributing to the $ decline by allocating funds away from domestic equities to foreign equities
  3. Sovereign wealth funds allocating to passive commodity strategies

Errors made by the Fed

  1. Failure to recognize the influence of pension funds on inflation and aggregate demand
  2. Failed to understand reserve accounting and liquidity issues
    1. Thought open market operations altered functional quantitative measures, not just interest rates
    2. Delayed implementing the TAF for several months to accept additional bank assets as collateral
    3. Failed to recognize that the liability side of Fed member banks is not an appropriate source of market discipline
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Re: update

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Dear Philip,

Seems there’s a break between Mishkin and Kohn that previously wasn’t there.
Markets are thinking Kohn supports a 50 cut and that he and Bernanke are alligned.

Today Bernanke may show whether he leans towards Mishkin, the co academic, or Kohn, more the practitioner.

Meanwhile, another ‘inflation day’ with oil and commodities up, $ down, and headlines like ‘Honda says no recession in US.’

All the best,
Warren

On 27 Feb 2008 09:09:43 +0000, Prof. P. Arestis wrote:
>
> Dear Warren,
>
> Many thanks.
>
> > Do you think Kohn’s speech indicates he’s ready to cut another half point
> > on Mar 18?
>
> I think the simple answer to the question is probably no with a question
> mark. I say this in the sense that before March 18 we will probably hear
> more about Kohn’s views, which may be clearer in terms of whether he is
> ready for another half point reduction. However, in terms of the analysis
> he offered in the piece you kindly sent me I did not see anything that
> suggested half point cut, although there is plenty in the piece to suggest
> that he is in favour of more cuts. I say this in that although he sees
> problems with the real economy he is also mindful of inflation, but he is
> not an ‘inflation nutter’ as some others are. So at this stage I believe he
> will go for a cut but not as much as half point.
>
> What do you think?
>
> Best wishes, Philip

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Inflation, growth, and Fed policy

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Stocks up big, oil up big, dollar down big, and interest rates lower. How does this happen?

Review

Twin themes remain

  • weakness
  • inflation

Sources of weakness

  1. Shrinking gov budget deficit caused the financial obligations ratio to get too high by Q2 2006 to support the private sector credit growth needed to sustain previous levels of aggregate demand.
  2. Subprime business plan failed (mainly due to lender fraud) and removed that bid from the housing market.
  3. Lower interest rates reduce personal/household income.

Supporting GDP

  1. Exports booming due to a reduced desire of non residents to accumulate $US financial assets. (This drives the $US down to levels where non residents are spending them on US goods and services.)
    1. Paulson branding any country that buys $ a ‘currency manipulator’
    2. Apparent lack of Fed concern about inflation discouraging holders of $US financial assets
    3. Bush policies discouraging ‘less then friendly’ oil producers from accumulating $US financial assets
  2. Govt. spending moved forward from 07 to 08 now kicking in.
  3. Fiscal package begins to distribute funds in May.
  4. Pension funds adding to allocations for passive commodity strategies

Sources of Inflation

  1. Sufficient demand for Saudis/Russians to act as swing producers and set crude prices as high as they want to
  2. Biofuels linking energy prices to food prices as we burn up the world’s food supply for fuel
  3. Govt. payrolls and transfer payments indexed to CPI
  4. Weak $US policies driving higher import and export prices
  5. Pension funds adding to allocations for passive commodity strategies
  6. Pension funds contributing to the $ decline by allocating funds away from domestic equities to foreign equities
  7. Sovereign wealth funds allocating to passive commodity strategies

An export economy looks like this

  1. Weak domestic demand and domestic consumption
  2. Exports strong enough to sustain reasonable levels of employment (but generally not full employment)
  3. Employment and output stays reasonably high.
  4. Domestic prices are high enough relative to domestic wages to subdue domestic consumption.
  5. Foreigners ‘outbid’ domestics for the remaining output that thereby gets exported.
  6. The domestic economy works more and consumes less (lower standard of living), with the difference accounted for as ‘rising savings.’

Mainstream history (not mine) will show the following errors made by the Fed

  1. They ‘paused’ a couple of years ago as the great commodity boom was hitting it’s stride, monetizing (whatever that is) the price increases, and allowing a relative value story to turn into an inflation story.
  2. They cut aggressively into a triple negative supply shock exacerbating the monetization (whatever that is) process due to the following fundamental errors of judgement:
    1. They read futures prices in food and energy as ‘expectations’ of lower prices in the future, rather than as indicators of current inventory conditions.
    2. They assumed gold standard tail risks to a non convertible currency regime.
    3. They failed to recognize the source of rising crude prices was foreign monopoly pricing.
    4. They delayed introducing the TAF for several months.
    5. They pushed the President and Congress into increasing the budget deficit with an inflationary cash give handout.
  3. Failure to recognize the influence of pension funds on inflation and aggregate demand
  4. Failed to understand reserve accounting and liquidity issues
    1. Thought open market operations altered functional quantitative measures, not just interest rates
    2. Delayed implementing the TAF for several months to accept additional bank assets as collateral
    3. Failed to recognize that the liability side of Fed member banks is not an appropriate source of market discipline

Back to the present

  • Stocks are up as financial risks ease with the monolines sorting things out, and energy and export businesses boom.
  • Stocks are up as markets believe the Fed doesn’t care about inflation and will leave rates low for an extended period of time.
  • Crude is up as Saudis/Russians continue to hike prices.
  • The falling dollar results in higher import prices including gold, silver, copper, and most everything else.

Interest rates are down as markets read the Kohn speech as saying the Fed expects inflation to come down so there’s no need to be concerned or take action. And inflation is a lagging indicator that historically comes down after the Fed cuts rates when the economy weakens.

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Reuters: Oil Falls Below $98 on Swelling US Crude Supplies

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Supplies probably aren’t ‘excessive’ or US companies wouldn’t import so much and futures spreads would be in contango instead of backwardation, and WTI now trading above Brent is another sign inventories are back towards the tight side.

Oil Falls Below $98 on Swelling US Crude Supplies

Oil held steady around $98 a barrel on Friday, off its recent record above $101 as rising U.S. crude and gasoline stockpiles added to evidence of slowing demand in the world’s largest consumer.

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More on ‘now vs the 70’s’

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Comments people emailed me and my responses:

Bob Hart wrote:

http://www.wtrg.com/prices.htm

This graph supports your statement below:
Prices fell from a high of maybe $40 per barrel to the $10-15 range for the next two decades

2008-02-21 Crude Oil Production OPEC Countries

Thanks!

“So, there is nothing the US can do to keep core inflation in check? Only the Saudis (and other oil producers) control US inflation?”

In this case, yes. If the Saudis keep hiking cpi goes up and an inflation begins via the various channels that connect energy with other prices. And in this case exacerbated by our pension funds.

Randall Wray wrote:

right: previous high inflations have always been: energy, food, and shelter costs. I haven’t looked at shelter costs this time around.

Haynes wrote:

Great piece. I’ve been thinking along the same lines over the last few weeks. I wish I had been a lot shorter the long end but think that trade still makes sense, especially given future deficits over the next 3-5 years. Having been born in the 1980s and not lived through oil embargos, stock market stagnation and hyper inflation, I am not exactly sure what the play is over the near-term and longer term. If you were to set up a portfolio that couldn’t be changed over the next 3 yrs / 5yrs / 10yrs what do you think the mix should be?

I like AVM’s current mortgage construction: buy FN 5’s versus tailored swap at LIBOR plus 25 basis points with a ‘free’ embedded put. Put it on and sit tight for Fed hikes. Worst case you get LIBOR plus 25.

Call your AVM salesman ASAP before the spread vanishes!!!

Do you buy TIPS / Broad based commodities indices (DJP) / Gold / Stocks / short end / long end?

‘Raw’ TIPS imply a low real rate. If the Fed decides to rais the real rate, you lose.

You could do a 10 year break even bit, especially in Japan, but I like the mortgage trade better.

Think that you could get killed owning bonds but input prices have already run so much its hard to buy commodities in a potentially declining demand environment. Do you buy stocks hoping they simply stay inline with inflation or do you just hold cash?

In the medium- and long-term the S&P will probably more than keep up with inflation, but help to get the right one and to get the right entry point.

Thanks for the help. I know you are busy but any insight would be much appreciated. thanks.

Philip wrote:

I agree entirely with the view that the 1970s was a question of energy prices, a supply-side phenomenon rather than anything else. The implications for policy are important; we might produce a problem where it does not exist if policy is predicated on the wrong interpretation of the problem.

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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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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

Posted on by

(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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Oil AND interest rates up?

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It’s only been a few hours, but seems the first time since August higher oil doesn’t mean lower interest rates, and might even mean higher rates.

Up until now, higher oil prices meant a weaker economy and therefore Fed rate cuts.

I’ve been watching for a shift to higher oil prices meaning higher inflation and therefore Fed rate hikes.

Recent developments- Yellen (the biggest Fed dove) says core inflation is above her comfort zone, and that energy prices are finding their way into core inflation.

Why did she volunteer that when no one was asking? Signalling?

Why not just repeat something like ‘inflation expectations remain well contained but we remain vigilant…’ as before?

Plosser, Fisher, Lasker said much the same, but they are the hawks. It’s not news when they say it.

Maybe they all got an update from the Fed’s economics staff?

Might be revising q2,3, and 4 upwards due to the fiscal package?

They had already expected a second half return to ‘trend’ due to their interest rate cuts.

So let’s guess at what might conservatively be the current mid points of the Fed’s forecast with the new fiscal package-

0% q1, 1% q2, 2.5% q3, 3% q4?

Here’s the problem. The mainstream belief is that inflation is a function of the output gap.

If inflation is too high- above your comfort zone- you bring it down by engineering a sufficient output gap.

That means it takes a weaker economy with higher unemployment to bring down core inflation.

The first step is to try to estimate the GDP ‘speed limit’ which is the max growth rate with inflation staying within Fed comfort zones.

Well, the Q4 data point was .6% gdp growth and inflation above comfort zones. Forward looking Q1 data points are 0 growth with inflation above comfort zones and rising. Q2, Q3 and Q4 now show increasing growth which means at best inflation won’t be projected to fall, and probably continue to deteriorate.

So what is the best guess for the max GDP growth rate consistent with inflation within FOMC member comfort zones?

The hawks said slower growth might not bring down inflation. The dove said she expects slower growth to bring down inflation.

But the forecasts are now for increasing rates of growth, and current conditions are already driving up prices past the Fed’s comfort zones.

Also, the Fed forecasts for 2 years forward always presume about a 2% inflation rate.

That’s because the forecast assumes ‘appropriate monetary policy’ to meet the Fed’s objectives.

The Fed’s interest rate forecast is not released with the rest of the forecast. Built into that model’s forecast is the staff’s calculation of ‘appropriate monetary policy.’

Seems to me that with growth revised up and inflation persisting even with weak q4 and weak q1 growth the model’s ‘appropriate monetary policy’ would be expected to include sufficient rate hikes to be consistent with the 2% inflation rate 2 years down the road.

Recap-

The only way the Fed knows to bring inflation down is to manage the output gap.

You don’t wait for the economy to get strong (achieve a 0 output gap) and then hike rates. That just makes it worse and more costly to keep an appropriate monetary policy/output gap to bring inflation down.

You have to not let the output gap too close to 0.

The Fed has always known this, but since August has feared a deflationary collapse due to supply side issues in the financial sector.

The recent past and the Fed’s forecast shows that instead of the feared deflation, inflation has now climbed above their comfort zones and appears to be persisting. And even looking higher, even with near 0 growth.

And last week’s Fed speeches raised concerns about the possibility that slowing growth has not and may not bring down inflation as anticipated.

And even Yellen volunteered that energy prices are beginning to elevate core inflation measures, and inflation expectations are showing signs of moving up.

Yes, the economy is weak. Yes, there are downside risks. But the economy is strong enough to be relentlessly pushing up prices, including core, and now the forecasts for growth have all been revised up due to the fiscal package.

If the FOMC shifts from fear of a deflationary collapse to fear of a moderate recession with prices holding firm, rate cuts are no longer appropriate monetary policy.

♥

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