Monthly Archives: February 2008

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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February 19 recap

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Might be a revealing day coming up.

I’m watching for markets to begin to link higher oil prices to the potential for higher interest rates, rather than the reverse as has been the case since August.

With oil up to the mid 97 range this am, the question is whether short term interest rates move higher due to possible Fed concerns about inflation, even with weak growth and continuing financial sector issues. Even Yellen recently voiced concerns about energy prices now feeding into core inflation measures which are now above her ‘comfort zone.’ And Friday Mishkin said more than once in a short speech that the Fed had to be prepared to reverse course if inflation expectations elevate.

Yes, credit spreads are a lot wider, but when, for example, I ask the desk if any of the wider AAA’s are ultimately money good, I get a lot of uncertainty. So it seems to me in many cases markets are functioning to price risk at perceived potential default levels? So some of the current spreads may be wider than they ‘should be’ but maybe not all that much?

Yes, the financial sector has been damaged (and damnaged).

Yes, housing is weak without the bid for subprime housing of 18 months ago.

And yes, the consumer has slowed down some.

However, exports are booming like a third world country- growing around 13% per year, also do to financial market shifts, this time away from $US financial assets.

This is offsetting weakening domestic demand and keeping gdp positive, at least so far.

Meanwhile, it looks like a full blow 1970’s inflation in the making if food, fuel, and import/export prices keep doing what they are doing.

And with Saudi production continuing to creep up at current pricing, seems demand is more than strong enough for them to keep hiking prices.

And suddenly Yellen and Mishkin, both doves, substantially elevate their anti inflation rhetoric, as core levels have gone just beyond even their comfort zones.

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Mishkin’s speech

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From today’s speech:

A central bank must always be concerned with inflation as well as growth. As I have emphasized in an earlier speech about inflation dynamics, the behavior of inflation is significantly influenced by the public’s expectations about where inflation is likely to head in the long run (Mishkin, 2007a). Therefore, preemptive actions of the sort I have described here would be counterproductive if these actions caused an increase in inflation expectations and in the underlying rate of inflation; in other words, the flexibility to act preemptively against a financial disruption presumes that inflation expectations are firmly anchored and unlikely to rise during a period of temporary monetary easing.

There have been recent signs of inflation expectations rising, including today’s jump in the one year Michigan expectation to 3.7%.

Indeed, as I have argued elsewhere, a commitment to a strong nominal anchor is crucial for both aspects of the dual mandate, that is, for achieving maximum employment as well as for keeping inflation low and stable (Mishkin, 2007b). Policymakers therefore need to closely monitor information about underlying inflation and longer-run inflation expectations, and the central bank must be ready to hold steady or even raise the policy rate if the evidence clearly indicates a significant rise in inflation expectations.

Says here he will vote to hike if expectations elevate.

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2008-02-15 US Economic Releases

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2008-02-15 Empire Manufacturing

Empire Manufacturing (Feb)

Survey 6.5
Actual -11.7
Prior 9.0
Revised n/a

Down, but it has been lower, not yet to previous recession levels.

2008-02-15 Industrial Production

Industrial Production (Jan)

Survey 0.1%
Actual 0.1%
Prior 0.0%
Revised 0.1%

Modestly positive, and not at recession levels.

2008-02-15 Capacity Utilization

Capacity Utilization (Jan)

Survey 81.3%
Actual 81.5%
Prior 81.4%
Revised 81.5%

Holding up reasonably well.

2008-02-15 U. of Michigan Confidence

U. of Michigan Confidence (Feb P)

Survey 76.0
Actual 69.6
Prior 78.4
Revised n/a

The CNBC effect keeping expectations down.

One year inflation expectations jumped to 3.7% putting the Fed on high alert.

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Preliminary February Michigan survey

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Survey shows people are watching TV and reading the newspapers.

For the third consecutive month, more households reported that their financial situation had worsened rather than improved over the past year.

But due to inflation, not falling nominal income:

Moreover, due to a higher expected inflation rate and smaller expected wage gains, 46% of all households anticipated declines in their inflation adjusted incomes during the year ahead, the worst reading since the 1990 recession.
Overall, consumers expected a year-ahead inflation rate of 3.7% in early February, up from 3.4% in the prior three months.

The Fed uses this as one of their inflation expectation indicators. It has gone from too high to even higher.

In contrast, long term inflation expectations, a proxy for core inflation, was unchanged and well anchored at 3.0% in February.

Yes, but still too high.

Eighty-six percent of all consumers thought that the national economy was in decline, the highest level recorded since 1982. Year-ahead prospects for the national economy were just as bleak as 72% expected bad times, a level comparable to the worst levels in the recessions of the early 1990’s and 1980’s. The anticipated downturn is expected to result in more joblessness in the year ahead, a prime concern of consumers. A rising unemployment rate was expected by 52% of all consumers in early February, up from 33% a year ago, and comparable to the peak levels recorded in the months surrounding prior recessions.

The rest is more of the same and shows influence of the media.

Personal Finances—Current went from 98 to 96

Not bad.

Personal Finances—Expected 116 to 108

As above.

The survey clearly shows expectations have deteriorated for both the economy and inflation.

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Re: RBA – 86% OIS odds of a hike in March

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(an interoffice email)

Looks familiar – the CB forecasting inflation falling from higher and higher levels as it move up rather than down as originally forecast.

———- Forwarded message ———-
From: Milo
Date: 2008/2/14
Subject: This Picture says it all, I recon – 86% OIS odds of a hike in March
To: Warren Mosler, Karim

Core inflation and successive RBA forecast tracks

The RBA has come to grips with Australia’s stark inflation reality. Inflation forecasts have been revised up significantly (see Figure 1), the RBA will deliver

more rate hikes and domestic demand will eventually slow. At the moment, forecasters are grappling with how high the terminal cash rate will be. Is it

7.5%, 8.0% or higher?

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Zimbabwe

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“However, the downside risks to growth have intensified since the last meeting, and markets are pricing in another rate cut..”

Zimbabwe’s Inflation Rises to Record 66,212%

by Brian Latham

(Bloomberg) Zimbabwe’s annual inflation more than doubled to 66,212 percent in December, the Central Statistical Office said in a document released to local banks.

The December figure “was an increase of 39,741 percentage points on the November rate of 26,470 percent,” the office said in the document released in the capital, Harare, this week.

Food and non-alcoholic beverages rose 79,412 percent in December, while non-food inflation was 58,492 percent, the office said.
Zimbabwe has the world’s highest rate of inflation and the world’s fastest-shrinking peace-time economy, according to the World Bank. The International Monetary Fund estimated inflation reached 150,000 percent in January, the Zimbabwe Independent reported, citing a document that hasn’t been officially released by the lender.

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Connolly

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Agreed that government can buy stocks to keep them from falling, as HK did.

But the 1930s was a gold standard deflationary collapse.

The Fed was constrained from net buying anything due to the risk of losing gold reserves.

The risks are very different now with non-convertible currency/floating fx:

Depression risk might force U.S. to buy assets

by John Parry

“The Fed probably can’t fix it all on its own now,” Connolly said. “There is a chance the Fed gets forced into unconventional cooperation with government,” which could involve buying a range of assets to reflate their value.

Operationally this can be readily done. But what assets would the Fed want to reflate? Equities represent a return on investment, which is what it is. Yes, it might make sense to have a bid, like HK did, for ‘market-making stabilization’ purposes, but not to hold longer term, as that would be public ownership of the means of production, etc.

That would be reminiscent of some steps the U.S. government took in the 1930s when the economy was mired in deflation and high unemployment.

One turning point came when agricultural prices were restored to their pre-slump levels, Connolly said. Such measures were among the New Deal programs that President Franklin D. Roosevelt launched to bolster the economy.

Note that we don’t have a problem with low agricultural prices today!

Nor with low energy prices or plunging nominal wages.

Only housing prices have been falling due to excess inventory that I calculate will be cleared in a few months. The risk is that housing prices rise after that.

Either way, investors face bleak prospects now without some kind of further government intervention, he said.

Investors, yes. Consumers, not so bleak. Jobs and income are holding up, and most forecasts are only minor rises in unemployment. And with booming exports and the fiscal package in place, GDP has been revised up.

Those steps might offer clues to investors in stocks and commodities, which Connolly expects the government might be ultimately force to step in and buy to stabilize markets.

Yes, as above. Maybe some market stabilization in the financial sector. I don’t see anything in the real sector that needs more government buying right now. Seems CPI is high enough as is for more mainstream economists.

He expects that a depression may be averted, but only by the state and the Fed reinflating the price of such assets.

If we do get a recession, it will be due to falling demand from something like a tax hike to balance the budget.

Beleaguered housing, non-government fixed-income securities and even the now overvalued Treasury market have little hope of generating substantial returns for investors over the next few years, he said.

Earned income is sufficient to drive effective demand, even without investor income.

“If we don’t avoid depression, the only thing worth holding is cash,” he added.

As we watch it buy less and less CPI? Looks more like we are turning the currency into wallpaper, at least so far.

As long as resources producers spend their incomes on imports of real goods an services (and don’t ‘save’ it), world demand is likely to be sustained at whatever prices they wish to charge.

Twin themes seem to be continuing: weaker demand with higher prices. But no recession, yet.

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Year over year export growth

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Year over year export growth is looking strong and today’s Dec number revises Q4 GDP estimates to up 1% (vs initial government report of up 0.6%).

Also note that Q4 lost 1.25% as inventories built in Q3 were drawn down. Smooth the inventory numbers for Q3/Q4 and that implies Q3 would have been up 3.65% and Q4 up 2.25%.

This also supports the upwardly revised December payroll number.

The likelihood of strong January exports is one factor that leads me to suspect the January employment number will be revised up as well.

And if exports continue to grow at current rates though Q1 it will also be higher than expected, with exports continuing to pick up the slack from housing.

2008-02-14 YoY Export Growth

YoY Export Growth

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