Category Archives: Inflation

Japan update

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Looks to me they are at least as afraid of becoming the next Greece as they are afraid of nuclear contamination.

I have seen no statements about ‘spending what it takes’ to secure the safety of the world’s population and to rebuild their nation.

The prime minister isn’t saying that, probably because of his concerns about finance.
He probably believes that Japan is dependent on lenders and may be at a tipping point with a 200% debt to gdp level.
He likely believes that with one false move the government’s ability to spend could be cut off.

In fact, they have been floating trial balloons about this being the right time for a new consumption tax to pay for any rebuilding.

In fact, and ironically, the actual risks of a major yen spending initiative that did substantially increase their deficit spending is not solvency but inflation. A massive rebuilding effort would have a good chance of raising the measured inflation rate a few points, and send the currency lower as well.

Both of which they have been desperately trying to accomplish, largely with ‘monetary policy’ that has yet to restore aggregate demand to full employment levels and promote real growth after nearly two decades of near 0 rates and massive QE initiatives.

And I still don’t see how any of this makes the yen stronger.
The repatriation story is nonsense, so if that’s what’s been driving prices watch for a sharp reversal.

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QE and the term structure of rates

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Background information first, answer later-

The Fed sets the fed funds target at their regular meetings, and lets the market then determine the term structure of rates.

That term structure of rates is therefore largely a function of anticipated future fed funds rate settings.

Then the Fed does QE- buys longer term securities at market prices- to try to bring longer term rates down, particularly mortgage rates.

But longer term rates don’t come down as much as hoped for.

Now to the point all this:

What the market place believes QE does, and not what QE actually does, is the same ‘force’ that largely determines the term structure of rates.

And so when the Fed does QE,
and the market place believes that QE will work to promote a strong economy and risk inflation,
the term structure of rates goes up in anticipation of higher fed funds rate settings by the Fed down the road.

And when the Fed ends QE,
that same market place then believes that support has been pulled from the economy,
the future is no longer as inflationary,
and the term structure of rates falls as fears of future fed funds hikes subside.

It doesn’t matter that the mainstream beliefs are wrong with regard to QE,
because the term structure of rates only reflects those same mainstream market place expectations, regardless of their actual validity.

And yes, this all highly problematic for a Fed trying to keep long rates down.

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Weber/LBS/Rehn

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Karim writes:

Weber being more explicit than what LBS said earlier today. Basically, if 1% is considered too low, 1.25% or 1.5% would be as well.

Domestic orders in Germany today and BdF Confidence survey both firm. Expect 25bp/qtr from ECB until they get to at least 2%.

Weber:
“I wouldn’t do anything here to try to correct market expectations at this point,” Weber told Bloomberg News in Frankfurt today when asked about investors pricing in an increase in the benchmark rate to 1.75 percent by the end of the
year. It was the intention of the ECB to bring forward market expectations and “I see no reason at this stage to signal any
dissent with how markets priced future policies,” he said.\

Weber also said the ECB’s latest inflation forecasts may underestimate price pressures.

LBS:
ECB Board Member Bini Smaghi said this morning that the increase in energy and agricultural raw materials prices is a “permanent” phenomenon. He also said that the wider the gap between real interest rates and GDP growth, the higher the risk of instability, and that keeping interest rates at 1% would further increase the rate of monetary expansion.


Also, EU Commissioner for Economic Affairs Rehn keeping positive sentiment alive about reducing borrowing rates for Ireland and Greece:

“The issue now, today and tomorrow is debt sustainability and I can see that there’s a case to be made to reduce the interest rates paid by Greece and Ireland”.

Agreed, and should it happen this is not good for the euro, though markets will think it is.

Higher rates both increase national govt deficits and exacerbate credit issues.

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China’s Top Priority in 2011 Is Controlling Inflation: Wen

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Sounds like very strong language to me.
As previously discussed, in the past inflation in China has led to regime change.
And also as previously discussed, China would have to be the exception to the rule to do it without a recession.

China’s Top Priority in 2011 Is Controlling Inflation: Wen

March 4 Reuters) — China’s Premier Wen Jiabao said on Saturday the nation had to tame inflation that threatened social stability as the government seeks to steer the world’s second-biggest economy towards more balanced, greener growth.

In China’s version of a “State of the Union” address to be presented later to the annual parliament session, Wen said the government aims to contain inflation to within 4 percent this year.

Failure to rein in price rises for food, housing and other goods could become more than an economic problem for the ruling Communist Party, which is jittery about social unrest especially after the upheavals shaking the Middle East.

“Recently, prices have risen fairly quickly and inflation expectations have increased. This problem concerns the people’s well-being, bears on overall interests and affects social stability. We must, therefore, make it our top priority in macroeconomic control to keep overall price levels stable,” Wen said in a work report prepared for delivery before the National People’s Congress.

Wen said that inflation was among the immediate worries weighing on China’s efforts to unleash new sources of domestically driven growth that will spread wealth more evenly.

“Expanding domestic demand is a long-term strategic principle and basic standpoint of China’s economic development as well as a fundamental means and an internal requirement for promoting balanced economic development,” said the prepared text of his speech.

The Premier’s annual address is given in the cavernous Great Hall of the People, crowded with thousands of delegates who are vetted by the Communist Party to acclaim and approve its policies.

But the Premier’s televised speech is also aimed at hundreds of millions of ordinary citizens who the Party leaders fear could become sources of discontent unless their grievances about price rises, unaffordable housing and expensive healthcare are eased.

Wen made clear that addressing those concerns would preoccupy China’s economic policy, shaping decisions on everything from farmers’ incomes to the yuan exchange rate.

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EU Daily | Europe’s Bank Signals It May Raise Interest Rates to Tamp Down Inflation

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So the ECB,
which is funding the entire euro zone banking system,
and for all practical purposes backstopping the funding of the national govts as well
to keep their funding costs manageable as they struggle with the terms and conditions of the austerity mandates,

That same ECB is now looking to raise rates, a proposal which is already working to increase the funding costs of those national govts.

They must think hiking rates is the tool to use to control the ‘inflation’ they are concerned about?

‘Inflation’ that’s come from tax hikes and relative value shifts in food and energy, as a foreign monopolist hikes crude prices and the burning up of our food supply for fuel hikes food prices?

Rate hikes that shift funds from borrowers, like the national govts they are supporting, to rentiers who will be getting the pay increase from higher rates?

And rising interest rates will require more austerity measures to offset the increased interest expense?

Yes, they also believe ‘inflation’ comes from elevated ‘inflation expectations’ but even that channel of causation, as far fetched as it is, has to be confused by the large output gap and general weakness of aggregate demand? Higher interest rates will somehow cause trade unions to soften demand for pay increases so their members can afford to eat?

Seems it goes back to the old Bundesbank dynamic, where the CB would threaten politically distasteful rate hikes if the govt didn’t tighten fiscal?

Well, today the ECB is already controlling fiscal, so it’s all moot.

But the old reflexes are still there.

Somewhat the like the old reflex with regard to export driven growth, but without the ideological option of buying dollars previously discussed.

So putting it all together, they have the export driven policy reflex without the dollar buying that’s undermining itself by driving the euro higher, working to limit demand from exports,
as the ECB both funds the financial structure and imposes austerity which is working against domestic demand.

And the rate hike reflex which won’t alter the price pressures from food, energy, and taxes.

And no telling what they may do next.
With their levels of unemployment, food price increases, and a general feeling that there are no ideas from on high to get them out of this mess, and large pools of newly arrived immigrants getting hurt them most, civil unrest is not impossible?

Maybe recognize that Europe is nothing more than a poorly managed theme park, and get a Disney exec to run it?

German Two-Year Yields Climb to Two-Year High on ECB Rate Bets

By Emma Charlton and Keith Jenkins

March 4 (Bloomberg) — German two-year government notes rose while their Greek equivalents fell, on concern higher borrowing costs may hamper the region’s most indebted countries, spurring demand for the euro zone’s safer assets.

Greece’s two-year yields reached the highest since May 10, the first trading day after the European Union and the international Monetary Fund announced the creation of a bailout fund to backstop the euro. European Central Bank President Jean- Claude Trichet said yesterday it’s “possible” that rates will rise at the central bank’s April meeting. His comments drove the German two-year yield up 23 basis points yesterday, the biggest increase since January 2009.

“There are some questions being asked about what tighter policy does for wider Europe, so that’s helping the bid toward core product,” said Eric Wand, a rates strategist at Lloyds Bank Corporate Markets in London. “Trichet was pretty clear that there would be a hike come April, so that’s going to underpin the German front-end going forward.”

The two-year note yield was two basis points lower at 1.76 percent as of 10:56 a.m. in London after reaching 1.84 percent, the highest since December 2008, according to data compiled by Bloomberg. The 1.5 percent security due March 2013 rose 0.035, or 35 euro cents per 1,000-euro ($1,387) face amount, to 99.49. The yield on German 10-year bunds, Europe’s benchmark government debt securities, was one basis point lower at 3.32 percent.

March 25 Deadline

Trichet will speak alongside governing council members including Mario Draghi and Christian Noyer at a Banque de France conference in Paris today. The ECB’s anti-inflation stance comes as European Union leaders approach a March 25 deadline for a reinforced plan to aid debt-strapped countries.

Greece’s two-year yields surged 24 basis points to 15.16 percent. The yield difference between German 2-year notes and Greek securities of a similar maturity was 13.41 percentage points, the widest since May 7, according to data compiled by Bloomberg.

Ten-year bunds were higher before a U.S. labor market report that is forecast to show employers added 196,000 workers last month, after a 36,000 gain in January, according to the median forecast of 84 economists surveyed by Bloomberg News. The report may also show the jobless rate increased to 9.1 percent from 9 percent.

“Right in front of payrolls data, people aren’t going to want to set too much risk on their books,” Wand said.

German-U.S. Spread

The yield difference, or spread, between German two-year notes and U.S. securities of the same maturity, narrowed four basis points to 98 basis points. It reached 103 basis points yesterday, the highest since Dec. 30, 2008, as traders added to bets that the European Central Bank will raise borrowing costs before the Federal Reserve.

The Frankfurt-based central bank, which left its key rate at a record low of 1 percent yesterday, is concerned about so- called second-round inflation effects, when companies raise prices and workers demand more pay to compensate for soaring energy and food costs, Trichet said. Euro-area inflation accelerated to 2.4 percent last month.

Euribor futures fell, pushing the implied yield on the contract expiring in December 2011 up two basis points to 2.18 percent. Earlier it rose to 2.215 percent, matching the highest since Feb. 22, 2010, as investors added to bets that the ECB will increase borrowing costs.

Forward contracts on the euro overnight index average, or Eonia, signal investors think the ECB will increase the key rate 25 basis points by its July meeting, Deutsche Bank AG data shows.

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Claims/ECB

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Karim writes:

  • Claims drop to new cycle low of 368k; prior week revised down to 388k from 391k.
  • No special factors cited

Trichet Introductory Statement KeyLine:
It is essential that the recent rise in inflation does not give rise to broad-based inflationary pressures over the medium term. Strong vigilance is warranted with a view to containing upside risks to price stability. Overall, the Governing Council remains prepared to act in a firm and timely manner to ensure that upside risks to price stability over the medium term do not materialise.


In the 2005-7 rate hiking cycle, ‘strong vigilance’ or ‘vigilance’ was used in the introductory statement in the month prior to all 8 rate hikes in that cycle. Base Case: Look for the ECB to start raising rates 25bps every 3mths until they get to 2%, likely starting next month. Other key messages were ‘act in a firm and timely manner’ and the absence of the phrase ‘rates are still appropriate’.

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Bernanke/ISM

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Bernanke qualifying a key phrase from 1mth ago.

Feb 3
Even so, with output growth likely to be moderate for awhile and with employers reportedly still reluctant to add to their payrolls, it will be several years before the unemployment rate has returned to a more normal level.


March 1
Even so, if the rate of economic growth remains moderate, as projected, it could be several years before the unemployment rate has returned to a more normal level. Indeed, FOMC participants generally see the unemployment rate still in the range of 7-1/2 to 8 percent at the end of 2012. Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established.

Standard response on cmmdty prices: “the most likely outcome is that the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S. consumer price inflation–an outlook consistent with the projections of both FOMC participants and most private forecasters. That said, sustained rises in the prices of oil or other commodities would represent a threat both to economic growth and to overall price stability, particularly if they were to cause inflation expectations to become less well anchored.”


Karim writes:

ISM

  • Encouraging news with index at its highest level since May 2004 and employment component highest since 1973
  • Gap between orders and inventories remain wide
  • Some strength in orders and shipments likely reflect inventory rebuild from huge Q4 drawdown vs entirely reflecting a change in demand



ISM Feb Jan
Index 61.4 60.8
Prices paid 82.0 81.5
Production 66.3 63.5
New Orders 68.0 67.8
Backlog of orders 59.0 58.0
Supplier deliveries 59.4 58.6
Inventories 48.8 52.4
Customer inventories 40.0 45.5
Employment 64.5 61.7
Export Orders 62.5 62.0
Imports 55.0 55.0

  • “A continued weak dollar is increasing the cost of components purchased overseas. It is going to force us to increase our selling prices to our customers.” (Transportation Equipment)
  • “We continue to see significant inflation across nearly every type of chemical raw material we purchase.” (Chemical Products)
  • “Our plants are working 24/7 to meet production demands.” (Fabricated Metal Products)
  • “Prices continue to rise, while business limps along at last year’s pace.” (Nonmetallic Mineral Products)
  • “Overall demand is off 10 percent.” (Plastics & Rubber Products)
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US Budget Gap Is Top Worry for NABE Economists

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So much for their legacies:

US Budget Gap Is Top Worry for NABE Economists

February 28 (Reuters) — The massive U.S. budget deficit is the gravest threat facing the economy, topping high unemployment and the risk of inflation or deflation, according to a survey of forecasters released Monday.

The National Association for Business Economics said its 47-member panel of forecasters increased its estimate for the 2011 federal deficit to $1.4 trillion from $1.1 trillion in its previous survey in November.

“Panelists continue to characterize excessive federal indebtedness as their single greatest concern,” with state and local government debt the second-biggest worry, the survey said.

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central bankers comment on QE

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Recent statements regarding QE show at least some key Central Bankers have it right:

Don Kohn (Former FRB Vice Chair):”I know of no model that shows a transmission from bank reserves to inflation”.

Vitor Constancio (ECB Vice President): “The level of bank reserves hardly figures in banks lending decisions; the supply of credit outstanding is determined by banks’ perceptions of risk/reward trade-offs and demand for credit”.

Charlie Bean (Deputy Governor BOE): in response to a question about the famous Milton Friedman quote “Inflation is always and everywhere a monetary phenomenon”: “Inflation is not always and everywhere a monetary base phenomenon”:

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the Mideast, the Saudis, and our markets

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First, I’ve been pretty quiet on the mideast goings ons.
I’ve been watching intently from the time Egypt made headlines,
and have yet to see anything of particular consequence to us, beyond oil prices.

I’ve yet to come up with any channel to world aggregate demand, inflation, etc. apart from oil prices.

Seems all moves in stocks and bonds have been linked directly or indirectly only to actual and potential changes in crude oil and product prices.

And the mainstream has yet to realize that ultimately the Saudis- the only producer with excess capacity, continues as price setter, at least until their excess capacity is gone.

So the price of crude oil remains set by decree, and not market forces.
And markets don’t yet seem to know that.
Credit the Saudis for outsmarting the world on that score.
They say they don’t set prices, but let the market set price, as they only set spreads to benchmark market prices they post for their refiners.
The world completely misses the simple difference between the Saudi’s reaction function as a price setter, and prices set competitively in the market place.

That’s like the Fed saying they don’t set $US interest rates, because they have a reaction function that guides them.

So what does that mean?

It means the price of crude will come down only if the Saudis want it to come down (assuming they do have excess capacity).

And my best guess is that their survival strategy includes a lower price of oil.

They will play the maestro with grand gesture and international ‘faux diplomacy’ with ‘high level’ behind the scenes goings ons with pledges to come to the rescue with promises of production increases to replace any lost output due to the crisis, making it clear that they are going the extra mile and taking extraordinary measures to ensure the western economies both won’t see any supply disruptions and prices will be contained. Making it clear that we owe them for their selfless, gargantuan, efforts and expenditures of political capital on our behalf.

It’s all a big show to ingratiate themselves to the West in the hopes of getting the western support needed to sustain their position of power.

And the west will never realize that prices went up only because the Saudis raised their posted prices under cover of their reaction function that the west mistakes for ‘market forces,’ and that prices will go down only as the Saudis simply lower their posted prices, as they continue to play us for complete fools.

Much like China does to us because we think we need to sell our Tsy secs to fund our federal spending.

And with lower crude prices we go ‘risk off’ and much of the recent moves in other markets reverse.

The other possibility is that the Saudis don’t cut price, maybe because they decide they want the increased revenues to sustain control domestically with increased distributions to their population.

One way or another, it’s all their political decision, and we don’t even understand how it works, which reduces the odds that whatever influence we might have will be used to our ultimate benefit.

Before the early 1970’s the price of oil was set by the Texas Railroad Commission, who kept it relatively low and stable, fueling growth with reasonable price stability, while govt policy fostered relatively high levels of employment and low output gaps.

Since the hand off to the Saudis in the early 1970’s, when circumstances allowed them to take over as swing producer/price setter, prices have increased dramatically with very high levels of volatility, disrupting the world order and fostering today’s very high levels of unemployment and massive output gaps, as govts struggle with fears of inflation and seemingly no understanding of the process that’s got us into that mess.

And now with the world turmoil perhaps largely a function of mass unemployment, and govts with no idea how to keep that from happening, the pendulum is shifting from order to chaos.

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