Tag Archives: Fed

Friday mid day

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Food, crude, metals up, dollar down, inflation up all over the world, well beyond CB ‘comfort levels.’

Nov new home sales continue weak, though there are probably fewer ‘desirable’ new homes priced to sell, and with starts are down the new supply will continue to be low for a while.

The December Chicago pmi was a bit higher than expected, probably due to export industries. Price index still high though off a touch from Nov highs.

So again it’s high inflation and soft gdp.

Markets continue to think the Fed doesn’t care about any level of inflation and subsequently discount larger rate cuts.

Mainstream theory says if inflation is rising demand is too high, no matter what level of gdp that happens to corresponds with. And by accommodating the headline cpi increases with low real interest rates, the theory says the Fed is losing it’s fight (and maybe its desire) to keep a relative value story from turning into an inflation story. This is also hurting long term output and employment, as low inflation is a necessary condition for optimal growth and employment long term.

A January fed funds cut with food and energy still rising and the $ still low will likely bring out a torrent of mainstream objections.

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Calories, Capital, Climate Spur Asian Anxiety

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Higher oil prices mean lower rates from the Fed, and higher inflation rates induced by shortages mean stronger currencies abroad.

Why do I have so much trouble getting aboard this paradigm, and instead keep looking for reversals? Feels a lot like watching the NASDAQ go from 3500 to 5000 a few years ago.

:(

Calories, Capital, Climate Spur Asian Anxiety

2007-12-26 17:51 (New York)
by Andy Mukherjee

(Bloomberg) — The new year may be a challenging one for Asian policy makers.

Year-end U.S. closing stocks for wheat are the lowest in six decades; soybeans in Chicago touched a 34-year peak this week. Palm oil in Malaysia climbed to a record yesterday.

The steeply rising cost of calories may be more than just cyclical, notes Rob Subbaraman, Lehman Brothers Holdings Inc. economist in Hong Kong. Growing use of food crops in biofuels and increasing demand for a protein-rich diet in developing countries may have pushed up prices more permanently.

The wholesale price of pork in China has surged 53 percent in the past year.

“Consumer inflationary expectations may soon rise, feeding into wage growth and core inflation, but we expect Asian central banks to be slow to react, initially due to slowing growth and later because of strong capital inflows,” Subbaraman says.

If the U.S. Federal Reserve continues easing interest rates to combat a housing-led economic slowdown, a surge in capital inflows into Asia may indeed become a stumbling block in managing the inflationary impact of higher commodity prices.

Food and energy account for more than two-fifths of the Chinese consumer-price index, compared with 17 percent for countries such as the U.K., U.S. and Canada, and 25 percent in the euro area, according to UBS AG economist Paul Donovan in London.

As Asian central banks raise interest rates — when the Fed is cutting them — they will invite even more foreign capital into the region. That will cause Asian currencies to appreciate, leading to a loss of competitiveness for the region’s exports.

Carbon Emissions

On the other hand, paring the domestic cost of money prematurely may worsen the inflation challenge.

That isn’t all.

Higher oil prices will also boost the attractiveness of coal as an energy source, delaying any meaningful reduction in carbon emissions in fast-growing Asian nations such as China and India.

As Daniel Gros, director of the Centre for European Policy Studies in Brussels, noted in recent research, the price of coal — relative to crude oil — has been halved since the end of 1999. And per unit of energy produced, coal is a much bigger pollutant than oil or gas.

This doesn’t augur well for the environment.

“Given that China is likely to install over the next decade more new power generation capacity than already exists in all of Europe, this implies that the current level of high oil prices provides incentive to make the Chinese economy even more intensive in carbon than it would otherwise be,” Gros said.

Beijing Olympics

Climate-related issues will be in the spotlight in Asia next year. China’s eagerness to use the Beijing Olympic Games to showcase solutions to its huge environmental challenges will be one of the “big things to watch for” in Asia in 2008, Spire Research and Consulting, a Singapore-based advisory firm, said last week.

Even if China succeeds in reducing air pollution during the Olympics, the improvements may not endure after the sporting event ends on Aug. 24, especially since the underlying economics continue to favor higher coal usage.

A drop in hydrocarbon prices might help check emissions and global warming, Gros noted last week on the Web site of VoxEu.org.

In fact, lower oil prices may also make food costs more stable by lessening the craze for biofuels.

That will leave capital flows as Asia’s No. 1 challenge in 2008. And it won’t be an easy one for policy makers to tackle.

Capital Inflows

Take India’s example.

The $900 billion economy has attracted $100 billion in capital in the 12 months through October, with a third of the money entering the country as overseas borrowings, according to Morgan Stanley economist Chetan Ahya in Singapore.

This has caused the rupee to appreciate more than 12 percent against the dollar this year, knocking off more than three percentage points from India’s inflation index, says Lombard Street Research economist Maya Bhandari in London.

Naturally, exporters are complaining.

So why doesn’t India cut domestic interest rates? It can’t do that without the risk of stoking inflation.

Money supply is growing at an annual pace of more than 21 percent in India, compared with the central bank’s target of between 17 percent and 17.5 percent. Inflation has held well below the central bank’s estimate of 5 percent for five straight months partly because of the government’s insistence on not passing the full cost of imported fuel to local consumers. It isn’t yet time for monetary easing in India.

China has it worse. Monetary conditions there remain dangerously loose. And China may be reluctant to do much about the undervalued yuan — the root cause of its record trade surpluses and the attendant liquidity glut — until the Olympics are out of the way.

Asian economies may, to a large extent, be insulated from the subprime mess. Still, 2008 won’t be all fun and games.

(Andy Mukherjee is a Bloomberg News columnist. The opinions expressed are his own.)

–Editors: James Greiff, Ron Rhodes.

To contact the writer of this column:
Andy Mukherjee in Singapore at +65-6212-1591 or
amukherjee@bloomberg.net

To contact the editor responsible for this column:
James Greiff at +1-212-617-5801 or jgreiff@bloomberg.net

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Saudi/Fed teamwork

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Looks like markets are still trading with the assumption that as the Saudis/Russians hike prices the Fed will accommodate with rate cut.

That’s a pretty good incentive for more Saudi/Russian oil price hikes, as if they needed any!

Likewise, the US is a large exporter of grains and foods.

Those prices are now linked to crude via biofuels.

And the new US energy bill just passed with about $36 billion in subsidies for biofuels to help us keep burning up our food for fuel and keeping their prices linked.

This means cpi will continue to trend higher, and drag core up with it as costs get passed through via a variety of channels. In the early 70’s core didn’t go through 3% until cpi went through 6%, for example.

Ultimately everything is made of food and energy, and margins don’t contract forever with softer demand. In fact, much of the private sector is straight cost plus pricing, and govt is insensitive to ‘demand’ and insensitive to the prices of what it buys. And the US govt. indexes compensation and most transfer payments to (headline) cpi.

And while the US may be able to pay it’s rising oil bill with help from its rising export prices for food, much of the rest of the world is on the wrong end of both and will see its real terms of trade continue to deteriorate. Not to mention the likelihood of increased outright starvation as ultra low income people lose their ability to buy enough calories to stay alive as they compete with the more affluent filling up their tanks.

At the Jan 30 meeting I expect the Fed to be looking at accelerating inflation due to rising food/crude, and an economy muddling through with a q4 gdp forecast of 2-3%. Markets will be functioning, banks getting recapitalized, and while there has been a touch of spillover from Wall st. to Main st. the risk of a sudden, catastrophic collapse has to appear greatly diminished.

They have probably learned that the fed funds cuts did little or nothing for ‘market functioning’ and that the TAF brought ff/libor under control by accepting an expanded collateral list from its member banks.

(In fact, the TAF is functionally equiv of expanding the collateral accepted at the discount window, cutting the rate, and removing the stigma as recommended back in August and several times since.)

And they have to know their all important inflation expectations are at the verge of elevating.

They will know demand is strong enough to be driving up cpi, and the discussion will be the appropriate level of demand and the fed funds rate most likely to sustain non inflationary growth.

Their ‘forward looking’ models probably will still use futures prices, and with the contangos in the grains and energy markets, the forecasts will be for moderating prices. But by Jan 30 they will have seen a full 6 months of such forecasts turn out to be incorrect, and 6 months of futures prices not being reliable indicators of future inflation.

Feb ff futures are currently pricing in another 25 cut, indicating market consensus is the Fed still doesn’t care about inflation. Might be the case!

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Strong gdp and high credit losses

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CNBC just had a session on trying to reconcile high gdp with large credit losses. Seems they are now seeing the consumer clipping along at a +2.8% pace for Q4. No need to rehash my ongoing position that most if not all the losses announced in the last 6 months would have little or no effect on aggregate demand. Credit losses hurt demand when the result is a drop in spending. And yes, that happened big time when the subprime crisis took the bid away from would be subprime buyers who no longer qualified to buy a house. That probably took 1% away from gdp, and the subsequent increase in
exports kept gdp pretty much where it was. But that story has been behind us for over a year.

The Fed is not in a good place. They should now know that the TAF operation should have been done in August to keep libor priced where they wanted it. They should know by now losses per se don’t alter aggregate demand, but only rearrange financial assets. The should know the fall off in subprime buyers was offset by exports.

The problem was the FOMC- as demonstrated by their speeches and actions- did not have an adequate working understanding of monetary operations and reserve accounting back in August, and by limiting the current TAFs to $20 billion it seems they still don’t even understand that it’s about price, and not quantity. Too many members of the FOMC
are mostly likely in a fixed exchange rate paradigm, with its fix exchange rate/gold standard fractional reserve banking system that drove us into the great depression. With fixed exchange rates it’s a ‘loanable funds’ world. Banks are ‘reserve constrained.’ Reserves and consequently ‘money supply’ are issues. Government solvency is an issue.

With today’s floating exchange rate regime none of that is applicable. The causation is ‘loans create deposits AND reserves,’ and bank capital is endogenous. There are no ‘imbalances’ as all current conditions are ‘priced’ in the fx market, including ANY sized trade gap, budget deficit, or rate of inflation.

The recession risk today is from a lack of effective demand. There are lots of ways this can happen- sudden drop in govt spending, sudden tax increase, consumers change ‘savings desires’ and cut back spending, sudden drop in exports, etc.- and in any case the govt can instantly fill in the gap with net spending to sustain demand at any level it desires. Yes, there will be inflation consequences, distribution consequences, but no govt. solvency consequences.

So yes, there is always the possibility of a recession. And domestic demand (without exports) has been moderating as the falling govt budget acts to reduce aggregate demand. But the rearranging of financial assets in this ‘great repricing of risk’ doesn’t necessarily reduce aggregate demand.

Meanwhile, the Saudis, as swing producer, keep raising the price of crude, and so far with no fall off in the demand for their crude at current prices, so they are incented to keep right on hiking. And they may even recognize that by spending their new found revenues on real goods and services (note the new mid east infrastructure projects in progress) they keep the world economy afloat and can keep hiking prices indefinitely.

And food is linked to fuel via biofuels, and as we continue to burn up every larger chunks of our food supply for fuel prices will keep rising.

The $US is probably stable to firm at current levels vs the non commodity currencies, as portfolio shifts have run their course, and these shifts have driven the $ down to levels where there are ‘real buyers’ as evidenced by rapidly growing exports.

Back to the Fed – they have cut 100 bp into the triple negative supply shock of food, crude, and the $/imported prices, due to blind fear of ‘market functioning’ that turned out to need nothing more than an open market operation with expanded acceptable bank collateral (the TAF program). If they had done that immediately (they had more than one outsider and insider recommend it) and fed funds/libor spreads and other ‘financial conditions’ moderated, would they have cut?

There has been no sign of ‘spillover’ into gdp from the great repricing of risk, food and crude have driven their various inflation measures to very uncomfortable levels,and they now believe they have ‘cooked in’ 100 bp of inflationary easing into the economy that works with about a one year lag.

Merry Christmas!

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Repo Mkts and TAF

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(an interoffice email)

On 12/21/07, Pat Doyle
wrote:
>
>
>
> It is becoming apparent that the funding pressures for year end are ebbing.
> The ease in pressure has a lot to do with the TAF and coordinated CBK
> interventions. The Fed is getting the cash to the people who need it.
> Discount window borrowings have been slowly climbing as well approx 4.6bb
> now. The Fed statement that they will provide this TAF facility for as long
> as needed is easing concerns amongst banks and providing a reliable source
> of funding for “hard to fund” assets.

Should have done this in August!
>
>
> There is and has been a lot of cash in the markets still looking for a home.
> Balance sheets are slowly cleaning up but balance sheet premiums (repo) will
> remain stubbornly high as long as the level 3 type assets remain on
> dealer/bank balance sheets.
>
>
>
> The current spread between the 1×4 FRA vs. 1×4 OIS is 57bps..

This looks like a good play – seems unlikely LIBOR will be at a wider spread than the discount rate. Load up the truck?

1×2 FRA vs.
> 1×2 OIS is 40bps. Spot 1mos LIBOR VS 1MOS FFs is 4.86 vs. 4.25 or 61bps.
> These spreads still represent continued unwillingness to lend in the
> interbank market and also illustrate a steeper credit curve.
>
>
>
> Turn funding has not changed substantially. While funding appears to be
> stabilizing, balance sheets are still bloated and capital ratios are still
> under pressure therefore balance sheets will remain expensive in repo land.
>
>
>
> From another bank;
>
> Mortgages over the year-end turn traded at 5.25 today, which we still feel
>
> is a good buy here considering the amount of liquidity the fed has been
> dumping
>
> into the system as of late (via the TAF and standard RP operations) and the
>
> expectation that they will continue to do so on Dec 31. Treasuries also
> traded
>
> over the turn traded today at 2.50, the first treasury turn trade we’ve seen
> in
>
> quite some time.
>
>
>
>
>
> Yesterday Tsy GC O/N’s backed up from the low 3s to 3.70. The FED has been
> actively trying to increase the supply of treasuries in the repo markets.
>
>
>
> AGENCY MBS repo has been steadily improving. 1mos OIS vs 1mos AGCY MBS has
> gone from a spreads of 63bps last week to 15bps last night. And spreads to
> 1month LIBOR have widened by 33bps AGCY MBS from L-23 12/13 to L-56 12/20.
> Again LIBOR still showing the unwillingness of banks to lend to each other.
>
>
> -Pat
>
>
>
>
> Patrick D. Doyle Jr.
>
> AVM, L.P. / III Associates
>
> 777 Yamato Road
>
> Suite 300
>
> Boca Raton, Fl. 33431
>
> 561-544-4575
>
>

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Fed finally gets it?

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The Fed was finally successful in cutting the fed funds/libor spread with a glorified 28 day repo, after failing to narrow the spread with 100 bp of rate cuts.

Narrowing the ff/libor spread ‘automatically’ lowers various libor based funding rates, probably including jumbo mtg rates, which have been a concern of the Fed as well.

Makes me wonder if they would have cut the ff rate if they had used this ‘facility’ and narrowed the ff/libor spread right away back in August?

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Libor rates & spreads: down in GBP & EUR, stable in US

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Thanks, Dave, my thought are the Fed will also ‘do what it takes’ which means setting price and letting quantity for term funding float.

The ECB doing 500 billion without ‘monetary consequences’ beyond lowering the term rates should have been no surprise to anyone who understands monetary ops, and confirmation of same for those central bankers who may have needed it demonstrated.

Libor rates; no surprises, most of them are down, especially in longer expiries (3mth+) -see table below-. GBP3m -18bp helped by yesterday’s auction. EUR 3m -4.75bp and probably more tomorrow.

Libor spreads.- In 3mth -spot- rates, sharp declines in EUR (-6bp to 78bp) and GBP (-14bp to 76bp) while the US spread remains fairly stable at 80.3bp (-1bp).

It seems the BoE and ECB have taken bolder actions to provide liquidity (see this morning’s message on the ECB LTRO). Let’s see the results of the 1st $20bn TAF later today.

19-Dec
Libor Rate		 18-Dec
Libor Rate		 Change in
% Points		 18-Dec
Libor		 17-Dec
Libor		 Change in
% Points
USD Overnight 4.34500% 4.40000% -0.05500% 4.40000% 4.41750% -0.01750%
USD 1 Week 4.38875% 4.38625% 0.00250% 4.38625% 4.36375% 0.02250%
USD 3 Month 4.91000% 4.92625% -0.01625% 4.92625% 4.94125% -0.01500%
USD 12 Month 4.41750% 4.47188% -0.05438% 4.47188% 4.51875% -0.04687%
EUR Overnight 3.86125% 3.82750% 0.03375% 3.82750% 3.98875% -0.16125%
EUR 1 Week 4.01000% 4.01625% -0.00625% 4.01625% 4.06625% -0.05000%
EUR 3 Month 4.80125% 4.84875% -0.04750% 4.84875% 4.94688% -0.09813%
EUR 12 Month 4.80250% 4.80750% -0.00500% 4.80750% 4.88313% -0.07563%
GBP Overnight 5.58750% 5.59750% -0.01000% 5.59750% 5.59750% 0.00000%
GBP 1 Week 5.61125% 5.63250% -0.02125% 5.63250% 5.64125% -0.00875%
GBP 3 Month 6.20563% 6.38625% -0.18062% 6.38625% 6.43125% -0.04500%
GBP 12 Month 5.88000% 5.94500% -0.06500% 5.94500% 5.96375% -0.01875%

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Greenspan sees early signs of U.S. stagflation

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Agree, if food/crude/import&export prices keep rising, there will be serious fireworks between congress and the fed. This will include blaming the fed for the high gasoline prices, for example.

Greenspan sees early signs of U.S. stagflation

U.S. economy is showing early signs of stagflation as growth threatens to stall while food and energy prices soar, former U.S. Federal Reserve Chairman Alan Greenspan said on Sunday.

In an interview on ABC’s “This Week with George Stephanopoulos,” Greenspan said low inflation was a major contributor to economic growth and prices must be held in check.

“We are beginning to get not stagflation, but the early symptoms of it,” Greenspan said.

“Fundamentally, inflation must be suppressed,” he added. “It’s critically important that the Federal Reserve is allowed politically to do what it has to do to suppress the inflation rates that I see emerging, not immediately, but clearly over the intermediate and longer-term period.”

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Re: liquidity or insolvency–does it matter?

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(email with Randall Wray)

On Dec 15, 2007 9:05 PM, Wray, Randall wrote:
> By ________
>
> This time the magic isn’t working.
>
> Why not? Because the problem with the markets isn’t just a lack of liquidity – there’s also a fundamental problem of solvency.
>
> Let me explain the difference with a hypothetical example.
>
> Suppose that there’s a nasty rumor about the First Bank of Pottersville: people say that the bank made a huge loan to the president’s brother-in-law, who squandered the money on a failed business venture.
>
> Even if the rumor is false, it can break the bank. If everyone, believing that the bank is about to go bust, demands their money out at the same time, the bank would have to raise cash by selling off assets at fire-sale prices – and it may indeed go bust even though it didn’t really make that bum loan.
>
> And because loss of confidence can be a self-fulfilling prophecy, even depositors who don’t believe the rumor would join in the bank run, trying to get their money out while they can.

If there wasn’t credible deposit insurance.

>
> But the Fed can come to the rescue. If the rumor is false, the bank has enough assets to cover its debts; all it lacks is liquidity – the ability to raise cash on short notice. And the Fed can solve that problem by giving the bank a temporary loan, tiding it over until things calm down.

Yes.

> Matters are very different, however, if the rumor is true: the bank really did make a big bad loan. Then the problem isn’t how to restore confidence; it’s how to deal with the fact that the bank is really, truly insolvent, that is, busted.

Fed closes the bank, declares it insolvent, ‘sells’ the assets, and transfers the liabilities to another bank, sometimes along with a check if shareholder’s equity wasn’t enough to cover the losses, and life goes on. Just like the S and L crisis.

>
> My story about a basically sound bank beset by a crisis of confidence, which can be rescued with a temporary loan from the Fed, is more or less what happened to the financial system as a whole in 1998. Russia’s default led to the collapse of the giant hedge fund Long Term Capital Management, and for a few weeks there was panic in the markets.
>
> But when all was said and done, not that much money had been lost; a temporary expansion of credit by the Fed gave everyone time to regain their nerve, and the crisis soon passed.

More was lost then than now, at least so far. 100 billion was lost immediately due to the Russian default and more subsequently. So far announced losses have been less than that, and ‘inflation adjusted’ losses would have to be at least 200 billion to begin to match the first day of the 1998 crisis (August 17).

>
> In August, the Fed tried again to do what it did in 1998, and at first it seemed to work. But then the crisis of confidence came back, worse than ever. And the reason is that this time the financial system – both banks and, probably even more important, nonbank financial institutions – made a lot of loans that are likely to go very, very bad.

Same in 1998. It ended only when it was announced Deutsche Bank was buying Banker’s Trust and seemed the next day it all started ‘flowing’ again.

>
> It’s easy to get lost in the details of subprime mortgages, resets, collateralized debt obligations, and so on. But there are two important facts that may give you a sense of just how big the problem is.
>
> First, we had an enormous housing bubble in the middle of this decade. To restore a historically normal ratio of housing prices to rents or incomes, average home prices would have to fall about 30 percent from their current levels.

Incomes are sufficient to support the current prices. That’s why they haven’t gone down that much yet and are still up year over year. Earnings from export industries are helping a lot so far.

>
> Second, there was a tremendous amount of borrowing into the bubble, as new home buyers purchased houses with little or no money down, and as people who already owned houses refinanced their mortgages as a way of converting rising home prices into cash.

Yes, there was a large drop in aggregate demand when borrowers could no longer buy homes, and that was over a year ago. That was a real effect, and if exports had not stepped in to carry the ball, GDP would not have been sustained at current levels.

>
> As home prices come back down to earth, many of these borrowers will find themselves with negative equity – owing more than their houses are worth. Negative equity, in turn, often leads to foreclosures and big losses for lenders.

‘Often’? There will be some losses, but so far they have not been sufficient to somehow reduce aggregate demand more than exports are adding to demand. Yes, that may change, but it hasn’t yet. Q4 GDP forecasts were just revised up 2% for example.

>
> And the numbers are huge. The financial blog Calculated Risk, using data from First American CoreLogic, estimates that if home prices fall 20 percent there will be 13.7 million homeowners with negative equity. If prices fall 30 percent, that number would rise to more than 20 million.

Not likely if income holds up. That’s why the fed said it was watching labor markets closely.

And government tax receipts seem OK through November, which is a pretty good coincident indicator incomes are holding up.

>
> That translates into a lot of losses, and explains why liquidity has dried up. What’s going on in the markets isn’t an irrational panic. It’s a wholly rational panic, because there’s a lot of bad debt out there, and you don’t know how much of that bad debt is held by the guy who wants to borrow your money.

Enough money funds in particular have decided to not get involved in anyting but treasury securities, driving those rates down. That will sort itself out as investors in those funds put their money directly in banks ans other investments paing more than the funds are now earning, but that will take a while.

>
> How will it all end?

This goes on forever – I’ve been watching it for 35 years – no end in sight!

> Markets won’t start functioning normally until investors are
> reasonably sure that they know where the bodies – I mean, the bad
> debts – are buried. And that probably won’t happen until house prices
> have finished falling and financial institutions have come clean about
> all their losses.

And by then it’s too late to invest and all assets prices returned to ‘normal’ – that’s how markets seem to work.

> All of this will probably take years.
>
> Meanwhile, anyone who expects the Fed or anyone else to come up with a plan that makes this financial crisis just go away will be sorely disappointed.

Right, only a fiscal response can restore aggregate demand, and no one is in favor of that at the moment. A baby step will be repealing the AMT and not ‘paying for it’ which may happen.

Meanwhile, given the inflationary bias due to food, crude, and import and export prices in genera, a fiscal boost will be higly controversial as well.

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