Tag Archives: Inflation

Mar 15 update

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The question for the Fed: Will further rate cuts help or hurt the credit crisis?

The Fed has been cutting to support the financial sector, and address risks (as they see them) of financial sector issues spilling over to the real sector.

How does the Fed see rate cuts helping the financial sector?

Lower payments for borrowers assist in servicing/refinancing outstanding debt and facilitate continued ‘borrowing to spend.’

However, in this cycle, it seems that rate cuts have been instrumental in the USD decline that correlates with rising gasoline/food/import prices.

‘Well anchored’ wages mean consumers are spending more on food/energy and have less for other goods and services.

And less for debt service, as evidenced by rising delinquencies and the (still mainly subprime, but starting to spread) deteriorating credit quality of consumer loan portfolios.

Yes, exports are increasing dramatically, supporting GDP, keeping the output gap reasonably low, but not increasing income for debt service where that is needed.

So the question for the Fed is, on balance, will further rate cuts help or hurt the credit crisis?

Will further cuts ‘ease financial conditions’ via interest rate channels?

Or will further cuts ‘tighten financial conditions’ via the current fx/inflation/debt service income channel?

And, even if those potential outcomes for the credit crisis are approximately equal, does the nod go to not cutting for reasons of residual inflation issues?

So far, not a single ‘real economy’ company has had problems beyond a slowdown in earnings and concern over future earnings. And slowdowns in sales have all been related to consumers being hurt by higher food and energy prices.

This implies the falling dollar/higher import prices is what has hurt the companies that have been subject to consumer weakness.

This implies Fed policy designed to protect the real economy from from potential spillover from the financial sector crisis has, as a side effect, done direct damage to the real economy.

And, of course, this is only relevant for the Fed if it comes up for discussion at the meeting on Tuesday.

Close friends tell me it probably won’t.

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Dow Jones: No mof intervention

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The MOF would have bought USD long ago if Paulson hadn’t gone around branding any CB a ‘currency manipulator’ and an international outlaw.

The USD is in freefall and is now the major source of inflation.

And maybe the Fed as seen the connection?

MOF Frets Over Yen, But No Hint Of Intervention

by Takeshi Takeuchi

(Dow Jones) Japanese currency authorities expressed alarm about the dollar’s fall close to the Y100-mark for the first time since 1995 but didn’t offer any clues about whether or when they might take any countermeasures.

Finance Minister Fukushiro Nukaga and his vice minister on currency affairs, Naoyuki Shinohara, separately voiced caution after the dollar fell to Y100.19 in the mid-day Tokyo session.

Nukaga said it is “a shared perception among the G7 (Group of Seven industrialized countries) that excessive exchange rate moves are undesirable,” while Shinohara also noted “excessive foreign exchange moves are undesirable.”

The two point men for Japan’s currency policy also said they will “continue closely watching foreign exchange markets,” a code phrase that shows their displeasure about current dollar/yen moves.

Neither of them, however, commented on whether they are considering taking countermeasures against the dollar’s rapid fall against the yen.

But Shinohara repeated the word “excessive” a few times in exchanges with reporters, suggesting the ministry’s level of caution has been at least raised in response to the imminent possibility of the dollar’s break below the Y100-mark.

In the past, finance ministry officials usually stepped up their currency rhetoric in stages before intervening. Their remarks on yen strength often changed from “rapid” to “a bit sharp” to “brutal,” while they also threatened “appropriate action” as an advance warning before intervening.

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Reuters: payrolls and the output gap

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U.S. Feb payrolls drop for second straight month

by Glenn Somerville

U.S. employers cut payrolls for a second straight month during February, slashing 63,000 jobs for the biggest monthly job decline in nearly five years as the labor market weakened steadily, a government report on Friday showed.

The Labor Department said last month’s cut in jobs followed an upwardly revised loss of 22,000 jobs in January instead of 17,000 reported a month ago. In addition, it said that only 41,000 jobs were created in December, half the 82,000 originally reported.

December was first reported as a ‘very weak’ 17,000 increase, revised to up 82,000 a month later (not ‘as originally reported’ as above) and now further revised to up 41,000.

These are substantial swings with current market sensitivities, and January and February will likely be further revised next month.

At the same time, the unemployment rate fell to 4.8%. The previous increases corresponded to an unexpected jump in the labor force participation rate, which has now fallen back some in line with Fed expectations.

The Fed has long been anticipating that demographic forces would reduce the labor force participation rate and thereby tighten the labor markets.

That is, we are running out of people to hire; so, new hires fall while the unemployment rate stays the same or goes down.

The last several months are consistent with this outlook, and it means the output gap isn’t all that large, as 4.75% unemployment is deemed by the Fed to be full employment with anything less further driving up inflation.

All this makes things more difficult for the Fed:

  • Stagnant GDP
  • Declining labor force
  • Very small output gap
  • Dangerously rising inflation

Without a major net supply response (a 5+ million bdp jump in crude or crude substitutes or drop in demand), crude prices will likely continue to rise. The drop in net demand for OPEC crude that cuased the price to break was about 15 million bdp in the 1980s, for example.

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Reuters: Yellen the Dove turing more hawkish

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Yellen: Fed faces unpleasant mix on prices, growth

by Ros Krasny

CHICAGO (Reuters) – San Francisco Federal Reserve Bank President Janet Yellen said on Friday that the U.S. central bank faces an “unpleasant combination” of risks to inflation and growth in setting interest rate policy.

“The U.S. economy is particularly exposed to downside risks from the unwinding of the housing bubble and disruptions in financial markets,” Yellen said in remarks prepared for Banque de France’s symposium on globalization and monetary policy in Paris.
“There is some slack now in the U.S. labor market and, if these downside economic risks materialize, quite a bit more slack could emerge,” she said, which would tend to dampen inflation.

The dove position: OK to cut now because inflation coming down later anyway.

Still, Yellen said inflation risks were “roughly balanced” and that the Fed “cannot afford to take for granted that inflation expectations will remain well-anchored.”

The hawk position: if you let inflation expectations elevate (and there are signs this is happening), it’s too late, and a much larger output gap is needed to bring it back down.

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Bloomberg: from Fisher the hawk

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While Fisher is perhaps the most hawkish voting member and voted against Bernanke at the last meeting, continuously rising crude/food prices and a not so large output gap are causing more voting members to firm their anti-inflation rhetoric in recent weeks:

Fisher Says Credit Markets May Not Force Fed to Act

by Naga Munchetty and Scott Lanman

Enlarge Image/Details

(Bloomberg) Federal Reserve Bank of Dallas President Richard Fisher said investors shouldn’t assume that rising credit costs will force the central bank to cut interest rates as deeply as it did in January or in an emergency meeting.

“We reacted with very deliberate actions that took place over a very short timeframe” in January, Fisher said in an interview with Bloomberg Television in Paris. “That shouldn’t lead markets to expectations that we will continue to react in that manner.”

Fisher also downplayed speculation that the Fed is set to reduce its benchmark interest rate before policy makers’ next scheduled session on March 18. Yesterday, yields on agency mortgage-backed securities rose to a 22-year high relative to U.S. Treasuries, while the cost to protect corporate bonds from default climbed to a record.

“I would discourage you from thinking that simply because of a significant action in the credit markets, like we had yesterday, that suddenly we’re going to have an Open Market Committee meeting, and that suddenly we’re going to move Fed funds rates in response,” said Fisher. “It doesn’t work that way.”

Traders see a 100 percent chance that the Fed will lower its 3 percent benchmark rate by three-quarters of a percentage point this month, according to futures contracts. The probability a month ago of such a move was 30 percent.

`Process’ Turmoil
At the same time, Fisher said that the credit-market turmoil “has to be processed.”

That is, the Fed is more inclined to give markets time to work things out. While demand is weak, the output gap has remained modest.

And now, with inflation and inflation expectations elevated, they need a larger output gap to bring it down (rising MNOG).

The world’s 45 biggest banks and securities firms have written off $181 billion since the beginning of 2007, reflecting the collapse of the U.S. subprime-mortgage market.

Without a failure, so far, and without the feared supply-side constraints. Yes, credit standards have tightened, but not due to actual ‘money shortages’.

“There’s a danger if the Fed reacts to new information immediately,” said Fisher, 58, a former money manager and U.S. Senate candidate who joined the Dallas Fed in 2005. “But obviously we take into account all the information as closely as we can.”

Fed officials have cut the target for the overnight interbank lending rate by 2.25 percentage points since August, taking it to 3 percent. The 1.25 percentage point of reductions in January was the fastest easing of policy in two decades. Yields on two-year Treasuries fell to 1.41 percent at 11:55 a.m., the lowest since 2003, as traders anticipate further cuts.

Fisher was the lone voting member of the Federal Open Market Committee who dissented from the Jan. 30 decision to reduce the rate by a half point.

Jobs Report
The FOMC’s decisions in January were in response to a “weaker prospect for the economy,” Fisher said.

Which is why he voted against it. When the risks shifted from ‘market functioning induced collapse’ to ‘slowing demand/weaker GDP/larger output gap’, he stepped aside.

The U.S. Commerce Department releases February payroll- growth and unemployment figures at 8:30 a.m. Washington time today. The jobless rate probably rose to a two-year high and payrolls increased at a quarter of last year’s pace as builders and manufacturers fired more workers, economists said before the report.

A modestly larger output gap is expected. Fisher and others aren’t so sure that it will be large enough to bring down the rate of inflation, as it’s still going up even with current weakness.

Yes, inflation is a lagging indicator, but oil prices are a leading indicator and drive future inflation for years down the road.

Fisher was in Paris for a conference on globalization, inflation and monetary policy, hosted by France’s central bank. In a speech before the interview, Fisher said “persistent” increases in commodity prices make it harder for central bankers to determine precisely how much inflation may be rising.

Exactly. And so far, the rate cuts are seen to have been driving down the dollar, driving up crude prices and future inflation, and not doing a whole lot for market functioning.

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Bernanke and the beast: beware the MNOG!

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4:20 pm Eastern time, March 6

2008-03-06 Tips 5y5y fwd

TIPS 5y5y fwd

Twin themes remain since Q2 2006: weakness and inflation.

Weakness:
The great repricing of risk continues driving credit spreads wider, bid/offer spreads wider, volumes lower, and market forces continue to drive a general, massive deleveraging in the financial sector.

Housing is very weak: sales and construction are down more than 50% from the highs.

Unemployment is up a few tenths, and domestic demand in general is subdued.

Overall, strong exports keep us out of recession, and the real economy muddles through with GDP near zero.

Inflation:
Crude back up through $105, and the $ index down big to all time lows, driving up import prices and external demand (and rising export prices), and our own pension funds are driving up commodity prices by allocating funds to passive commodities.

CPI is up about 4.5% year over year, and core is moving up towards 2.5% as well.

The Fed
The Fed strategy has been to cut rates as an expression of doing what’s necessary to help the financial sector’s problems from spreading to the real economy.

The Fed sees a risk of a massive, 1930’s like, output gap and deflation. They see no reason to worry about the current 4.5% inflation when a potential 10%+ deflation/depression is looming, and with their models forecasting lower inflation.
And as they see inflation expectations remaining now ‘reasonably well anchored,’ and futures markets indicating lower prices for the out months vs the spot months, the Fed’s models continue to forecast lower inflation in the months and years ahead.

Policy is necessarily formed on forecasts, not rear view mirror observations, even if those forecasts have been continuously wrong for the last year. As a point of logic, there is no choice but to continue to forecast to the best of their ability and to continue to formulate policy around those forecasts.

Unfortunately, things have gone awry.

Rather than adding to demand and supporting GDP through the anticipated monetary and credit channels, the Fed’s rate initial rate cuts instead have seemingly driven the $US down and raised the price of imports, particularly energy.

With nominal wages ‘reasonably well anchored’ this has acted as a tax on the consumer and further reduced domestic demand. Falling real wages did coincide with increased exports, but not enough to keep GDP from falling ‘below trend’ and the output gap somewhat wider than it was previously.

Further rate cuts did the same – drove the $ down/prices up further, and reduced real wages and domestic demand. And further increased exports just enough to keep GDP near zero.

And the ‘credit crisis’ continues.

And inflation expectations have elevated. Note the attached chart of 5 year TIPS 5 years forward. The Fed has indicated this is one of their important indicators of inflation expectations and was taking comfort that it had been reasonably well anchored up to a few months ago. Now it’s just passed previous all time highs.

Even the Fed doves have recently said inflation is above their comfort zones, and they have been qualifying their support for rate cuts with statements like ‘if oil prices fall or remain at current levels’ when crude was around $100 or less.

Here’s the problem for the Fed:
They rely on output gaps to bring inflation down to their comfort zones. When they see even tail risk of major deflationary forces setting in they feel more than justified in addressing that risk of an excessive output gap that would not only slow inflation but bring on outright deflation.

But as inflation persists and expectations become less well anchored, the Fed believes the required output gap to bring inflation back down increases substantially, as their most recent studies show that it takes ever larger moves in interest rates to alter unemployment, and ever larger moves in unemployment to alter inflation.

Should housing simply stop contracting, and housing prices only level off, tail risk of an output gap large enough to cause a massive deflation fades.

Suddenly, the forecast output gap, while positive, is far too low to bring inflation and inflation expectations back into the Fed’s comfort zones.

The Fed is already out on the fringes of mainstream economics, including the text books Bernanke and Mishkin have written.

Mainstream economics says that if you are at full employment (believed by the Fed to be a 4.75% unemployment rate) when faced with rising energy costs that drive up prices and reduce consumer demand, leave it alone.

Don’t cut rates and add to demand, and turn a relative value story into an inflation story.

Instead, let demand weaken, let GDP fall, so that other prices will remain stable and and only relative value adjusts as markets allocate by price.

If you do support demand with rate cuts, you only drive inflation higher, real wages fall anyway, inflation expectations elevate, and the real cost of then stopping/reversing this process and bringing inflation back down is far higher than if you had left it alone.

In fact, that’s what all Fed members said continuously up to last August. In recent testimony, for example (see recent postings on this website), Bernanke said the Fed didn’t cut rates because there was an inflation problem.

If crude stays at current levels or continues higher (which I suggest it will as Saudis/Russians continue to act as swing producers, and demand remains far higher than needed for them to continue to support prices at current levels), all inflation measures will continue to march higher.

And with oil producers and other foreigners now spending their $ revenues rather than holding $US financial assets, exports keep rising and keep the current output gap from widening.

For the Fed, this means the MNOG (minimum non-inflationary output gap) needed to bring inflation down to comfort zones goes up substantially.

Their current MNOG could now very well be substantially higher than the current output gap (unemployment was last reported at 4.9%).

And this MNOG beast seems to be growing by the day.

So today’s news of initial claims coming down some, retail sales showing some Feb recovery vs Jan, pending home sales flattening, muni markets reorganizing and selling bonds again, and the ISM bouncing back yesterday, and mainstream companies in general reporting reasonably good to excellent current earnings, all indicate the MNOG is growing faster than the current output gap is growing.

And less than 60 days away are the $150 billion in tax rebate checks.

For the Fed, however, ‘deflationary spiral’ tail risk remains, particularly if you see the risks as those of the 1930’s gold standard days. Back then, the supply side of credit would abruptly shut down for both the private and the public sector, and financial sector issues were immediately transmitted to the real economy. (It doesn’t work that way with today’s non convertible currency and floating exchange rate regime, where public sector spending is not operationally constrained, but the Fed doesn’t yet seem to see it that way.)

Today’s equity markets contribute to the Fed’s tail risk fears- they see the stock market as a reliable leading indicator.

The equity markets are under pressure from both directions: a weak economy is bad for business and a rebound means higher interest rates from the Fed.

And with a Fed that believes the only tool it has to fight tail risk deflation is changing interest rates (see Bernanke testimony), it is rational for markets to expect the Fed to toss another big chunk of raw meat to the MNOG with another big fed fund rate cut after the March 18 meeting.

Data dependent, of course.

Payrolls tomorrow. Jan revision probably more relevant than the Feb number, as the pattern has been for substantial revisions a month after the initial announcement.

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Delta Farm Press: aggregate demand

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Looks like inflation as measured keeps ripping.True, there isn’t a shortage of available crude. the issue is that at the margin the available crude is sold by a ‘swing producer’ /monopolist who can hike prices indefinitely until there is a supply response as in the 1980’s when OPEC production dropped by 15 million bpd as they attempted to hold up prices.

I don’t see that kind of supply response this time around any time soon.

Markets volatile with index funds influence, bio-fuel requirements

by David Bennett
Farm Press Editorial Staff

The grain and livestock industries have experienced a certain change in attitude since USDA’s late January crop report.

RICHARD BROCK, right, author of the Brock Report, and Carl Brothers, vice president at Riceland Foods, both spoke at the recent 2008 ASU Agribusiness Conference in Jonesboro, Ark.

Several weeks ago, agriculture economist Richard Brock was at a conference with a professor from Kansas State University who “… indicated that currently in Kansas there’s such a quick liquidation that there’s a three-year wait to get slaughter space for sows.

“There is a wait list, but I don’t think it’s three years. In Illinois, we’re seeing a lot of 1,000- to 1,300-sow units being liquidated,” said Brock, author of the Brock Report and contributor to Delta Farm Press, at Arkansas State University’s Agribusiness Conference in Jonesboro, Ark., on Feb. 13.

Regardless, if the corn market isn’t corrected soon, “frankly there will be irreparable damage in the pork industry. Pork prices will be absolutely through the roof in 12 to 18 months.”

As for problems the poultry industry is having, it was announced in early February prices for chicken breasts are set to rise 7 to 10 percent. “We’re seeing probably a cutback in poultry for the first time since I’ve been in business over 30 years. So there are repercussions from this strong grain market and changing world.”

In the grain elevator business, “the last three weeks have been the most chaotic I’ve ever seen. A week ago, I was speaking at the Minnesota Feed and Grain Convention. I had dinner with a banker from a large, national bank the night before. Just (days) before they’d notified some of their clients, independent grain elevator operators, not to come back for additional lines of credit.”

There are “huge problems” in the grain elevator business. “If they can’t increase a line of credit, they must liquidate their position. That means an increasingly wide basis.”

Further, a large, regional Midwest elevator company announced two weeks it wouldn’t even make bids for new-crop soybeans, wheat or corn. A farmer in that region “can’t even get a price, right now. These are some of the issues the industry as a whole will be facing.”

Economic rules
While studying agriculture economics at Purdue University, one of Brock’s professors said, “the laws of economics have never been repealed and probably never will be. If you keep the price of any commodity too high, too long, someone will find a way to produce more of it, use less of it or use something else.”

Brock finds that “particularly true of the energy market, right now. We’ve kept prices much too high for way too long. We don’t have a shortage of energy, of crude oil. We have a perceived shortage of crude oil.

“The only time we’ve had a real energy shortage was in 1973. That’s the only time I can remember lines at gas stations because of shortages.”

What is happening now is a huge change in technology. For example, China has eight nuclear plants under construction with 45 others on the drawing board.

Few are aware that within the next 18 months, six nuclear plants will start up in the United States, the first built in the country since the frightening Three-Mile Island incident in 1979.

Meanwhile, “if you drive through the Midwest, you can’t go 10 miles without seeing windmill farms. They’re going up everywhere.”

Regarding the value of the U.S. dollar, Brock takes a position contrary to many agriculture economists. “I don’t understand why a lot of the press and ag economists have convinced producers that a cheap dollar is good for us. I think — particularly if you’re a corn or soybean farmer — a cheap dollar hurts more than helps.”

The value of the dollar is a relative issue. “We don’t compete against anyone in the corn market so what difference does the value of the dollar make? We’re the majority of the world’s corn export market. We have no significant competition.”

Last year, the United States exported more corn at $4.50 than it did two years ago at $2. Is there any correlation between the value of the dollar and price of corn? “Countries buy corn based on need not price.”

What about soybeans U.S. farmers are competing against in South America? “Again, show me a correlation between the value of our currency and Brazil’s and soybean exports. My guess is you’d find a much stronger correlation between ocean freight rates and soybean exports.”

Fifty percent of the nitrogen used in U.S. agriculture is now imported along with 80 percent of the potash. What has really happened “is the value of the dollar has substantially increased the price of our inputs. And I’d argue it has helped the selling price not at all. Yet, for some reason, we’re led to believe the (lower) value of the dollar is good for us.”

Funds
Very few are aware one of the biggest issues impacting U.S. agriculture are index funds.

“There are two commodity funds. Regular funds can be both long and short. In 2002, those had about $51 billion in. By last September, the most recent data, that number had risen to about $185 billion.”

The real issue, though, is with index funds. “The granddaddy of them is the Goldman and Sachs Index Fund. Our last estimate was it had $103 billion.”

Three or four years ago, any fund that traded commodities was subject to position limits. Suppose the position limit on corn was around 18 million bushels. “If you’re a manager of a Goldman Sachs fund and the market moves $1, that’s (potentially) $18 million dollars. That’s a lot of money to us but if you’re working with $103 billion, it’s a pimple on an elephant’s back.”

So the index funds petitioned the Commodity Futures Trading Commission (CFTC) to be classified as commercial companies. The limits on a commercial company like ADM or Cargill are only the amounts of grain being sold or bought.

Meanwhile, the index fund companies don’t have any grain, only cash. Their only limit is the amount of money on hand. This allows them to go long on as much corn, beans, wheat and crude oil as they have cash.

There are smaller index funds “and they all have perspectives and must maintain balances at the end of each month. For the Goldman Sachs fund, 74 percent of its money must be invested in the energy market. In other words, the fund has $75 billion to be used in crude oil and gas futures. Further, 8.2 percent of its money must be traded in grain markets.

“Think about this, the fund has $8.5 billion for corn, soybeans and wheat and $74 billion for crude oil and heating oil. I never thought I’d be considering a conspiracy theory. But I can see a novel being written in about five years as to where the money was coming from for these funds. Wouldn’t it be ironic if we discovered that of that $103 billion, a lot is oil money from the Middle East. And the fund is self-perpetuating: put the money in the fund, they have unlimited access to buying oil futures to keep the price of oil up and keep the flow of money going. I’m not saying that’s happening, but I’ve seen stranger things.”

What does worry Brock is that, as of a month ago, the index funds position in Chicago on soft red winter wheat represented 270 percent of the crop.

“That was the position! People wonder why the wheat market is so volatile — because the funds are buying more wheat than we produce. In the corn market, (the funds) represent only about 15 percent of the crop. They actually have a current position in cotton of over 50 percent of the crop.”

The largest long position is held by the index funds — currently long on about 400,000 corn contracts. “That’s 2 billion bushels of corn. The regular funds are long on another 100,000 contracts. So, between the two types of funds, they’re long on over 3 billion bushels of corn.”

Brock is unsure of a solution. However, the livestock and poultry industries are “all over” the CFTC to get regulations changed.

The index funds distort the market, insists Brock. With such a high futures market, “the cash can’t keep up. There are basis swings like we’ve never seen before because the grain elevators can’t meet margin calls.

“The one thing that could happen is — and let’s use the Goldman Sachs fund as an example — if, hypothetically, crude oil dropped $15 a barrel. At the end of the month, the fund must adjust assets.” If all other commodities stay the same and no other cash flow is coming into the fund, “they’ll have to sell corn, soybeans, wheat and cotton in order to bring their percentages back in line.

“If they have more money coming into their fund, though, instead of selling corn, beans, wheat and cotton they could buy more energy to maintain the monthly balances.”

Fuel
Currently, there are 127 U.S. ethanol plants with an average capacity of 59 million gallons. There are 68 facilities under construction with an average capacity of 84 million gallons. Another 88 facilities are on the drawing board with over 89 million gallons of capacity.

“If you take a look at the mandate in the energy bill that just passed, 36 billion gallons of ethanol (are required) by 2015 and 15 billion of that is to come from corn.… In 12 to 18 months, we’ll already be producing enough ethanol with what’s already under construction to reach the 2015 mandate.”

If the plants proposed are built, by 2015 the United States will produce about 22 billion ethanol. “But I don’t think we’ll get there because of what’s happened in the last month. By year’s end, in Illinois 22 percent of the corn crop will be used for ethanol. In Indiana 41 percent, Iowa 53 percent, Kansas 38 percent, Kentucky 8 percent, Nebraska 40 percent, North Dakota 45 percent, South Dakota 58 percent.

Ohio — which a year ago was at zero — will be at 35 percent. Ohio has always been a corn-deficit state because it ships corn east and southeast to pork and poultry industries. Here they are, already in a corn deficit, and now 35 percent of their crop will be in an ethanol plant. That doesn’t make a lot of sense, but it’s being done.”

With current corn prices, some ethanol plants are losing money. “I received an e-mail last night from the president of a feed company in California. He named three (plants) that are under construction and have stopped building and six plants that were on the drawing board and (have been dropped).

“I think what the industry will find is if the corn market stays high much longer, a lot of the plants being planned will disappear. We won’t reach the big (predictions) made.

“This industry has changed enormously in just the last six weeks. The economics have changed because of the price of corn.”

Another issue in California is almost all of the corn used for ethanol is coming from Nebraska, South Dakota and Minnesota.

This year, there’s plenty of corn. However, next year is a concern.

“Corn can be found, but as anyone in the railroad industry knows, the problem is there aren’t enough railcars to get it from the western Corn Belt to California. And even if you could get the railcars, there isn’t enough track. It isn’t like building a new track through Arkansas — there are these things called the Rocky Mountains that aren’t flat. Getting new track built won’t happen.”

Ethanol is about $2.20 per gallon. That means using a break-even formula, $6 corn is required. In California, by the time “they pay about $1.40 per bushel to get the corn from the western Corn Belt the price (is too high). That’s why some plants are shutting down.”

Brock estimates that about 3.2 billion corn bushels from this year’s crop will go to ethanol. Next year, he says, the number will be between 3.8 billion and 4 billion.

A possible bearish factor to add to the mix: the 54-cent tariff on imported ethanol expires in 11 months.

“If you’d asked me three months ago about the chances of that being renewed, I’d have said 95 percent. But with political pressure in Washington, D.C., right now, I’m not so sure it’ll be renewed. It’s up in the air and might depend on who the next president is.”

Genetics and enzymes
The next thing that could change things around is genetic improvements. “Talk to executives at Pioneer and Monsanto and they’ll say a 10-bushel-per-acre increase in the next two years is inevitable. Most are more optimistic than that. Add 10 bushels to the corn yield and it would solve a lot of problems. We’d have corn running out of our ears.”

Two weeks ago, Brock made a mistake while giving a speech. “I said someone would be coming along with an enzyme that would allow poultry and pork to digest more than the 10 percent of DDG (Dry Distillers Grain) equivalent in their rations.”

As soon as the speech was over, “some executives (approached me and explained) they’d released a product called Allzyme SSF about a month ago. This is being commercially marketed to the poultry and pork companies. If (it works), this would change the demand for corn quite a bit. DDG could be fed more aggressively to poultry.”

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Re: Crossing curves

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(an email exchange)

>
>   Warren,
>
>   Claims just printed before I finished this….351 (down from revised 375) But Con’t Claims
>   made a new local high @ 2831……….the water coming into the boat, is still coming in at
>   a fast rate than the water getting bailed out………..Con’t Claims going higher is
>   bad………as the FED already knows…..
>
>   Best
>   Please call with any questions
>   RMG
>
>

Hi Rob,

Problem for the Fed-

With inflation both where it is and where it’s going over the next few quarters due to price pressures already baked in, it now NEEDS a larger output gap to keep it under control as per it’s own models.

And as crude/food/import prices go even higher, the required output gap grows.

The question is where the curves cross. At some point even the pessimistic output gap projection isn’t sufficient to bring down inflation.

The mainstream view (not mine) is that higher food/crude takes away demand for other products. And it’s the lack of demand for these other products that keeps high food/crude a relative value story and not an inflation story, and inflation expectations remain anchored.

If, at this point, if the Fed adds to demand- becomes accommodative- the result is inflation. , ,

At least up to now, the fed has seen risk of a collapse large enough to bring on an output gap large enough to not only bring inflation down, but drive us into a 30’s style deflation.

The main channel for this to happen is the housing channel.

They see a potential drop in housing prices to drive us down into a widespread deflationary spiral.

Now, with inflation rising as fast as it is, what I’m saying is they are getting closer to NEEDING a housing collapse just to both bring inflation into their comfort zone over a multi year horizon, and to keep inflation expectations from elevating near term.

Any sign of a bottom or even a near bottom in home prices could now mean they’ve overdone it on the easing, as even a 6% unemployment rate might not be a sufficiently large output gap for their models to show the declines in inflation they need, and we are far from that. .

warren

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CNNMoney.com: Dallas Fed President: Inflation, not recession, is No. 1 woe – Mar. 4, 2008

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Yes, Fisher is on record as the lead inflation hawk.

If he’s right and it turns out Bernanke cut rates into a 70’s style inflation Fisher has to be a leading candidate for Fed Chairman. Much like when Volcker replace Miller in 1979. And Kohn gets passed over a second time, this time for missing the inflation surge, if it happens.

Too early to tell which way it will go. I give the odds to inflation, whether the economy strengthens or weakens.

Bernanke is betting his career that the economy will weaken and bring inflation down. And, as he stated last week, ‘and the futures markets agree.’

Fed officials debate recession risk

Dallas Fed President Fisher argues inflation greatest threat to economy, while Fed Governor Mishkin says recession risks are greater than central bank’s forecast.

by Chris Isidore

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The central bank’s decision to slash rates are raising inflation fears as the economy shows signs of slowing. Play video



NEW YORK (CNNMoney.com) — Two members of the Federal Reserve’s rate-setting body gave conflicting speeches Tuesday as to whether rising inflation or a recession is the greater risk for the economy.

Inflation risk greater Dallas Federal Reserve President Richard Fisher said Tuesday he believes inflation is a greater threat, saying he would accept a slowdown of the U.S. economy in order to keep price pressures in check. The remarks suggest that Fisher, a so-called inflation hawk, will keep pushing his Fed colleagues to stop cutting rates.

But Frederic Mishkin, a Fed governor and a close ally of Fed Chairman Ben Bernanke, argued in a speech to the National Association for Business Economics that the risks are so great that the economy will not be able to meet even the Fed’s modest forecast, which essentially calls for little or no growth in the first half of the year. He argued price pressures remain in check and that the threat from inflation should wane in upcoming years.

The Fed made a 0.75 percentage point rate cut at an emergency meeting Jan. 21, and another half-point cut at the conclusion of the Jan. 29-30 meeting. Fisher, who joined the Federal Open Market Committee for the two-day meeting, was the sole vote against that cut.

The FOMC is next set to meet March 18, and investors are widely expecting another half-point cut at that meeting.

In remarks prepared for a speech in London, Fisher said that he’s upset by talk that recent Fed rate cuts represent an “easy money” policy by the U.S. central bank.

“Talk of ‘cheap money’ makes my skin crawl,” he said in his prepared remarks. “The words imply a debased currency and inflation and the harsh medicine that inevitably must be administered to purge it.”

“So you should not be surprised that I consider the perception that the Fed is pursuing a cheap-money strategy, should it take root, to be a paramount risk to the long-term welfare of the U.S. economy,” he added.

Fisher points out that yields on long-term bonds have risen, not declined, in the wake of the Fed rate cuts, a sign of growing concern about inflation – although he conceded that traders could be mistaken about the effect of the cuts on prices.

“Twitches in markets that have occasionally led me to wonder if they were afflicted with the financial equivalent of Tourette’s syndrome,” he said.

But Fisher said inflation readings have not been encouraging and that he believes price pressures can continue to build even in the face of an economic slowdown, an economic condition popularly known as “stagflation.”

Fisher argues it’s better to have the economy go into an economic downturn than to risk a pickup in inflationary pressure through low rates due to global forces.

“We cannot, in my opinion, confidently assume that slower U.S. economic growth will quell U.S. inflation and, more important, keep inflationary expectations anchored,” he said. “Containing inflation is the purpose of the ship I crew for, and if a temporary economic slowdown is what we must endure while we achieve that purpose, then it is, in my opinion, a burden we must bear, however politically inconvenient.”

Recession risk greater But Mishkin said he believes the economy is at greater risk than seen in the Fed forecast released last month which called for modest growth between 1.3% to 2% between the fourth quarter of 2007 and the end of this year.

“I see significant downside risks to this outlook,” he said. “These risks have been brought into particularly sharp relief by recent readings from a number of household and business surveys that have had a distinctly downbeat cast.”

The Fed governor argues that the housing prices are at risk of falling more than forecasts, and that if that happens, he believes it will put a crimp in both consumer confidence and their access to credit. He said that the declines also could create greater upheaval in the financial markets, which he argues “causes economic activity to contract further in a perverse cycle.”

Mishkin also said he expects the problems in the economy to cause a rise in unemployment. And while he believes the Fed needs to keep an eye on inflation pressures, he doesn’t believe they pose a significant threat anytime soon.

“By a range of measures, longer-run inflation expectations appear to have remained reasonably well contained even as recent readings on headline inflation have been elevated,” he said.

“I expect inflation pressures to wane over the next few years, as product and labor markets soften and the rise in food and energy prices abates,” he added. He also said he believes that inflation measures that strip out volatile food and energy prices should be close to 2% a year going forward, which is the upper end of what is generally believed to be the Fed’s comfort zone that leaves the door open for further rate cuts.

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