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Yearly Archives: 2011
John Silvia update on employment and inflation
John Silvia, chief economist at Wells Fargo (formerly at Wachovia), gives his update on employment and inflation outlook. John is a top macro forecaster, whom I often listen to.
Taylor rebuffs Bernanke
John Taylor thinks Bernanke misinterpreted his Taylor Rule on monetary policy…he's not happy about it. According to original Taylor Rule, the Fed should raise interest rate to 1%.
When you have a Fed that can change rule as they wish, you know more troubles are ahead.
Reinhart comments on Bernanke’s Fed
Vincent Reinhart discusses the Fed’s monetary policy outlook – Fed first need to unload its balance sheet before raising rates.
Who’s paying taxes? v2
Another graph, very similar to my previous post , on who’s paying taxes in America.
(click to enlarge)
Update on Junk Bond Market
Junk bond market had given investors great return in both 2009 and 2010. With junk yield approaching historical low, one of the greatest short opportunities starts to take shape.
The memory of the great credit bubble burst in 2007 is still fresh . Back then, junk bond spread (with comparable treasuries) reached its lowest point in history, about 2.6%. Now the yield spread stands in 4.5% range – looking relatively high and indeed the spread may go even lower – This is exactly the argument from junk bulls.
But a simple analysis clearly defies bulls’ logic, in favor of junk bears.
First, interest rate is at historically low. It can only go up in the future, regardless whether it’s due to true economic recovery or because high inflation forces interest rate to rise. When the Fed reverses its monetary policy, bond market will be hit hard. Junk bond, with its bigger default risk and higher volatility, will be hit hardest.
Second, if the economy instead turns southward, entering a period of protracted low growth, mimicking Japan after its housing bubble burst, then the default risk will rise sharply. By then, Bernanke co. may print more money, but it won’t matter any more. Ask yourself: What real effect have QE1 and QE2 really had on the economy, besides popping up asset prices?!
For investors, timing again is important. Watch the Fed’s move and hear their talks- any sign of rate hike will be the trigger.
This short video from Financial Times gives you a nice historical perspective on the junk bond market.
(click on the graph to play the video).
Maybe “stagflation” is for real…
Yield curve is telling a very different story than the stock market. Echoing Meltzer’s earlier piece, “Bernanke’s 70s show“, maybe stagflation is for real…reports WSJ:
Treasurys may be signaling trouble.
The market is behaving in ways that suggest investors are starting to fret over the potential for stagflation in the U.S. …
Consider the Treasury “yield curve.” It refers to the difference between short-term and long-term interest rates on U.S. Treasury debt. Typically, as the economy is expanding, this curve has an upward slope, and is usually at its steepest during the earliest stages of a recovery.
Eventually, investors anticipate the Fed will begin raising interest rates to stave off inflation. That tends to lift short-term rates, compress long-term ones, and generally flatten the curve, or even invert it if investors expect the outcome could be recession.
Lately, with the U.S. growth outlook improving, the slope of the curve hasn’t started flattening, as might be expected at this point in the recovery. Instead, it has gotten steeper.
Earlier this week, the spread between two-year and 30-year Treasury yields hit a record-wide four percentage points, notes RBS Securities. At the same time, the implied annual inflation rate over a five-to-10 year horizon, based on Treasury yields, has moved up above 3% and towards levels last seen before the Fed’s previous rate-rise cycle began in mid-2004.
Investors, in other words, don’t expect the Fed to be as aggressive as in the past in raising rates—even as they see inflation on the rise.
“I think the Fed’s credibility is in question here,” says Priya Misra, head of rates strategy at Bank of America Merrill Lynch.
Or perhaps investors simply realize the Fed has put itself between a rock and a hard place. The U.S. unemployment rate is currently 9.4%, after all. It was at 5.6% in June 2004.
In a twist, the best scenario for the U.S. now is that interest rate increases in China, Brazil and other emerging markets rein in global cost pressures, giving the Fed—and the recovery—some breathing room.
The U.S. needs strong growth more than ever, especially with limited appetite for serious fiscal overhaul, to assuage the market’s other worry: wide deficits and heavy debt.
The clock is ticking.
![[AOT]](https://si.wsj.net/public/resources/images/MI-BH984_AOT_NS_20110120183303.jpg)
Catherine Mann: Fed should give up its job rate target
Interview of Cathy Mann at Brandeis University. She noted there was inconsistency in the Fed’s monetary policy —given the current unemployment rate, the Fed can’t be fighting inflation and unemployment at the same time — Either the Fed will have to give up their target on unemployment rate (6%), or they’ll have to give up their inflation target. And since neither QE1 or QE2 did much to job creation, it’s better to give up the target on unemployment rate, rather than letting the market form expectations that inflation is going to get out of control.
America’s new export – Inflation
It’s the replay of 1H of 2008, only with more severity. If were not for Lehman’s collapse, the prices of commodities would have shot to the roof more than two years ago. Now the still-the-same super easy monetary policy made commodity prices, especially food prices, come back again, evident everywhere in the world.
(click to enlarge, source: BOE)
China just reported its latest CPI number of close to 5%, but food prices jumped over 10% year over year. The food inflation forced China’s Bureau of Statistics to adjust down the weight of food in the CPI calculation. Isn’t this ridiculous! — The government wanted to you to believe as if inflation does not exist!
At the same time, various signs show that the huge excess reserves are being gradually unleashed from banks’ balance sheets — one indicator is that the yield on junk bonds has almost reached historical lows; another sign is that banks now started to relax their lending standards to both consumers and small businesses.
What we are seeing is exactly the divergence of traditional inflation measure (CPI) and asset inflation. Let’s call it “biflation”.
(click to enlarge, source: BOE)
Ronald McKinnon, an expert of exchange rate and US dollar at Stanford University, labels inflation as America’s latest export:
What do the years 1971, 2003 and 2010 have in common? In each year, low U.S. interest rates and the expectation of dollar depreciation led to massive “hot” money outflows from the U.S. and world-wide inflation. And in all three cases, foreign central banks intervened heavily to buy dollars to prevent their currencies from appreciating.
When central banks issue base money to buy dollars, domestic interest rates are forced down and domestic inflationary pressure is generated. Primary commodity prices go up quickly because speculators can easily bid for long positions in organized commodity futures markets when interest rates are low.
The world saw a surge in the dollar prices of primary commodity prices in 1971-73 following the Nixon shock of 1971 when the U.S. abandoned the gold standard. There was also a commodity price surge during the Greenspan-Bernanke shock of 2003-04, when the federal-funds rate was reduced to an unprecedented low of 1% followed by a falling dollar.
Now we have what one might call the Bernanke shock. The Fed has set U.S. short-term interest rates at essentially zero since September 2008, followed in 2010 by quantitative easing to drive down long-term rates. Predictably, primary commodity prices in 2009-10 surged. In 2010 alone, all items in the Economist’s dollar commodity price index rose 33.5%, while the industrial raw materials component soared a remarkable 37.4.%.
The longer-term inflationary and economic consequences over the next decade of this most recent U.S. loose money shock remain to be seen. But we can glean useful hints by looking at the aftermaths of the two earlier shocks. In the 1970s, “stagflation” (inflation combined with cyclical bouts of unemployment and wide swings in exchange rates) seemed intractable. Productivity growth in mature industrial countries fell sharply.
…
The Greenspan-Bernanke interest rate shock of 2003-04, followed by a weakening dollar into the first half of 2008, created the bubble economy. Primary commodity prices began rising significantly in 2003-04, then flattened out before spiking in 2007 into the first half of 2008.
But the biggest bubble was in real estate, both commercial and residential. With low mortgage rates and no restraining regulation on mortgage quality, average U.S. home prices rose more than 50% from the beginning of 2003 to the middle of 2006. This led to an unsustainable building boom—with echoes around the world in countries such as the U.K, Spain and Ireland. The bubbles in primary commodity prices collapsed mainly in the second half of 2008. But the residue of bad debts, particularly ongoing mortgage defaults, led to the banking crisis and global downturn of 2008-09.
So what lessons can we draw from these episodes of U.S. easy money and a weak dollar for the stability of the American economy itself?
First, sharp general price increases in auction-market goods such as primary commodities or foreign exchange (i.e., a weakening dollar) is an early warning sign that the Fed is being too easy—a warning that the Fed is again ignoring as we enter 2011.
Second, beyond the rise in primary commodity prices, general price inflation in the U.S. only comes with long and variable lags. After the U.S. monetary shock, hot money flows into countries on the dollar standard’s periphery cause a loss of monetary control and general inflation to show up there more quickly than in the U.S.
In 2010, consumer price indexes shot up more than 5% in major emerging markets such as China, Brazil and Indonesia, while the consumer price index in the U.S. itself rose only 1.2%. Similarly, after the Nixon shock of 1971, there was much more explosive inflation in Japan in 1972-73 than in the U.S. But by December 1979, inflation in America’s producer and consumer price indexes was more than 13%.