March 31, 2005
The dollar bulls are hoping (some may even be praying) that the economists at the Levy Economics Institute of Bard College (LEI) are wrong.
Yes, the U.S. economy enjoyed four-percent-plus growth last year, a new paper from LEI concedes. But don't let that fool you, the report goes on to effectively say. The prospects for growth are dimming, and the "stark choices" facing the consumer is the gremlin in this machine.
LEI's outlook boils down to this: consumers can't spend more without taking on materially higher risks, but neither can they pull back without threatening recession. Damned if they do, damned if they don't.
U.S. consumers, who've collectively amassed a record mountain of debt, are at or near the point where even the prospect of low financing may not be enough to trigger the purchase of a new personal computer, widescreen television, SUV or that summer home on the coast that the family's always wanted. Or so LEI's economists believe: "If [consumers] continue piling up new debt," they write, "the combination of their rising debt burdens and rising interest rates will produce rapidly increasing and unsustainable ratios of debt service to income. A jump in personal bankruptcies and a sharp drop in consumer spending will be inevitable."
We've all heard that one before, and a few others, and to date nothing's come of it. Should we continue to remain nonchalant? Or is it time to bury bars of gold and spam in the backyard?
The future isn't that bad, by LEI's reckoning; then again, it isn't all that good either: "If
households recognize that they cannot go much further in mortgaging their incomes to debt service, they will begin to cut back on further borrowing and slow down their current spending." This, we're told, is the more likely outcome of the two scenarios. "Furthermore, a new Washington and Wall Street consensus, encompassing the view that it is important to increase personal saving, is emerging in response to recent speeches by Federal Reserve Chairman Alan Greenspan, other Federal Reserve governors, and administration officials."
Is fiscal prudence about to be imposed upon us by necessity? God help the K-mart shoppers.
Of course, evidence for LEI's prediction may be less than imminent. The decline and fall of Joe Sixpack as a shopping entity is a losing forecast, and one with the lengthy history to prove it. And once again, there's a fresh reason to wonder when Joe will succumb, if ever, to the fate that so many see for our middle-aged her. Consider this morning's
Bureau of Economic Analysis release that revealed that personal income in February rose $33.2 billion, or 0.3 percent, while disposable personal income advanced $29.6 billion, or 0.3 percent.
Consumers, it seems, continue to confound the experts and spend what they earn. In fact, they're spending more than they earn, and therein lies the problem, or so goes one line of thinking. But the other shoe has yet to drop, and in fact both shoes have been purchased on zero- and low-interest credit cards. Indeed, same-store retail sales in February rose 4.9 percent from a year earlier, the International Council of Shopping Centers announced earlier this month, based on results at 69 chains, Bloomberg News reports.
And Joe, if he's like many lucky consumers with mailboxes, receives more than his share of credit card applications--applications that promise fresh plastic no matter one's credit history. How's LEI ever going to find intellectual satisfaction if credit card companies keep extending credit to consumers who can't afford to pay off the debt they've already accumulated?
Then again, one month a trend does not make, and so the latest personal spending numbers should be used cautiously. But a decade or two certainly makes for more compelling evidence, doesn't it? America's love of buying is no recent fad. Breaking the habit, as such, won't come easy, especially when there's no real effort at the Fed, or Visa or MasterCard, for forcing the overextended victims to go cold turkey.
That doesn't mean the consumer can't mend his ways, or that personal financial probity won't reverberate in the form of recession in the economy at large. But, we might ask, when might the day of reckoning arrive? And under what circumstances?
Everyone's offering a theory of course, but for the moment let's stick with LEI's: "The personal consumption spending machine, including household investment, again raced ahead of personal income in December 2004, but its growth is unsustainable and likely to stabilize or even fall in 2005…."
This year, in short, threatens to be a pivotal one for consumer spending trends, LEI warns. What could be the trigger for the new world order? It's any one's guess, obviously. But considering how long consumers have been spending, and how much debt they've racked up, it's not inconceivable that the game could roll on for longer than reasonably minded economists expect.
In surveying the potential catalysts for change on the consumer front, energy once again rears its ugly head, gasoline in particular. But before we go off the deep end (again), it's worth considering just how much of a financial impact $2.00 a gallon gas has on consumers. Less than the casual observer might expect. On that subject, Legg Mason today runs off a bit of statistical perspective:
Consider that the average driver in the U.S. puts about 12,000 miles on their vehicle in a given year…. In addition, consider that the average vehicle gets somewhere around 18 miles per gallon, leaving us with an average consumption of roughly 650 gallons of gas a year. At $2 a gallon, the average capital consumers must allocate towards gasoline a year is roughly $1,300. Because gasoline is considered an inelastic good, meaning consumers will use the same amount regardless of the price, if gas prices increase 10% to $2.20 a gallon, the average amount spent will increase to $1,430. How significant of a factor is $130 a year? With an average per capita income in the U.S. of $31,500 in 2003, $130 is less than half of one percent. While it is certainly shocking to see gas at $2.20 a gallon, the overall impact to the economy and consumers themselves is really not too shocking.
If no one's shocked at $2.20, maybe $3, $4 or even $5 a gallon might do the trick. Too far-fetched you say? Perhaps, although parts of Europe already pay such prices, and it has nothing to do with Opec. Is it relevant that consumption in Europe is something less than robust by American standards. Regardless, some governments on the Continent have ruled that it's in the best interest of their respective economies to hike up the price of gasoline by political means, above and beyond what a free and fair market would otherwise charge.
Nothing's imminent in the U.S. on that front, at least for the moment. Then again, one never knows what a government, any government will do given the right--or should we say wrong?--context. Or, as John Huston's character in Chinatown tells Jack Nicholson's Jake Gittes: "You see, Mr. Gits, most people never have to face the fact that at the right time and in the right place they're capable of anything."
Of course, if Goldman Sachs keeps coming out with bullish predictions that crude oil may be poised for a "super spike" that will run up a barrel to $105--as the investment bank did today--governments may be out of job when it comes to manipulating energy prices upward. Indeed, the prognostication helped drive the price oil up today over $55 a barrel after declines in previous sessions. Perhaps there's still hope for persuading the consumer to stay home and read a book. Just be careful what you wish for.
March 30, 2005
WALLS OF WORRY
The naybobs of negativism have a tough time these days when it comes to predicting the demise of growth. The final tally for GDP's fourth-quarter expansion came in at a 3.8% annualized real rate of increase, the Bureau of Economic Analysis reports today. That's a bit lower than the consensus outlook of 4.0% that economists expected, but a respectable advance nonetheless. Indeed, 4% to 5% is the average annualized GDP growth rate (based on quarterly data) that's prevailed over the past ten-plus years, and so it's not out of bounds to say that the economy's close to advancing at its average pace.
And the momentum looks set to continue, by some accounts. "The economy at the moment has a pretty good tail wind," Anthony Chan, senior economist at JP Morgan Asset Management, tells BusinessWeek today. Some economists expect this year's first quarter GDP will rise by around 4%. If that holds up, when the government's first estimate of the January-March period hits the street on April 28, the labor market will show respectable gains too, Ken Mayland predicts in the same BW article: "We are going to produce better growth on the job front," says the president of ClearView Economics.
Mark Vitner, senior economist at Wachovia Securities, thinks the first-quarter GDP will rise by 3.9%. "Real final sales were revised up slightly to a 3.4% annual rate in the fourth quarter, reflecting less inventory building than previously thought," he writes today. "With inventories already lean relative to sales, production now appears set for slightly stronger gains in 2005."
What's driving GDP? As usual, the consumer plays no minor role. Joe Sixpack has been busy handing his credit card around town. We know that because we see him at the malls, the car dealers, and audio shops. He's not quite sated, and there's one more credit card application waiting for him in today's mail. Par for the course. "The major contributors to the increase in real GDP in the fourth quarter were personal consumption expenditures, equipment and software, and private inventory investment," BEA reports.
Presumably, Joe will be at the forefront of any first-quarter GDP advance as well. But it's an open question if the stock market sees the same future unfolding. The S&P 500 has slipped 2.5% so far this year. That's hardly a ringing endorsement of the notion that the economy has continued to hum along this year. True, earnings have been quite strong in recent quarters, but on a valuation basis the trailing price-earnings ratio remains stuck around 20, or roughly where it's been since last summer.
The view from the equity markets doesn't get any better if you break stocks into growth and value components. The Russell 1000 Growth Index (a proxy of large-cap growth stocks) is off more than 8% year to date. That's a steeper fall than the 5.6% loss YTD for the Russell 1000 Value Index, and more than two times the red ink logged by the broad market, measured by the S&P 500.
So what's an optimist to think? Perhaps he can start with some questions. How about this teaser: Shouldn't growth stocks be taking the lead over value stocks if the economy is advancing at a healthy clip? Or, are we to conclude from the recent meanderings of the major indices that Mr. Market has stumbled in connecting the macro-economic dots to equities.
Clearly, the stock market was encouraged today by the drop in oil prices and the confirmation that the fourth-quarter GDP exhibited decent growth. But additional declines in oil are needed to inject more life into stocks. Meanwhile, the consumer needs to keep spending. The two may be connected to a degree that some investors aren't yet willing to accept.
By one measure, there's reason to wonder if consumers are willing to forge ahead with purchases above and beyond current levels given the still-uneasy outlook for energy prices. "It's clear that concerns over prices -- especially gasoline -- are hitting consumer confidence hard," says Jerry Thomas, president and CEO of Decision Analyst, which today announced that its U.S. Economic Index fell to its lowest since last October. "As long as consumers remain uncertain about the cost of such an essential commodity, it's hard to see a strong performance for the economy."
It's even harder to see the stock market barreling higher without a material fall in energy prices. Indeed, when it comes to energy, gasoline prices offer a closer measure of how consumers will be thinking in the near future. On that score, there's reason to stay cautious, despite today's drop in crude oil prices. Gasoline futures, in short, keep flirting with new highs. The sell-off in crude, in other words, has yet to carry over into gasoline. Or do we have that backwards: the sell-off in crude has yet to catch up to gasoline?
Deciphering a proper answer may not be imminent in the divergent paths of two the two fuels. Consider today's confusing signal in the latest inventory reports from the Energy Department. Crude oil stocks continue to rise, and now reside in the upper half of the average range for this time of year. "Everyone who can produce oil is pumping whatever they can because of these high prices,'' John Kilduff, senior vice president of energy risk management with Fimat USA, tells Bloomberg News. But gasoline supplies fell, surprising many analysts who thought a rise was in the offing. Was that just an anomaly in a marketplace where gasoline stocks are otherwise building? Or was today's gasoline stocks' drop a sign of continued stress on the nation's aging, and increasingly overworked refinery system?
For the moment, gasoline's bull market is offsetting crude's decline. Crude futures, after dropping sharply, rallied near the end of the session. Crude v. gasoline. Who's right? Who knows, but we'll soon find out, and the implications will be something more than trivial for the consumer, and thereby the economy and the stock market. Welcome to the other conundrum.
March 28, 2005
PICK YOUR POISON
It's not about inflation; it's about taming the real estate bubble.
Or so opines Ed Yardeni in his latest missive to clients. The chief investment strategist at Oak Associates writes that the Fed's hiking interest rates these days because of worries of a "speculative bubble" in real estate. Inflation per se, by contrast, isn't the trigger this time around in the tightening of the monetary screws.
It's an interesting theory, and one that an open-minded investor shouldn't dismiss out of hand. But at the end of the day one might ask, does it matter? That is, should an investor care if the Fed's elevating rates because of real estate vs. inflation, or flying saucers, for that matter? An interest rate hike by any other name would sting no less. And while we're at it, one might also wonder, is there really that much difference between a housing bubble and a traditional rise in inflation?
For those inclined toward a monetarist's view of the world, the money supply is the start and end to all such questions. And at the moment, there's too much supply floating about, to judge by any number of traditional measures. The Fed funds rate is currently 2.75%, and it doesn't take a professional economist to recognize that two-and-three-quarters looks pretty low next to, say, the rate of real annualized GDP growth (3.8%, at last count) or the real (inflation-adjusted) Fed funds rate (-0.25%, using the latest CPI number for adjustment).
Regardless, some of the money that's being printed by our friends at the Fed is finding its way into housing, to understate a trend. In a sign of the times, blogs dedicated in whole or part to outing the real estate bubble, real or perceived, are a growth industry, as Corante observes. Among the pithy observations found in the associated travels among property oriented blogs is this little gem from Curbed: "To summarize our philosophy: of course there's a bubble; you can't do anything about it; go ahead, keep buying; see you in hell!"
Meanwhile, let's assume for a moment that Yardeni's right about the Fed's motivation for raising rates. If so, a logician might continue, it's only fair that the Fed clean up the bubble since it was the central bank that created the mess--a talent, by the way, that's no stranger to the maestro's regime, in any number of asset classes. Or so John Makin of the American Enterprise Institute suggests (for real estate, that is) in an essay published Monday. Cleaning up the mess, he counsels, is no great mystery, but it's hardly painless: "The Fed should eliminate the 'measured pace' language from its statement," Makin argues, "and simply indicate that monetary policy is currently accommodative and that accommodation will be removed at a pace dictated by the future path of growth and inflation."
But that's not so easy. Inflation, after all, may be accelerating, in which case the Fed may have to raise rates substantially and sharply to keep pace. In short, 25-basis-point hikes may soon give way to something more ambitious.
Does the cure then threaten to be worse than the disease, at least in the short term? As Yardeni explains: "The problem is that if they raised the Fed funds rate more aggressively, the bond market might actually rally! The Bond Vigilantes might actually cheer that tougher monetary policy will probably keep inflation at bay. It might also burst the housing bubble and send the economy into a recession."
There was, in fact, a whiff of cheering today in the bond market. Traders were in a buying mood, relative to recent sessions, and the yield on the 10-year Treasury Note slipped to roughly 4.58%, the lowest in a week.
As for a bursting of a housing bubble, assuming it exists, the jury's still out, but the second-guessing goes on. To be fair, some of the commentary attempts to explain away the fear that a real estate bubble is upon us. Among the arguments advising that panic is unfounded, unnecessary, and unenlightened: real estate, unlike stocks, has perennial, fundamental demand, i.e., we all need to live somewhere. Stocks, bonds, and Picassos, by contrast, we can all do without, and from time to time that's reflected in the prices.
But while there's an intellectual case to be made for erring on the side of optimism on real estate's bubble, er, bull market, there's a reason to sleep with one eye open, and MaxFunds.com, captures the sentiment succinctly: "The main reason investors should worry about real estate bubbles is this: most experts say that real estate bubbles are simply impossible."
March 24, 2005
THE GAS-MAN COMETH?
Every solution potentially carries the seeds of a new problem in the quest to solve America's energy challenges.
The history of crude oil is the gold standard in measuring the trials and tribulations of trying to secure new supplies so as to keep pace with rising demand. The record with crude has been mixed and fraught with peril, some of it self inflicted. Does a similar fate await the future of natural gas?
It's getting easier to answer in the affirmative. The underlying dynamic for the anxiety is a familiar one: consumption is rising, thereby provoking questions about supply. The U.S. Energy Department, in its Annual Energy Outlook 2005 that was published last month, predicts that this nation's natural gas consumption will ascend by an average 1.5% annually through 2025. That's slightly higher than the expected 1.4% growth for total U.S. energy consumption.
Several catalysts give rise to increasing demand for natural gas. One is that the fuel burns cleaner than crude oil, making it the politically correct energy source of choice when compared with oil or coal. Two, there's a relative abundance of natural gas within the United States. But while the environmental advantage is written in stone, the supply issue is an evolving truth, and therein lies the problem.
More to the point: where will the additional natural gas that's required to satisfy future demand come from? Imports will play an increasingly larger role, the Energy Department predicts. America has a fair amount of natural gas, but rising demand and current consumption trends threaten to marginalize that advantage over time. No wonder then that through 2025, natural gas imports will grow at a 4.1% rate, or more than two-thirds faster than crude oil imports, the government forecasts.
The not-so-subtle suggestion is that domestic natural gas production won't be able to keep pace with demand. Sound familiar? You've heard it before, and you'll hear it againâ€¦and again, starting now: "U.S. supply is not likely to grow meaningfully over the remainder of the decade," warns Simmons & Co. The Energy Department suggests as much in projecting that domestic NG production will rise by around half as much as consumption's rate of increase in the years ahead.
If importing more natural gas (NG) is an obvious solution, the details are nonetheless complicated. And we're not even talking here about the hazards of relying on foreign supplies. While that's not to be dismissed, for the moment we're focused on the opponent within.
That starts with the fact that NG is traditionally moved via pipeline. That's works well on terra firma, but NG imports are transported across oceans, and that means moving the stuff by ship. To make the NG shipping business economical, the gas is liquefied, or compressed. So far, so good.
The glitch is that compressing and decompressing NG is a technically sophisticated enterprise and thereby it ends up being a fairly capital intensive project. Indeed, the United States doesn't have enough liquefied natural gas (LNG) terminals that can perform such tasks at the moment to handle a material increase in imports. Yet the Natural Gas Supply Association, informs that LNG imports will rise sharply in the years ahead, jumping more than 1,000% by 2010 from 2002's totals. Perhaps, although that outlook can only become reality if the U.S. builds more LNG terminals.
That's neither news nor theoretically beyond the pale. In fact, the Federal Energy Regulatory Commission (FERC) reports that a number of new LNG terminals have been proposed. Indeed, companies are willing and able to build new LNG terminals, if only the powers that be would let them. But what's planned and what's delivered are two different things, and at the intersection lies politics.
In a sign of the times, Sen. Jack Reed (D-R.I.) has become a poster boy for LNG opposition. "The LNG terminal approval process is flawed," he charges, according to Intelligence Press via Rigzone.com. The gentleman from the Ocean State goes on to explain,
There is no regional approach to determine how many facilities a region needs and where they should be placed. Developers in the name of federal 'preemption' are challenging states' basic authority to approve permits for these facilities. And FERC has moved ahead with its process while the Coast Guard struggled to get its safety and security reviews completed.
Make no mistake: there are bona fide safety concerns with LNG terminals, as there are with oil refineries, nuclear power plants, and backyard propane tanks for BBQs. The safest course would be to avoid building new plants, which pretty much sums up the state of affairs with oil refineries and nuclear power plants of late. Are LNG terminals headed for a comparable future? At the very least, LNG terminal projects look set to get stuck in the quagmire of political and legal debates.
The issue at hand is whether the states' power to regulate the building of new LNG terminals trumps FERC's. The advocacy group Public Citizen issued a battle cry on the topic by proclaiming like-minded voters to "Stop Congress From Undermining Local Control Over LNG."
Tyson Slocum, research director of Public Citizen's energy program, explained last November in a press release, "Communities are leery of LNG facilities because of security reasons. LNG tankers and marine terminals make significant terrorist targets because of the enormous quantities of fuel carried by the tankers (up to 10 times the amount of fuel of a typical crude oil ship), the risk of fires, and the hazards associated with the heating of the LNG at the marine terminals."
A pessimist could argue that the natural gas debate in the 21st century is headed for this reduction ad absurdum: safety or energy. (Go ahead, take a minute before you decide.)
In the meantime, the dialogue over who has the authority to give the green light to new LNG terminal construction will play out in the legal and legislative systems. Whatever the merits and flaws of the arguments pro and con, it seems clear that if the states win, there could very well be fewer LNG terminals than would otherwise be built. We don't have any hard evidence to support that speculation, but we do have eyes in our head. As such, even a cursory study of Joe Sixpack's historic predilection for seeing the world through NIMBY (not in my backyard) colored glasses on matters of oil refineries suggests a few ideas.
Taking the obvious cue, one could leap off the deep end and predict that no new LNG terminals will be developed if the forces aligned with Public Citizen emerge triumphant in the courts. The reasoning may fly under the cover of safety, or environmentalism, or god knows what (lawyers are clever souls). But no matter the argument, the result would be the same. A missing LNG terminal would leave a void no less empty (apologies to Billy S.).
If that future proves accurate, veteran energy observers aren't likely to be surprised. Indeed, no new oil refineries have been built in the U.S. since 1976, a Knight Ridder News story last year advised, even though demand remains in a perennial upswing. Why, a skeptic can rightly ask, should LNG terminals fare any differently?
March 23, 2005
TWIST & SHOUT
Foreign exchange traders are nearly giddy at the prospect of higher interest rates in the United States. The U.S. Dollar Index jumped sharply today in the wake of yesterday's 25-basis-point rise in the Fed fund rates. But there's more to the dollar buying than is dreamed of in quarter-point rate hikes. The dollar bulls, a feisty if contrarian group that's run up the U.S. Dollar Index to its highest in about a month, are looking to the FOMC meetings scheduled for May and June for aid and comfort, perhaps in the form of 50-basis-point hikes.
The primary source for such expectations, warranted or not, is the Fed, which yesterday announced what everyone already knew, namely, that "pressures on inflation have picked up in recent months and pricing power is more evident." It's a short jump from that curt observation to anticipating a 50-basis-point jump in the Fed funds when the maestro's banking troupe convenes again on May 3.
"Inflation is percolating higher and the Fed will aggressively respond to that," Mark Zandi, chief economist at Economy.com, tells the Associated Press via Jacksonville.com. In fact, Zandi predicts that Fed funds, currently at 2.75% after yesterday's hike, will be 5% or so by late 2006.
Perhaps, although the case for higher interest rates, at whatever pace of increase, certainly looks prudent if corporate earnings continue to bubble, as Ed Yardeni predicted in a report to clients earlier this week. "I am starting to think that profits growth might be stronger than expected this year," writes the chief investment strategist of Oak Associates. If his outlook proves accurate, profits in S&P 500 companies will climb 12% in 2005 and 6% next year. His emboldened optimism is hardly irregular, he says, claiming that "profits recoveries tend to be stronger than expected."
A "boom in world trade" is the reason this time around, Yardeni continues. trade. "U.S. manufacturers are shipping more exports and distributors are distributing more imports. U.S. manufactured exports now account for 15% of factory shipments excluding petroleum products. That’s up from 14.3% and 12.7% five and 10 years ago."
But not every corner of the free market agrees. Indeed, the sharp drop in oil prices today is premised partly on the notion that an increasingly aggressive Federal Reserve will slow growth, thereby shaving demand for crude, at least temporarily. The bond market, for what it's worth, seems to side with the oil traders and the higher-rates-will-slow-the-economy school. The yield on the 10-year Treasury Note slipped today to under 4.6% after shooting above that mark yesterday for the first time since last July. It's only been a day since the fixed-income set saw their lives flash before them, but that's not necessarily a reason to abandon a 20-year-old bull market in bonds.
One day a trend does not make, of course. But in light of today's consumer price index report for February, the forces calling for tightening the monetary strings are gaining momentum. Indeed, the CPI advanced 0.4% last month, the highest monthly advance since October. And while the year-over-year CPI doesn't look threatening by the standards of late, the Fed is surely paying close attention to the bull market in the core (less food and energy) CPI rate, which climbed 2.4% over the past year in February—the fastest pace in nearly two years.
"We are seeing price pressures, especially non-energy components, working into the retail level," Richard DeKaser, chief economist, National City Corp. explains to Reuters today by way of Netscape News.
The new new era of the post-bubble world has arrived in earnest. Contradictions, cross currents and the mixed signals born of short-term speculations are in full swing. That's nothing new, of course, although it's a safe bet that the usual suspects will be arriving in larger doses. Hedge funds will be having a field day, and making noisy signals for everyone else.
March 22, 2005
STILL "MEASURED" AFTER ALL THESE MONTHS
The Federal Open Market Committee, after raising the Fed funds rate today by a widely anticipated 25-basis points to 2.75%, explained in its statement, "even after this action, the stance of monetary policy remains accommodative…." Lest anyone worry that the liquidity is overdone, much less permanent, the stewards of the nation's money supply presumed to put such fears to rest by explaining that "policy accommodation can be removed at a pace that is likely to be measured."
Twenty-five-basis-point hikes, it seems, will remain a fixture on the American economic landscape for the foreseeable future. The Fed wears its pre-emptively disclosed monetary strategy on its sleeve these days while virtually patting itself on its institutional back for coming up with such a clever and enlightened scheme. But it remains to be seen if Mr. Market is willing to extend the admiration.
Indeed, the first draft of the bond market's reaction to today's FOMC action is less than encouraging. The yield on the trusty 10-year Treasury Note took flight after the Fed decision was made public. Tying up money for a decade with government debt will now lock you in at 4.63%, or thereabouts, as of today's close in New York trading. That's materially better than the 4% that prevailed in early February, but the burning issue is whether 4.63% will suffice tomorrow and beyond.
Count one John Bollinger as a skeptic. "Inflation is here, big-time, and we're all in denial about it," the president of Bollinger Capital Management tells TheStreet.com today.
The bond market has been no stranger to denial in recent months, but it's rapidly becoming less so with each passing day. The Fed, arguably, has yet to start drinking from the same cup of illumination by which the fixed-income set has started quenching its thirst for reality. Twenty-five-basis-point increases, in other words, are no longer convincing traders that the central bank is dispatching inflation-fighting ammunition in adequate quantities.
But hope springs eternal in the halls of banking's nerve center. As evidence, we return again to the FOMC's press release du jour. Exhibit A: oil's bull market, the Fed advises, is of small consequence for the central bank. "The rise in energy prices, however, has not notably fed through to core consumer prices," the Fed statement croons.
Perhaps, although a deeper confirmation, or rejection, will come in tomorrow's consumer price report for February. Meanwhile, in the here and now, we have the producer price index, which was updated for February and dispatched to the data-hungry masses this morning. As it turns out, core PPI, which excludes energy and food, advanced at a 2.8% pace for the 12 months through February. In case anyone cares, that's the highest annual pace for PPI since 1995. Adding food and energy only heightens the price momentum, to the tune of a 4.7% advance for the year through last month.
Fed Chairman Alan Greenspan by law must step down on January 31, 2006. But while his official retirement is ten months away, the bond market is openly debating if the maestro has already relinquished his monetary responsibilities.
March 21, 2005
TODAY, TOMORROW & EVERYTHING IN BETWEEN
The stakes are always high when the Federal Open Market Committee meets. But when the Fed convenes its interest-rate-setting board tomorrow, the tension between risk and reward threatens to be the highest in recent memory.
The reason? Oil. The price of crude is creeping into every conversation in matters financial, and the price of money is granted no exception. The question: what is a prudent Fed funds? Always a tricky question, even under the best of circumstances, but these are less than the best of circumstances and the times are more than a little tricky.
This, after all, is a world marked by rising energy prices. Whether the Fed should consider the trend or ignore it is the query du jour. Yes, Fed funds have jumped to 2.5% from 1% in less than a year, and so one could argue that your public servants in the central bank are awake, alert, and turning the monetary wheel in an appropriate fashion. But before we break out the vintage champagne, it's also worth noting that by the gauge of the consumer price index the central bank hasn't kept the price of money rising as fast as inflation. The real Fed funds rate, in short, remains negative.
That's nothing new, of course: the real Fed funds rate has been negative since 2002. The difference is that inflationary pressures in 2002 were a shadow of their current incarnation. To be sure, the latest CPI report hardly depicts runaway inflation. But with inflation advancing at a 3% annualized pace as of January, that's a world above the 1.1% rate logged for a time in 2002.
If there's one lesson that arises out of the mistakes made in the name of monetary policy of the last 40 years, the deputy governor of Norway's central bank observed in a recent speech, it's the need to be proactive and forward looking.
The past, of course, is crystal clear. It's the future that raises doubts and inspires hope, not necessarily at the same time. The Fed arguably is now faced with a significant milestone in its management of the nation's money supply in terms of deciding what, if anything, to do about the price of oil. The central bank has only one lever to work with so, in theory, the decision is fairly simple. But the factors driving that decision are as complicated as any in analyzing the economy.
Namely, does the prospect of rising, or a sustained higher oil price, raise the inflation threat? If so, should the Fed should raise interest rates with an eye on slowing the economy so as to take some of the marginal demand growth, at least for the moment, out of the oil market?
The situation is complicated by the fact that the Fed has a dual, and at times contradictory mandate: maximizing employment and minimizing inflation. Succeeding with one can easily generate failure, or something less than robust success, with the other. The study of the oil-price shocks of the 1970s and 1980s presumably has cast enlightened choices onto the desks of policy makers, but in practice the choice between jobs and inflation still lurks, albeit in muted form of late. Of course in the long run, as the 1970s so starkly remind, there's really no choice.
Meanwhile, there's plenty of talk. Fed Governor Edward Gramlich opined last September that there are no easy monetary policy answers in managing oil shocks today than there were in decades past. "Today the question of how to respond to oil price spikes is better understood, but the outcomes are no more pleasant," he asserted. "It is virtually inevitable that shocks will result in some combination of higher inflation and higher unemployment for a time. But I must stress that the worst possible outcome is not these temporary increases in inflation and unemployment. The worst possible outcome is for monetary policy makers to let inflation come loose from its moorings."
The worst possible outcome is in fact what worries one David Gitlitz, chief economist with TrendMacrolytics, who warns in an essay to client today, "Record crude prices mean a monetary mistake could be not just dumb, but disastrous." Some at the Fed look at the recent past and conclude that since the economy's chugged along nicely despite the higher oil prices there's little to worry about on this front. "This reasoning," Gitlitz writes, "also accords with the idea that since the oil price moves have apparently been marked by significant speculative excess, they are not a 'fundamental' factor that need be of particular policy concern."
Of course, it all depends on what your definition of "fundamental" is. But as Gitlitz points out, and detailed in an earlier piece, the dollar price of oil is up significantly more so than crude's euro-based jump. The implication: oil's rise is partly due to the fall in the dollar. That's hardly a radical notion, given that oil is a global commodity priced in dollars and that the U.S. is the world's leading importer of the stuff.
Clearly, there are fundamental factors behind crude's bull market, and in the long run those factors tower over all others. But Gitlitz and others remind that the Fed's sluggish reaction to maintaining the dollar's value isn't doing oil consumers any favors. Granted, oil per se doesn't come under the central bank's purview, but the greenback's health is priority one for Greenspan. And since oil's purchase in dollars….
On the even of the FOMC confab, the forex crowd seems inclined to give the Fed the benefit of the doubt. The dollar rose sharply today against major currencies. The threat of another hike in Fed funds will do that. But the after-effects of a 25-basis-point rise in interest rates, as is widely expected, doesn't carry much staying power. But that's a worry for another day. Today, on the other hand, was all about optimism. "We're getting closer to the point where yields are giving the dollar some benefit,'' Robert Rennie, a currency strategist at Westpac Banking Group in Sydney, Australia, tells Bloomberg News. "It doesn't make sense to be selling the dollar ahead of the Fed meeting.''
Fair enough. But inquiring minds want to know, what makes sense after the Fed meeting?
March 18, 2005
FROM HERE TO ETERNITY
Spending is easy, cutbacks are hard. True for Joe Sixpack, true for the U.S. government. Well, maybe it's a little harder for Uncle Sam.
The latest evidence comes from yesterday's news that the deliberative body known as the Senate rejected $14 billion in Medicaid cuts recommended by the Bush administration. "The 52-48 vote was a setback for the Bush administration and Republican congressional leaders, who had identified Medicaid cutbacks as a key element in a plan to shrink the federal budget deficit," reports New York Newsday.
In fact, canceling the budget cuts in Medicaid required the support of a few Republicans—seven, to be exact, who joined forces with the full lineup of Senate Democrats. Republican or Democrat, it seems, doesn't lend much help in overcoming the spending inclination that sooner or later finds every pol and corners him or her in the dead-end of budgetary profligacy. Yes, there are always a few exceptions, keeping hope alive that self-corrective financing will emerge triumphant in the U.S. Congress. But for the moment, the empirical record suggests otherwise.
Paring the nation's budget deficit, in short, isn't going to be easy if one draws the pessimistic interpretation from yesterday's Senate action. But just when you thought you had it all figured out, the dollar opted for rosy perspective. Indeed, forex traders have been chasing the greenback of late, helping the U.S. Dollar Index reach its highest point at one point today since March 8. A catalyst for the jump came from yesterday's release of the Conference Board's leading indicator for February. It was the fourth rise in four months and the biggest monthly gain since November.
The primary contributor to the increase in the leading index, which is designed to predict future economic activity, were falling unemployment claims. The implication: the economy is poised to continue expanding through the spring. "The leading indicator, and others, suggests trend-like real [economic] growth of around 3.5 percent after more than 4 percent this quarter," Steven Einhorn of investment advisory firm Omega Advisors tells Bloomberg News.
With the import-hungry American economy bubbling, is it any wonder that import prices are up? The obvious answer is "no" in the wake of this morning's release of import prices for February, which posted a stronger-than-expected rise of 0.8%, reports the Labor Department.
In sharp contrast, export prices were unchanged in February. One could argue that the U.S. is importing inflation and exporting deflation, or at least a milder form of inflation. Indeed, the thesis holds up when looking at the 12-month numbers. For the year through last month, import prices rise by 6.1% while export prices advanced by only 3.4%. Deflation proper seems to be alive and kicking when it comes to agricultural export prices, which declined by more than 8% in the 12 months through February 2005.
But all commodities aren't created alike when it comes to pricing, as the continuing rise of oil prices reveals. And as the U.S. imports more oil, the higher prices for the commodity are feeding into rising import prices.
The buzz on the Street in the wake of the import price report is that the Fed will be that much more inclined to raise interest rates at the next Federal Open Market Committee meeting on March 22. And beyond. Some say that the current 50-basis-pont gap between Fed funds and the equivalent at the European Central Bank is set to widen further. "If the Fed continues to raise rates by 25 basis points every meeting then we will get a 2 percent gap with Europe and that will be significant,'' Momtchil Pojarliev, senior currency manager in London at Invesco Asset Management, opines to Bloomberg News. "I am more bullish on the dollar.''
But isn't the U.S., overtly or otherwise, engaged in a scheme to lessen the dollar and thereby boost exports to lessen the trade deficit? Or was that last week?
March 17, 2005
IF AT FIRST YOU DON'T SUCCEED, TRY, TRY AGAIN
When one quota doesn't do the job, maybe another one will.
Therein lies Opec's rapidly evolving strategy when it comes to its ongoing struggle to convince oil traders that the cartel's in charge of crude's price destiny. Kuwait's oil minister and Opec's president, Sheikh Ahmad al-Fahad al-Sabah, detailed the new-new philosophy on Thursday, explaining, "We believe that if prices stay as they are in the next seven to 10 days, we will start contacting minister colleagues to discuss the other 500,000 (barrels a day) that the president has the authority (to decide on) after consultations," reports AP via ABC News. Hey, at this rate, maybe they'll be a new meeting about having a meeting about talking about even future potential production hikes…maybe.
But talk (and talk of talk) continues to decline in value, suggests a fellow Kuwaiti who happens to be an oil analyst. "Opec is no longer the same influential power that controls oil prices as it did in the past," Kamel al-Harami told AFP, reports Channel NewsAsia. "Today, they have a small output capacity and they cannot control increase in demand."
Or so the theory goes. Opec, for the moment, says otherwise. Whether they can do otherwise keeps the world economy on pins and needles.
Meanwhile, it was no accident that Opec's public rethinking of its Wednesday announcement of a production hike, which was greeted early today with another sharp jump in oil prices in New York to yet another new high. At one point on Thursday, the near-term futures contract on oil threatened the $58-a-barrel range before pulling back under $57 by the close.
The situation is precarious in the short run if only because the world economy remains increasingly dependent on the likes of Nigeria, Iraq, Venezuela, Russia and Iran for crude. Stability and political calm don't necessarily come to mind when such names pass one's lips. That's old news, of course, but the dependence on those countries takes on a new twist as the world's spare oil production capacity recedes to nail-biting levels. Opec's spare capacity, most of which resides in Saudi Arabia, has dropped to an optimistic estimate of 1.6 million barrels a day, according to the Energy Information Administration. That's cutting it close, considering that global oil consumption was recently running at 83 million barrels a day, by one estimate. That puts Opec's spare capacity at under 2%.
There are two threats that make 2% something to worry about. As always, it comes down to demand and supply. Demand is rising rapidly, courtesy of China, India and other emerging markets. Supply, meanwhile, isn't keeping pace, or so we're told. But the more immediate concern is that Iran, Iraq, and so on may be vulnerable to a variety of unnatural and ultimately self-inflicted export disruptions.
But all's not lost, at least in the matter of hope. There are still some who take an optimistic view of the markets. Neil McMahon, oil analyst with Sanford Bernstein & Co., writes today in a letter to client, "With crude reaching new record highs, it is clear that pricing levels continue to discount the fact that the market is currently well supplied as evidenced by rising inventory levels." Accordingly, he predicts a correction looming that will bring crude back to the $40 to $50 range.
Meanwhile, it's not clear how much more "discounting" the global economy can take, although we may soon find out. In any case, there's more than one way to spin crude inventories. James Williams of energy consultancy WTRG Economics writes in a missive to clients today that U.S. crude oil stocks are in the upper half of the normal range. "However, when the additional demand over the last five years is factored in total crude oil and petroleum inventories remain near historic lows." Williams goes on to observe,
For the last two years the number of days of inventory has averaged 46.3 days compared to the current 45.3 days. The last two years have had the lowest sustained level of days coverage in over 25 years.
Not surprisingly this two-year period coincided with a sustained increase in petroleum prices.
Williams is wrong about one thing: some of us (you know who you are) were surprised.