March 31, 2011
The Deflation Factor & Real Wages
Economist Bob Dieli of NoSpinForecast.com writes in to point out that the chart posted earlier today (reproduced below) that compares real (inflation-adjusted) wages with personal consumption expenditures was dramatically skewed in late-2008 and 2009 by the brief but potent round of deflation that hit the U.S. economy.
In particular, Dieli reminds that "the 'improvement' in real wages suggested by the line late in the recession was entirely the product of the deflator going negative." He goes on to advise:
While it is true that this is an increase in the purchasing power of the wages during the period in which the aggregate price level was falling (and it fact it was just energy prices doing the deed) people have a tendency to think that a rise in that line reflects some rise in compensation.
In fact, quite a bit of it was simply the statistical blowback from the financial crisis. At one point in late-2008, deflation was roaring. The worst of it came during November of that year, when the consumer price index swooned by 1.8% in that month alone on a seasonally adjusted basis.
Deflation has since given way to mild inflation, and the annual pace in real wages has since returned to something approaching "normal" levels. But the question remains: Is the trend in real wages headed down? If so, there's a case for expecting a decline in the pace of real consumer purchases, which may raise fresh concerns about the economic outlook. A dip in consumption per se isn't necessarily a problem, assuming the trend isn't persistent. But given the precarious state of economic concerns once again (as Alan Blinder, for instance, reminds today), one might wonder if Joe Sixpack's recent fondness for spending (real retail sales are up more than 6% over the past year) has legs.
A Technical Detail On Calculating Real Wages
In an earlier post today, I published a chart that compares real (inflation-adjusted) personal consumption expenditures with real average hourly earnings for production and nonsupervisory workers. The goal, as explained in detail in Joseph Ellis' book Ahead of the Curve, is getting a handle on future consumer spending, which in turn is a useful measure for estimating the turning points in the economic cycle. In order to calculate real hourly earnings, however, we must deflate the nominal earnings data reported by the U.S. Bureau of Labor Statistics. In the chart in the earlier post, I deflated using the consumer price index (seasonally unadjusted). Ellis recommends using the personal consumption expenditures deflator (via the Bureau of Economic Analysis), and this preference is used in the chart below.
The magnitude of the inflation-adjusted results differ with CPI vs. the PCE deflator, but the basic message about the trend is the same. In any case, judge for yourself. Here's the updated chart with PCE deflator. For comparison, take a look at the same data using CPI-adjusted hourly wages here.
Using the PCE deflator raises the real hourly wages level into positive territory on a rolling 12-month basis. By comparison, using unadjusted CPI data shows real hourly wage data in a general retreat on an annual pace, most of the time. But for purposes of using the trend to provide clues about turning points in consumer spending, both methodologies offer similar messages.
Jobless Claims Fall By 6k
For the third week in a row, and for only the sixth time since the Great Recession officially ended in June 2009, new weekly filings for jobless benefits are under the 400,000 mark on a seasonally adjusted basis, the Labor Department reports. Last week, initial claims slipped by 6,000 to 388,000. The four-week moving average of claims remains well under 400k as well, continuing a trend that's been in place for over a month.
“The modest pace of layoffs is allowing job gains to accelerate,” Joel Naroff, president of Naroff Economic Advisors, told Bloomberg before today's report was released. “Businesses are hiring. And with layoffs being minimal, it appears that the labor market is indeed getting better.”
The improvement, however, remains slow and therefore vulnerable to the proverbial unknown unknowns. Although the trend in new claims is favorable in terms of direction, the cycle remains lethargic. Consider the much larger population of existing claims, which tracks unemployed workers who have been collecting jobless benefits for some time. Although the tally here has been falling steadily for nearly two years, the recent 3.714 million total is still well above even the cyclical peaks of the last two recessions.
All of which implies what's well understood in the market: the labor market is likely to continue recovering, but surprises in favor of growth will be minimal. Economists are expecting that tomorrow's nonfarm payrolls report for March will report a net gain of just under 200,000, or roughly in line with February's rise. A respectable gain, but far short of spectacular, and therefore far short of what's needed to make a material dent in February's 8.9% unemployment rate--the highest level since 1983.
There's Always A New Recession Lurking
Former Minnesota Gov. Tim Pawlenty and newly minted Presidential candidate thinks that a new recession is coming. He's right, of course. There's always a new recession coming. There have been 33 economic contractions in the U.S. since the mid-1800s, according to NBER, and it's a safe bet that number 34 is waiting in the wings. As Richard Fisher, president of the Dallas Fed, recently remarked: "I devoutly hope our next downturn won’t come for quite some time, but it surely will come eventually."
A recession could start tomorrow, or five years from now. The challenge is developing some insight that improves the odds of calling the next turning point in the economic cycle with something better than random odds. Pawlenty's forecast can be dismissed as political commentary, of course. After all, he's formally announced his candidacy and so he has a vested interest in sowing doubts about the economic outlook under the stewardship of the current President. It doesn't help that his analysis is a bit thin on the details. But even if Pawlenty's motives are suspect, his conclusion isn't beyond the pale.
Alan Blinder, an economics professor at Princeton, also worries about the economy, although he's cautiously optimistic that growth will prevail, as he explains in today's Wall Street Journal.
Calling turning points in the business cycle is tricky business, of course, even for respected economists. The future's always uncertain and that makes fools of everyone eventually. Yet there are a number of productive approaches to evaluating the odds that a new recession is approaching. In fact, countless volumes have been written on the subject. The challenge for investors is paring the list down to a manageable list for monitoring and evaluating this risk. One that deserves to be on the short list is keeping an eye on consumer spending, which accounts for 70% of the economy.
A few years ago, Joseph Ellis offered an intriguing take on how to analyze this critical factor, offering details in his book Ahead of the Curve: A Commonsense Guide to Forecasting Business and Market Cycles. In essence, Ellis says that the annual pace in real (inflation-adjusted) personal consumption expenditures (PCE) has a strong history of dispensing early warning signs of approaching recessions. He also notes that real average hourly earnings of nonsupervisory workers sheds light on changes in PCE's trend.
With that in mind, how do these metrics stack up these days? The trend in real PCE continues to look strong, as the chart below shows. But there's a warning sign in the recent weakness in average hourly earnings. The basic message seems to be that if inflation continues rising, the economy could be in trouble.
The next update on consumer price inflation is scheduled for release on April 15. As we discussed yesterday, the market's inflation forecast appears relatively stable. But some analysts worry that the stability will be short lived and so inflation is headed higher, a change that would put more downward pressure on real wages, which in turn could bite into consumer spending. If so, there's' at least one reason for thinking that the risk of recession may be inching higher.
Update: For a technical note on an alternative methodology for calculating real hourly wages (a methodology that Ellis recommends in his book), please read this addendum.
March 30, 2011
ADP: Private Nonfarm Payrolls Rise In March
U.S. private sector employment rose by a net 201,000 (seasonally adjusted) last month, according to this morning’s release of the ADP Employment Report. That’s slightly down from February’s 208,000 gain, although the message is clear: job growth rolls on, albeit at modest levels relative to what the economy needs to bring about a large and relatively quick drop in the still-elevated jobless rate.
Modest, perhaps, but persistent. For the 14th consecutive month, the labor market expanded, according to ADP. The rise suggests that Friday’s release of the Labor Department’s payrolls update for March will also report a similar gain. The crowd is expecting no less. The consensus forecast (according to Briefing.com) among economists anticipates that the government’s estimate of private payrolls for March will jump by a net 203,000. If so, that would be slightly lower than February’s 222,000 gain, although basically in line with what today's ADP report is telling us.
"The March ADP report leaves us comfortable with our forecast of a 200,000 increase in private payrolls in the month and a 185,000 gain in total nonfarm employment," advises RDQ Economics via MarketWatch.com.
Speaking for the optimists, Joel Prakken, chairman of Macroeconomic Advisers, which helps compile the ADP Employment Report, says in a conference call today: "This data is pointing to a turnaround in labor-market conditions. It’s pretty clear that employment now has in fact accelerated. Equally encouraging is the breadth of the strength."
The accompanying press release with today's ADP report notes that "the average monthly increase in employment over the last four months--December through March--has been 211,000, consistent with a gradual if uneven decline in the unemployment rate. This is almost three times the average monthly gain of 74,000 over the preceding four months of August through November."
In any given month, the ADP numbers can vary considerably relative to what the Labor Department reports for private nonfarm payrolls. But in terms of capturing the trend, the ADP series generally does a fair job of dropping clues about the government's estimate of private employment, which is always released a few days after the ADP update.
Consider the historical record for the two series over the last 10 years. Although there's quite a bit of variation at times in the short run, there's a relatively high degree of correlation between the two over time, as the chart below suggests.
Treasury Market's Inflation Forecast: 2.5%
The Treasury market's inflation forecast has recently risen to the levels that prevailed before Lehman Brothers collapsed in September 2008, which triggered a financial crisis and fears of a deflationary spiral. Using the yield spread between the nominal and inflation-indexed 10-year Treasuries, the market's outlook has come full circle since the dark days of late-2008.
As of yesterday, 10-year Treasuries expect inflation on the order of roughly 2.5% in the years ahead. The question is whether that outlook will remain stable?
This is the second time since the financial crisis that the market priced Treasuries for 2.5% inflation. A year ago, something similar was built into prices, only to give way as heightened fears of recession risk, triggered by troubles in Europe, changed the crowd's sentiment.
There's no shortage of worries these days, of course, but the market's outlook on inflation remains relatively stable… so far. In fact, investors should watch this market gauge as an early warning sign of trouble. If the economy is headed for a new rough patch, clues of what's coming may show up in the market's inflation prediction.
In May 2010, the market's forecast turned down relatively quickly in advance of the summer economic troubles that eventually convinced the Fed to launch QE2. That decline was accompanied by a fall in stock prices. The S&P 500 peaked in late-April 2010, dropping sharply through the spring and summer.
If there are new problems brewing in the economy, it wouldn’t be surprising to see the Treasury market's inflation forecast wilt. For the moment, there's no sign that the market expects inflation to fall. Meanwhile, U.S. equities have rebounded strongly in the latter half of March after a correction in the first half of the month.
Friday brings the first data points for March's economic profile, with updates on the ISM Manufacturing Index and nonfarm payrolls. The market will be carefully analzying these reports for confirmation, or rejection, that the economy is weathering the Ides of March.
March 28, 2011
Bound For Boston...
Blogging will be light to nonexistent for a day or so as I head up to Boston to chat about asset allocation at tomorrow's World Series of ETFs and Indexing.
Consumer Spending & Income Rise In February As Inflation Bubbles
Personal income and spending rose again last month, the U.S. Bureau of Economic Analysis reports, although the numbers are tainted somewhat by the fact that inflation ticked up as well.
Meantime, there’s no denying the trend in spending and income. Personal consumption expenditures rose for the eighth consecutive month, posting their biggest rise in February since last October. Disposable personal income advanced for five straight months through February.
“The rise in food and energy prices is not derailing consumer spending, it’s just taking a little bit of steam out of it,” Julia Coronado, chief economist at BNP Paribas, tells Bloomberg.
How does the longer-term trend compare? There’s still a favorable wind blowing. Income and spending continue to inch higher on a year-over-year basis.
Comparing private sector wages, industrial production and private nonfarm payrolls also suggests that positive momentum may have some legs in the months ahead, perhaps spilling over into job growth.
But inflation is worrying some analysts. Although consumer spending rose 0.7% last month, after inflation the rise was cut by more than half to a 0.3% gain. "The data provide yet more evidence that higher prices are denting economic growth," Paul Dales, a senior U.S. economist at Capital Economics, tells Reuters.
Housing Will Recover. But When?
What passes for optimism on the housing market these days is a pale reflection of the glory days of five years ago. "Housing is dead," writes MarketWatch's Rex Nutting. "There is no doubt about that. Housing is as dead as a door nail." The good news, such as it is, is that "housing is just too small to do any real damage to the economy any more," he adds. Perhaps, but housing's not likely to help any time soon either.
Even after five years of a nonstop housing recession, there's little confidence that the sector is poised for a rebound. And after last week's dismal news on sales of new single-family homes last month, some analysts wonder if a new round of trouble is coming for residential real estate.
Part of the problem is the glut of homes on the market, a byproduct of the Great Recession. The surfeit of supply is exacerbated by weakness in traditional sources of new demand to soak up the excess. As USA Today reports,
Many first-time home buyers are sitting on the sidelines of the U.S. housing market, hampering its ability to gain traction.
Last month, 34% of existing-home purchases were made by first-time buyers, according to the National Association of Realtors. In January, they were 29% of the market, the lowest since NAR surveys started tracking them monthly in late 2008.
In healthy markets, first-time buyers make up 40% to 45% of all purchasers. They play a critical role in buying starter homes so those owners can buy more expensive homes.
Everyone has to live somewhere, of course. Where are the would-be first-time buyers going? Maybe they're renting. "Rather than buy homes, growing numbers of Americans are renting apartments and houses," NPR advises. "The Census Bureau says the national rental vacancy rate for the fourth quarter of 2010 was 9.4 percent, a significant improvement over the 10.7 percent rate in 2009. In fact, landlords haven't seen rental vacancy rates this low since the winter of 2003."
If you look hard enough, you can find signs of life in residential real estate. In Las Vegas, for example, one of the hardest-hit regions in the housing crisis, some observers see a recovery approaching... maybe. "The resale home market is up, and the delinquency rate is down," according to The Las Vegas Sun. But the news is tempered by the accompanying data that shows "sales of new homes are declining, and foreclosures are nudging higher."
Fortune's Shawn Tully opines that "the most attractive asset class in America is housing" and so "it's time to buy again." According to Mike Castleman, CEO of Metrostudy, a real estate data firm: "The talking heads who are down on real estate will hate to hear this, but America needs to build a lot more houses. And in most markets the price of new homes is fixin' to rise, not fall."
If the logic of buying when blood runs in the street has any merit, the housing market surely looks intriguing. By several measures of activity in residential real estate, the sector has suffered a dramatic decline in recent years.
Meanwhile, there have been positive changes on household balance sheets in the wake of the recession. For instance, household debt service payments as a percentage of disposable personal income have dropped substantially since 2007.
At some point, real estate will turn up, offering buyers extraordinary opportunities. It's unclear if that point is now, next year, or a decade down the line. For all of Castleman's optimism that the bottom is near, it's a sign of the depth of the uncertainty that one his colleagues at Metrostudy is unabashedly cautious. The ongoing rise in an already elevated level of residential vacancies is pinching the housing market, warns Brad Hunter, Metrostudy's chief economist. "More vacant homes equal more downward pressure on home prices," he tells CNNMoney.
March 25, 2011
Book Bits For Saturday: 3.26.2011
● Future Babble: Why Expert Predictions Are Next to Worthless, and You Can Do Better
By Dan Gardner
Review via New York Times Book Review
What does the future hold? To answer that question, human beings have looked to stars and to dreams; to cards, dice and the Delphic oracle; to animal entrails, Alan Greenspan, mathematical models, the palms of our hands. As the number and variety of these soothsaying techniques suggest, we have a deep, probably intrinsic desire to know the future. Unfortunately for us, the future is deeply, intrinsically unknowable. This is the problem Dan Gardner tackles in “Future Babble."
● Economic Facts and Fallacies: Second Edition
By Thomas Sowell
Summary via publisher, Basic Books
In Economic Facts and Fallacies, Thomas Sowell exposes some of the most popular fallacies about economic issues in a lively manner that does not require any prior knowledge of economics. These fallacies include many beliefs widely disseminated in the media and by politicians, such as fallacies about urban problems, income differences, male-female economic differences, as well as economic fallacies about academia, about race, and about Third World countries.Sowell shows that fallacies are not simply crazy ideas but in fact have a certain plausibility that gives them their staying power--and makes careful examination of their flaws both necessary and important.
● The End of Energy: The Unmaking of America's Environment, Security, and Independence
By Michael Graetz
Summary via publisher, MIT Press
Americans take for granted that when we flip a switch the light will go on, when we turn up the thermostat the room will get warm, and when we pull up to the pump gas will be plentiful and relatively cheap. In The End of Energy, Michael Graetz shows us that we have been living an energy delusion for forty years. Until the 1970s, we produced domestically all the oil we needed to run our power plants, heat our homes, and fuel our cars. Since then, we have had to import most of the oil we use, much of it from the Middle East. And we rely on an even dirtier fuel—coal—to produce half of our electricity. Graetz describes more than forty years of energy policy incompetence—from the Nixon administration’s fumbled response to the OPEC oil embargo through the failure to develop alternative energy sources to the current political standoff over “cap and trade”—and argues that we must make better decisions for our energy future.
● What G20 Leaders Must Do to Stabilise Our Economy and Fix the Financial System
Edited by Barry Eichengreen and Richard Baldwin
Summary via Amazon.com
In late 2008 the world was at a dangerous point. Governments and central banks had just about stopped the bleeding in their financial systems following the fall of Lehman Brothers, but they were unprepared for the recession that was to infect all parts of the global economy and become a truly global crisis. This book, first published as an eBook to coincide with the November 2008 G20 meeting in Washington, provides the views of some of the world's leading economists on what world leaders needed to do - act quickly in: • The financial sector to strengthen and coordinate emergency measures to staunch the bleeding • The real sector using fiscal stimulus to get the patient's heart pumping again • The global arena to empower the IMF and other existing institutions to deal with the crisis in emerging markets. Above all, though, the recommendation was to do no harm. The authors knew that the wrong outcome from this meeting could have damaged the world economy rather than repair it. Fortunately, much of their advice was heeded. And while events have moved on, policymakers and opinion formers today could still do with a refresher.
● Financial Jiu-Jitsu: A Fighter's Guide to Conquering Your Finances
By Scott Ford
Summary via publisher, John Wiley
In martial arts and personal finance, fundamentals are important. But while failing in Brazilian Jiu-Jitsu may be disappointing, it's nothing compared to failing to build wealth and creating a better future for your family. Nobody understands this better than Scott Ford, a top-ranked financial advisor and Jiu-Jitsu enthusiast. Now, in Financial Jiu-Jitsu, he shows you how to overcome your emotions and state of mind to excel at your investing endeavors. Along the way, Ford teaches you fundamental skills such as automating your savings and investments, the importance of paying yourself first, and managing credit wisely.
● Super Boom: Why the Dow Jones Will Hit 38,820 and How You Can Profit From It
By Jeffrey Hirsch
Excerpt via publisher, John Wiley
Dow 38,820 by 2025 may seem incredible at this current juncture in our economic, political, and financial history, but as you will find out throughout these pages, it is mathematically reasonable and requires no big leap of faith. Moves of this magnitude have happened several times before at similar points in history with such regularity and clear causes that you will agree by the book’s end that the potential for another super boom is undeniable.
Q4 GDP Growth Revised Up To 3.1% Pace
The U.S. economy grew at a 3.1% real annual rate in last year’s fourth-quarter, the government reports in its third and final estimate for Q4 GDP. That’s up from the previously reported 2.8% pace. For all of last year, the economy expanded by 2.9%.
U.S. corporate profits surged by more than 20% in 2010, the best year for the private sector since 2004. The final estimate of Q4 corporate profits shows a 9.7% gain. “That's impressive when you have nominal GDP growth of only 3.1%,” Joseph LaVorgna, chief U.S. economist with Deutsche Bank,” tells CNNMoney. “To get that kind of corporate profit growth is impressive, and a good sign for 2011.”
Looking backward, here’s how GDP and its major components have fared since the Great Recession ended in the second quarter of 2009:
Spending on capital goods (gross private domestic investment) has been leading the rebound on a relative basis since the recession ended, although the trend hit some turbulence late last year. In 2010’s fourth quarter, capital goods spending retreated for the first since the recovery began.
Personal consumption expenditures (PCE) are routinely the largest slice of GDP, accounting for roughly 70% of the economy. Here’s how PCE and its major subgroups have performed since the recession ended:
Spending on durable goods is far and away the leader in the PCE category on a relative basis. In last year’s fourth quarter, durable goods spending accelerated sharply, rising 21% on a real, seasonally adjusted annual basis, up from 7.6% in Q3.
Strategic Briefing | 3.25.2011 | Inflation & Oil Prices
Another year of living dangerously
The Economist | Mar 24
Even as higher oil prices and hobbled Japanese production reduce growth they add to mounting inflation risks (Britain is now fretting over inflation of 4.4%). But most rich-world economies have ample economic slack, and in several countries fiscal tightening will tug at recovery. Britain’s coalition government has reaffirmed its commitment to austerity with this week’s budget (see article), and America has begun to cut spending. Both the Bank of England and the Federal Reserve should resist the temptation to tighten soon. The European Central Bank seems intent on raising interest rates next month. That would be a mistake. In the euro zone underlying inflation and wage growth are both subdued and inflation expectations are under control. By raising rates the ECB would strengthen the euro and frustrate the efforts of countries like Greece, Ireland and—the next in line for bailing out—Portugal to grow their way out of their debts. There is only so much economic policymakers can do about crises that spring from war or nature. In this case, the priority should be not making matters worse.
Fed Wins Deflation Battle But Faces Tough Task On Inflation Investors
Dow Jones Newswires | Mar 24
"The Fed cannot have both low inflation and strong growth going forward," said Mihir Worah, head of inflation-linked bonds at Pacific Investment Management Co., one of the world's biggest asset management firms with over $1 trillion global assets under management. "The latest developments in Japan, Middle East and North Africa are on the margin stagflationary which means lower growth and higher inflation. This makes [the] Fed's job harder."
Will Central Banks Accommodate the Oil Price Shock?
Ed Dolan's Econ Blog | Mar 24
The Fed seems least likely of any of the big three central banks to tighten its policy in response to rising oil prices. As in the case of the ECB, both legal and attitudinal factors come into play. Unlike the ECB, the Fed, by law, is tasked with balancing price stability against the need to fight unemployment, which remains very high. Also, the Fed, more than other central banks, focuses on core inflation, and on measures of expected inflation, neither of which is rising as rapidly than the headline CPI. Unless some strong indications of higher inflation emerge, for example, a sharp increase in long-term interest rates, it seems almost certain that the Fed will keep interest rates low and carry its current program of quantitative easing through to its scheduled completion in June. At that point, if oil prices are still on an upward trajectory, if Congress has still done nothing about the deficit, and if there are signs that headline price increases are spilling through into core inflation and indicators of expectations, a turn to a less accommodative policy becomes likely.
OBR warns on effect of inflation and rising oil price
The Telegraph | Mar 25
Inflation and oil prices remain the biggest risks to Britain's economic recovery, the Office for Budget Responsibility has warned.
European Loan Growth Accelerated in February on Stronger Economy
Bloomberg | Mar 25
Increased lending may bolster the ECB’s case for an interest-rate increase next month. Officials, including President Jean-Claude Trichet and executive board member Juergen Stark, have signaled economic uncertainty caused by Japan’s earthquake may not deter them from lifting borrowing costs. The ECB wants to stem faster inflation fueled by stronger euro-area economic growth and oil prices surging above $100 a barrel. “Obviously loan growth mirrors the state of the economy so the overall trend is up,” said Nick Matthews, an economist at Royal Bank of Scotland Group Plc in London. “While loan and money growth are not yet inflationary, the ECB is still on emergency setting for policy rates and it wants to get away from that.”
Allianz Global Picks Gold, Oil to Lead Commodity Gains on Inflation, Rates
Bloomberg | Mar 25
Gold and oil will lead gains in commodities this year as investors seek to guard against rising inflation stemming from a global economic recovery and low interest rates, according to Allianz Global Investors.
China PBOC's Yi urges caution on interest rate rises
Reuters | Mar 23
China is facing strong inflationary pressure, but will tread cautiously in raising interest rates, said Yi Gang, a deputy governor with the People's Bank of China. Yi told a business conference in Hong Kong on Wednesday that he was confident the government would be able to keep annual average consumer price inflation to 4 percent this year. "We will see high (inflation) numbers in the first half of the year because of the base effect. Inflation in the second half will be lower," Yi said. "So for the whole year, we will be able to meet the 4 percent goal." Chinese inflation topped expectations at 4.9 percent in the year to February, near its fastest level in more than two years, and looks set to accelerate further in coming months as the economy races ahead and prices of food and commodities such as oil remain high.
Living With Rising Oil
International Business Times | Mar 24
The rise in the oil price will also boost inflation with roughly a $US10 a barrel rise adding 0.5% to inflation in the US and Australia and 0.7% to inflation in Asia. What would central banks focus on - inflation or growth? The European Central Bank is more likely to focus on headline inflation and so raise interest rates as it is threatening to do. However, the US Federal Reserve is likely to see a fuel inspired boost to inflation as temporary and would probably give more weight to weaker growth. At this stage it's too early to get overly worried given that it's quite possible that significant tensions in the Middle East and North Africa will be confined to current countries. Just as the much feared nuclear meltdown didn't happen a week ago, a worst case oil price surge may be avoided.
The effects of the recent oil price shock on the U.S. and global economy
Nouriel Roubini and Brad Setser | 2004
Oil prices shocks have a stagflationary effect on the macroeconomy of an oil importing country: they slow down the rate of growth (and may even reduce the level of output – i.e. cause a recession) and they lead to an increase in the price level and potentially an increase in the inflation rate. An oil price hike acts like a tax on consumption and, for a net oil importer like the United States, the benefits of the tax go to major oil producers rather than the U.S. government.
Oil Price Volatility and U.S. Macroeconomic Activity
St. Louis Fed | 2005
Oil shocks exert influence on macroeconomic activity through various channels, many of which
imply a symmetric effect. However, the effect can also be asymmetric. In particular, sharp oil price changes—either increases or decreases—may reduce aggregate output temporarily because they delay business investment by raising uncertainty or induce costly sectoral resource reallocation.
High Crude Oil Prices Biggest Inflation Threat
YTWHW.com | Mar 24
Climbing international crude oil prices are the biggest threat to inflation in Chile as the country imports 98.7% of the crude it consumes, Finance Minister Felipe Larrain said Thursday.
March 24, 2011
Durable Goods Unexpectedly Fall In February
Orders for durable goods, a leading indicator of economic activity, fell 0.9% last month on a seasonally adjusted basis, the Census Bureau reports. The decrease follows a strong 3.6% gain in January. Economists were expecting a gain. Monthly data is volatile, however, and so it’s not clear if there’s something more ominous afoot.
For deeper perspective, let's review the rolling 12-month change and put it in context with other economic indicators. From that vantage, the downshifting in new orders doesn't look all that surprising. The annual pace of durable goods orders recently appeared to be running at an unsustainably high level, as the chart below suggests. Accordingly, the odds of trimming the proverbial sails have been higher than normal lately, and so perhaps we're merely witnessing gravity reasserting its pull.
If this was a "normal" post-recession growth phase, there'd be little peril. But with the labor market showing only modest growth, the danger here is that persistently higher oil prices take a toll on sentiment.
“Persistent strength in durable goods orders should be taken as a sign that both consumers and businesses are confident enough in the economy to engage in spending on big-ticket items,” Pimco’s Tony Crescenzi explained in his book The Strategic Bond Investor. There's been strong persistence in durable goods orders for much of the past two years, a signal that's proven more or less prescient in signaling a broader albeit modest economic revival. Is there still persistence in new orders for manufacturers?
Yes, as the second chart below reminds. But with higher energy prices lurking, one might wonder if the persistence is headed for a rough patch. New orders for capital goods (ex defense and aircraft) have been slipping for three months straight (this slice of new durable goods orders is considered an especially useful window on the economic outlook). It's debatable in real time where a routine downshift ends and something more threatening begins, although it's not hard to imagine that buyers are becoming more cautious as energy prices rise.
MarketWatch notes that "oil prices are likely to remain supported as the U.S., U.K. and France continue airstrikes against the forces of Libyan leader Col. Moammar Gadhafi." Accordingly, “Supply disruption still trumps participants’ concerns,” says Mike Fitzpatrick, partner at the Kilduff Group, in a note, via MarketWatch.
Perhaps it's accurate to say that the Pentagon holds the key for the next move in the economy.
Update: In an earlier version of this post, the first chart above (Rolling 12-month % changes) mistakenly switched labels for durable goods and capital goods. The chart has been corrected: Capital goods are accurately indicated by the black line, durable goods are in red. Sorry for the confusion.
Jobless Claims Fall Again. Will Rising Energy Prices Slow or Derail The Trend?
New jobless claims fell again last week, dropping by a seasonally adjusted 5,000 to 382,000, the Labor Department reports. The widely watched four-week moving average slipped as well, retreating to its lowest level in two-and-a-half years. It’s clear that new filings are trending lower once more, if slowly. But the ongoing strength in the oil market raises the question of whether higher energy prices are a threat?
The answer’s unclear, of course, since no one knows if oil prices will keep climbing. Meantime, the impact of higher energy costs, which may or may not be temporary, is only just beginning to filter into the wider economy. It's going to take time to learn how higher oil prices will affect the recovery, which means that economic reports will be less informative for a time.
Meantime, we have to make due with the numbers we have. On that basis, it’s clear that the labor market is showing signs of progress again, or at least it has been. It’s interesting to note that the renewed decline in jobless claims began last fall, roughly in line with the point when expectations started bubbling for the Fed’s QE2 monetary stimulus. Coincidence? Maybe, although a number of economists say there’s a connection. Of course, you can find many dismal scientists who disagree.
Whatever the cause, the now-routine reporting of jobless claims under the 400,000 mark, while a long time coming, is encouraging. Let's just hope it's not about to be derailed by oil prices.
“The labor market recovery is on track,” David Semmens, an economist at Standard Chartered Bank in New York, tells Bloomberg. “The unemployment rate will see a slow-but-steady grind down.”
Strategic Briefing | 3.24.2011 | Portugal: The Next Phase Of Euro Crisis
Portugal in crisis after prime minister resigns over austerity measures
Guardian | Mar 23
Portuguese prime minister José Sócrates has said he has submitted his resignation to the president after parliament rejected his minority Socialist government's latest austerity measures. The loss of the vote "has taken away from the government all conditions to govern," Sócrates said. It brings the country closer to needing a bailout.
Portugal bailout 'could cost UK £3bn'
Guardian | Mar 23
"Portugal will inevitably ask for a bailout," said Open Europe's Raoul Ruparel. "But the cases of Ireland and Greece clearly illustrate that the EU's strategy – to throw good money after bad – is failing. Rather than simply taking a bailout, it would be better in the long run for Portugal to restructure its debt now," Ruparel added.
Merkel Says Socrates Was ‘Right’ to Push for More Portugal Cuts
Bloomberg | Mar 24
German Chancellor Angela Merkel said that Portuguese Prime Minister Jose Socrates did the right thing in putting a “far-reaching” program of austerity measures to parliament. Merkel, in a speech to lower-house lawmakers in Berlin today, said that Socrates had been “right and courageous” in presenting an additional round of budget cuts, and that she was “grateful” to him for taking responsibility for his country’s finances.
New Phase in Europe Crisis
The Wall Street Journal | Mar 24
Portugal's crisis will be at the forefront of the agenda of an EU summit meeting in Brussels on Thursday. European leaders have spent recent months cobbling together a comprehensive package they hope will solve once and for all the euro zone's debt crisis. Thursday's meeting is expected to settle a new post-2013 bailout fund, able to lend €500 billion, or about $710 billion, and an accord to improve countries' competitiveness. But a decision on enlarging the lending capacity of the current bailout fund beyond its roughly €250 billion has been put off.
Portugal in crisis, unlikely to seek bailout at summit
Reuters | Mar 24
The resignation of Portugal's prime minister will dominate a summit of EU leaders on the European economy on Thursday and Friday, with pressure intense on Lisbon to seek a bailout package. Prime Minister Jose Socrates resigned on Wednesday after parliament rejected his government's latest austerity measures aimed at avoiding EU financial assistance. But he said he would still attend the two-day summit in a caretaker capacity. Socrates remains adamantly opposed to requesting EU/IMF aid and has made it clear he intends to hold that line, at least until a new Portuguese government is formed in the weeks ahead. That leaves Portugal in limbo, but the likelihood remains that a bailout will have to be taken in the end.
The death of Sócrates
The Economist | Mar 23
Portugal’s political turmoil and its urgent need for a rescue will create new problems at the EU summit, which is due to sign off on an effective expansion of the bail-out fund and a German-led “pact for the euro”. If EU leaders agree to bail out Portugal, they may find they have already used quite a big chunk of their fund. Judging by experience, the markets will then move on to attack the Spanish. The bail-out fund can easily finance Portugal. But it is not clear that it could deal with Spain.
Portuguese vote stokes Europe debt concerns
Washington Post | Mar 23
“Portugal is essentially doomed,” said Jacob Kirkegaard, an analyst at the Peterson Institute for International Economics who has followed the European debt crisis. “They cannot finance themselves.” Portugal’s economy is small, and it does not have the extensive banking system or other global ties that would make its crisis an immediate cause for broader concern. But the resolution of Portugal’s problems will be important in determining whether the euro area puts a lingering debt crisis behind it and adds to the world recovery with a stronger outlook for growth, or whether it remains under a cloud of possible sovereign default. More significant European economies such as Spain, Belgium and Italy also have high levels of public debt. Although analysts say it is unlikely that any will need international help, the situation is volatile. Spanish banks have about $100 billion at risk in Portugal, the type of transnational “exposure” that could allow problems in Portugal to spill beyond its borders.
Spanish Banks Hit by Moody's
The Wall Street Journal | Mar 24
Iberian bank shares are expected to drop after the market opens Thursday, following a downgrade of the Spanish sector by Moody's Investors Service Inc. and the collapse of Portugal's minority government overnight. Moody's said its downgrade comes after a similar move on Spain's sovereign debt earlier this month, and reflects heightened financial pressures on Spain's sovereign credit and that of "many" weak banks, and decline of the systemic importance of smaller banks amid quick consolidation in the sector, and the expectation of a weaker support environment for banks across Europe.
Socrates quits, no deal of EFSF, no deal on Irish rates, anger over Merkel – another fine mess
EuroIntelligence | Mar 24
Not looking too good. Irish spreads now at over 7%, Portugal’s at 4.6%. While Portguese ten-year bond yield 7.6%, five year bonds are now over 8%. The financial markets are not expecting any relief from the summit .
George Soros (Project Syndicate) | Mar 21
The so-called euro crisis is generally seen exclusively as a currency crisis, but it is also a sovereign-debt crisis – and even more a banking crisis. The situation’s complexity has bred confusion, and that confusion has political consequences. Indeed, Europe faces not only an economic and financial crisis, but also, as a result, a political crisis. The various member states have forged widely different policies, which reflect their views rather than their true national interests – a clash of perceptions that carries the seeds of serious political conflict.
March 23, 2011
New Home Sales Tumble In February
New single-family home sales retreated again last month, falling by nearly 17% in February on an annualized basis, the Census Bureau reports. That’s the biggest monthly fall since last May.
Although all regions of the country suffered declines, the heavily populated Northeast section of the U.S. posted the steepest drop with a 57% tumble.
The positive spin is that it’s merely the weather mucking up the trend. A variation on this view is that the housing market may not be poised for recovery, but it’s not headed for a new downturn either. "We do not believe the housing sector is on the verge of renewed contraction," Michelle Girard, an economist at RBS in Stamford, Connecticut, tells Reuters. "Rather, we continue to expect the recovery in housing to be disappointingly and frustratingly slow."
The question is whether the distinction is meaningful in terms of the economic cycle. It’s a subject worth thinking about when you consider the positive role that housing’s played in every previous recovery cycle since 1970. Sales of new single-family homes began rebounding during every recession of the last four decades. In each case, by the time growth was established and the recession was over (based on NBER cycle dates), new home sales had more or less climbed back to levels posted when the contraction began. Within a year of every economic rebound’s start, new home sales were clearly rising at a robust year-over-year gain. A similar story describes the dynamic for new housing starts.
This time is different. The deep recession in housing showed signs of recovery last year, but it’s looking more like a dead-cat bounce these days vs. a bonafide revival in the fortunes of residential real estate. Comparing the annual pace of change for housing starts and new home sales on a rolling basis suggests a renewed decline this year isn't beyond the pale. It’s debatable if this drag on the economy threatens the modest rebound in the labor market and other sectors of the economy. The good news is that the broad trends for job growth and industrial production (a proxy for the overall macro trend) remain positive... so far, at least.
“Housing is a mainstay of the U.S. economy, consistently accounting for more than one fifth of the gross domestic product (GDP),” writes Alex Schwartz, chairman of the New School’s Department of Urban Policy Analysis and Management, in his book Housing Policy in the United States
Does that matter for the year ahead? Maybe not, according to the optimists, who say that housing’s negative aura will be minimal for the economic recovery. Let’s hope that’s true, since expectations for a strong rebound, or any rebound in residential real estate, appear muted at best.
"Overall, the sentiment among our expert panel regarding the U.S. housing market outlook continues to deteriorate," warns Robert Shiller, chief economist of MacroMarkets, via the firm’s March 2011 Home Price Expectation Survey. "Now they are expecting only a weak recovery, and even that is not until 2013. This uninspiring view must be influenced by the persistently weak market fundamentals - high unemployment, supply overhang, an unabated foreclosure crisis, and constrained mortgage credit."
Update: The original version of this story incorrectly noted that existing home sales fell last month. In fact, we should have reported that single famly homes declined.
Strategic Briefing | 3.23.2011 | High Yield Bonds
Junk Bonds: What to Do Now
The Wall Street Journal | Mar 22
It may be time to take some junk out of your trunk. Until recently, high-yield or "junk" bonds have been on a tear, posting double-digit returns in 2009 and 2010 and sending prices higher and yields close to all-time lows. But investors are starting to pare back their appetite for risky assets. For the first time since early December, there were net outflows from high-yield bond funds last week—some $801.9 million—according to EPFR Global, a Boston research firm that tracks fund flows.
ProShares Debuts Short Junk Bond ETF (SJB)
ETFdb | Mar 22
ProShares, the Maryland-based firm known for a suite of leveraged and inverse ETFs, has launched the first ETF offering daily inverse exposure to junk bonds. The ProShares Short High Yield (SJB) will seek to deliver daily results that correspond to -100% of the daily change in the iBoxx $ Liquid High Yield Index. That index serves as the underlying for the ultra-popular iShares iBoxx $ High Yield Corporate Bond Fund (HYG), which has more than $8 billion in assets and consists of more than 400 individual junk bonds.
High Yield Debt Sales Revive as Concerns Ease
BondSquawk | Mar 22
High yield bond issuance is reviving this week after falling over 50% for the past two weeks on increased concerns about a nuclear disaster in Japan and growing tensions in the Middle-East. The amount of new issues sold fell to $2.45 billion in the week ended March 18, just two weeks after markets saw $12.6 billion worth of high yield bond sales. This week will see Intelsat issuing $2.65 worth of speculative debt in 10-12 years maturity spectrum, among many others.
Gundlach Sets the Record Straight
Advisor Perspectives | Mar 22
[Jeffrey] Gundlach [of DoubleLine Capital] said the risk premium in equities is superior now to that in the corporate bond market, and the opportunities in the junk market are especially bad. High-yield bonds, Gundlach said, are more than twice as volatile as investment-grade bonds. On a loss-adjusted basis, however, their yields are only 100 basis points higher. He said yields of 4% to 4.5% are available in the investment-grade market, and junk yields are now 6.75%, assuming no losses from defaults. “We all know that there will be losses [from defaults],” he said, perhaps not this month or next month, but certainly over the next two to three years. He said those losses would be in line with their historical rate of 4% and, assuming a 50% recovery rate, that would reduce the effective yields on high-yield bonds by approximately 200 basis points.
High Yield Default and Recovery Rate Volatility in Recession and Recovery
Fitch Ratings (via Raw Finance) | Mar 17
The U.S. high yield par default rate fell to 1.1% at the end of February, a level far below 2009’s recession induced 13.7% and also well below the long-term average annual rate of 5.1%. A low default rate, however, is not synonymous with low risk. In 2011, for example, key risks to the default outlook center firmly on factors that could derail the recovery. These include soaring oil prices, significantly higher interest rates or other funding disruptions due to risk aversion, and sticky unemployment. In this new study, Fitch examines the factors that have contributed to the recent dramatic, but not entirely unprecedented, swing in default rates, offering context relative to the longterm cyclical behavior of default and recovery rates.
Market Anthropology | Mar 22
When I think about the Big Picture and forming guesstimates of the future (don't fool yourself, it's still more art than science you tin foil hat wearing efficient market theorists) - I like to look at the proportions of the contributing forces. The chart below provides and excellent example contrasting the two most recent recessions and their effects to the low-grade corporate credit markets.
Bank of America Merrill Lynch US High Yield Master II Option-Adjusted Spread
St. Louis Fed | Mar 21
March 22, 2011
Worrying About Inflation
Wharton professor Jeremy Siegel, author of the best seller Stocks for the Long Run, worries about mounting inflation pressures. Last week, he said in a TV interview with Bloomberg that the Fed should consider raising rates soon.
Siegel’s hardly alone in calling for the Fed to act, but so far there are few signals from the market for expecting a hike in interest rates in the near term. Fed fund futures are priced this morning on the expectation that the current zero-to-25-basis-point policy range will prevail for the foreseeable future. The January 2012 contract, for instance, is priced for Fed funds at roughly 30 basis points as we write.
The Treasury market doesn't seem worried about inflation either. The market's inflation forecast, based on the yield spread between the nominal and inflation-indexed 10-year Treasuries, was a modest 2.44% yesterday.
Federal Reserve Bank of Cleveland President Sandra Pianalto said in a speech today that she thinks inflation will remain moderate:
I expect the underlying trend in broad consumer prices, which is currently quite low, to rise only gradually toward 2 percent by 2013. I think several factors will keep inflation in check. One factor is the continuing slow growth in wages, which helps determine the cost of producing goods and services and, in turn, the prices set by firms. Another factor is many retailers' reluctance to raise prices in the face of strong competition and soft business conditions
What about the rise in commodity prices that has Jeremy Siegel worried? Pianalto says the associated inflation risk is "transitory":
Some of the most recent rise in gasoline prices reflects the dramatic recent global events that have pushed oil prices significantly higher. The natural question in these times is whether these higher prices will be enough of a driving force to cause a lasting increase in the rate of inflation. At this point, I don't think they will, and let me explain why.
First, large increases in food or energy prices have often been balanced out over time by sharp declines. For example, in 2006, oil prices rose significantly over the first eight months of the year but then dropped in the remainder of the year. While periods of rising energy prices cause inflation to rise, the subsequent periods of falling energy prices cause inflation to fall.
Second, to cause a lasting rise in inflation, the increases in food or energy prices have to be large enough and persist long enough that they spill over and cause sustained increases in a wide array of other consumer prices. At this point, there is no evidence of broad spillover, but as a central banker I keep a close eye on this.
To assess the underlying trends in a broad array of consumer prices, my staff at the Federal Reserve Bank of Cleveland calculates and publishes an indicator known as the median CPI. This index is designed to provide a reliable measure of the average increase in a wide set of consumer prices, and it has been shown to be a superior predictor of future inflation rates. To this point, inflation in the median CPI remains very low: just 1 percent over the past year. Based on the behavior of the median CPI, I don’t expect recent rises in food and energy prices to cause broader inflation.
For the moment, at least, the market seems to agree.
End The Fed? And Replace It With... ???
The celebrated investor Jim Rogers thinks we should abolish the Federal Reserve. Asked in an interview yesterday what he'd do as Fed chairman, he replied: "I'd shut it down."
Rogers is a long-time critic of the central bank, and so his view is old news. He also has lots of company. Perhaps the most prominent and powerful critic is Rep. Ron Paul, head of the House subcommittee that oversees the Fed and author of End the Fed.
Attacking the Fed is an old sport, dating to the bank's founding in 1913. Inspiring the legion of critics over the years is the simple fact that the central bank is far from perfect. As an institution run by humans, policy errors are inevitable. But closing the Fed, for all its populist appeal these days, wouldn't solve much, if anything because something would need to take its place. Wouldn't a successor institution suffer from all the problems that bedevil the Fed? What's that? You have a solution to insure the delivery of superior monetary policy decisions? Really? Why don't we apply those cures to the Fed?
The hard reality is that a modern economy needs a central bank. Some institution has to oversee monetary policy, unless we're going to go back to bartering. Letting Congress assume these duties is asking for trouble. The Fed is far from immune from political influence, but imagine how monetary policy would be run via debates on the floor of the House of Representatives.
Some Fed critics like to argue for a return to the U.S. to a gold standard. That's unlikely for a number of reasons. But let's say the impossible happens. Even on a gold standard, a central bank is necessary to supervise the details and insure that the rules of the game are satisfied. Of course, one could argue that the country could return to the pre-Fed-era banking chaos of the late-19th century, but that's the monetary equivalent of advocating the use of horses as a solution to the traffic problems created by cars.
The irony in all the recent calls to end the Fed is that inflation is quite low by historical standards. Paul and others worry that the Fed's quantitative easing policy will soon unleash higher inflation. That's always a concern, and the solution is, as always, enlightened decisions on monetary policy. Unwinding QE2 doesn't have to bring higher inflation. It might, of course, but that's hardly a reason to shut down the Fed. By that standard, we should close the Pentagon because it might make a mistake in the next war.
Meantime, some Fed critics point to rising commodity prices as a harbinger of things to come. Rising oil prices in particular raise fears of future inflation in the hearts and minds of many Fed bashers. Maybe, although as Bloomberg's Caroline Baum points out, higher prices and inflation aren't always one and the same:
For folks who use the term “inflation” interchangeably with higher prices -- as in wage inflation or commodity inflation --they are not the same thing. A higher price for oil and/or other commodities is a higher relative price until ratified by the central bank.
What does the central bank have to do with it?
Inflation is a monetary phenomenon: too much money chasing too few goods and services…
Higher oil prices don’t cause inflation. They aren’t synonymous with inflation. Higher oil prices represent a relative price increase until proven differently.
None of this is an argument for giving the Fed a free hand. Debates about how the central bank—any central bank—conducts monetary policy are always fair game. There's certainly room for improvement; the past decade has revealed quite a few lessons about how to run monetary policy. But that's quite a different animal from calling for the institution's demise.
It's easy to say the Fed's makes mistakes and therefore it should be closed. But what's the follow-up plan? Will you create a new institution to run monetary policy? Are you willing to give Congress that power? The critics don't usually have good answers to such questions. No wonder that it's hard to take the kill-the-Federal Reserve-system crowd seriously.
March 21, 2011
What Goes Up...
It’s no secret that the Federal Reserve’s balance sheet has exploded in recent years, courtesy of the blowback from the financial crisis of late-2008 and the Great Recession. That includes holding more Treasuries. But not all Treasuries are equal when it comes to maturities on the books at the central bank. Most of the ballooning portfolio of government-held debt is in medium-term Treasuries with maturities of 5-to-10-year maturities, according to Fed data. Some of this (all of this?) will flow back into the private sector with QE2’s scheduled unwinding later this year. Barring any glitches, the market’s on track to see a fair amount medium-term Treasuries on sale this year.
March 20, 2011
The Limits Of The Yale Model
The Economist wonders if the so-called Yale model, an aggressive use of conventional and alternative asset classes, will shine as brightly in the years ahead as it has over the past quarter century. The rationale for thinking positively comes from the capable investment hands of David Swensen, who's managed Yale's endowment since 1985, delivering stellar results. His strategy, explained in his 2000 book Pioneering Portfolio Management, has been hailed by many as the only way to fly for institutional investors. Individuals, too, can also learn a thing or two from Swensen, argue his supporters.
Success never lacks for a crowd, of course. And in this case, there's economic logic driving the idea. Owning a broad array of assets with varying degrees of correlation is the basis for building optimal portfolios, a.k.a., funds that maximize return with minimal risk. Harry Markowitz formally introduced the idea more than 50 years ago, and it's as relevant today as it was when he first wrote about it in his famous 1952 paper. But the problem has always been forecasting the three critical variables: return, correlation and volatility.
Estimating performance is especially tricky. In fact, relatively few money managers are able to deliver much more than middling performance over time. That's true for efforts within a given asset class, as numerous studies on the power of indexing remind. It's not widely known that passive asset allocation does quite well too.
For example, consider the track records of more than 1,000 mutual funds with at least 10 years of operating history and a mandate for some degree of multi-asset class investing, as reported by Morningstar Principia software. As you'd expect, there are some spectacular winners—and losers. But most of the results fall into the middle. That's not surprising, since earning excess returns is a zero-sum game. The winners are financed by the losers.
That profile also lays the foundation for expecting an unmanaged, market-value weighted asset allocation to capture the middle ground with a fair amount of consistency. The numbers tell us as much. Imagine a benchmark that holds all the major asset classes, and weights them based on their respective market values. Set it and forget it. Let's call it the Global Market Index (GMI). How's it done over the last decade? Pretty good, as the performance chart below shows. Mindlessly rebalancing the mix every December 31 to the previous year's mix raises return a bit more.
Compared with the 1,000-plus actively managed mutual funds over the past 10 years, GMI's performance ranks at roughly the 80th percentile (blue line in chart above). In other words, it beat 80% of its competitors. That's actually better than expected, although the past 10 years have been unusually tough for navigating the world's markets. Between financial crises and wars, it's been a ripe era for black swans.
Indeed, the fundamental challenge in managing asset allocation is deciding how to adjust the weights in real time. Suffice to say, this challenge isn't getting any easier, and for a familiar reason: the future's uncertain. No one knows, for instance, how the war in Libya will turn out, or what its effect on oil prices will be. It's also unclear how the Japanese crisis will end. What is known is that the outcomes of these events, and countless others, will collectively cast a long shadow on risk and return over the long haul. It's just not clear how, or when. No wonder that a passive strategy of navigating treacherous and uncertain waters has a reliable history of minting average performance. It remains the same even after adjusting for risk.
This isn't an argument for owning a passive asset allocation, but it is a reminder that beating the market writ large is still hard--even after we add alternative asset classes. Alpha still sums to zero, no matter how broad your asset allocation horizons. Even so, everyone needs to customize their portfolio strategy to match the specifics of their risk tolerance, expectations, time horizon and skill set. But it's also true that very few of us are David Swensen.
March 19, 2011
Book Bits For Saturday: 3.19.2011
● The Little Book of Alternative Investments: Reaping Rewards by Daring to be Different
By Ben Stein and Phil DeMuth
Excerpt via publisher, John Wiley
This book is largely about finding legitimate assets that will make your finances less tied to the churn of the stock market. To the extent that you succeed, the tradeoff is that you really will be less tied to the stock market. When stocks are rocketing to the stars, you won’t be. When stocks are melting through the earth, you won’t be. It will be less clear to you from day- to- day how you are doing. This can be liberating but also can be anxiety producing, especially if you’re used to checking the Dow Jones Industrial Average every 15 minutes or 15 seconds. It requires a leap of faith that there is life beyond stocks. We want to interest you in accepting a higher degree of stock market de- correlation into your life than you probably have at present.
● Guaranteed to Fail: Fannie Mae, Freddie Mac, and the Debacle of Mortgage Finance
By Viral V. Acharya, Matthew Richardson, Stijn Van Nieuwerburgh & Lawrence J. White
Excerpt via publisher, Princeton University Press
In 1818, a nineteen-year-old English girl, Mary Shelley, published her first novel. The novel tells the story of a young, talented scientist who discovers how to create life from the inanimate. Collecting old human bones and tissue, the scientist constructs a man from scratch and brings him to life, only to be disgusted by his appearance and shape, calling him the Monster. The scientist deserts the monster,and,left to its own devices, his creation causes havoc and mayhem. In the finale of the story, as the scientist confronts the monster, the monster eventually destroys its creator and, stricken with grief, takes its own life. Shelley decided that the name of the talented scientist should be the title for the novel: Frankenstein.
Former executives of Fannie and Freddie, members of Congress, and past administration officials all talk about the good work of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac; and, they will add, if it were not for the equivalent of an economic asteroid hitting the markets, all would be fine. They will point to affordable housing goals and the benefits to the underprivileged.
We are skeptics.
● Better by Mistake: The Unexpected Benefits of Being Wrong
By Alina Tugend
Audio interview with author via KUOR/Southern California Public Radio
Does practice really make perfect? Or is perfection a mythical, unattainable goal? These are some of the questions author Alina Tugend explores in her new book, Better by Mistake: The Unexpected Benefits of Being Wrong. Also a columnist for the New York Times, Tugend once made a mistake in one of her articles, ultimately resulting in a dreaded public correction. Before ‘fessing up, she agonized over her error. She tried to ignore it. She contemplated keeping quiet about it. She even went so far as to rationalize that she was actually correct. Eventually, however, journalistic ethics won out and she told her editor. The internal struggle she experienced at the presence of a singular, superficial mistake led her to investigate further the nature of human error and how it’s perceived on both a personal and societal level. With the zeal of a recovering perfectionist, Tugend delved into how mistakes are dealt with from the dynamic of errors between parents and children, to those between corporations and consumers. Are mistakes really deserving of humiliation and punishment? Or should they be accepted – even revered – for their powerful learning potential?
● The Information: A History, a Theory, a Flood
By James Gleick
Review via The New York Times Book Review
The universe, the 18th-century mathematician and philosopher Jean Le Rond d’Alembert said, “would only be one fact and one great truth for whoever knew how to embrace it from a single point of view.” James Gleick has such a perspective, and signals it in the first word of the title of his new book, “The Information,” using the definite article we usually reserve for totalities like the universe, the ether — and the Internet. Information, he argues, is more than just the contents of our overflowing libraries and Web servers. It is “the blood and the fuel, the vital principle” of the world. Human consciousness, society, life on earth, the cosmos — it’s bits all the way down. Gleick makes his case in a sweeping survey that covers the five millenniums of humanity’s engagement with information, from the invention of writing in Sumer to the elevation of information to a first principle in the sciences over the last half-century or so.
● The Overloaded Liberal: Shopping, Investing, Parenting, and Other Daily Dilemmas in an Age of Political Activism
By Fran Hawthorne
Summary via publisher, Random House
We live in a society that is at once the most politically aware and the most consumer oriented in human history. Twenty-first-century shoppers don't just consume; we investigate and categorize the impact of our decisions on climate change, animals, our health, our political views, geopolitical relationships, working conditions, and more. Yet when we actually try to live according to our principles, it can be so overwhelming, contradictory, and demanding that we want to scream. Every step, every dollar, every swipe of a paper towel has become a decision that can make the world a better—or worse—place.
Take one daily dilemma: what jacket should I buy? If it was made in El Salvador, China, or Vietnam, was it sewn by workers in a sweatshop at near-starvation wages, forced to labor twenty-hour days in dangerous conditions? Are those jobs actually considered desirable in those countries? Can I even find a jacket made in the United States? If I do, should I insist on union-made? But what if that's more expensive? And what fabric is it made of? Does it contain animal skins? Is the cotton organic? What kind of dyes were used? Does it have fair-trade certification? Oh, and by the way: does it look good on me? Veteran journalist and levelheaded mom Fran Hawthorne sets out to answer these questions—and spark more.
March 18, 2011
Strategic Briefing | 3.18.2011 | Stagflation Risk
Supply Disruptions Pose Threat of Stagflation
The Wall Street Journal | Mar 17
A scramble for supplies prompted by Japan's crisis may add to the specter of stagflation stalking the U.S. economy. Already, high oil prices and geopolitical uncertainty have taken some of the buzz out of 2011 growth prospects. The first quarter in particular looks like it will end on a much weaker note than initially thought. Morgan Stanley's tracking estimate of annualized real gross-domestic-product growth has dropped from 4.5% to 2.9% over the past six weeks. A similar one from tracking firm Macroeconomic Advisers has slipped to 2.5%.
The Economic Consequences of the Arab Revolt
Nouriel Roubini (Project Syndicate) | Mar 14
Political turmoil in the Middle East has powerful economic and financial implications, particularly as it increases the risk of stagflation, a lethal combination of slowing growth and sharply rising inflation. Indeed, should stagflation emerge, there is a serious risk of a double-dip recession for a global economy that has barely emerged from its worst crisis in decades. Severe unrest in the Middle East has historically been a source of oil-price spikes, which in turn have triggered three of the last five global recessions. The Yom Kippur War in 1973 caused a sharp increase in oil prices, leading to the global stagflation of 1974-1975. The Iranian revolution in 1979 led to a similar stagflationary increase in oil prices, which culminated in the recession of 1980-1981. And Iraq’s invasion of Kuwait in August 1990 led to a spike in oil prices at a time when a US banking crisis was already tipping America into recession.
BofA Merrill Lynch Fund Manager Survey Reveals Growth and Profitability Fears After Oil Price Spike
Bank of America | Mar 15
Following the recent oil price spike, investors fear for corporate profitability and global growth, according to the BofA Merrill Lynch Survey of Fund Managers for March. A net 24 percent of asset allocators now expect corporate operating margins to fall over the next 12 months. This represents the sharpest month-on-month decline since the survey began asking this question in 2004. As recently as January, a net 10 percent was expecting margins to expand. A net 32 percent of fund managers still look for corporates to increase profits in the next year, but this is down significantly from a net 51 percent a month ago. A net 31 percent now views consensus earnings estimates as too high, moreover. This decline in confidence is reflected in the survey participants' macroeconomic outlook. A net 31 percent of fund managers still believe the global economy will strengthen in the next year, but this is down from a net 51 percent last month. In the U.S. the fall was even sharper, from a net 52 percent to a net 21 percent, while respondents in Asia outside Japan turned negative. A net 25 percent sees the region's economy weakening over the period. While fears of recession remain remote, the threat of stagflation has risen, according to the survey findings. In the space of two months, the proportion of fund managers anticipating below-trend growth and above-trend inflation has doubled to 38 percent. Among four possible outlooks, this is now the most common among respondents.
Stagflation, 70s icon, dusts off disco shoes
Reuters | Mar 11
"I hate to mention the word stagflation, but that seems to be what fears are out there at the moment," said Martin Hegarty, who co-heads the management of about $22 billion in global inflation-linked portfolios for BlackRock, the world's largest asset manager. Hegarty sees inflation concerns as contained for now, though the rise in oil is threatening momentum in the economic recovery at the same time as a number of other economic headwinds are threatening the rosy outlook.
PPI: Mixed Results in February
Wells Fargo Economics Group | Mar 16
The good news for the Federal Reserve is that the producer price index for finished goods increased by 1.6 percent due to strong increases in food and energy prices, while the core index only increased by 0.2 percent, a slowdown compared to the 0.5 percent increase during the first month of the year. Prices for finished energy goods increased by 3.3 percent during the month, while prices for finished consumer foods increased by 3.9 percent. According to the report, the 3.9 percent spike in finished consumer foods was the largest monthly increase since November of 1974, when it posted a rate of 4.2 percent. This comparison should not be taken lightly. The comparison to 1974 is very telling because that was the year when the “stagflation” period started. Recall that stagflation is defined as a combination of economic stagnation and inflation. Having said this, it is still too early to try to make more analogies to the 1970s even though there are several characteristics that are very similar. While in 1974 the world was shocked by the first oil embargo, today’s situation is void of an oil embargo but the same region of the world that declared the oil embargo is going through very difficult times and the end outcome could have similar effects on the petroleum market that the oil embargo had in 1974. Of
course, this is only if the situation in the Middle East and North Africa continues to deteriorate and the crisis continues to spread to Saudi Arabia and other oil producing countries. Thus, this is the worst possible scenario, which, today, is not our base case, with our forecast of 2.7 percent GDP growth for 2011.
Fed Needs Better Barometer to Detect Inflation
Alliance Bernstein | Mar 4
According to the Fed, a sustained rise in US inflation is unlikely while the economy has substantial idle capacity. We think the Fed’s output gap framework relies too much on domestic conditions, and overlooks important changing dynamics in the global economy that may eventually create new inflationary pressures... The Fed’s view on inflation is rooted in an output gap framework, which argues thata sustained rise in inflation is unlikely to develop as long as underutilized resources and idle capacity exist in the economy. It’s always been difficult to reliably estimate an output gap that effectively translates slack in the economy into actual price trends. These days, it’s perhaps even more difficult to do so, as the main drivers of US economic growth are changing and emerging markets are playing a more dominant role in the global growth cycle.
Stagflation will have more bark than bite
CityWire | Mar 16
It seems that we are never happier in the investment community these days than when we have something new to worry about. Indeed, two numbers caught the attention of the media in January – inflation and growth. The former was high and the latter was low. Speculation soon started as to whether the UK was returning to days of old and a period of stagflation. I think that assumption is highly premature. The current cycle will have plenty of issues, but stagflation is unlikely to be one of them. To understand why, we should separate the two elements of the equation, stagnation and inflation, and analyse them separately. Consumer price inflation was reported at an annual rate in December of 3.7%, well above the Bank of England target of 2%. Price increases were fairly broad, but not even. Oil and oil-related goods and services were especially strong. Overall inflation has been exacerbated recently by a fall in sterling, the general rise in commodity costs and the new year rise in VAT. The numbers are not comfortable, but they are a very long way from the double-digit inflation recorded in the 1970s. It is possible that some of these influences – particularly rising commodity costs – might persist for some time. It is also fair to suggest that some of the favourable deflationary dynamics of recent years – notably the emergence of China as a source of low cost goods – are coming to an end.
JP Morgan | Mar 14
Last week’s data releases suggested that the Chinese economy may be undergoing a mild dose of stagflation. The manufacturing purchasing managers’ index eased back from 54.5 to 51.7, well off the January 2010 peak of 57.4 though still signalling expansion. The services equivalent tells a similar story. Export growth slowed markedly, from 38% to 2% y/y contributing to a trade deficit of USD 7.3bn. However, comparisons are rendered meaningless by the timing of Chinese New Year, although the trend of the trade data suggests that activity may be slowing significantly. Nevertheless, it will probably take until the end of Q2 to confirm this impression. Consumer prices rose 4.9% y/y, unchanged from January with food prices once more proving to be the driver of inflation. This week will be interesting to gauge if monetary growth is still powering ahead, or whether the People’s Bank of China’s efforts to slow the economy are bearing fruit. It does look as if China may be experiencing a combination of slowing activity and sticky inflation. In particular, further measures may be needed for the Chinese authorities to address a sizeable monetary overhang.
Investment Comment – March 2011
Melville Jessup Weaver | Mar 14
The Japanese earthquake is expected to dent the outlook for oil usage which will counteract the continuing political upheaval in the Middle East which had put upward pressure on oil prices. Coupled with already rising prices for other commodities and food, this had led to the spectre of stagflation (rising prices in a stagnant growth environment). US and Euro-area industrial production indexes both declined in late 2010 and early 2011, Euro-area GDP grew just 0.3% in the 3 months to December 2010. However inflation is still running above targets in several markets – most notably in the UK where the January CPI release was 4.0% for the year, twice the Bank of England’s target. Despite the sluggish growth in the West, the developing world continues to expand strongly. China’s economy grew 9.8% over the 2010 year and inflation is running at 4.9% (above the official target of 4%). Indeed, China’s central bank raised interest rates by 0.25% for the 3rd time in 4 months in an attempt to cool its economy. China has officially passed Japan to become the world’s second biggest economy. Japan’s GDP was US$5.5 trillion in 2010 whereas China’s was US$5.9 trillion. However the Chinese story is not all good news. Prices there are rising sharply and this will impact on the prices in New Zealand on Chinese imports. There are further the real problems posed by a working population unhappy at not sharing in the growing wealth of the upper strata of communist China; this has led to stories about a possible Jasmine Revolution following on from events in the Middle East.
March 17, 2011
Initial Jobless Claims Fall & Industrial Production Slips
New filings for jobless benefits dropped by 16,000 last week to a seasonally adjusted 385,000, the U.S. Labor Department reports. That’s the fifth reading below the 400,000 mark since the end of recession in June 2009. Meanwhile, the widely watched four-week moving average slipped to just over 386,000, the lowest level since the recovery began.
“As demand has picked up, and the labor component of the economy has been relatively tight, businesses are now seeking to add more to their employment ranks,” Russell Price, a senior economist at Ameriprise Financial, tells Bloomberg.
Industrial production, however, suffered a small setback last month, falling a slight 0.1% in February, the Federal Reserve reports. That’s the first monthly loss since last October.
While overall production from the nation’s factories, utilities and mines slipped last month, the primary component of industrial production—factory output—rose 0.4% in February. This slice of industrial activity is considered relatively influential in job creation, and so its gain last month bodes well for the labor market.
“Manufacturing is going to remain healthy and expand at a moderate pace,” predicts Neil Dutta, an economist at Bank of America Merrill Lynch Global Research. “A lot of the weaknessm [in the broad industrial production reading] was centered in the utilities component, with February maybe a little warmer than people were expecting.”
Consumer Prices Accelerate In February On Higher Energy Costs
U.S. consumer price inflation ticked higher last month, the Bureau of Labor Statistics reports. Headline inflation rose by a seasonally adjusted 0.5% in February, up from 0.4% the month before. Core inflation, however, remained modest, advancing 0.2% last month, unchanged from January’s rate.
Rising energy prices were the main culprit, posting a 3.4% increase in February, up sharply from January’s 2.1% rate. “Food indexes also continued to rise in February,” the Labor Department notes, “with sharp increases in the indexes for fresh vegetables and meats contributing to a 0.8 percent increase in the food at home index, the largest since July 2008.”
The price increases are lifting the annual pace of CPI inflation, as the chart below shows. Headline consumer price inflation rose 2.2% over the past year through February, the highest since April 2010. Core inflation, which tends to cast a bigger influence on the Fed’s monetary policy, inched higher too. Core CPI is now higher by 1.1% over the past year. Based on recent history, however, that’s still quite low and at the lower end of the Fed’s reported target range of 1% to 2%.
A number of economists advise that inflation still isn't worrisome if energy and food costs moderate in the months ahead, as some analysts expect. Unless commodity prices continue rising, anticipating a relative slowdown in inflation's higher pace of late is reasonable. As Reuters reports this morning,
Though the increase in core CPI was a touch above economists' expectations for a 0.1 percent gain, it suggested that surging costs for energy and other commodities, which have been hitting producers and consumers alike, had yet to generate the type of broad inflation that would spur the Federal Reserve to respond.
The Fed said on Tuesday it expected the upward price pressure from commodities to be temporary but it would closely monitor inflation and inflation expectations.
"I don't think it means anything for the Fed. They're going to probably wind up saying some of this is transitory. It won't be sustained," said Tom Porcelli, U.S. economist at RBC Capital Markets in New York.
Strategic Briefing | 3.17.2011 | Producer Price Inflation
U.S. producer prices surge in February
RBC | Mar 16
February producer prices rose a much stronger than expected 1.6% in the month following a 0.8% rise in January. Expectations had been for a sizeable increase although by a more moderate 0.7%. The strong monthly increase resulted in the year-over-year rate jumping to 5.6% from 3.6% in January. On a core basis, prices rose an expected 0.2% although this was sufficient enough to move the annual rate up to 1.8% from 1.6% in January and a recent quarterly low of 0.9% at the end of 2009.
Wholesale prices up 1.6% on steep rise in food
LA Times | Mar 16
David Resler, an economist at Nomura Securities, said the jump in prices is likely temporary, echoing remarks made by the Federal Reserve on Tuesday. Much of the increase in food prices was due to winter freezes in Florida, Texas and other agricultural areas, Resler said. Turmoil in the Middle East is a major reason that motorists are facing higher gas prices. "Both food and gasoline prices are going to stop rising so rapidly," Resler said. But John Ryding, an economist at RDQ Economics, disagreed, noting that consumers will feel the impact for some time. "We do not buy the Fed's reassurance that these pressures will be temporary and we believe the public, seeing these strong increases in food and energy will not be marking back down their inflation expectations," Ryding said.
Inflation pressure bubbles, home building dives
Reuters | Mar 16
Economists said the jump in food and energy costs that drove the U.S. producer price index higher last month would likely steal from other spending and slow growth. "I don't believe that this is a general rise in prices across the board, it's not the stuff of an inflationary spiral, but you are starting to have some pricing pressures," said Brian Levitt, an economist at OppenheimerFunds in New York.
MorganKeegan | Mar 16
The bigger surprise to the market came from this morning’s PPI report. During the month of February, the Producer Price Index increased by 1.6%, which is quite a bit higher than the 0.7% widely expected. On a year-over-year basis, this translates to an increase of 5.6% against expectations for an increase closer to 4.7%. The “silver lining” of the report is that “core” producer-level inflation came in more or less as expected with a monthly increase of 0.2% and a year-over-year increase of 1.8%. This leaves us with a couple of questions to ponder: (1) will producer-level inflation spill over to consumer prices, and (2) how much longer can we credibly argue that energy and food inflation don’t really “count”? Tomorrow’s CPI report should provide some clues about the first question, but only time will tell if the investment community eventually abandons the practice of ignoring food and energy prices when thinking about inflation.
U.S. Producer Prices Jump Amid Higher Food And Energy Prices
RTT News | Mar 16
Paul Ashworth, Chief U.S. Economist at Capital Economics: "We have been warning for some time that the 85 percent surge in agricultural commodity prices since last summer would eventually feed through into the PPI and CPI and here it is. There is plenty more to come over the next few months, although agricultural commodity prices have fallen back quite sharply over the past couple of weeks," he added.
United States: Producer Price Index
Moody's Analytics/Dismal Scientist | Mar 16
Excluding food and energy, core prices for finished goods rose 0.2% in February. Prices for core intermediate and crude goods were also higher in February. Rising prices at all stages of production indicate improved strength in the recovery. Moreover, faster price inflation at earlier stages of production is beginning to put modest upward pressure on the core index, a trend that will continue in the months ahead.
Producer Prices Highest Since 1974
Progressive Grocer | Mar 16
February 2011 marked the largest one-month increase in 37 years for wholesale food prices, climbing by 3.9 percent. That’s according to an analysis of the latest Producer Price Index Report by the Food Institute, which indicates that wholesale prices have not experienced an increase this great in many years. This number was only exceeded in November 1974 when spiraling oil prices resulted in sharp food price increases amounting to 4.2 percent. “Food retailers in the U.S. have been very adept at holding price increases at a minimum for the past 18 months but the February surge will make that task more difficult in future months,” said Brain Todd, Food Institute president and CEO.
Rising wholesale prices ring inflation alarm bells
CNNMoney | Mar 16
"The big difference today relative to the 2008 commodity rise is that underlying demand is significantly more robust. This means that price gains are more likely to stick," said a note from Joseph LaVorgna, chief U.S. economist for Deutsche Bank.
March 16, 2011
New Housing Starts Drop Sharply As Building Permits Fall To Record Low
Housing starts fell sharply in February, dropping the most in a single month since 1984, the U.S. Census Bureau reports. The 23% retreat left starts at an annualized rate of 479,000 in February, or just above the previous low for this cycle—477,000 in April 2009. It’s unclear if starts are headed for new lows, but the possibility surely went up a notch or two in light of today’s numbers.
The drop in starts is all the more dramatic considering January’s 18% surge—the best monthly gain in nearly two years. But in the wake of today’s update, it looks like the January revival was a one-off number. More ominiously, the new report suggests that apparent stability in housing starts may be eroding. The key question: Is the housing market poised for a new leg down?
The weakening trend in new building permits only strengthens the case for thinking that housing will continue to struggle in the months ahead. Permits fell 8% in February, with the annualized tally for the month at 517,000, the lowest on record for this series, which dates to 1960. As a leading indicator for the housing market, the latest drop in permits leaves little room for optimism on the prospects for a revival in the foreseeable future.
The basic problem is still the ongoing ample supply of existing homes for sale. “At this point new homes are likely to continue to lose to existing homes because distressed properties pose a better bargain for buyers,” Millan Mulraine, senior U.S. strategist at TD Securities, tells Bloomberg. “We’re not seeing a strong rebound in the horizon because permit approval is just marginally above starts.”
Housing's Muted Role In The Economic Recovery
The February update on housing starts arrives later today, but a repeat performance of January's near-15% rise isn't in the cards. The consensus forecast calls for a 3.5% decline for last month, according to Briefing.com. The housing market, in other words, is still treading water after a severe correction. Housing starts may be stabilizing after falling more than 50% from the glory days before the Great Recession, but a rebound of any magnitude is widely discounted as improbable for the foreseeable future. The question is how that pinches the economic recovery?
Historically, "the housing component of GDP (more formally known as residential investment) tends to be a solid contributor to GDP growth during a recovery," according to a recent report from the St. Louis Fed. "Although residential investment is a small component of GDP in levels, it can contribute substantially to the GDP growth rate for short periods of time."
This time is different, however. As St. Louis Fed economist Michael McCracken reports: "A year and a half after the official end of the recent recession, residential investment has yet to make a sizable contribution to GDP growth and is, in fact, presently making a negative contribution." Today's update on housing starts (scheduled for release at 8:30am Washington time) isn't expected to change that perception.
"Housing is lagging, and that's another reason why jobs aren't coming back," William Dunkelberg, chief economist of National Federation of Independent Business, noted in a speech yesterday.
March 15, 2011
Is Fiduciary Oversight In Retirement Plans MIA?
Grant Thornton has published Retirement Plan Survey 2011, and it holds a number of intriguing factoids. Here's one:
How often is fiduciary training provided to the administrative/investment committee for your plan (other than by your record keeper)?
Very infrequently and with no set pattern... 41%
When new members are added... 12%
In turn, the study advises: "In light of the many new developments annually impacting internal plan fiduciaries, we recommend more frequent (and regular) fiduciary training. The best practice is to provide fiduciary training every year, as well as legal updates as new developments occur."
Charting The Trend | Real Estate and Commercial & Industrial Loans
Last week’s Federal Reserve update on loans at commercial banks in the U.S. reports the fourth straight monthly rise in C&I loans in February. The relative size of the increases continues to slip, however, increasing by $2.3 billion, well down from January’s $5.3 billion advance. Meantime, real estate loans continue to retreat in absolute terms. Last month’s decline accelerated, posting the biggest monthly drop in a year in seasonally adjusted dollar terms.
Reviewing the numbers in context with a longer span of history suggests that C&I loans are stabilizing. Real estate loans, by contrast, continue to weaken.
Measured on a rolling 12-month percentage basis, the rebound in the C&I trend looks more pronounced. There’s also a hint that real estate loans may finally be stabilizing as well when tracked by their annual percentage change.
Update: The first paragraph was rewritten for clarity as the original text was misleading.
Strategic Briefing | 3.15.2011 | Japan's nuclear crisis
Japan Nuclear Crisis Deepens
Voice of America | Mar 15
The crisis at Japan's damaged nuclear power complex in the northeastern part of the country is worsening. Top government officials acknowledge further, significantly higher radiation leaks and explosions at a total of three reactors. Tuesday morning, Japanese Prime Minister Naoto Kan delivered a nationally broadcast message to citizens, after a third reactor building explosion was confirmed in Fukushima. Urging the public to heed his words calmly, Kan acknowledged one of the damaged reactors is facing a much higher risk of releasing radiation into the atmosphere. The prime minister asked those living between 20 and 30 kilometers from the plant to stay indoors. Those living closer, about 200,000 people in all, had previously evacuated.
Japan panics as nuke plant belches high levels of radiation
Indian Express | Mar 15
The radiation fears added to the catastrophe has been unfolding in Japan, where at least 10,000 people are believed to have been killed and millions of people have spent four nights with little food, water or heating in near-freezing temperatures as they dealt with the loss of homes and loved ones. Asia's richest country hasn't seen such hardship since World War II. The stock market plunged for a second day and a spate of panic buying saw stores running out of necessities, raising government fears that hoarding may hurt the delivery of emergency food aid to those who really need it.
Radiation hazard detected / Massive leak feared after fire at spent nuclear fuel pool
Daily Yomiuri | Mar 15
High levels of radiation were detected at the Fukushima No. 1 nuclear power plant Tuesday morning after a fire broke out near a pool in the No. 4 reactor where spent nuclear fuel is temporarily kept, Tokyo Electric Power Co. said. TEPCO said radiation measuring 400 millisieverts (400,000 microsieverts) per hour was detected at 10:22 a.m. following the fire, which broke out at 9:38 a.m. "There is no doubt [these radiation levels] may pose health risks to humans," Chief Cabinet Secretary Yukio Edano told a press conference.
World stocks, oil slump on Japan nuclear fears
Reuters | Mar 15
World stocks hit 2-1/2 month lows on Tuesday and oil fell and the yen surged after reports of rising radiation near Tokyo triggered a 10 percent fall in Japanese stocks, hurting risky assets across the board. German government bonds and the low-yielding dollar were the biggest beneficiaries of increased risk aversion while a measure of European equity volatility surged to an 8-1/2 month high. Tokyo stocks fell 14 percent at one point before posting their worst two-day losing streak since 1987 after Japan said the risk of nuclear contamination was rising.
Emerging Economies Move Ahead With Nuclear Plans
New York Times | Mar 15
Despite Japan’s crisis, India and China and some other energy-ravenous countries say they plan to keep using their nuclear power plants and building new ones. The Japanese disaster has led some energy officials in the United States and in industrialized European nations to think twice about nuclear expansion. And if a huge release of radiation worsens the crisis, even big developing nations might reconsider their ambitious plans. But for now, while acknowledging the need for safety, they say their unmet energy needs give them little choice but to continue investing in nuclear power.
Japan's disaster could spare global economy
Montreal Gazette | Mar 15
While the current disaster is complicated by the added damage from a tsunami and devastated nuclear plants, many analysts expect that Japan's economy will recover essentially all of its lost output by the end of this year. That was the case when the Kobe disaster hit and it seems to be a pattern: developed economies bounce back very quickly from even very large natural disasters, said Douglas Porter, deputy chief economist at BMO Capital Markets. His forecast for Japanese economic growth is that it will be little changed from expectations before the disaster. This expectation of resilience was a key reason for the mild reaction in global markets, noted Julian Jessop, chief international economist at Capital Economics. As well, Jessop said in a note to clients, Japan is more a supplier to the world economy than a source of demand, so it won't hurt other countries too seriously if its growth should falter.
Tokyo Shares End Day Down 11%
Wall Street Journal | Mar 15
"What the world is watching right now is whether Tepco's Fukushima nuclear power plant is going to turn into Chernobyl," said Norihiro Fujito, senior investment strategist at Mitsubishi UFJ Morgan Stanley Securities, referring to the world's worst nuclear disaster at the Chernobyl Nuclear Power Plant in 1986 in present-day Ukraine.
Radiation fears after Japan blast
BBC | Mar 15
The drastic action to conserve electricity was ordered by the government in the wake of the devastating earthquake and tsunami which crippled several nuclear reactors.The resource-poor country depends on nuclear energy for about a quarter of its electricity. Out of Japan's 54 reactors, 11 are closed. With the quake-stricken Fukushima Daiichi plant lost to the national power grid, there is a power shortfall of 10 million kilowatts per day, according to the economy, trade and industry minister.The rationing is expected to last weeks rather than days, affecting millions of people from the northeast coast down to Shizuoka, 200km south of Tokyo.
March 14, 2011
Charitable Donations For Japan
There's been no shortage of tragedies in the short history of the 21st century to date, although the disaster in Japan surely rivals the worst of the worst. In this century, or any other. It's also a catastrophe that's still unfolding, and it may very well deteriorate further beyond the already horrific news. If ever an event needed the better angels of our nature, the calamity in Japan is it. With that in mind, here are some reference links for topics bound up with helping a country in distress.
A list of organizations offering aid of one form or another to Japan via The Chronicle of Philanthropy
10 Ways To Help Japan via The Jewish Journal
Finally, a few tips on making sure your donations are destined to reach the victims:
Before you give, a few tips to consider via Charity Navigator
Japan's Pain & Suffering Will Have Global Consequences
The week ahead will bring fresh news on a number of key economic fronts for the U.S., including housing starts and consumer price inflation. But the numbers may be irrelevant before they’re published as the tragedy in Japan alters perceptions and economic activity. The global economy was already under a shadow in the wake of the Middle East turmoil due to the resulting jump in oil prices. That threat appears to have eased a bit, although it’s premature to dismiss this factor in the weeks and months ahead. Meantime, there’s Japan to consider, starting with the huge scale of human suffering. In economic terms, the first hurdle is dealing with lots of new uncertainty that's arrived in the wake of the tragedy. Dated economic news in the period ahead is likely to be of limited value for assessing the trend.
"It is too soon to develop good estimates of the likely economic and financial effects of last Friday’s massive earthquake and subsequent devastating tsunami, particularly with the situation in the damaged nuclear plants still unresolved," advises Bill Witherell, chief economist at Cumberland Advisors, in a note to clients today. The next-best thing, he suggests, is looking for perspective by reviewing the aftermath of the Kobe earthquake that hit Japan in January 1995. Witherell continues:
It has often been the case that the effect of a natural disaster on a nation’s economic growth turns out to be less than initially expected. In 1995, the Japanese economy had considerable spare capacity that could be used to offset the reduced production from the area affected by the quake. That situation is also present today in Japan. While the Japanese economy expanded at a 3.9% clip last year, better than many other advanced economies, it remains well below full-capacity production levels.
Reports that the Bank of Japan is prepared to inject huge amounts of fresh liquidity into the country’s economy may help too. But for the moment, at least, Witherell and other economists warn that there’s still too much uncertainty to be confident about what happens next, either for Japan or the global economy. Indeed, Japan was hit by two catastrophes over the week: a tsunami and the ongoing nuclear power crisis that’s leaking small amounts of radiation into the atmosphere. It's hard to overemphasize that there's a continuing health risk of unknown magnitude for Japan, and perhaps other countries as well.
Whatever happens, the main risks obviously cut deeply for Japan. "In the short term, the market will almost surely suffer and stocks will plunge," says Koetsu Aizawa, economics professor at Saitama University in Japan. "People might see an already weakened Japan, overshadowed by a growing China, getting dealt the house-finishing blow from this quake."
No wonder, then, that the Bank of Japan is wasting no time in mustering its monetary forces. It's unclear how much this will help, but there's little reason not to try. The country's central bank today launched what's reportedly its most-ambitious liquidity injections to date.
History suggests that even large disasters in big industrialized economies tend to be slight when measured in GDP over several years. But this time might be different for Japan, opines Peter Morici, an economics professor at the University of Maryland School and former chief economist at the U.S. International Trade Commission:
Japan has encountered two disasters—the tsunami and earthquake, and the explosions at nuclear plants, and globalization may make Japan more vulnerable rather than in the past.
The double whammy has the potential to keep the Japanese economy shut down longer and globalization offers Japan’s export customers alternatives they might not have enjoyed a decade or two ago. Hyundai and Ford now are good substitutes for Toyota’s cars, and even more so, Caterpillar tractors made in China can replace Komatsu’s land movers.
The pause and uncertainty effected by the nuclear shutdowns will cause production to rev up more outside Japan and take longer to return to full capacity inside the country. Longer term, the nuclear disaster will accelerate the implosion of Japan’s economy caused by an aging population, just as Hurricane Katrina caused people and activities to permanently leave more economically depressed areas of the Gulf region permanently for faster-growing places in the U.S.
Japan is the world's third-largest economy after the U.S. and China, and so it's a safe bet that there will after-shocks for the world economy. But as Morici suggests, Japan's pain may provide new opportunities elsewhere, distressing as it is to even discuss such matters with so much pain still fresh and ongoing. In any case, "the fallout of the earthquake could extend beyond Japan as production cycles are affect[ed] across Asia," John Briggs, U.S. interest rate strategist at RBS Securities, tells The Wall Street Journal. "And Asia has been an engine of growth in the global economy."
The only sure thing is that the huge toll in human misery and the massive expenses that are coming for cleaning up and rebuilding are likely to rise. Meantime, there are lots of unanswered questions about how Japan's tragedy ripples out into the wider world. The stakes are certainly high. As Mohamed El-Erian, chief executive of bond manager Pimco, writes in today's FT: "The world has a shared interest in the economic recovery of this systemically important country. The good health of Japan is central to a robust global economy that generates lots of jobs and enhances productivity. And, at the most basic human level, we wish for the well-being of all those in Japan who have been affected by a truly horrible tragedy."
Strategic Briefing | 3.14.2011 | Economic Blowback From Japan
Analysis: Japan quake risks severe near-term economic damage
Reuters | Mar 14
A triple blow of earthquake, tsunami and one of Japan's worst nuclear accidents is set to damage the world's third largest economy, possibly more deeply and for longer than initially expected. Power outages and possible tax rises are likely to hurt companies and households and could outweigh the mild economic aftershock from the 1995 Kobe earthquake, given that oil prices and the yen are stronger and Japan's debt pile is much bigger.
Supply Disruptions of Power and Water Threaten Japan’s Economy
New York Times | Mar 14
As the humanitarian and nuclear crises in Japan escalated after the devastating earthquake and tsunami, the impact on the country’s economy appeared to be spreading as well... “The big question is whether this will seriously affect Japan’s ability to produce goods for any extended period of time,” said Edward Yardeni, an independent economist and investment strategist. The bleak outlook prompted a 6.2 percent plunge in the Nikkei 225 stock index in Tokyo on Monday, as companies from Sony to Fujitsu to Toyota scaled back operations. The Bank of Japan, in an effort to preempt a further deterioration in the economy, eased monetary policy on Monday by expanding an asset buying program. ‘‘The damage of the earthquake has been geographically widespread, and thus, for the time being, production is likely to decline and there is also concern that the sentiment of firms and households might deteriorate,’’ the central bank said in a statement.
Quake to Test Japan's Economy, Markets
Wall Street Journal | Mar 14
The major factor in oil markets, of course, is what happens next in the Middle East. Japan is the world's No. 3 oil importer, after the U.S. and China; its troubles do nothing to global oil supply. Disruptions in production may limit Japan's near-term demand for energy; oil prices fell in the immediate aftermath of the quake. Over time, though, the shut nuclear plants could lead Japan to increase imports of oil, natural gas and coal. Analysts estimated that replacing all of Japan's nuclear capacity with oil would mean importing 375,000 more barrels a day, on top of the current demand of about 4.25 barrels.
Japan Adds $183 Billion to Economy, Doubles Asset Purchases
Bloomberg | Mar 14
The Bank of Japan poured a record amount of cash into the financial system and doubled the size of its asset-purchase plan to shield the economy from the effects of the nation’s strongest earthquake on record... Policy makers said they were concerned corporate and household sentiment will worsen, with production set to decline in the aftermath of the temblor and an ensuing tsunami. The March 11 catastrophe killed an estimated number of more than 10,000 people, shut down factories, prompted rolling power cuts and sparked the risk of a meltdown at a nuclear power plant. “The disaster will push down gross domestic product in the short run, and the BOJ wants to mitigate the deflationary impact through liquidity injections,” said Tomo Kinoshita, a Hong Kong-based economist at Nomura Holdings Inc.
Oil below $99 as Japan disaster stuns economy
Washington Post | Mar 14
Oil prices dropped below $99 a barrel Monday in Asia after a massive earthquake and tsunami devastated northeastern Japan, likely denting demand for crude from the world's third-largest economy... "This disaster has in effect temporarily frozen the world's third largest economy," said Richard Soultanian of NUS Consulting. "It seems clear that Japan's appetite for crude oil may be diminished in the near-term which should provide previously unforeseen slack in international oil markets."
Japan quake may be world's costliest disaster
CNN | Mar 14
The disaster comes at a difficult time for the fragile Japanese economy, which slipped to the world's third largest behind China in 2010. Japan's export-driven business was hit by the financial crisis and a strong yen, which hurt profits from sales abroad. The rebuilding from the quake also will add to Japan's towering load of public debt; it is nearly twice the size of its total GDP and the highest in the developed world. S&P downgraded Japan's long-term credit ratings in January, citing its high fiscal deficits.
Japan Disaster May Have Global Economic Impact
NPR | Mar 13
Japan's economy — like much of the world — was already facing serious challenges before the earthquake struck. Economist Robert Madsen, a senior fellow at MIT's Center for International Studies, discusses the effects of the disaster in Japan on the economy there and around the globe...
Mr. ROBERT MADSEN: The effects are different in the short and the medium term. You have to remember that Japan is a country that has been either in or on the verge of recession for over 20 years. And the major reason for that is that there's simply not enough domestic spending. In that sense, anything which causes government to - or companies to spend more actually helps the economy. And the precedent for this is the 1995 Kobe earthquake. A great deal of damage was done to the economy, and over the next couple of years, companies and the government had to spend massive amounts of money rebuilding infrastructure and factories. So if we use that, apply that analogy to today's situation, in the short term, of course, because there's been so much disruption, growth will decelerate. But over the medium term, say, the next two or three years, my guess is that there'll be a massive increase in spending on plants and equipment and highways and ports. So Japan's economy is likely to grow significantly faster as a result of this crisis over the medium term.
March 12, 2011
Book Bits For Saturday: 3.12.2011
Oil is topical again--for all the wrong reasons. The change for the worse inspires reviewing some of the classics in the library of energy books. The genre is extensive and so the following list hardly scratches the surface. But these titles deserve to be on everyone's short list. There are more recent books on the topic, of course, but here are five standards in the niche that will stand the test of time.
● The Prize: The Epic Quest for Oil, Money & Power
By Daniel Yergin
An ambitious review of how the oil industry became so powerful. From the politics to the economics to the personalities, this comprehensive volume is now the standard work on the subject. If you could only read one book about the history of this business, this is it. Well written, comprehensive, and engaging. Quite simply, a magnificent tome.
● Titan: The Life of John D. Rockefeller, Sr.
By Ron Chernow
This is a biography of a man and not an industry, but John D. Rockefeller virtually invented the oil industry as we know it and so the two are inseparable. Ron Chernow's considerable talents with a pen only sweeten the deal. You can't really understand the oil business unless you understand John D.
● Out of Gas: The End of the Age of Oil
By David Goodstein
A Caltech professor muses on life after the fossil fuels run out. A short book, but a powerful one that considers what comes after cheap gasoline.
● Hubbert's Peak: The Impending World Oil Shortage (New Edition)
By Kenneth Deffeyes
An oil geologist explains and interprets Hubbert's Peak, a reference to the peaking in oil production. It's already happened in U.S. production, and the worry is that a global peak is near. An amazingly insightful little book; it's also well-written and even humorous. Deffeyes has quite a bit of flair with the written word, and he knows energy geology inside and out to boot. Educational and entertaining.
● The Seven Sisters: The Great Oil Companies and the World They Shaped
By Anthony Sampson
Although this best seller of the 1970s is dated, it's a well-written account of the business that's still worthy for understanding how the big oil firms became BIG OIL. One of the genre's timeless classics. A tour de force for describing the power and the drama of oil companies during the zenith of their influence on the world stage.
March 11, 2011
Retails Sales Rise For 8th Consecutive Month In February
Retail sales jumped 1% on a seasonally adjusted basis last month, the Census Bureau reports. That’s the best monthly gain since last October’s 1.6% surge. It’s also the eighth straight monthly increase. Consumption, in other words, is doing fine. But quite a bit has changed on the global stage in recent weeks, namely, the Mideast turmoil and resulting jump in oil prices. The question is whether February data is dated?
Once again, the waiting game is back in vogue. We can celebrate the recent pop in economic numbers, but there are fresh reasons to wonder if newly accelerated economic rebound is headed for rougher waters. It's premature to dismiss the revival in growth, but it's also short-sighted to ignore the mounting hazards.
Even ignoring recent events, the case for expecting a slowing in the retail sales trend is plausible. Consider how consumption fares in recent history vs. industrial production and new orders for durable goods on a rolling 12-month basis. As the chart below reminds, retail sales have been performing rather well, perhaps a little too well vs. other economic measures. Or does this mean that the rest of the economy is poised to catch up with retail consumption?
But optimism is still bubbling that the Mideast trouble is temporary. “The data have been quite encouraging,” Rohit Garg, an interest-rate strategist at BNP Paribas, tells Bloomberg. “Of course we all think the sell-off is going to be limited for various reasons, like geopolitical risk.”
Perhaps the single-most important factor in assessing the future path of consumer spending is the price of gasoline. So far, the rise in gas prices doesn't seem to be hurting retail sales. But if gas prices remain high and/or continue to increase, it’s only a matter of time before consumers will feel pinched.
Exxon Mobil CEO Rex Tillerson said Wednesday he doesn't think the recent jump in oil prices is hurting the U.S. economy -- at least, not yet.
The head of the world's largest publicly traded oil company said that in 2008, when oil surged to near $150 per barrel, Americans didn't change their driving and spending habits until gasoline prices topped $4 per gallon. Gas peaked at $4.11 in July of that year.
"I don't know if that tip-over is still at the same $4 level or not," Tillerson told reporters at the New York Stock Exchange. "We'll see."
Oil is now about $104 per barrel after rising more than 20 percent over three weeks because of civil unrest in Libya. Tillerson hasn't seen any reduction in the demand for fuel from consumers or businesses.
The national average for gas has increased 40 cents to $3.52 per gallon at the same time.
Research Review | 3.11.2011 | Mutual Fund Expenses
Brokerage Commissions: The Hidden Costs of Owning Mutual Funds
Xiaohui Gao (University of Hong Kong) and Miles Livingston (University of Florida) | Mar 4, 2011
Brokerage commissions represent hidden costs to investors because commissions are not included, nor reported, in the fund expense ratio. This paper analyzes unique fund level data on brokerage commissions paid by U.S. diversified equity mutual funds from 2000 to 2007. There are three main conclusions. First, an average fund pays 25.72 basis points (bp) per dollar of assets, in addition to an average expense ratio of 131.96 bp, resulting in a total out-of-pocket cost of 157.68 bp. Second, a one bp increase in annual commissions per dollar of assets is associated with a decline of about 5.8 bp in a fund’s annual return. Third, our analysis yields a number of substantive policy implications, such as commissions being included in the fund expense ratio, and mutual funds detailing their soft dollar arrangements. These disclosures would enable investors and regulators to make more informed decisions.
Evaluating the Performance of Global Emerging Markets Equity Exchange-Traded Funds
David Blitz (Robeco Asset Mgt) and Joop Huij (Robeco and Erasmus University Rotterdam) | Feb 8, 2011
We examine the performance of exchange-traded funds (ETFs) that provide passive exposure to global emerging markets (GEM) equities. We find that the tracking error of GEM ETFs is substantially higher than previously reported levels for developed markets ETFs. At the same time the long-term average underperformance of GEM ETFs does not appear to be worse than that of developed markets ETFs. We find that, on average, GEM ETFs fall short of their benchmark indexes by around 85 basis points per annum, which is in line with the expected drag on return due to fund expenses and the impact of withholding taxes on dividends. Because we observe large differences in performance across funds, we argue that investing in GEM ETFs requires a careful selection process.
Paying the High Price of Active Management: A New Look at Mutual Fund Fees
Ross Miller (Miller Risk Advisors and SUNY at Albany) | Sep 2010
Financial economists have long known that actively managed mutual funds
underperform comparable index funds and that investment management fees are a major contributor to this underperformance. This article shows that the impact of mutual fund fees is even greater when one examines what funds actually do with investors’ money. Many actively managed mutual funds have returns that are closely correlated with comparable index funds and yet have annual fees that can be 100 times higher. Because such “shadow” or” closet” index funds provide minimal active management of the assets they hold, the implied annual cost of the active management can dwarf the stated cost. This article provides a simple measure of what investors are actually paying fund managers for that active management that they can compute for themselves data available for free on the Internet. A sample of 731 actively managed large-cap U.S. mutual funds analyzed for the three years ending December 31, 2009 has a mean active expense ratio of 6.44%, more than 400% greater than their mean reported expense ratio of 1.20%. This article also finds that even large, seemingly low-cost, mutual funds common in retirement plans frequently have active expense ratios above 4% a year.
Mutual fund performance: measurement and evidence
Keith Cuthbertson (Cass Business School), Dirk Nitzsche (Cass Business School), and Niall O’Sullivan (University College Cork) | May 2010
The paper provides a critical review of empirical findings on the performance of mutual funds, mainly for the US and UK. Ex-post, there are around 0-5% of top performing UK and US equity mutual funds with truly positive-alpha performance (after fees) and around 20% of funds that have truly poor alpha performance, with about 75% of active fund s which are effectively zero-alpha funds. Key drivers of relative performance are, load fees, expenses and turnover. There is little evidence of successful market timing. Evidence suggests past winner funds persist, when rebalancing is frequent (i.e. less than one year) and when using sophisticated sorting rules (e.g. Bayesian approaches) - but transactions costs (load and advisory fees) imply that economic gains to investors from winner funds may be marginal. The US evidence clearly supports the view that past loser funds remain losers. Broadly speaking results for bond mutual funds are similar to those for equity funds. Sensible advice for most investors would be to hold low cost index funds and avoid holding past ‘active’ loser funds. Only sophisticated investors should pursue an active ex-ante investment strategy of trying to pick winners - and then with much caution.
Redemption Fees and the Risk-Adjusted Performance of International Equity Mutual Funds
Iuliana Ismailescu and Matthew R. Morey (Pace University) | Nov 5, 2010
In the wake of the market timing and late trading mutual fund scandals, many mutual funds adopted redemption fees to limit market timing. In this paper we investigate the impact of redemption fees on the risk-adjusted performance of U.S. based international equity funds, the very funds that many market timers used. We find three interesting results. First, using event study methodology we find that after the introduction of redemption fee there is a significant increase in the risk-adjusted fund performance. Second, we find that funds that introduced larger-size redemption fees have significantly better performance after the introduction of the redemption fee than other funds. Third, we find that the main reason for the improvement in fund performance after the introduction of the redemption fee is due to lower amounts of cash being held by the fund after the redemption fee. In sum our results suggest that implementation of redemption fees are performance enhancing for international equity funds. As such, long-term investors of international equity funds should actively look for international equity funds that have redemption fees.
March 10, 2011
Jobless Claims Rise Last Week. Meanwhile, The Oil Risk Looms
This morning’s latest on weekly jobless claims is a bit of a setback, but it’s too early to panic. For one thing, last week’s seasonally adjusted 26,000 jump in new filings for jobless benefits is small for this series, given how much it bounces around from week to week. That argument won’t wash with the thousands of newly unemployed, of course, but as a macro matter there’s nothing particularly worrisome in today’s report. That is, until you start looking beyond the data.
But before we consider the wider world, it's worth noting that even after last week’s rise, jobless claims remained under the seasonally adjusted 400,000 mark for the third straight week—a new record for this cycle. Should we anticipate four in a row?
In another bid to see the glass as half full, consider that the biggest changes in last week’s declines for new claims overwhelmed the biggest increases. The largest pops in initial claims for the week through February 26: Massachusetts (+3,804), Washington (+976) and Rhode Island (+776). On the flip side, the largest decreases: California (-12,730), Illinois (-2,430) and Missouri (-2,255).
Nonetheless, there’s still plenty of room for anxiety for wondering what comes next, not just for jobless claims but for the labor market as well as the broader economy. The recent data is encouraging, but suddenly the stats look dated.
Even if all was right with the global economy, analysts aren’t shy about discounting the recent decline in the jobless claims trend. “We’re just giving back the distortions from the holiday in the prior week,” says Mike Englund, chief economist at Action Economics, via Bloomberg. “It does appear that tightening in the labor market has gained a little steam.”
The broader puzzle is deciding if the rising price of energy has legs and, if it does, will it run long enough and high enough to impair the recovery if not derail it? The jump in oil prices is already taking a toll in some corners. The U.S. trade deficit, for instance, rose sharply in January to a seven-month peak, the Commerce Department reports. U.S. exports rose to record levels in this year’s first month, but the surge of imports overwhelmed the trend.
As The Wall Street Journal notes:
With oil prices surging above $100 a barrel amid continuing unrest in the Middle East, the U.S. is paying a lot more to meet its energy needs. The U.S. bill for crude oil imports in January climbed to $24.51 billion from $22.54 billion the month before. The average price per barrel jumped $4.56 to $84.34, its highest level since October 2008, during the last big price spike. Crude import volumes rose to 290.67 million barrels from 282.58 million. The U.S. paid $32.16 billion for all types of energy-related imports, up from $29.20 billion in December.
And that was before the latest pop in oil prices.
Higher energy costs lessen forecasts of growth, given the fundamental role of crude as an input for GDP. But the crucial question of how long oil prices rise (or not) is unknown—more so than ever, thanks to the current mayhem in the oil-rich Middle East. Even by the usually wobbly standards of Middle East politics, the outlook is exceptionally murky. Short of a sudden calming in that region, it seems clear that some (most?) of the economic news scheduled for release in the coming days will be of limited value until the new realities of crude expectations are reflected in the data. That's going to take a few weeks, and probably a few months.
Meantime, some analysts are warning that higher oil prices pose a serious threat, perhaps pushing global growth close to stall risk. That’s probably overstating the risk, at least for the moment, but dismissing the idea isn’t getting any easier. Deutsche Bank today is considering the dark side of the near term. "While we remain very much of the view that global growth will remain a priority for government authorities over the course of the year, the recent increase in oil prices has threatened this objective,” the firm warns via The Economy News. "Indeed, spikes in oil prices have often been followed by periods of weak or recessionary economic activity.” The report goes on to warn:
According to DB economists, a USD10/bbl increase in oil prices (to USD110/bbl) would lower global GDP by about 0.4% (taking our global GDP forecast from the current estimate of 4.3% to 3.9% YoY). If, however, oil prices were to rise USD50/bbl (to USD150/bbl), such a shock would negatively impact global growth by 2.0% (this implies a linear relationship between oil pricing and global growth of -0.4% with each USD10/bbl increase).
Pondering Austerity In The Months Ahead
There are more green shoots in the economy these days, but there are more risks as well. The question is whether the risks have enough momentum to overwhelm the positives? No one really knows the answer, of course, but it's clear that the stakes are higher than just a month or two ago.
Even the more optimistic scenarios have been precarious, largely because the blowback from the massive debts left over from the boom weigh heavily on the U.S. economy. That's been there all along, of course, but the case has been strengthening for thinking that the forces of growth had the upper hand, albeit marginally so. But the upheaval in the Middle East, transmitted through higher oil prices, is a new hazard to consider.
There's also the unknown variable of pressing austerity in Washington. No one doubts that imposing fiscal rectitude is a net plus for the years and decades ahead. There's too much red ink for comfort these days. The unknown is how, or whether, taking steps to reverse the deficit casts a shadow for the macro outlook in the months ahead. More specifically, will the political push to cut government spending now nip the precarious economic revival 2.0 in the bud? There's a fair amount of mystery here since the political outcome is, as yet, unknown and the situation, as they say, remains fluid.
The Democratic-controlled U.S. Senate, yesterday, said nay to the Republican plan to trim $61 billion from the federal budget. What happens next is anyone's guess. Will the cuts end up rising, or falling? Meantime, there are two schools of thought on whether cutting more will help or hinder the near-term outlook. We know what awaits in the long run, but it's the year ahead that comes first. Navigating this fine line isn't going to be easy.
In a prepared statement delivered to Congress on Tuesday, Erskine Bowles and Alan Simpson of the President’s Commission on Fiscal Responsibility and Reform warned:
If the U.S. does not put its fiscal house in order, the reckoning will be sure and the devastation severe. We believe that if we do not take decisive action our nation faces the most predictable economic crisis in its history. The current fiscal path we are on is simply not sustainable. Spending is rising rapidly, and revenues are failing to keep pace. As a result, the federal government is forced to borrow huge sums each year to make up the difference. In bad economic times, such borrowing might make sense in order to soften the blow of a recession. Our concern is not so much the record deficits we face today, although they do cause us real worry. Our principle concerns are the prospects that borrowing will remain high throughout the decade, and rise substantially as time goes on. Under a reasonable set of assumptions, our national debt will surpass 90 percent of Gross Domestic Project (GDP) by the end of the decade, a level not seen since just after World War II, and a level most economists find problematic.
The power of such thinking is only strengthened by the message in history, as shown in the must-read book This Time Is Different: Eight Centuries of Financial Folly. For hundreds of years, nations continue to defy the law of fiscal gravity and continue to pay a heavy price. In the long run, there's little doubt how this story ends.
But the details of navigating a precarious recovery in the here and now are no small complication. It's unclear how high oil prices can go before derailing the rebound. But with prices trending higher, the wiggle room is clearly shrinking.
Meanwhile, what of the countries that are aggressively pursuing austerity? Is that helping in the short run? As usual, real time debate falls well short of a consensus. There's evidence that the UK's recent embrace of budget slashing is helping the bond market and arguably averted a debt crisis. Meanwhile, forecasters are cutting estimates for growth in the British economy.
Deciding if fiscal austerity will help, or hinder, the near-term U.S. outlook depends on several factors, starting with the path of oil prices over the next 6 to 12 months. Austerity with oil at $150 a barrel is quite a different animal vs. $90 a barrel. Unfortunately, predicting how the turmoil in Libya plays out, and whether that spreads to other large crude exporters, is a mug's game.
What's obvious is that higher oil prices create hazards for growth. Until (or if) oil prices settle down, the details on budget cutting remain unstable. That raises the question anew: Can budget cuts spawn growth?
March 9, 2011
Strategic Briefing | 3.9.2011 | Sentiment Surveys
CR Index: At last, consumers' financial lives improve
Consumer Reports | March 8, 2011
Despite international unrest and escalating energy prices, the March Consumer Reports Index reveals its most positive results in two years. A major decline in consumer financial troubles and positive sentiment provide some encouraging news for the American consumer. The Consumer Sentiment Index has broken into positive territory at 50.3, which is up from 48.7 a month ago. The Consumer Reports Sentiment Index captures respondents’ attitudes regarding their financial situation, asking them if they are feeling better or worse off than a year ago. When the index is greater than 50, more consumers are feeling positive about their situation. This is the first time sentiment has been in positive territory since it was first measured in October, 2008.
U.S. Economic Optimism Declines in February
Gallup | March 8, 2011
Gallup's Economic Confidence Index worsened to -24 in February from -21 the prior month as Americans' optimism about the U.S. economy receded from a three-year high reached in January. Gallup's Economic Confidence Index is based on two questions. One measures consumers' perceptions of current economic conditions and shows them to be the same in February as in January, with 42% of Americans rating current economic conditions "poor." The second Index component asks Americans to rate the outlook for the U.S. economy. In February, 38% said economic conditions are "getting better," down from 41% a month earlier. However, this decline follows a January optimism level that tied for the highest since Gallup Daily tracking began in January 2008.
Independent Investment Advisor Optimism Sharply on the Rise According to Latest Schwab Survey
Charles Schwab Corp | March 7, 2011
Independent registered investment advisor (RIA) optimism has risen significantly since July 2010 according to Charles Schwab’s latest survey of more than 1,300 RIAs representing $284 billion in assets under management. More than three-quarters of advisors surveyed (77%) expect the S&P 500 to rise in the next six months, up from 63 percent in the previous survey in July. Reflecting this growing optimism, more than half of advisors (56%) classify themselves as “bulls,” while only 10 percent see themselves as “bears” when it comes to stock market performance over the next six months.
AARP Survey: Half of 50+ African Americans in NY Will Delay Retirement If Economy Doesn't Improve
NY AARP | March 8, 2011
A new AARP survey of New Yorkers age 50 and older, which takes a special look at how African Americans view their financial security and retirement, finds that 49 percent would delay retirement if the economy does not improve. Of those who planned to delay retirement, 41 percent said they would delay retirement for five or more years and 13 percent expect never to retire.
AICPA/UNC Quarterly Economic Outlook Survey
American Institute of CPAs | March 3, 2011
This quarter’s 20% increase in optimism for the US economy was the sharpest upturn ever seen on the survey. It was accompanied by an 11% decrease in pessimism with less than a quarter of respondents (18%) expressing a pessimistic outlook for the US economy. Optimism was driven primarily by signs of improvement in broad based economic indicators, increased customer spending and an improving outlook on employment. Pessimists were most likely to cite continuing unemployment, housing and growing government debt and deficits as reasons for their pessimism. Optimism for organizations continued to lead optimism for the US economy as a whole with 57% of the CPA decision-makers saying that they were optimistic about the outlooks for their own organizations. This is the highest point since 4Q07. This outlook was backed by expectations of expansion with 66% of respondents expecting their organizations to expand in the next 12 months and only 13% expecting to contract.
Investor Sentiment Survey
American Association of Individual Investors | March 2, 2011
The AAII Investor Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis. Only one vote per member is accepted in each weekly voting period.
Week ending 3/2/2011
Data represents what direction members feel the stock market will be in the next 6 months.
For week ending March 2:
Change from last week:
The Conference Board Consumer Confidence Index Improves Further
Conference Board | Feb 22, 2011
The Conference Board Consumer Confidence Index®, which had increased in January, improved further in February. The Index now stands at 70.4 (1985=100), up from 64.8 in January. The Present Situation Index improved to 33.4 from 31.1. The Expectations Index increased to 95.1 from 87.3 last month... Says Lynn Franco, Director of The Conference Board Consumer Research Center: “The Consumer Confidence Index is now at a three-year high (Feb. 2008, 76.4), due to growing optimism about the short-term future. Consumers’ assessment of current business and labor market conditions has improved moderately, but still remains rather weak. Looking ahead, consumers are more positive about the economy and their income prospects, but feel somewhat mixed about employment conditions.”
March 8, 2011
Inflation Worries Creep Higher
The president of the European Central Bank is worried about inflation. "We're in an environment where we have a spike in the price of oil, commodities – it's more acute in the present circumstances," he says. Is the market also worried? Yes, at least on the margins.
aThe inflation forecast is creeping higher, based on the yield spread between the nominal and inflation-indexed 10-year Treasuries. As of yesterday, this market-based prediction of inflation was 2.51%, the highest since July 2008. By long-run historical standards, inflation in the 2.5% range is still quite low, although bond traders won't fail to notice that the Treasury forecast has been climbing, albeit slowly, for several weeks.
“Investors are increasingly nervous that higher oil prices will push up headline inflation,” Nick Stamenkovic, a fixed-income strategist at RIA Capital Markets Ltd., tells Bloomberg. “The longer end [of the Treasury curve] is being influenced by the perceptions on inflation and creeping concerns that the Federal Reserve is getting a bit behind the curve compared to other central banks.”
Michael Pond, co-head of interest rate strategy at Barclays Capital, agrees that there's a slight change in the trend these days. "Longer term the market has started to price in some inflation risk," he explains via Reuters, "because there is concern about the effect of longer-term stimulative monetary policy, combined with growth in emerging markets, which are becoming an inflationary force."
But it's unclear if the tactical concerns of the moment will overwhelm what appears to be a solid strategic demand for Treasuries. Foreign investors continue to hold higher levels of U.S. debt. China, for instance, raised its stake in Treasuries by 39% as of December 2010 vs. a year earlier.
December numbers, of course, are suddenly stale, given the recent turmoil in the Mideast and the resulting pop in oil prices. Even if inflation isn't a serious challenge at the moment, pricing pressures continue to threaten economies elsewhere around the globe. Standard & Poor's today issued a warning about the "upward momentum" for inflation pressures in Asia.
Nonetheless, there's still some debate about how much inflation threatens the mature economies. The IMF's chief economist Oliver Blanchard, for one, thinks the risk is still minimal. For the U.S. and Europe, "oil prices and food prices don't seem to have large inflationary effects," he says.
Deciding if that view is informed, or something less, depends on whether the rise in commodity prices is a temporary phenomenon or the start of a new secular bull market. The case for thinking it's the former may be frayed, but it's still alive and kicking. CNNMoney reports that "a majority of investment strategists and money managers are leaving their year-end forecasts unchanged." CNN continues: "On average, experts expect gold and oil prices to edge up about 4% by the end of 2011. That would put oil at around $95 a barrel and gold just under $1,500 an ounce by the end of the year. Crude prices started the year around $91 a barrel, while gold was at $1,420."
General mayhem in the Mideast surely plays a role in driving oil and other commodities higher. To that extent, a return to relative calm could easily bring prices down. The real question is how much of the price hikes are related to stronger demand and a recovering global economy? Those factors represent more durable support for higher commodity prices, which in turn makes a stronger case for worrying about inflation.
The future, of course, is uncertain. Modeling political upheaval is about as reliable as herding cats. Even ECB President Trichet is reluctant to say for sure what comes next. Responding to a question about whether the latest advance in prices of raw materials was sustainable or fleeting, he advises: "We consider that we are in a universe that from that standpoint is uncertain."
March 7, 2011
The Recovery Isn't Jobless, But Job Growth Is Still Weak
A number of pundits warn that the U.S. is suffering from an era of jobless recoveries. It's a popular complaint and it's surely grounded in legitimate concerns about the labor market's strength. But taken at face value, the claim that we're in a jobless recovery is false. The economy's recovering and new jobs are being created. Since the private-sector labor market started growing in the latest cycle in March 2010, total nonfarm private payrolls are higher by 1.5 million through February 2011, based on seasonally adjusted figures, which are used in the analysis below as well. That's a fraction of the jobs lost in the Great Recession, but modest job growth isn't the same thing as a jobless recovery.
The real issue is deciding how the trend in job creation compares with history. To start, let's look at a graph of the monthly change in private nonfarm payrolls over the last 30 years. The average monthly rise for those decades is roughly 93,000, as indicated by the blue line in the chart below. Obviously, the economy has a history of creating jobs over the previous three decades. But it's also true that running a linear regression over those years on the month numbers reveals a gently falling trend (red line). In other words, it appears that the strength of job creation has been weakening through time.
Analyzing the trend over long stretches of time has limits, of course. A more productive focus is comparing job creation during the recovery phases. Considering that there are several ways to proceed, the challenge is deciding how to evaluate the data. One possibility is adding up the total of monthly changes in nonfarm payrolls for each post-recession growth period, based on NBER's cycle dates. By that standard, the last full growth cycle was weak for minting jobs. Nonfarm private payrolls rose by just 6 million from December 2001 through December 2007. By comparison, the gain in jobs during previous cycles was far higher: nearly 22 million for 1991-2011, and 18 million from 1982 to 1990.
Other measures of the labor market's strength also show that the 2001-2007 period looks weak vs. its predecessors. Average monthly job creation was substantially lower in 2001-2007 vs. the earlier periods, for instance. The trend doesn't look any better if we measure the total net change in private nonfarm payrolls as a percentage of the civilian labor force at the peak of each cycle.
Clearly, there's a subpar recovery in jobs in recent years. The big question is whether the 2001-2007 period was an exception or a sign of things to come? Based on the trend since the Great Recession was formally declared history, the case for optimism looks weak.
Measured from the first month of the current expansion, the net change in total private nonfarm payrolls is a mere 362,000. This figure includes the first eight months of the current "expansion," when the economy continued to lose jobs. Before the next recession arrives, surely many more jobs will be created. Indeed, the recent economic news is relatively upbeat for thinking that the recovery is picking up speed. February's jobs report, for instance, was the best in nearly a year.
But it's also true that we are now 21 months into the recovery and total job creation is, at best, modest on both relative and absolute levels. The hope is that this expansion runs longer than usual (the post-World War Two average is 59 months) and/or the labor market accelerates. The prospects on these fronts are mixed. What is clear is that there's a huge amount of ground to make up from the Great Recession and the record so far in repairing the damage is uninspiring. It's not a jobless recovery, but that's cold comfort given the hole we're in.
March 5, 2011
Book Bits For Saturday: 3.5.2011
● Endgame: The End of the Debt SuperCycle and How It Changes Everything
Excerpt via publisher, John Wiley
The bankruptcy of Lehman Brothers in the fall of 2008 drew the curtain on a very long 60-year Act I in the debt supercycle. You could feel in the air the end of a golden period, when everincreasing quantities of debt could lead to ever more consumption and “wealth.” As stock markets crashed globally and the lines of unemployed lengthened, the end of the era was something we could observe in real time.
● The Evil Axis of Finance: The US-Japan-China Stranglehold on the Global Future
By Richard Westra
Summay via publisher, Clarity Press
In a nutshell, the rigged global game undergirding Axis power is that of dollar seigniorage. The way it works is that the US furnishes international money for the cost of running a printing press while the rest of the world produces goods and services in a wage race to the bottom to access those dollars. And select states, predominately Japan and China (though others as well), then store the surpluses they amass in dollar denominated savings. US access to investment capital through little substantive economic effort, as it in fact incurs exponentially burgeoning debt, underpinned its seemingly out-of-this-world economic performance across the 1990s and early 21st century. China’s export bonanza to the US props up its brutal authoritarian regime: The latter, in turn,finding further support from the powerful new coastal exporting elite. China’s slave-like labor conditions set wage rates for global producers and maintain a flow of consumer goods to the US and the world at deflated prices. With the rising export prowess of China Japan maintains demand for its capital goods beyond East and Southeast Asia which the US had supported as Japan’s “sphere of influence” in the post-World War II (WWII) era. Japanese corporations are thereby enabled to retain their core competencies bucking global trends while Japan further defies global tendencies toward spiraling unemployment to sustain its post-WWII social and political consensus.The book deftly explores the set of momentous though largely unrecognized consequences for the global future which flow from this rigged game:
● Inside the Fed, Revised Edition: Monetary Policy and Its Management, Martin through Greenspan to Bernanke
By Stephen Axilrod
Summary via publisher, MIT Press
Stephen Axilrod is the ultimate Federal Reserve insider. He worked at the Fed’s Board of Governors for more than thirty years and after that in private markets and as a consultant on monetary policy.With Inside the Fed, he offers his unique perspective on the inner workings of the Federal Reserve System during the last fifty years—writing about personalities as much as policy—based on his knowledge and observations of every Fed chairman since 1951. This new, post-financial meltdown edition offers his assessment of the Fed’s action (and inaction) during the crisis and expanded coverage of the Fed in the Bernanke era.
In this revised edition, Axilrod gives an account of the Fed’s dramatic, even mind-bending, experiences in the great credit crisis of 2007-2009. He assesses the full range of the Fed’s unusual and innovative actions during the crisis and the beginnings of its aftermath. He questions whether the Fed used its monetary and regulatory powers to full effect to minimize and contain the disruption of the nation’s—and the world’s—financial stability. And, in an entirely new chapter, he evaluates Bernanke’s performance through his full first term (as well as the early part of his second) in light of his actions during the crisis. In later chapters he also reevaluates the image, stature, and structure of the Fed in the aftermath of the crisis and the new comprehensive financial legislation subsequently enacted.
● The New Global Rulers: The Privatization of Regulation in the World Economy
By Tim Büthe & Walter Mattli
Summary via publisher, Princeton University Press
Over the past two decades, governments have delegated extensive regulatory authority to international private-sector organizations. This internationalization and privatization of rule making has been motivated not only by the economic benefits of common rules for global markets, but also by the realization that government regulators often lack the expertise and resources to deal with increasingly complex and urgent regulatory tasks. The New Global Rulers examines who writes the rules in international private organizations, as well as who wins, who loses--and why.
● Triumph of the City: How Our Greatest Invention Makes Us Richer, Smarter, Greener, Healthier, and Happier
By Edward Glaeser
Review via The New York Times
Glaeser’s essential contention is that “cities magnify humanity’s strengths.” They spur innovation by facilitating face-to-face interaction, they attract talent and sharpen it through competition, they encourage entrepreneurship, and they allow for social and economic mobility. Glaeser takes us on a world tour of urban economics, collecting passport stamps in Athens, London, Tokyo, Bangalore, Kinshasa, Houston, Boston, Singapore and Vancouver. Along the way, he explains how urban density contributed to the birth of restaurants, why supermarket check-out clerks demonstrate the competitive advantage such density confers and how the birth of Def Jam Records illustrates the way cities spur artistic innovation. Here, his enthusiasm for cities is refreshing. Glaeser’s got some tough words for poorly reasoned public policies that feed suburban living: federal highway programs, the mortgage tax deduction, low gas prices. While he understands the lure of big houses and lush lawns, he’s against subsidizing them. And he chastises city planners in Paris and Mumbai, making a passionate argument for building up — and up and up.
March 4, 2011
February Private Sector Job Growth Is The Highest In 10 Months
Today’s employment report for February suggests that the stock market rally that began last September correctly anticipated rebound 2.0 in the post-recession period. Private sector employment rose by a net 222,000 last month, the most since last April and a sharp rise from January’s feeble 68,000 advance. Even better, job growth was widespread across the economy. Only retail trade suffered a setback in the private sector. In short, today’s employment news is good—the best, in fact, in nearly a year.
But today’s report is also a reminder that it’s going to take even higher levels of job growth to make a substantial dent in the elevated jobless rate. Unemployment barely budged last month, falling to 8.9% in February from January’s 9.0%. That’s a big yawn, and more than a little frustrating when you consider that we just received word of the best month for the labor market since last spring. The implication: If the economy maintains a monthly pace of job growth at February's rate, that’s probably enough to keep the jobless ranks from rising, but it’s well short of pulling down unemployment in the short run by anything more than a modest amount.
Keep in mind, too, that expecting job growth of 200k a month on a sustained basis requires a fair amount of thinking optimistically relative to recent history. An average of 127,000 new private sector jobs were created over the past 12 months. Bumping that up to 200,000 would be a substantial improvement, but it would still be modest relative to what’s needed to repair the deep employment losses in recent years.
It doesn’t help that there’s still some doubt if today’s report, which was more or less expected, has legs. February’s numbers look good, or at least materially better than what we’ve seen lately. The fact that the labor market has been growing for 12 straight months is encouraging as well. But as everyone knows, the rate of increase has been sluggish, and at times erratic, and so it’ll take a few more reports to make a stronger case that there’s real improvement here.
That said, there’s mounting evidence for thinking that job creation may accelerate in the months ahead. But that’s not a free lunch, since anything less would, at this late date, constitute a major disappointment. Indeed, the market is probably expecting at least 200k a month from here on out at a minimum, and so the risk of falling short comes with higher stakes.
Strategic Briefing | 3.4.2011 | The Crowding Out Effect On Interest Rates
The theory of "crowding out" predicts that higher government borrowing may force interest rates higher than they otherwise would if the private sector prevailed in the money markets. How does this theory jibe with recent history? Read on for some perspective...
Crowding Out Watch, Updated
Menzie Chinn, Econobrowser | Mar 1
I'm teaching the concept of portfolio crowding out in my intermediate macro course (handout with algebra here) now, and as I was going through the notes, I observed that last I had checked, there was (still!) little evidence of crowding out... Relative to my September post, the ten year TIPS is slightly up, but the five year remains at zero (well, actually negative). This means that whatever upward pressure there is on government interest rates due to the large supply of government debt, it is being offset by low demand from the private sector (or by demand from offshore sources).
A Federal Shutdown Could Derail the Recovery
Mark Zandi, Moody's Analytics | Feb 28
While the government spending cuts proposed by House Republicans for this fiscal year mean only modest fiscal restraint, this restraint is meaningful. If fully adopted, the cuts would shave almost 0.5% from real GDP growth in 2011 and another 0.2% in 2012. This wouldn’t be true if the current budget deficits were crowding out private investment, but they aren’t. Business demand for credit has recovered modestly, and households continue to lower their debt obligations. Interest rates also remain extraordinarily low. Some of this is due to the Fed’s credit easing, but global investors also remain willing buyers of U.S. debt even at low interest rates.
Dollar for Dollar Crowding Out in the Textbook Keynesian Cross Model When the Economy is Below Full Employment
Sheldon Stein, Cleveland State University | Jan 15, 2010
We cannot have full employment without more national savings and we cannot have more national savings without having full employment.
Economist Argues The Deficit Isn't Issue No. 1
Dean Baker, Center for Economic and Policy Research | Feb 28
The reason why we should be concerned about a deficit is it's crowding out private-sector spending, private-sector investment. You're really hard-pressed to tell that story right now. We still have extraordinarily low interest rates. We have excess capacity in just about every sector of the economy. You'd be very hard-pressed to say how let's say the government were to spend another three or $400 billion this year. How would that crowd any substantial amount of private-sector investment? You'd be very hard-pressed to say that.
Spend or cut: US economists split on best medicine
AFP | Mar 3
Washington politicians seeking support in their bitter budget battle aren't getting much help from economists, who are divided over whether spending is the best medicine for the struggling economy. Democrats have recruited a phalanx of economic stars to support their fight against some $61 billion in cuts Republicans are trying to force on the White House. Democrats say such cuts will cost hundreds of thousands of potential jobs this year, at a time when the unemployment rate languishes at nine percent. But Republicans are answering with their own heavyweights, who insist that more government spending -- and the mounting deficits that come with it -- hurts job creation and endangers the economy over the long run...The White House's opponents largely reject the Keynesian model embraced by many economists, which holds that government spending can jump-start an economy in a depressed, low-inflation situation.
"There's no scientific consensus on that model," argued Adam Gifford, chairman of the economics department at California State University -- Northridge, who signed the letter backing budget cuts. [Stanford University economics professor John ] Taylor says his own economic models show, in contrast to the Keynesian view, that in a supposed competition for funds, government spending crowds out the private sector. "A reduction in the growth of spending will immediately 'crowd in' private investment," he said. But Gifford was less certain on that point. "With the low real interest rates, it's hard to make a case that there is real crowding out of the private sector right now," he said.
Fiscal Positions and Government Bond Yields in OECD Countries
Joseph Gruber and Steven B. Kamin, Federal Reserve | Jan 5, 2011
Using a large panel dataset of OECD countries, we have identified a robust and significant impact of fiscal performance on long-term bond yields. Based on our estimates, by 2015, yields could be 60 basis points higher in the United States than would have been the case in the absence of the projected increases in debts and deficits since the advent of the financial crisis. Excluding Japan, whose bond yields are not well-explained by our model, bond yields in other G7 countries would be up by lesser amounts. All told, these estimates point to a material, but not overwhelmingly large, impact of the global fiscal deterioration on bond yields...
Our econometric results provide no evidence for the view that concerns about inflationary effects underlie the linkage between fiscal deficits and bond yields: we identify such a linkage even controlling for projected inflation; removing projected inflation as an explanatory variable does not affect our estimation results; and there is little evidence of a direct effect of fiscal performance on inflation expectations in our sample.
Does Government Debt Crowd Out Investment?
Nora Traum, Indiana University Bloomington and Shu-Chun Yang, CBO | Apr, 2010
We estimate the crowding-out effects of government debt for the U.S. economy using a New Keynesian model with a detailed fiscal specification. The estimation accounts for the interaction between monetary and fiscal policies. Whether private investment is crowded in or out in the short term depends on the fiscal or monetary shock that triggers debt expansion. Contrary to the conventional view of crowding out, no systematic relationship among debt, the real interest rate, and investment exists. At longer horizons, distortionary financing is important for the negative investment response to a debt expansion.
March 3, 2011
Late Night Reading...
● A Vice President in the research division of the Federal Reserve Bank of St. Louis responds to the attacks on the central bank via one rather prominent critic in Congress: Ron Paul's Money Illusion
● The case for arguing that QE2 worked: Quantitative Easing and America’s Economic Rebound
● Scott Sumner also argues that QE2 succeeded: Feldstein–>Glasner–>Feldstein
● But Mark Thoma thinks it's too early to say for sure: Long and Variable Lags in Monetary Policy
● Meanwhile, central bankers aren't completely immune to learning from history: An historical perspective on the Great Recession
Is The Stalled Decline In Jobless Claims Really Over This Time?
Was that a tipping point for the trend in jobless claims? Today’s update of weekly filings for new unemployment benefits shows a drop to a seasonally adjusted 368,000 for the week through February 26. Initial claims haven’t been this low since May 2008. Today’s number also marks another milestone since the end of the recession: the first back-to-back weekly readings below 400,000.
It still too early to declare victory for the trend in jobless claims, but it’s a bit harder to argue that this metric remains in neutral. Indeed, the more relevant four-week moving average for this series also dipped below 400,000 last week for the first in nearly three years. It’s going to take another few weeks to decide if this is real, but today’s report surely offers the best news for this measure of labor market activity in many months.
Adding to the encouraging profile is the ongoing decline in continuing claims. As the second chart below shows, the number of workers previously collecting jobless benefits dipped again in the latest reading, falling to just over 3.8 million for the week through February 12 (this series lags new claims by one week). That’s the lowest since October 2008.
It all adds up to an encouraging batch of numbers. Of course, there are caveats to consider. First is the obvious one. Initial claims data can and does swing wildly from week to week and so one has to take any given report with a grain of salt. But for the reasons noted above, that’s suddenly becoming less of a hazard, given what appears to be a new leg down.
Second, and more importantly, is the question of whether today’s update on claims will translate into stronger growth in job creation? History suggests it will, although the downturn in new claims tends to precede sharply higher job growth by several months at least. As such, it may be some time before we see better numbers in nonfarm payrolls, which is scheduled for an update tomorrow. Given the various macro challenges haunting the economy, waiting for confirmation on this front isn’t going to be easy.
Another issue is how the new rise in oil prices plays out. It would more than a little frustrating to learn that the latest round of turmoil in the Middle East triggers a new bull market in energy prices that marginalizes if not derails the nascent acceleration in the labor market. It’s not yet clear if we’re looking at that scenario, but the crowd is surely pondering the possibility now that oil’s routinely trading over $100 a barrel.
Even if energy prices remain stable in the months ahead, there may be another joker in the deck: monetary policy. The key reason that the Fed has kept its target rate at just over zero percent is the ongoing weakness in job growth. If the labor market is set to grow at a faster pace than we’ve seen recently, the probability of raising rates goes up. The Fed funds futures market isn't pricing in big gains for rates any time soon, but that may change if—if—the labor market starts showing more muscle. In that case, the future could be tricky. Raising rates is inevitable, although the margin for error is relatively narrow for timing and magnitude. Hike rates too fast and it could marginalize job growth before it really gets started. Wait too long, and inflation could build up a head of steam—no trivial risk with Fed funds at virtually zero.
Navigating the future is always risky, and that goes double these days. But at least the possibility for positive outcomes is a bit brighter if the labor market’s revival is progressing. It’s still one day at a time, but today’s numbers keep hope alive. Let’s see what tomorrow’s payrolls report brings.
Carving Up Betas Is Only A Partial Solution
More is better when it comes to asset allocation, at least in theory. But how much is too much? Common sense suggests that there's a point of diminishing returns to dividing up portfolios into ever finer slices. Exactly where that point lies is unclear, however. That's partly because analyzing widely divergent portfolio choices rapidly spins out of control as a quantifiable research project intent on dispatching a few concise insights. Reviewing the infinite, in other words, doesn't help much in the search for one-size-fits-all advice.
The issue is topical once again with the recent launch of the first style-focused emerging market equity funds. A pair of new funds divides this beta into two ETFs: Global X Russell Emerging Markets Growth (EMGX) and Global X Russell Emerging Markets Value (EMVX). Emerging market stocks have traditionally been securitized as one market-cap weighted portfolio, as represented by, say, iShares MSCI Emerging Markets Index (EEM) or Vanguard MSCI Emerging Markets (VWO).
Carving up risky assets into finer slices isn't new, nor is it a radical notion. You can trace the idea back a few thousand years to the Talmud, which recommended the diversification of wealth into liquid assets, property and commercial enterprise. In the modern era, the idea of managing asset allocation dates to Markowitz's famous 1952 paper "Portfolio Selection," which introduces the concept of quantitatively optimizing the mix. The conventional interpretation of Markowitz (1952) focuses on individual securities, although the paper notes that "aggregates, such as, say, bonds, stocks and real estate" can be used as inputs.
The subsequent theory and practice of asset allocation in the decades since Harry Markowitz penned his seminal study has evolved considerably, of course. The basic intuition of diversifying and the progression of finance theory and the empirical record add up to a powerful case for investing across the major asset classes. The good news is that owning a multi-asset class portfolio is getting easier every year with the proliferation of ETFs.
In broad terms, the investable "market portfolio" can be defined as 12 major asset classes, plus cash. We're talking here of standard betas in long-only, unlevered form that are available as ETFs, ETNs, and mutual funds. The key reason for owning individual pieces of this global risk beta is bound up with exploiting the rebalancing bonus. Because the various markets exhibit something less than perfect correlation through time, there's considerable opportunity for reweighting the portfolio by selling high and buying low.
The choices above provide a rich opportunity set for earning a reasonable risk premium. In fact, using the ETF proxies for each of the asset classes above can deliver a wide array of outcomes, from relatively tame portfolios to hedge fund-like results. It all depends on how you weight the individual pieces initially and how you manage the volatility.
Dividing one or more of the major asset classes into additional parts can enhance the possibilities for earning higher risk-adjusted returns, but you need to think carefully about going too far down this road and applying the concept to more than one or two asset classes. If you can't earn a sufficiently satisfying return with the broadly defined betas listed above, it's not obvious that you'll do much better by holding a more granular asset allocation. If it were otherwise, building portfolios with individual securities would be a short cut to beating the relevant market index. But the historical record from thousands of mutual funds suggests that mediocrity is the path of least resistance.
What is clear is that owning a broad mix of different asset classes and rebalancing the mix periodically represents a robust strategy for earning decent and perhaps exceptional results. The biggest challenge is less about expanding the set of risk factors beyond the list above vs. embracing a contrarian-oriented investment strategy. Taking advantage of volatility is at the heart of earning superior risk-adjusted results. It's a simple concept, and yet relatively few investors come anywhere near to taking full advantage of the benefits.
Over the course of a business cycle, there's likely to be wide range of correlations across the major asset classes. In addition, these correlations will fluctuate by more than a trivial degree. And most, probably all, of the standard asset classes have positive expected returns for the long term, albeit in varying degrees. There lies the raw material for earning something better than average returns. Yes, you can do better by focusing on a more granular definition of betas. Indeed, most of the major asset classes can be broken up into numerous pieces. But if you're not successful in exploiting the basic choices, slicing up broad betas into multiple parts probably isn't going to help.
March 2, 2011
A Fresh Take On Factor Indexing
My latest story for Financial Advisor is hot off the press. The focus is factor indexing, which is getting easier. The question, of course, is whether easier means better when it comes to juicing risk-adjusted returns, particularly in a multi-asset class framework. For some perspective, you can read the digital version of the article here.
ADP: Employment Growth Accelerates in February
There’s enough upward momentum in today’s ADP Employment Report for February to encourage the belief that the labor market is healing. But true to form these days, there’s still not enough juice in the numbers to slay worries that job growth will be anything other than modest for the foreseeable future.
Last month, nonfarm payrolls rose by a net 217,000, according to ADP. That’s up slightly from January’s 189,000 gain. Based on ADP’s historical data, February’s advance looks quite good. As good as the glory days of 2004-2007, in fact. Perhaps, then, today's number is a sign of better times approaching. Let’s see what comes from this Friday’s jobs report from the Labor Department, the more influential number. The consensus forecast calls for a rise that's more or less in sync with today's ADP report.
"Today's ADP National Employment Report shows another solid increase in U.S. private sector employment, with gains across all size businesses and in both the goods-producing and service-providing sectors," says Gary C. Butler, president and CEO of ADP, in a press release today. "Employment gains in the small-business sector have been positive for twelve consecutive months, an encouraging sign for the job market. ADP's key business metrics for its small-business segment through December 2010 also reflected a strengthening labor market, as well as robust demand for payroll and human resource services."
After yesterday's encouraging rise in the ISM Manufacturing Report for February, the case for optimism is arguably higher today. But while it's clear that the labor market is recovering, and the recovery is persistent, it's not yet obvious if there's more than moderate growth ahead. Today's ADP number is a down payment on thinking positively, but the macro backdrop is still too shaky for deciding if we're headed for a stronger and sustainable period of job creation.
The next clue arrives in tomorrow's weekly update on jobless claims. Last week's new filings dipped under 400,000 (seasonally adjusted) for only the third time since the Great Recession ended. Witnessing a fourth would boost sentiment, although the forecasts for tomorrow's number suggest that it's going to be close for delivering another report under 400k.
The Madness of Mr. Market
Reuters blogger Felix Salmon grumbles that the market's driving him batty, and so he urges us to ignore it, if only for sanity's sake. "The one thing I’ve learned over the past three years is that the market just isn’t a sensible or rational place," he writes.
It's not the first time that Mr. Market has confused and perplexed innocent bystanders. Looking into the miasma of trading on any given day is just as likely to reveal perspective, or leave you with a dizzy spell that baffles and befuddles. There are two general reactions to these possibilities, one of which Salmon champions with some amount of irritation:
So when the market seemed unreasonably sanguine, in early 2007, it was wrong. And when the market seemed reasonable in its pessimism, in late 2008, it was also wrong. Right now we’re back to unreasonably sanguine again…
If you’re being logical about such things, stocks look incredibly frothy right now, just as bonds do, both in terms of valuation and in terms of psychology. But this market has a way of making everybody look foolish, no matter how logical they are. Which is ultimately just another reason to spend as little time as possible paying any attention at all to the market. It’ll just drive you mad.
Sometimes the market's wrong, and sometimes it's… wrong? Not quite. The market can't always be mistaken. Prices eventually reflect fundamental value. That doesn't preclude lots of volatility on the path to uncovering that value. Figuring out the future is hard and subject to quite a bit of error in real time, but rest assured that the truth will out.
A few decades ago, it was widely believed that price fluctuations really were random. Now there's lots of evidence to the contrary. Some people automatically think this is a smoking gun that derails the case for market efficiency. That's one possibility, although simply disproving random price behavior isn't definitive. Why? The short answer is that the market discounts the future at varying rates. This looks like chaos on a daily or even weekly basis. But when you step back and consider the longer perspective, there's quite a bit of economic logic just below the superficial anarchy.
As one example, the current dividend yield in the stock market has done a convincingly good job of discounting expected return for the five- to 10-year period ahead. This is particularly true at extremes. In 2000, for example, equity prices were high and dividend yields were spare; the opposite was true in 1980.
The problem is that the market isn't usually at extremes, and so reverse engineering the expected return isn't always easy. It can be done, though, and some investors actually succeed in this dark art. But it tends to be the exception. This empirical fact has been documented so often, and in so many different ways over the year, that to restate it seems ludicrously redundant. And yet it's one of the most controversial topics in money management. But rather than belabor the details, let's simply quote Ben Graham, who, in his best seller The Intelligent Investor, observed:
Since anyone—by just buying and holding a representative list—can equal the performance of the market averages, it would seem a comparatively simple matter to "beat the averages"; but as a matter of fact the proportion of smart people who try this and fail is surprisingly large. Even the majority of the investment funds, with all their experienced personnel, have not performed so well over the years as has the general market. Allied to the foregoing is the record of the published stock-market predictions of the brokerage houses, for there is strong evidence that their calculated forecasts have been somewhat less reliable than the simple tossing of a coin.
That was written many years ago, although it's not obvious that much has changed. Keep in mind that Graham was and remains the dean of active stock pickers. And yet he seems to be making the case for indexing. At any rate, the operative question is still the devastatingly spot-on inquiry: Where Are the Customers' Yachts?
The biggest challenge to earning a respectable return on your investment is less about perceived chaos in the market vs. muster the personal discipline to respond to the varying expected return offerings extended by Mr. Market at any point in time. Being a contrarian is hard, though, but it has a long history of success. That's because the market sometimes extends a good deal, even a great deal, but it doesn't last. Expected return fluctuates, with some degree (perhaps a high degree) of economic logic. The odds of exploiting these fluctuations to your advantage improve if you follow some basic rules:
1. Embrace a reasonably long time horizon. The market looks a lot less chaotic when discounting returns five to ten years out vs. trying to estimate next week's risk premia.
2. Don't define "the market" too narrowly. The economic logic of the market is harder to recognize in a handful of securities or portfolio that own just one asset class. And let's face it: we're all mistaken at times. But we can reduce the blowback from mistakes by owning a wide mix of risk factors.
3. Avail yourself of Mr. Market's mood shifts, a.k.a. the constantly changing state of discounts on future return. If you've earned above average returns in recent history, take some profits; if returns are subpar or negative over the previous period, consider beefing up the position. But be careful. Most investors shouldn't try this with individual securities (see Rule 2). Companies can go bust; asset classes are forever.
In sum, develop an asset allocation plan, rebalance periodically, and stay focused on the medium to long-term outlook. That's hardly trivial advice. Indeed, the record of success in managing risk, rather than chasing return, is impressive. Don't get mad—invest opportunistically and think strategically.
March 1, 2011
Manufacturing’s Hot. Will Job Growth Follow?
Manufacturing is on a roll. Today’s update of the ISM Manufacturing Report for February shows that "economic activity in the manufacturing sector expanded in February for the 19th consecutive month." In fact, the latest rise brings the index to the previous high, set in 2004. The question is when, or if, the revival in manufacturing will spill over into the labor market?
One strategist is optimistic. "The employment component [for manufacturing] went up again," says Dan Greenhaus, chief economic strategist at Miller Tabak, via CNBC. "There's definitely a relationship between the ISM employment component of the manufacturing index and manufacturing payrolls in Friday's report."
Not everyone expects strong job growth from here on out, although there's no denying manufacturing's momentum. Dirk van Dijk of Zacks advises that the latest update on the ISM Manufacturing Index "is extremely strong by any historical perspective. In fact, it has been matched or exceeded in only 77 months since the start of 1948, or 10.2% of the time. Almost all of those instances are ancient history."
The stock market, however, isn’t impressed. As we write this afternoon, the S&P 500 is down by around 0.8%. Maybe that’s because Fed Chairman Ben Bernanke is out dispensing warnings today in testimony to Congress about the threat of rising oil prices for the economy. That includes the potential for higher inflation. "The most likely outcome is that the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S. consumer price inflation -- an outlook consistent with the projections of both FOMC participants and most private forecasters," Bernanke noted. He went on to say that
sustained rises in the prices of oil or other commodities would represent a threat both to economic growth and to overall price stability, particularly if they were to cause inflation expectations to become less well anchored. We will continue to monitor these developments closely and are prepared to respond as necessary to best support the ongoing recovery in a context of price stability.
But first things first. Will manufacturing’s rise translate into stronger job growth? "The strength of the ISM index, the drop in jobless claims and survey evidence all suggest we will see an above-consensus increase in February payroll employment," according to Chris Low, chief economist at FTN Financial, as reported by Reuters.
The first crack at fresh insight arrives in tomorrow’s ADP Employment Report. The consensus forecast: a net gain of 165,000 for nonfarm payrolls for February, down slightly from January 187,000, according to Briefing.com. Not great, but not bad. Let’s call it lukewarm.
It doesn’t look all that different for small businesses. Today’s update on the Intuit Small Business Employment Index shows a gain of 50,000 new jobs last month. "This month’s report is a lot like last month’s," says Susan Woodward, the economist who worked with Intuit to create the Index, in a press release. "Small businesses are hiring and their people are working more hours, but measures of compensation are pretty flat, showing that the labor market is still soft. While the rise in employment is good news, this rate of increase is still not going to get us back to full employment very fast."
Strategic Briefing | 3.1.2011 | Commodity Inflation
Prospects for the Economy and Monetary Policy
William Dudley, president and CEO, NY Fed | Feb 28
...we need to keep a close watch on how households and businesses respond to commodity price pressures. The key issue here is whether the rise in commodity prices will unduly push up inflation expectations. Although there have been commodity price cycles in the past, commodity prices have not consistently increased relative to other prices, and indeed have declined in relative terms over the very long term. Historically, if commodity prices rose sharply in a given year, it has been reasonable to expect that these prices would stabilize or fall within a year or two. This property has been important because it has meant that measures of current “core” inflation, rather than current headline inflation, have been more reliable in predicting future headline inflation rates.
In contrast, over the past decade, commodity prices generally have been on an upward trend....
Nevertheless, there are important mitigating factors that suggest that it would be unwise for the Federal Reserve to over-react to recent commodity price pressures. First, despite the general uptrend, some of the recent commodity price pressures are likely to be temporary. In particular, much of the most recent rise in food prices is due to a sharp drop in production caused by poor weather rather than a surge in consumption. More typical weather and higher prices should generate a rise in production that should push prices somewhat lower. This is certainly what is anticipated by market participants. Second, even if commodity price pressures were to prove persistent, the U.S. situation differs markedly from that of many other countries. Relative to most other major economies, the U.S. inflation rate is lower and the amount of slack much greater.
Moreover, for the United States, commodities represent a relatively small share of the consumption basket. This small share helps to explain why the pass-through of commodity prices into core measures of inflation has been very low in the United States for several decades.
EU Raises Growth Forecast, Expects Inflation to Accelerate
Bloomberg | Mar 1
The European Commission raised its economic-growth forecast for 2011 and said higher oil and commodity prices could keep inflation above the European Central Bank’s limit for most of the year.
Commodities in Longest Winning Streak Since '04, Beating Stocks
Bloomberg | Feb 28
Metals, crops and fuel beat stocks, bonds and the dollar for a third straight month, the longest stretch since June 2008, as inflation lifted cotton and cocoa and investors speculated violence in the Middle East and northern Africa will restrain energy supplies. The S&P GSCI Total Return Index of 24 commodities gained 3.8 percent in February and rose for a sixth consecutive month, the longest streak since 2004, data compiled by Bloomberg show. The MSCI All-Country World Index of equities in 45 nations returned 3 percent including dividends, while corporate and government bonds rose 0.13 percent, according to Bank of America Merrill Lynch’s Global Broad Market Index through Feb. 25. The U.S. Dollar Index, a gauge of the currency against six counterparts such as the euro and yen, fell 1.1 percent.
Tim Duy's Fed Watch | Feb 27
The recent surge in oil has been a blow to my rising optimism. With this surge coming on the heels of accelerating US activity, monetary policymakers will offer some concern over the inflationary impact. Recent history, however, suggests the opposite - that unless the tide of rising commodity prices is soon arrested, Fed officials will find themselves faced with the prospect of yet another round of quantitative easing.
Macro US: Commodity bubble? Well, US inflation is at an all-time low!
Trading Floor (Saxo Bank) | Feb 28
While personal spending and income may seem like the two biggies in today's spending report, we encourage you to study the price data - particularly in light of the recent rise in inflation as measured by the consumer price index. Of today's price series the PCE Core Price Index is of particular interest given the attention it gets from members of the Federal Reserve. Unlike the CPI, the core PCE price index does not yet show many signs of inflation. Indeed, the year-on-year rate is 0.7 - the lowest rate ever in its five decade history. To be fair the three month annualised measure has increased... but only to 0.4 percent from an all-time low of 0.3 percent. Keep this index in mind when worrying about U.S. inflation and Fed actions.
Reserve Bank of Australia member warns of commodity bubble
Australian Broadcasting Corp | Feb 28
Reserve Bank board member Professor Warwick McKibbin has warned of a potentially devastating bubble in global commodity prices and property prices in Asia. Professor McKibbin, who is also director of the research school of economics at the Australian National University, says if there is a big downturn in Asia Australia could be hit harder because of Australia's reliance on resource revenue...
"There are two things driving commodity prices. There is the fundamental shift in the demand for commodities coming out of China and India and other countries. That is a positive," he noted.
"The second component is the excess demand which is leading commodity prices, but generalised inflation will follow and that is not a good thing because that is a temporary phenomena for a country like Canada or New Zealand."
Nikkei gains helped by Japan's low inflation risk
Reuters | Mar 1
Japan's Nikkei average clawed back towards 10-month highs to add 1.2 percent on Tuesday as foreign investors piled into Japanese stocks on a lower inflation risk, with more hard-won gains seen in the medium term... "U.S. and European investors have been the main players in the Japanese market. But Asian investors have joined in as Japan is one of the few countries with a low risk of rate hikes," said Shun Maruyama, chief strategist at Credit Suisse. "They are buying Japanese stocks on a process of elimination as Japan has more tolerance for higher oil prices than other Asian countries."
High global crude, commodity rates may add to inflation: Pranab
The Hindu | Mar 1
Grappling with a high rate of price rice, the government today expressed concern that increasing prices of crude and other commodities in global markets could add to inflationary pressure in the country [India]. “The possibility of the global commodity inflation adding to domestic inflationary pressures cannot be ruled out,” Finance Minister Pranab Mukherjee said at the 83rd Annual General Meeting of industry chamber Ficci here.
Why is the GOP Overhyping Inflation Fears?
David Frum | Feb 28
It’s no mystery why Republicans should be more acutely sensitive to inflation than Democrats.
1) Republicans are the preferred party of people who have money. People who have money naturally dread anything that might impair money’s value.
2) Republicans are the party of older people. Older people naturally dread inflation, which corrodes fixed incomes and retirement savings.
Monetary Policy, Commodity Prices and Inflation - Empirical Evidence from the US
Florian Verheyen, University of Duisburg-Essen | Nov 19, 2010
While there was a strong link between commodity prices and CPI inflation in the 1970s and the beginning of the 1980s, the relationship has weakened, respectively diminished over time. Today we are unable to detect a reaction of commodity prices to commodity price shocks. Thus, commodity prices might not serve as good indicator variables for monetary policy...
Furthermore, a more restrictive monetary policy in face of rising commodity prices could depress economic activity. This is problematic especially for the Fed as she has to focus on price stability and the support of the economic performance of the American economy. Regarding the actual financial crisis, putting more weight on stimulating the economic activity might be superior to eliminate inflationary pressure. Additionally, higher inflation rates as a consequence of the fairly expansionary monetary policy would come along with a (to some minds) nice side effect of devaluating the governmental debt. Therefore, keeping interest rates low might lead to a reduction of the deficit relative to GDP for two reasons: higher growth rates decrease debt relative to GDP and inflation erodes the real value of the debt.
Nevertheless, central banks should monitor if commodity prices will influence inflation expectations. As food and petrol are goods which are bought quite frequently, a rise in these commodity prices can increase inflation expectations, with the risk of a stronger influence of commodity prices on the CPI in the future. So the hypothesis of a revival is not so far off which points to no quietening of the discussion about commodity prices, monetary policy and inflation.