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Posts Tagged ‘Inflation’

Chinese Government Officials May Have Leaked Key Economic Data

June 9th, 2010 Michael McDonough Comments off

“Dear all: One Chinese official apparently leaks May macro data According to Reuters, a senior Chinese government official leaked some key macro data during an internal investor conference. If confirmed, it will be one of the largest leakages in China in two years. Official numbers are yet to be released. Relevant numbers are for CPI, PPI, Industrial production, FAI, Exports, new loans, and M2. The most surprising number is the 52% export growth, though people are deeply (in our view, not so necessarily) concerned about the 3.1% CPI inflation which for the first time this year surpassed the targeted annual target at 3%.”  -Ting Lu (陆挺), Ph.D., CFA (Bank of America – Merrill Lynch)

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Money Supply Says No-Go to Inflation

June 1st, 2010 Michael McDonough Comments off

A precipitous decline in money supply could be choking the U.S.’s economic recovery, while supporting deflationary fears.  While the Fed no longer tracks M3, one of the broadest measures of the U.S. money supply, professional forecasters estimate the index has fallen 9.6% on an annualized basis from February through April; matching what was last seen during the Great Depression.  Looking at another broad measure of U.S. money supply, referred to as the St. Louis Fed’s MZM, which measures assets redeemable at par on demand, money supply has fallen 1.5% since the end of last year.  M2, a more popular measure of money supply, has remained positive, but diminished to a growth rate of 1.6% y/y from a peak of 10.1% in 2009. 

Professor Tim Congdon from International Monetary Research has called the trend in the M3 data ‘frightening’.  He also said, “The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US is not recovering properly.”  To put it simply, as long as banks remain hesitant or unable to lend inflation should remain tame in an environment of stunted economic growth.

Source: Fed

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Categories: Inflation, US Tags: ,

Pricing Pressure Building within the Depths of the PPI

May 18th, 2010 Michael McDonough Comments off

Rising producer prices eventually translate into higher consumer prices as businesses are forced to pass on a portion if not all of the price increments to their customers.  So what you might be asking, this morning’s PPI indicated that producer prices fell -0.1% on a monthly basis. While this is true the PPI is broken out into three sub-components crude, intermediate, and finished goods—the headline PPI only tracks finished goods.  As higher producer prices eventually pass-through to consumer prices; higher crude material costs ultimately impact intermediate good prices, while rising intermediate good prices in time increase the headline PPI.  As of April crude material rose roughly 30% y/y, while intermediate good prices climbed 9%, the highest reading since 2008 (See chart).   Core raw material prices rose 49.7% y/y–its largest yearly gain on record. While this isn’t an immediate recipe for higher consumer prices; it is definitely indicative that pressure is building in the pipeline. 

 

Source: Bloomberg

In terms of monetary policy, short-term inflation expectations as measured by the US TIPS breakeven curve have diminished significantly on waning commodity prices and a stronger dollar stemming from the ongoing crisis in Europe and concerns over Chinese tightening.  This will likely keep the Fed on hold through-out the remainder of the year as unemployment remains high and growth below what would be anticipated following a major recession.  Looking further ahead, inflation pressure is gaining some momentum and should become more of a factor in monetary policy decisions as the year progresses. 

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Categories: Inflation, US Tags: , ,

Short-Term Inflation Expectations Drop Like a Rock

May 14th, 2010 Michael McDonough Comments off

Rampant risk aversion, receding energy prices, and a USD rally have led to significant steepening in the short-end of the U.S. breakeven curve, with the potential for more to come ahead of next week’s CPI release (see chart).  So long as risks in Europe continue to escalate and CPI growth comes in at or below consensus on 5/19 the market could see further steepening in the breakeven curve as near-term inflation expectations continue to moderate.  The bottom line here is that if this trend continues inflation hawks may once again take a back seat, while deflation rhetoric creeps its way back into the market. 

 Breakeven Curve:

Source: Bloomberg

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Categories: Inflation, US Tags: , ,

China’s Tightening Tool Box…

March 12th, 2010 Michael McDonough Comments off

The wheels of tightening may be gaining momentum in China, after February’s higher than anticipated inflation release.  High inflation leading to negative real deposit rates may entice investors to withdraw deposits and invest in more speculative assets, potentially spurring what is arguably already a bubble in the country’s housing sector.  I believe that China has been avoiding an increase in its deposit rates, at least before tightening by the U.S. Fed, in order to avoid further spikes in hot-money inflows (from investors looking to take advantage of interest rate differentials and anticipated appreciation in the RMB).  But, China’s inflation may have passed a threshold forcing the government to act.

Chinese Consumer Prices on an Annual Basis:

Source: Bloomberg

So what does further tightening in China look like?  First off we will likely see China continue removing excess liquidity through open market operations, increasing the yields and issuance of PBOC paper.  As the chart below illustrates, China has already begun this process, but thus far has proven to not be enough.

China People’s Bank of China 1Y Reference Yield:

Source: Bloomberg

China will most likely continue raising its reserve required ratio (RRR), which they have already increased to 16.5% from 15.5% since the start of the year.  I expect the RRR will move to it’s historic high of 17.5% over the next several months.

Chinese RRR:

Source: Bloomberg

A recovery in Chinese exports and inflationary concerns should reignite a gradual appreciation in the RMB, which was suspended at the onset of the global financial crisis.  (For more on this please see my recent piece on the RMB NDF curve).

RMB/USD:

Source: Bloomberg

Finally, the coup de grâce in Chinese tightening will be any hike in the country’s reference deposit/lending rates.  This would be a clear indicator that Chinese authorities mean business, and the country’s tightening cycle is approaching full swing.  Many analysts suspect we could see a hike in this rate within the next three weeks. possibly as early as next week.  Reverberations from this move would be felt globally, especially in the material and global transport sectors.  Easy money and large increments in new lending spurred almost insatiable demand from the country for raw materials for both final use and speculative purchases.  But, let us not forget, despite creating short-term volatility, these moves are necessary to guarantee China’s future economic growth.  Therefore, China’s tightening cycle will likely lead to quite a few buying opportunities both inside and outside of the country going into the future.

Chinese 1Y Deposit Rate vs. Fed Funds Target:

Source: Bloomberg

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When Will the FOMC Turn From Dove to Hawk? Don’t Hold Your Breath…

September 3rd, 2009 Michael McDonough Comments off

Recently, concerns have been mounting over whether or not the Fed may need to consider a more hawkish stance over potential inflationary pressure.  Increments over the past several days in the price indices for both the Manufacturing ISM and Non-Manufacturing ISM have only exacerbated these worries.  To help quantify this situation I dusted off the old Taylor Rule, and constructed several scenarios, that could lead to an increment in the FOMC’s target rate.

For those of you unfamiliar with the Taylor rule, it is a tool used to estimate where the FOMC’s target rate should stand based on inflation and economic growth.  However, in my model instead of using actual GDP against potential GDP, I used the actual unemployment rate versus the non-accelerating inflation rate of unemployment or NAIRU; for this analysis I estimated NAIRU  at 4.5%. For the inflation component I used Core-PCE against the lower end of the Fed’s inflation threshold of 2.0%.   As you can see from the chart below, the model has quite accurately estimated the Fed Funds rate since 1990.

Source: St. Louis Fed

Source: St. Louis Fed

Source: My Calculations & St. Louis Fed

Source: My Calculations & St. Louis Fed

Presently, my model indicates the FOMC’s target rate should stand at -2.1%, which is more or less in-line with the Fed’s present range of 0% to 0.25% in addition to steps toward ‘quantitative easing’.  But, what type of scenarios could  place pressure on the Fed’s dovish stance?  First, lets start off with a highly unlikely scenario, leaving the Core-PCE constant, the unemployment rate would need to fall below 7.0% before my modified Taylor rule would indicate a Fed Funds Rate above 0.0%.  Alternatively, leaving unemployment constant at 9.4%, the model indicates Core-PCE would need to exceed 2.6% just to move the estimated target rate above 0%.  A more likely scenario would be an increase in the unemployment rate to 10%, which would place negative pressure on rates, coupled with a marginal increase in the PCE to 1.8%.  Using these inputs, my model signals a target rate of -2.2%.

What does this mean?  Given the current US macro-economic outlook it is very unlikely we will see any pressure on the Fed Fund target rate.  But, if there is a sharp unanticipated increments in core-PCE, there is a possibility the Fed could react regardless of the rule. The Fed is well aware of the damages prolonged excessive inflation–or deflation–could have on the US economy, and will react pro-actively to stem that risk .  Nevertheless, it is important to keep in mind that the Fed has a dual mandate to assure price stability and full employment.  Therefore, it is hard to believe the Fed would consider any deviations to its current policy while the country is experiencing rising unemployment, except in the most dire of circumstances.

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