Posts filed under “Commodities”
Tons of talk and pixels being spilled over the imminent inflation threat. It bears an eerie resemblance to what we heard from the likes of Jerry Bowyer and Art Laffer two years ago. I’d fade it now, exactly as I suggested back then (here and here, the latter piece co-authored with Bonddad):
Exhibit A — The Chicago Fed National Activity Index (PDF)
When the CFNAI-MA3 value moves above +0.70 more than two years into an economic expansion, there is an increasing likelihood that a period of sustained increasing inflation has begun.
Current read of CFNAI-MA3: +0.11, and that with three of the four subcomponents doing the heavy lifting while one — Consumption & Housing — remains mired near multi-year lows and shows no signs of recovering any time soon. We might actually get a good call out of Bowyer or Laffer before we get to +0.70 on CFNAI-3MA — it’s gonna be a while.
Exhibit B — The Money Multiplier — all that heavy breathing about the flood of liquidity that was going to pour into the system. Hyper-inflation! Except not so much, apparently. As David Rosenberg (who was spot-on in his assessment of the last bogus inflation scare) put it in his Monday note:
Fully 100% of both QEs by the Fed merely was new money printing that ended up sitting idly on commercial bank balance sheets. Money velocity and the money multiplier are stagnant at best.
Those who still think the credit spigots are going to open any moment now, consider this: We know that consumer credit, ex-student loans, is still contracting. And we know from National Federation of Independent Business that “the vast majority of small businesses (93 percent) reported that all their credit needs were met or that they were not interested in borrowing.”
Exhibit C — This remarkable chart that I’ve cribbed from Minyanville, though the original source is Bloomberg. What happens if there’s no QE3?
(The chart above was really a stunner.)
Exhibits D and E
Two more reasons with a couple of homemade charts: Inflation has a very high correlation to the labor market. Indeed, the roots of inflation are generally found in higher labor costs. We are just not seeing upward pressure on labor costs — there is simply still too much slack in the system and the Unemployment Rate is too high. Unit Labor Costs and CPI sport a high +0.88 correlation:
The Fed is on the record with their assessment that any bout of inflation will be “transitory.” I concur, as does this new Chicago Fed paper, and our old friend David Rosenberg (last week):
The key to the outlook for inflation is not commodities — it is the labour market. We have a situation where wages in nominal terms are running at +1.7% on a year-over-year rate and productivity is running at +2.0%. So we have unit labor costs fractionally deflating as they have been consistently since 2009 Q1. Go back to the 1970s, and guess how many quarters unit labor costs deflated? Try none. By the end of the 1970s, unit labor costs had surged at nearly a 7% annual rate for the decade as a whole; not sub-zero as is the case today.
And the last word to Rosie (from Monday’s note):
And it remains a legitimate question as to how we end up with inflation as credit contracts. Not just in the consumer and housing sectors, but in the government sector too. The state and local government sectors have dramatically cut back on bond issuance this year and are cancelling capital projects in the process. We see on the front page of the weekend WSJ this headline ― Inflation Drives a Shift in Markets and right above it is Deadline Drama Over Budget. Not only is household credit contracting, but the same is happening at the government level. This is deflationary, not inflationary, and once commodities settle down ― they are volatile and self-correcting as we have seen in the past ― all this talk of inflation is going to subside pretty quickly.
Finally, on a semi-related matter, the NY Times ran an interesting piece that follows up nicely on my recent post highlighting the growth in student loans.
A friend on an institutional desk writes tonight: Crude oil got crushed today with the May ’11 WTI contract trading below $109 per barrel as the stock market closed – and this after it traded above $113 for several hours Sunday evening. The IMF came out and slashed its 2011 GDP projections for the U.S….Read More
Most commodities remain deeply overvalued. As with other assets it does not really matter in the short-term (as long as the trend is positive) but it is paramount for longer-term projections. We have little doubts that commodity long-only who buy to hold are going to experience a >50% drawdown (from current levels) on their industrial…Read More
William C. Dudley, President and Chief Executive Officer
Remarks at New York University’s Stern School of Business, New York City
It is a pleasure to have the opportunity to speak here today. My remarks will focus primarily on two areas. First, what is the outlook for economic activity, employment and inflation? In particular, what are the areas of vulnerability that we should be most concerned about? Second, what does the outlook imply for monetary policy? As always, what I will say reflects my own views and opinions, not necessarily those of the Federal Open Market Committee (FOMC) or the Federal Reserve System.
In my talk, I’ll argue that the economic outlook has improved considerably. Despite this, we are still very far away from achieving our dual mandate of maximum sustainable employment and price stability. Faster progress toward these objectives would be very welcome and need not require an early change in the stance of monetary policy.
However, I’ll also focus on some issues with respect to inflation that will merit careful monitoring. In particular, 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.
Inflation expectations are well-anchored today and we intend to keep it that way. A sustained rise in medium-term inflation expectations would represent a threat to our price stability mandate and would not be tolerated.
Turning first to the economic outlook, the situation looks considerably brighter than six months ago. On the activity side, a wide range of indicators show a broadening and strengthening of demand and production. For example, on the demand side, real personal consumption expenditures rose at a 4.1 percent annual rate during the fourth quarter. This compares with only a 2.2 percent annual rate during the first three quarters of 2010
(Chart 1). Orders and production are following suit. For example, the Institute of Supply Management index of new orders for manufacturers climbed to 67.8 in January, the highest level since January of 2004 (Chart 2).
The revival in activity, in turn, has been accompanied by improving consumer and business confidence. For example, the University of Michigan consumer sentiment index rose to 77.5 in February, up from 68.9 six months earlier (Chart 3).
Indeed, the 2.8 percent annualized growth rate of real gross domestic product (GDP) in the fourth quarter may understate the economy’s forward momentum. That is because real GDP growth in the quarter was held back by a sharp slowing in the pace of inventory accumulation. The revival in demand, production and confidence strongly suggests that we may be much closer to establishing a virtuous circle in which rising demand generates more rapid income and employment growth, which in turn bolsters confidence and leads to further increases in spending. The only major missing piece of the puzzle is the absence of strong payroll employment growth. We will need to see sustained strong employment growth in order to be certain that this virtuous circle has become firmly established.
With respect to the labor market, there are conflicting signals. On one hand, the unemployment rate has fallen sharply over the past two months, dropping to 9.0 percent from 9.8 percent two months earlier (Chart 4). This is the biggest two-month drop in the unemployment rate since November of 1958. On the other hand, payroll employment gains have remained very modest—rising by only 83,000 per month over the last three months (Chart 5). Such modest payroll growth is not consistent with a sustained drop in the unemployment rate.
The true story doubtless lies somewhere in between—but probably more on the side of the household survey that tracks unemployment. That is because measured payroll employment growth in January was probably temporarily depressed by unusually bad winter weather. Although some of the recent decline in unemployment is due to a drop in the number of people actively seeking work, the household survey does show a pick-up in hiring. Other labor market indicators, such as initial claims and the employment components of the ISM surveys for manufacturing and nonmanufacturing, have also shown improvement recently
(Chart 6 and Chart 7), which suggests that the weakness in payroll growth is the outlier.
Although there is uncertainty over the timing and speed of the labor market recovery, I do expect that payroll employment growth will increase considerably more rapidly in the coming months. We should welcome this. A substantial pickup is needed. Even if we were to generate growth of 300,000 jobs per month, we would still likely have considerable slack in the labor market at the end of 2012.
In monitoring employment trends, we also need to recognize that the data are likely to be quite noisy on a month-to-month basis. This is particularly the case during the winter months, when weather can play an important role. Recall, for example, the aftermath of the blizzard of 1996 in the Northeast when the February payroll employment count was originally reported as rising by 705,000 workers. It will be important not to overreact to monthly data but to focus on the underlying trend.
So why is the economy finally showing more signs of life? In my view, the improvement reflects three developments. First, household and financial institution balance sheets continue to improve. On the household side, the saving rate, which moved up sharply in 2008 and 2009, appears to have stabilized in the 5 percent to 6 percent range. Meanwhile, debt service burdens have fallen sharply to levels that prevailed during the mid-1990s. Debt service has been pushed lower by a combination of debt repayment, refinancing at lower interest rates and debt write-offs (Chart 8). Financial institutions have strengthened their balance sheets by retaining earnings and by issuing equity. For many larger institutions, a release of loan loss reserves has been important in supporting earnings. Credit availability has improved somewhat as very tight standards start to loosen (Chart 9). As a result, some measures of bank credit are beginning to expand again
Second, monetary policy and fiscal policy have provided support to the recovery. On the monetary policy side, the unusually low level of short-term interest rates and the Federal Reserve’s large-scale asset purchase programs (LSAPs) have fostered a sharp improvement in financial market conditions. Since August 2010, for example, when market participants began to anticipate that the Federal Reserve would initiate another LSAP, U.S. equity prices have risen sharply and credit spreads have narrowed (Chart 11 and Chart 12). Long-term interest rates have moved higher after initially declining, but this does not appear troublesome as it primarily reflects the brightening economic outlook.
On the fiscal side, the economy has been supported by the shift in policy toward near-term accommodation. In particular, the temporary reduction in payroll taxes is providing substantial support to real disposable income and consumption. This could have a particularly strong impact on growth during the first part of the year.
Third, growth abroad—especially among emerging market economies—has been strong and this has led to an increase in the demand for U.S.-made goods and services. Over the four quarters of 2010 real exports rose 9.2 percent (Chart 13). After a disappointing performance earlier in the year, U.S. net exports surged in the fourth quarter (Chart 14).
The firming in economic activity, in short, is due both to natural healing and past and present policy support.
In this regard, it important to emphasize that we did expect growth to strengthen. We provided additional monetary policy stimulus via the asset purchase program in order to help ensure the recovery did regain momentum. A stronger recovery with more rapid progress toward our dual mandate objectives is what we have been seeking. This is welcome and not a reason to reverse course.
We also have to be careful not to be overly optimistic about the growth outlook. The coast is not completely clear—the healing process in the aftermath of the crisis takes time and there are still several areas of vulnerability and weakness. In particular, housing activity remains unusually weak and home prices have begun to soften again in many parts of the country (Chart 15 and
Chart 16). State and local government finances remain under stress, and this is likely to lead to further fiscal consolidation and job losses in this sector that will offset at least a part of the federal fiscal stimulus (Chart 17). And we cannot rule out the possibility of further shocks from abroad, whether in the form of stress in sovereign debt markets or geopolitical events. Higher oil prices act as a tax on disposable income, and the situation in the Middle East remains uncertain and dynamic. Also, we cannot ignore the risks stemming from the longer-term fiscal challenges that we face in the United States.
But in the near-term, the most immediate domestic problems may recede rather than become more prevalent. On the housing side, stronger employment growth should lead to increased household formation, which should provide more support to housing demand. And anxieties about the large overhang of unsold homes represented by the foreclosure pipeline may overstate the magnitude of the excess supply of housing. Families that have lost their homes through foreclosures are likely to seek new homes as their income permits, even though many may re-enter the housing market as renters rather than buyers. On the state and local side, a rising economy should boost sales and income tax revenue and help narrow near-term fiscal shortfalls.1
Moreover, although we do need to remain ever-watchful for signs that low interest rates could foster a buildup of financial excesses or bubbles that might pose a medium-term risk to both full employment and price stability, risk premia on U.S. financial assets do not appear unduly compressed at this juncture.
On the inflation side of the ledger, there are some signs that core inflation is now stabilizing. However, both headline and core inflation remain below levels consistent with our dual mandate objectives—which most members of the FOMC consider to be 2 percent or a bit less on the personal consumption expenditures (PCE) measure.
Recent evidence shows that the large amount of slack in the economy has contributed to disinflation over the past couple of years. This can be seen in the steady decline in core inflation between mid-2008 and the end of 2010. As shown in Chart 18, core PCE inflation in December had risen at just 0.7 percent on a year-over-year basis, down from 2.5 percent in mid-2008. Slack in our economy is still very large, and this will continue to be a factor that acts to dampen price pressures.
Nevertheless, there are several reasons why we need to be careful about inflation even in an environment of ample spare capacity. First, commodity prices have been rising rapidly (Chart 19). This has already increased headline inflation relative to core inflation, and the commodity price changes that have already taken place will almost certainly continue to push the headline rate on year-over-year basis higher over the next few months. Second, some of this pressure could feed into core inflation. Third, medium-term inflation expectations have recently risen back to levels consistent with our dual mandate objectives (Chart 20). If medium-term inflation expectations were to move significantly higher from here on a sustained basis, that would pose a risk to inflation and, thus, would have important implications for monetary policy.
> Take a look at the chart above constructed from the Bureau of Labor and Statistics 2009 Consumer Expenditure Survey. It conveys a sense of how Egypt’s poverty combined with the sharp rise in food prices sparked the political revolt against the Mubarek government. The chart illustrates how the lower income groups in the U.S….Read More
The WSJ has an article today looking at the ending of highly correlated asset classes. It seems that Equities are no longer correlated to the US Dollar and Gold as closely as they have been over the past 2 years. If history holds, this is positive for both the economy and markets longer term. It…Read More
MacroMan points out that Live Cattle Futures have gone parabolic; Daniel Dicker blames speculative derivative traders and a lack of oversight as the cause. I have no idea what is the underlying driver, but we are now at record prices for Live Cattle Futures — will Beef soon follow? > Source: Global Macro Monitor
I find I enjoy analyzing equity markets more than any other. But as I have always said, you must always be objective when reviewing the data. And what does that data show? Stocks have not been the best performing asset class over the past 40 years. Outperformed not just by Oil and Gold, but Bonds…Read More
We haven’t looked at Baltic Dry Index in a while – Despite the high CRB Index, the BDI has not managed to rally much off its post crisis lows. The reason for this: Massive over-building of new bulk transport ships. Here’s Bloomberg: “At a time when analysts anticipate record profits for the biggest mining companies…Read More