CurryBlog

Investor education

2005-02-08T21:27:00.000+01:00

Read this. Thank you.

Understatement of the year?

2005-02-07T22:49:00.000+01:00

A look at the calendar shows me that we're only in February but Federal Reserve Board Governor Edward Gramlich is already stepping up to the plate to swing for a home run in the understatement of the year award. Here he goes (via Reuters):

The one thing that I think is a little bit of a worry is that if you look at the share of output that the U.S. economy devotes to building up the future -- that share is called the nation's saving rate -- that's on the low side

Wow. How nice of someone from the Fed to explain things in terms even I can follow. But wait, there's more - he also explains vendor financing asian style:

In effect, Japan and China are printing money, buying Treasury securities and building up huge hoards -- they're over $2 trillion, which is a very large share of our debt and keeping the dollar strong and their own currency weak

Yeah, that's cool, gimme more Ed, don't stop

This really hasn't happened before to this degree in the history of world capital markets

But Ed, please tell me: how long will this keep going on? I can just see you, you manly man, grasping the tiller of monetary policy firmly in your gnarled hand - you turn to me with alook of utter confidence on your face and say:

We don't know how long it can last or how long it will last.

Oh. OK then. Sorry for asking. Let's change tack here: Ed, what do you think about the Fed's monetary policy - I mean, what's your opinion on the pace of tightening?

I stand by that. I voted for it, so it must be what I think.

Oh my.

Jobs?

2005-02-04T16:58:00.000+01:00

The first Friday of every month brings us the start of a weekend and jobs data. I was looking forward to both as an exceptional amount of work has forced me to keep my head down wrt real life. The weekend will bring me a brief respite from an insane workload.

The jobs data was not that amusing. Payrolls rose by 146k in January - this was nicely below the 200k consensus and caused the rolling 3m average to drop further away from the highs seen last year.

The unemployment rate managed a fall thanks to decreasing labor force participation an gains in hourly wages were very slim.

This is more of the sort of not-too-hot, not-too-cool news we've been getting over the past weeks. In particular it won't force the Fed to do anything radical - they'll continue to tighten at a measured pace (as they reiterated a couple of days ago) while the economy will continue to muddle through the proverbial soft patch.

What really bothers me is that I can't shake the feeling that we're experiencing a collective Wile E. Coyote moment in which Wile runs a while on thin air before realizing that gravity still works. In other words: it might just be that the economy is just running on momentum. Any decline in - say - manufacturing employment and/or (perish the thought) consumer spending might just kick-start the laws of Newton. If this should happen we should be prepared for the Fed to change tack pretty quickly.

Fed watching

2005-01-31T20:28:00.000+01:00

This week will see another FOMC meeting which will most probably provide us with another 25bp hike and some much watched language regarding this august conclaves further intentions.

The thing many people will be looking for is if the "measured pace" statement remains in place. Markets are generally looking for the Fed to hike up to 3,5% by year-end. This should put us somewhere near the (cough) neutral Fed Funds rate. So does the Fed need to change the verbiage it puts out? Is there still fear out there that the FOMC will hike quickly? If there isn't we should ask ourselves if the Fed needs to retain a qualitative phrase such as "measured pace" in lieu of more neutral and - quantitative - wording.

The economic backdrop against which the Fed is working is - at least to this commentator - pretty murky. I'm pretty sure that we'll see robust, but below consensus, growth this year. Before you ask: no, I don't really see inflation popping up from behind a rock somewhere.

So having said that I would conclude that Fed watching will be fun this time around as we look at how the Fed communicates a rate hike which we just "know" will come. More fun will be had in the middle of February, when Alan Greenspan testifies before the House and Senate.

Intense Workload

2005-01-26T20:18:00.000+01:00

Lots of pressure at work - so sorry for my not posting. Will try to put something up tomorrow. There's an offsite on Friday so no posting there.

Command economy anyone?

2005-01-25T13:41:00.000+01:00

Overnight news from China showed that economic growth continued at a fast pace in Q4. 9.5% GDP growth is high enough to give most other policy makers a bleeding nose.

The fascinating thing about this number was that it was accompanied by another number which was much more subdued. Inflation came in at a very modest 2.4%. A look at the numbers shows that the governments cooling activities seem to be paying off. Exports and consumer demand were very robust while investment in fixed assets was slightly lower.

This data makes me more confident that China is indeed managing a soft landing and has started to contain inflationary pressure. I believe (and this is not the consensus view) that Chinese inflation will come in below the 5% rate that we saw last year and which gave rise to much angst about the further economic perspectives for China. So in all this is good news for people playing the China story via commodities and commodity linked currencies.

Inflation?

2005-01-21T16:52:00.000+01:00

Many people spent large amounts of time last year worrying about inflation. I can remember reading lots of posts and "serious" analysis in the mainstream media which went on about the dangers of inflation. The hike in oil prices was seen as one of the proverbial horsemen of the apocalypse and people had serious arguments about the validity of looking at core vs. headline inflation.

If I look around right now I can't really say that anything much has happened. Inflation is still subdued - the headline number actually managed a little fall a couple of days ago. Economic growth, high energy prices and the seemingly insatiable Asian demand for commodities hasn't yet caused a massive inflationary push.

This is one of the reasons that I am more than a little skeptical about the future performance of the US economy. A whole host of leading indicators is pointing towards a slowdown which should/could occur any time now. If the Fed continues to tighten while the economy is decelerating we should stop worrying about inflation right now.

One person isn't worrying about inflation - Mr. Market has consistently revised his inflation expectations downwards over the past couple of months - and I for one trust his wisdom.

Sunrise

2005-01-20T09:24:00.000+01:00

Here I am sitting in the 30th floor of an office building in one of Europe's financial centers looking out into the semi-darkness of the morning. As always the screens in front of me provide me with my daily ration of economic news.

A look back at yesterday shows me that the US (core) CPI rose at 0.2% which is exactly the number that came in the past two months. This makes for an annualised rise of core inflation of 2.0% in Q4 2004. This ist well down from the numbers we saw in Q1 and Q2 2004. Year on year core inflation was steady at 2.2%.

The headline CPI number was actually down 0.1% because of lower energy costs in December (which sounds better than saying "the cost of energy rose by almost 20% in 2004 and declined slightly in December"). In all I believe that inflation pressure will remain low over the coming quarters. This allow the Fed to rexeamine further rate hikes sometime in the spring.

Long time readers of this blog will know that I'm not convinced that the pace of US economic expansion is sustainable. In fact, I'm pretty convinced that the soft patch we saw in the second half of 2004 will continue into Q1 2005. I do have to admit that this negative view was somewhat off the mark - I was expecting that the Fed would stop hiking by the end of the year.

Currency afficionados (and lots of other people) will look at what President Bush says in today's inaugural address. Any claim that his administration will "cut the deficit in half" will probably move markets for about 25 seconds or until people start thinking about what this will entail.

What email can do...

2005-01-19T13:43:00.000+01:00

David Tufte turned an email exchange we had a short while ago into a thoughtful post on constraints and lifestyles.

TICing up

2005-01-19T13:32:00.000+01:00

The November TIC data (aka foreign cash infusion) came in above the $70bn I was looking for in my last post. The final talley was $81bn which gave the US currency a brief respite. Most of the inflow was due to higher purchases of US fixed income assets. Most of this comes from our friends, the Asian central banks who continue to throw money after the sinking dollar for their own selfish reasons. Not much other news - the number the market is looking at today is the CPI which will be out at 13.30 GMT.

Monday Morning

2005-01-17T13:38:00.000+01:00

The Japanese finance minister Sadakazu Tanigaki started verbally shifting Japan back into intervention mode by saying things like:

"We will take decisive action if foreign exchange rates fail to move in such a way [Foreign exchange rates should move in a stable manner and reflect fundamentals of economies]"

In a not so veiled reference to the (cough) imbalances in the US economy he also went on record thusly

Tanigaki said each country's efforts to overhaul their economies should be the main tools to rectify global imbalances, rather than adjusting foreign exchange levels

Which is kind of funny if you look at what Japan has been doing over the past couple of years - persih the thought that they "adjusted" the value of their currency.

Speaking of currency: Tuesday will see the release of Treasury TIC data for the US which will show us how high portfolio inflows were into the US in November. This number has been looking weaker of the past couple of months in tune with the declining US currency. Let us all hope that the November Number nudges up to something around $70bn. Anything arount the $50bn we saw before could be very dollar bearish.

Great Cartoon

2005-01-14T21:35:00.000+01:00

Great cartoon!

Read this

2005-01-14T20:57:00.000+01:00

Pimco's Paul McCulley does an excellent job of Fed watching (as always). He also manages to explain the mechanism by which the Fed massages the economy in a way that is so persusasive that anyone will "get it" quicker than I can write "transmission mechanism".

Hey Amigo, Want Some Tequila?

2005-01-14T20:47:00.000+01:00

I was talking to a colleague a couple of days ago and he very nonchalantly compared the current situation in the US economy to the Asian currency crisis back in 1997. I was just about to say something along the lines of "come on, this is completely different" when it hit me: it isn't all that different.

We are looking at a country which threw open the sluice gates of easy money and which was kept afloat by misguided foreign investors who were intoxicated by a growth story which was actually mostly driven by their hunger for domestic assets.

This kind of situation goes on until someone wakes up and smells the coffee. This is what essentially took place in Mexico ("the tequila crisis") and Asia. Could the US be next? Probably not - the Fed chief and quite a few other officials have taken it upon themselves to talk down the dollar so that it can fall in a dignified way instead of just collapsing. At the risk of sounding callous: this is like surfing just in front of a tsunami.

If this particular surfer bails, the answer to the question in this post's title might just be: "No thanks, I'll have a Bud!".

Long time no see...

2005-01-06T21:44:00.000+01:00

Switched Jobs
Moved
No time at all
@ home internet access back as of yesterday
Looking forward to blogging again...

Quick Note

2004-10-08T13:26:00.000+02:00

Work ate into most of my blogging time this week. I hope that regular service will resume as soon as possible.

Expensive oil? No way!

2004-10-04T13:56:00.000+02:00

Markets are all about expectations - you buy stuff which you think will increase in value and sell stuff which you think will lose value. This basic rule holds true in the real economy as well - if a purchasing manager thinks that some vital resource is going to get more expensive, he might just buy more than he needs at today's price to hedge against rising prices in the future.

If we follow this line of reasoning we might just assume that sales of gas-guzzling SUVs would decline if people thought that high gas and oil prices are here to stay. This is not the case

General Motors Corp said its September sales jumped 25per cent, boosted by strong demand for its pick-ups and sport-utility vehicles.
[...]
GM said on Friday it sold 458,799 cars and trucks last month. GM's light-truck sales surged 38per cent to 283,161, while car sales edged up to 171,670. Third-quarter sales rose to 1.3million, up 2per cent.
GM, which has been aggressive with its sales incentives, said full-size pick-ups and SUVs both set industry sales records, led by Chevrolet and GMC Sierra trucks.

Consumers are looking at aggressive rebating on the one side and high gasoline prices on the other - the rebates seem to be winning. Time will tell who made the right call here. I guess most car buyers think that oil is going through an expensive phase right now which will normalize over the next couple of months. Otherwise today's cheap car might turn out to be really expensive a few months down the road.

Active vs. Passive

2004-10-01T16:40:00.000+02:00

One of the things that keeps me wondering is why people actually spend so much time discussing why active management is better or worse than passive management. The Hypertextual Financial Glossary tells us that

Active portfolio strategy
A strategy that uses available information and forecasting techniques to seek better performance than a buy and hold portfolio.

and

Passive portfolio strategy
A strategy that involves minimal expectational input, and instead relies on diversification to match the performance of some market index. A passive strategy assumes that the marketplace will reflect all available information in the price paid for securities, and therefore, does not attempt to find mispriced securities.

The great bull run (remember that?) led quite a few investors to conclude that passive management was the way to go - most active managers didn't manage to add any value, so why should the average Joe pay them anything? Much better to just ride the index up.

Needless to say: the investment empire stuck back during the past years. Passive investors learned that tracking an index means tracking up and down. Guess what also transpired - actively managed funds came right back into the spotlight.

I personally think that the entire discussion "active vs. passive" is flawed. I would contend that investment is work - i.e. decisions have to be made. The questions that you should be asking are:
a) Am I knowledgable enough to make these decisions myself?
b) What do I want to achieve?
c) Do I have time to implement and monitor my investment strategy?
d) What instruments am I going to use to implement my strategy?
Now most non-institutional investors will probably want to attain an asymetric return profile - i.e. avoid losses and participate in the upside. This kind of strategy is very difficult to attain via passive means as passive investing is about as far away from absolute return investing as you can get. So anyone who wants to avoid losses will not be able to do so without a modicum of activity.

Even someone who doesn't care about absolute returns and uses passive (index tracking) instruments to achieve his goals will not be able to implement pure buy-and-hold. There will have to be some measure of rebalancing over the years.

Investing requires at least some input from the investor. Period.

PMI again

2004-09-30T18:36:00.000+02:00

The Chicago Purchasing Managers Index (pdf!) came out today at a better than expected 61.3. Although the number is better than expected it is still below the average level seen during the beginning of this year.

The employment figure came in at 53.9 which constitutes a recovery from the lows seen in July. Inventories were up (same as new orders) while production was lower. In all this just looks to me as if the current muddle-through phase is still in place.

Now we wait for the ISM which is much less volatile than the Chicago PMI and then we wait for payrolls next week...

Gross on the CPI

2004-09-30T18:28:00.000+02:00

I have a great suggestion for all of you out there who think that the CPI is a sham: go over to Pimco's website and read Bill Gross' latest commentary.

The King of Bonds provides his readers with an industrial strength smackdown of hedonic adjustment. Some extracts follow

Talk about a con job! The government says that if the quality of a product got better over the last 12 months that it didn't really go up in price and in fact it may have actually gone down! Why, we could be back to Bernanke deflation real soon if the government would quality adjust enough products.
[...]
Similarly, government statisticians manipulate the price increases for cars and just about any durable good that comes off an assembly line but find it difficult to extend that theory to underwear or a pair of shoes. Perhaps that’s next.

A glass half full

2004-09-29T11:54:00.000+02:00

Remember the old adage about an optimist saying that a glass is half full while the pessimist says it is half empty? Something similar is happening with official attitudes to the US currency.

The strong dollar policy of the past has been tacitly abandoned over the past two years. While nobody has come out in defense of the greenback, officials have also refrained from loudly touting the benefits of a soggy currency.

It looks as if this is slowly changing. Letting the dollar gradually fade against other currencies could do wonders to help trim the current account deficit - that is a subject I wrote about a couple of days ago. Now the Federal Reserve Bank of Kansas President Thomas Hoenig is making the same kinds of noises

The dollar fell against the yen in Asia after Federal Reserve Bank of Kansas President Thomas Hoenig said a lower dollar "helped" with the U.S. trade deficit and that the news on inflation is "good."

This comes after the opening salvo fired by Fed Governor Susan Bies saying that

[T]he exchange rate is going to have to adjust just because we are running a current account deficit of 5 percent of gross domestic product, which is very large.

A fading dollar would of course reduce the current account deficit by making imports more expensive. The only problem with this kind of nifty solution would be that a dearth of cheap imports may just be the straw that breaks the consumers back. Stagnating wages, high(ish) energy costs (which a falling dollar won't solve) and more expensive doodads from China may just be the thing that causes the man and woman on the street to reconsider his financial health.

A weak currency does have one large advantage: an administration can always shift blame for it on the market. One thing remains burned into my cortex: the balancing act the Fed is trying to pull off is getting ever more difficult. They are juggling "soft patch" rhetoric whilst walking a tightrope over the valley of dollar collapse.

One last thought on our headline: the engineer says that the glass is twice as large as it needs to be.

A wave of warnings?

2004-09-28T13:55:00.000+02:00

While the Fed is still toeing the party line regarding the longevity of the recovery ("just a soft patch") a couple of influential market players are sounding the alarm klaxons. It looks as if Merrill Lynch put out a note warning investors to expect a Tsunami of earnings warnings. This is pretty consistent with my view that equity markets have been bid up so far as to be priced for perfection. Alas the picture is developing a few flaws and these are finding their way into the market.

Oil again

2004-09-28T13:29:00.000+02:00

Fighting in Nigeria caused oil to break through the "psychologically" important USD 50 level. This actually means - well - not much. Oil would have to rise to something like USD 80 to come near the historical highs in real terms.

Obscene Interest Rates?

2004-09-27T13:45:00.000+02:00

The Washington Post has a short primer on what the neutral Fed Funds rate is. You can find the article here (registration needed). The two most important points are reproduced below (italics mine)

The level at which the Federal Reserve's federal funds rate, the overnight rate charged between banks, neither stimulates nor slows economic growth.
A number that Fed Chairman Alan Greenspan has declined to specify, saying, "When we arrive at neutral, we will know it."

This reminded me of another quote which was about a very different subject (italics mine)

In 1964, Justice Potter Stewart tried to explain "hard-core" pornography, or what is obscene, by saying, "I shall not today attempt further to define the kinds of material I understand to be embraced . . . [b]ut I know it when I see it . . . "
Quote from here or here for the case

Now is it just me or is the neutral Fed Funds rate somewhat akin to obscenity?

Postcard

2004-09-24T13:45:00.000+02:00

My newest Postcard from Old Europe is up over at Angry Bear's place.

It's risk Jim, but not as we know it!

2004-09-23T13:27:00.000+02:00

The past years have given rise to quite a few conceptions about investing that are now firmly embedded in the consciousness of investors. One of these is the implied assertion that "expected return" means that an investor with a life span shorter than Methuselah can actually expect the quoted return.

Another is that your investment advisor means the same thing you do when he uses the word "risk". Almost everyone has seen those nifty risk/return graphs where you can easily see how much return to expect and how much risk you are going to have to take. But what exactly is "risk"? Your financial advisor will tell you that risk

"...is the financial uncertainty that the actual return on an investment will be different from the expected return."

Finance-types distill this concept of risk into a single neat number called "volatility". To make things just a little more complicated, volatility is an alias for the standard deviation of returns. In other words

Simply put, the standard deviation tells us how far a typical member of a sample or population is from the mean value of that sample or population. A large standard deviation suggests that a typical member is far away from the mean. A small standard deviation suggests that members are clustered closely around the mean.

If we put this in an investing context we can say that an investment whose yearly returns don't really deviate from the average return is less risky than an investment whose returns fluctuate wildly from year to year.

This concept looks pretty sound - the only sad part is that this concept of risk doesn't bear much resemblance to what an investor might perceive risk to be. An investor will probably welcome returns that diverge from the mean to the upside. In other words: normal people will gladly bear the risk of outperforming the average return - "real" risk is usually interpreted as downside risk.

If we take this line of argument further, we can say that risk can be broadly defined like this

"Risk is the potential future harm that may arise from some present action."

This is much more in line with what an investor might think. Risk could be the potential future harm which comes from not having enough money to retire on at age 60. This takes risk away from "failing to achieve the mean return" to "the possibility for disaster".

What exactly constitutes risk can be an extremely idiosyncratic decision. Some people might define risk as "the risk of missing a good opportunity" or the "risk of my investments underperforming those of my golfing buddy". There is no nice "one size fits all" definition of risk out there. You have to find out what financial event would cause you distress - that answer will be different for different people. Once you've figured that out you can see what kind of statistical wizardry will help you quantify your gut feeling.

So the next time someone lays out risk in a nice mathematical parcel be sure to check if that is the kind of risk you can live with in practice. Don't just nod and say "nice graph" - ask your broker or advisor to explain exactly what those little dots mean. You might just find yourself re-examining your investment decisions.

Roundup

2004-09-23T13:17:00.000+02:00

The FOMC statement came in almost exactly as expected. The T-word (as in "traction") surfaced in a sentence which encapsulated the Fed's mindset:

After moderating earlier this year partly in response to the substantial rise in energy prices, output growth appears to have regained some traction, and labor market conditions have improved modestly.

The statement on policy accommodation ("will be removed at a measured pace") is unchanged so we should see another 25bp hike in November. The only thing that could derail this policy is massive weakness in payrolls over the next two months.

Against the backdrop of my worldview things work out like this: Barring a complete disaster we'll get another hike in November. The economy will continue to lose momentum until then, which will in turn lead the Fed to take a break from raising rates.

Here is the full statement with the changes highlighted:

The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 1-3/4 percent.

The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. After moderating earlier this year partly in response to the substantial rise in energy prices, output growth appears to have regained some traction, and labor market conditions have improved modestly. Despite the rise in energy prices, inflation and inflation expectations have eased in recent months.

The Committee perceives the upside and downside risks to the attainment of both sustainable growth and price stability for the next few quarters to be roughly equal. With underlying inflation expected to be relatively low, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.

FOMC day

2004-09-21T09:55:00.000+02:00

Meetings of the FOMC show typical market behavior. Everyone is virtually certain the Fed is going to hike by around 25 basis points. But virtually certain also means that there is some residual risk of the Fed doing something crazy out there. This in turn means that everyone will stayed glued to their screens to then watch the inevitable unfold.

The FOMC statement will probably echo the views that Fed policymakers have espoused for a while now. We should expect something upbeat about employment and/or growth.

All this discussion about rate hikes has not found its way into the bond market lately. The yield at the long end doesn't actually look as if that segment of the market is looking for much higher rates going forward. A series of articles has looked at why this might be the case (hint: foreign buying of US Treasuries...) - a quick summation can be found here.

Not much other data out today - we'll see the latest on housing starts and not much else.

Smart CFOs?

2004-09-17T14:01:00.000+02:00

A survey of CFOs has revealed that almost 60% of those asked think that the US economy is at risk of suffering lower growth in the next twelve months. You can read about the results here, but I'll just give you the gist in the following couple of paragraphs

Financial executives are concerned that the U.S. economic engine might become derailed," said John Graham, the director of the survey and a finance professor at Duke.
[...]
"Maybe Main Street knows something that Wall Street and the Fed have overlooked," said Campbell Harvey, the founder of the survey and a finance professor.

Speaking of Campbell Harvey, be sure to visit his homepage - it is a treasure trove of material including the world famouse online hypertext financial dictionary!

Postcard

2004-09-17T13:57:00.000+02:00

My newest Postcard from Old Europe is up over at Angry Bear's place. This week's column looks at the economic soft patch the US economy is in.

The good news - brought to you by the IMF

2004-09-16T13:06:00.000+02:00

The real good news is that the global financial system is stable and that the sky will not fall. At least the IMF is saying so. The IMF is actually using pretty upbeat language to describe the current state financial markets are in. They write

The financial system has not looked as resilient as it does in the summer of 2004 in the three years since the bursting of the equity bubble.
[...]
Short of a major and devastating geopolitical incident or a terrorist attack undermining consumer confidence, it is hard to see where systemic threats could come from in the short term.

This doesn't mean that its all smooth sailing ahead - the risks are still there - or as the IMF puts it

"Overall, when conditions are as benign as they are at the moment, the major risks - especially in the medium term - are on the downside."

The IMF report cites complacency via "indiscriminate risk behavior" or "chasing yield" as the main risk. Other bogeymen are rising US interest rates because of higher inflation and "current account imbalances".

The current account situation in the US is something that does concern me. I very much agree with the IMF when they state that

The sustainability of capital flows to the United States, however, remains a matter of concern. A sharp and disorderly decline of the dollar would, among other things, cause significant losses to many international institutions holding dollar assets or generating dollar income.

True. But the converse is true as well - a gradual depreciation of the US currency would help redress the current account situation and might therefore look like a very appealing policy option for the next US administration.

The US current account deficit is like a 600 pound gorilla on a diet of steroids. It is equal to around 5% of the economy and keeps getting bigger. The deficit is being funded mostly by foreigners as the population of the US prefers to blow ever larger portions of their stagnating incomes on consumption.

This behavior is being mirrored by the Federal government which is running a budget deficit amounting to around 5% of GDP. If the US government makes no efforts to address this situation it might just find that the worst case scenario described by the IMF comes to pass. A loss of confidence in the fiscal stability of the US spell disaster against the backdrop of a strong reliance on foreign capital inflows.

Three bits of data

2004-09-16T11:29:00.000+02:00

All eyes are firmly on the US again as today sees the release of the CPI (i.e. the inflation number), weekly initial claims and the Philly Fed index.

Speaking of which: Yesterday's NY Fed index painted looked pretty strong - the data on new orders and employment were pretty solid. We shouldn't get all that carried away though, the Empire State survey is notorious for its volatility. The markets didn't really respond to the data anyway - methinks that people are girding their collective loins for next weeks FOMC meeting.

Shifting worldview

2004-09-15T17:20:00.000+02:00

Today's industrial production data was pretty robust - albeit at the second glance. The headline number was slightly weaker than expected but the data on manufacturing output was pretty heartening. Capacity utilization in manufacturing was up by almost 4% and confirmed the strong numbers seen in past manufacturing surveys. This should leave us on track for two more pretty certain rate hikes going forward.

I still believe that the rate of expansion will moderate in the fourth quarter and that we'll end the year at a Fed Funds rate of two percent. My belief in a slowing rate of growth was somewhat supported by the NY Fed data out today. Although the Empire State survey came in at a higher level than last month, the data series is still off its highs which it reached earlier this year. This is the same behavior we've been seeing in diverse other (leading) indicators so I still stand by my opinion that growth in Q4 will be around one percentage point lower that in Q3.

The OPEC meeting didn't bring us any real news so the oil story today was that US crude oil stocks were down by around 7.1 million barrels vs. last week. Oil caught a bid and rose by around 70 cents on the back of this.

Data flow

2004-09-15T13:29:00.000+02:00

Markets are looking at two things today - the OPEC meeting and the NY Fed survey. The OPEC meeting is expected to result in a hike of supply quotas to the tune of one million barrels a day. Sounds like much? Well, no. In the arcane world of OPEC, quotas are not really quotas. Confused? Reuters explains

OPEC started meeting at 5 a.m. EDT to discuss a deal that will do little to change real supplies -- it is already pumping some two million bpd over existing limits of 26 million bpd.
[...]
Although OPEC is delivering near flat out, most ministers do not want to legitimize all they are pumping in formal supply quotas.
[...]
Delegates said keeping official allocations lower than actual supply would allow OPEC more flexibility to cut back quickly, without readjusting quotas, should prices suddenly fall.

In another bit of divergence Fed representatives keep talking about the economy regaining "traction" after navigating a "soft patch". Just too bad that the economy continues supplying us with data that says "momentum slowing!". The NY Fed survey will shed some more light on where the economy is going.

Stay tuned for more...

Food for thought

2004-09-14T16:24:00.000+02:00

Interesting article over at The Christian Science Monitor regarding asset allocation.

The author does a good job defining (modern) portfolio theory thusly

Essentially, portfolio theory holds that investors reap the greatest return with the least risk when they allocate their money among diverse classes of assets, hold them for the long term, and rebalance the portfolio when the various classes of assets stray too far from their original allocation.

To make it work, you need to own asset classes that don't move in lock step, make accurate estimates of their future returns, and use a very long time horizon. A miscalculation in even one of these steps, however, can seriously hurt the prospects for reaching your ultimate goal.

True. The point that I still find woefully underexposed in these kinds of definitions is that people keep telling investors to maximize the expected value of their investment strategy. I take issue with this kind of reasoning because most investors have a finite period to live. In other words: you probably won't get the mean return.

The average return is just a bit of mathematical fiction which tells you what you can expect to achieve if you repeat your strategy a large number of times. Problem is that you don't have a large number of attempts. If your 30-year strategy doesn't pan out nobody gives you a second chance! That is why I keep saying that it is much better to maximize the modal return - i.e. the most commonly occurring return. You are much more likely to actually realize this value.

The article goes on to challenge conventional investing wisdom by asking questions such as "Should you own stocks at all?" and "Is buy and hold the way to go?". The answer is obviously "yes" to both questions if you happen to have the secret to immortality in your kitchen cupboard. In other cases you might do better with a much more conservative and/or active strategy.

Oil Update

2004-09-13T09:58:00.000+02:00

The oil price has come off of the levels we saw just one or two weeks ago leaving many people perplexed by the reasons for the hike. Is it supply-driven? Is it fear-driven? Is it just pure speculation?

The Bank for International Settlements has a very readable publication called which goes by the name of "BIS Quarterly Review: International Banking and Financial Market Developments". The current issue (linked above) looks at the speculative component of the oil price movements. The article looks at the CFTC data and thereby spares us the rather dull job of going through those numbers ourselves. In case you really want to look at the raw material, go here.

The BIS researchers find that (italics mine)

Open positions in crude oil futures - contracts entered into but not yet offset by a reversing trade or delivery - increased by more than 25% over the first eight months of 2004. Positions held by non-commercial traders increased to 37% of all open long positions on average over this period, up from 32% in 2003. By contrast, non-commercial traders' share of open short positions was on average down slightly from 2003. Changes in non-commercial traders' net long position - open long positions less open short positions - have tended to coincide with changes in the oil price. In fact, the correlation between weekly changes in oil prices and weekly changes in non-commercial traders' net long positions was close to 0.8 over the first eight months of 2004.

OK, looks like we have ~~fools~~ investors jumping in and out of the market based on momentum. Nothing new there. The only problem is that this still doesn't tell us all that much. The increase in speculative activity (defined as positions held be non-commercial traders) isn't large enough to convince me that that is the whole story. The economists at BIS come to the same conclusion and write

However, it is also possible that shifts in activity in the futures market were driven by changing perceptions of fundamental imbalances in the supply of and demand for oil, including the changing perceptions of commercial traders.

CotC

2004-09-13T09:43:00.000+02:00

If you're looking for something to sink your teeth into at the start of this week you just have to breeze by d-42 and sample this week's Carnival of the Capitalists.

Next week will see one of my favorite blogs, voluntaryXchange, host the Carnival.

Overnight news

2004-09-10T10:41:00.000+02:00

I've posted in some detail on the subject of the trade deficit (here or here) and I'm pleased to report that raw material for new musings will be released today. We should see some sort of rebound after last month's record low but I'm pretty sure that will still see something in the range of -$53bn.

Not much in the way of overnight news. The Bush administration has said no to calls to punish China for pegging its currency to the USD. As there is an election coming up the challenger has to weigh in on the subject.

Democratic presidential nominee John Kerry criticized the Bush administration for rejecting the petition just hours after it was filed at the U.S. Trade Representative's office. He accused President George W. Bush of leading the United States "in the wrong direction" by failing to enforce trade agreements and protect manufacturing jobs.

"As president, I would take America in the right direction -- acting vigorously to end China's illegal currency manipulation without tying one hand behind my back and taking potential options off the table," Kerry said in a statement.

Maybe someone can enlighten me as to how he would accomplish this without hurting the domestic economy? High taxes on Chinese imports? The answer is of course "yes"

The group's petition argued the yuan was undervalued by about 40 percent, which they said acted like an illegal export subsidy. If the United States won a case on that issue at the WTO and China refused to comply, it would open the door for Washington to slap 40 percent tariffs on Chinese goods.

Great idea - I'm sure that his constituents would love to pay through their collective noses for US-made doodads. Oh my.

New Postcard

2004-09-10T10:39:00.000+02:00

My weekly column is up over at Angry Bear's Blog.

The last line of defense...

2004-09-09T09:26:00.000+02:00

Planning for retirement usually rests on three pillars - whatever the government pays you, the pension you receive from your employer and your nest egg. Social security won't be enough for those people who have been working at good jobs and have become used to a high standard of living. Continuing budget deficits might also lead future administrations to increase taxes or lower benefits (...or to fund the system with more debt which would then probably erode benefits via higher inflation).

The record low in the US national savings rate doesn't bode well for the prospects of drawing down savings in the future. The lackluster performance of equity markets has been somewhat camouflaged by the strength in some housing markets so that the balance sheets of households probably don't look all that bad. The only problem is that a home is something rather illiquid and valuation is often quite tricky. You can't just sell the garage to finance your next cruise either. The concept that saving today means consuming more tomorrow seems to be defunct in a culture with EZ credit terms. Consumers demand instant gratification - who cares what happens tomorrow!

That leaves us with pensions. Sadly this last line of defense is creaking at the seams. Company's pension plans are often woefully underfunded and the Pension Benefit Guaranty Corp. is already running a deficit of about $2bn a year. And anyway, the guarantee provided by the PBG isn't all that great - plans which get taken over usually reduce payouts and slash other benefits such as medical insurance. The story here is much the same as with social security - either raise the amount paid in today or reduce the amount promised tomorrow.

The problem here is that higher funding of plans would divert huge amounts of a company's cash flow into the plan today. This is bad news for shareholders as the company is at that point being run for the benefit of current and future pensioners.

As always, something has got to give. I believe that the weakest link is the savings rate. If the current expansion slows markedly and we continue to be confronted with high geopolitical uncertainty and high energy prices we just might see a cultural shift at the consumer level. Ostentatious consumption might just slink out the back door over the next couple of years as consumers slowly retrench and start to build up their nest eggs again.

Blogger Time Warp

2004-09-08T22:24:00.000+02:00

Blogger was not very cooperative today. That is why my little post from this morning (the middle of the night for most of my US readers) just managed to pop up a couple of minutes ago.

The Fed chief was nice enough to do as I (and almost everyone else) predicted. So not much news there. My big picture is still intact - I expect a rate hike later this month and expect the Fed to do enter a little wait and see phase after that.

There was actually someone out there who did take the US government to task for the budget deficit - IMF head Rodrigo Rato gave out some free advice:

"The monetary stimulus has already been addressed by the monetary authorities in a very clear way..," he said.

"But the budgetary stimulus has not, so I think that the U.S. budgetary authorities have to match the monetary authorities in their clear determination to reduce the deficit"

The US President had better hope that not all to many people come around to this kind of view - it might just lead to yields rising without any Fed fiddling. But I'm pretty sure that word will not get out - after all, the IMF head honcho was on his way to Burkina Faso - not all that many US T-Bond holders in OUAGADOUGOU, Burkina Faso.

All eyes on Greenspan

2004-09-08T10:04:00.000+02:00

The day has started off here on a very slow note. Volumes are thin and everything which is in the newspaper today was already in the paper yesterday. Economic news addicts are looking forward to Fed Chairman Greenspan's testimony before the House Budget Committee today.

Not many people are waiting with bated breath though. Most everybody thinks that the strongish job data will allow Greenspan to reiterate the Fed's view that the expansion is still on track. This will allow the Fed to stick to Plan A and hike rates. If Greenspan does in fact mumble something about removing policy accommodation, then we can be virtually certain that the Fed will hike again this month.

Only two things might upset the apple cart:

1) The very unlikely possibility that the Fed Chairman says something to the effect that the recovery is dead
2) Greenspan throwing a curveball in the subsequent Q&A session

I'm pretty sure that Greenspan will use much of his allotted speaking time to talk about the fiscal impact that the impending retirement of the so-called baby boom generation will have. The Fed Chairman recently spoke about this very subject and had quite a few things to say that should be high on the agenda of something that calls itself the House Budget Committee. To give you a little taste:

The aging of the population in the United States will significantly affect our fiscal situation. Most observers expect Social Security, under existing law, to be in chronic deficit over the long haul; however, the program is largely defined benefit, and so the scale of the necessary adjustments is limited. The shortfalls in the Medicare program, however, will almost surely be much larger and much more difficult to eliminate. Medicare faces financial pressure not only from the changing composition of the population but also from continually increased per recipient demand for medical services. The combination of rapidly advancing medical technologies and our current system of subsidized third-party payments suggests continued rapid growth in demand, though future Medicare costs are admittedly very difficult to forecast.

This scenario is something that legislators will surely try to use to advance partisan agendas ahead of the election. This is going to be pretty difficult because nobody is really addressing the horrible budget situation in the campaign - I guess it is much more important to look at what the contenders did or did not do in 1968 than to look into the future.

Oil again

2004-09-07T11:02:00.000+02:00

I firmly believe that we won't run out of oil - we may however run out of money to pay for the stuff as it becomes ever more rare. The recent strength in oil prices has done exactly what one might expect - it has encouraged exploration and investment in companies that go out there and look for the black stuff.

In fact exploration companies have turned into a really hot sector. A Reuters article looks at the recent strength in exploration company's stock and notes

Shares in some exploration firms -- often a boom-or-bust bet for investors -- have tripled and quadrupled in value in the past year, outperforming the sector and giant integrated peers such as Shell and Total.

Investing in these companies is somewhat akin to buying into a certain portion of the biotech market - they either manage to actually invent something which gets FDA approval or they blow up.

Payrolls

2004-09-03T15:00:00.000+02:00

Contrary to what I wrote in the previous post I did get a chance to watch the payroll data come over the ticker. At 144k new jobs we have a solid number and the unemployment rate was a little better at 5.4%.

The good news is that weekly earnings increased by a larger than expected 0.3%. I watch the earnings numbers like a hawk because I'm pretty concerned about consumer's pocketbooks - any rise in income here is a good thing. The workweek was flat - I would have liked to see some strength here as well, but I guess you can't have everything. I'll look at the data over the weekend - if I find something intersting, I'll post on Monday.

To be fair: good call by the consensus this time!

Payroll day

2004-09-03T10:13:00.000+02:00

A familiar ritual will unfold today. We will glance at what the consensus is expecting (150k new jobs) and then wait for the reported number. This number will then be nothing like what the consensus is expecting.

If I look at the margin by which forecasters have been off over the past couple of months I feel pretty safe in saying that today's payroll number will be either 20k or 300k new jobs.

I probably won't stick around to see the number - because of the magic of time zones the release of the data will see me in my private helicopter flying out to my luxurious summer retreat.

Postcard

2004-09-03T10:10:00.000+02:00

My Postcard from Old Europe is up over at Angry Bear's place. This week I take a look on what kind of policy choices might result from the US trade deficit.

Data update

2004-09-02T11:37:00.000+02:00

The ISM followed the Chicago PMI downwards and came in at a "still-expansionary-but-not-blazing" level of 59 (down from 62 in the previous month). The story behind the numbers is not all that exciting - things are still looking good, just not as good as they looked a couple of months ago.

As everyone is waiting with bated breath for the payroll on data on Friday the employment part of the ISM garnered particular attention. The numbers in the ISM tell us that companies are continuing to hire, albeit at a slower pace than a couple of months ago. The sad part is that these hiring intentions have yet to make an impression on the hard employment data.

Singalong Time

2004-08-31T14:06:00.000+02:00

This week brings the return of the CurryBlog Singalong - this week's tune is ideally suited to be played whilst reading about the record low in the US personal savings rate. Alright, a one, a two, a one, two, three, four:

Sung to the tune of Subhuman by Garbage

Draw down all your savings, destroy your future
Create a scene
There goes all your reason, it's helter skelter
It's not a dream
Come back from the mall, remove your blindfold
What do you see?
Nothing left to do here, there's nothing new here
It's all the same
You're going down, down, down, how low can you go?
You're going down, down, down, how low can you go?
You're going down, down, down, how low can you go?

There, I feel better now.

Income? What income?

2004-08-31T13:46:00.000+02:00

The US consumer is one of the modern wonders of the world. The consumer's mantra must be

"neither rain, nor snow, nor sleet, shall keep me from shopping"

It seems as if no amount of hardship can keep people away from the shopping mall. The thing that keeps astounding frugal old me is that John Q. Public keeps growing his spending quicker than his income. The relevant data on Personal Income and Outlays came out yesterday and it tells us that

Personal income increased $11.0 billion, or 0.1 percent, and disposable personal income (DPI) increased $7.9 billion, or 0.1 percent, in July, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) increased $65.6 billion, or 0.8 percent.

This should help support GDP growth going forward - albeit at the price of rising indebtedness and a miniscule savings rate.

Speaking of which: the savings rate is now at a level where you need a microscope to see the number - the BEA says:

Personal saving as a percentage of disposable personal income was 0.6 percent in July, compared with 1.3 percent in June.

This low level of savings borders on the ridiculous - I mean what do people think? Is the market going to do their saving for them? Or is social security going to be enough to live off of in old age?

Negative terms of trade shock

2004-08-30T15:47:00.000+02:00

Wow, you're still reading after that headline! Congratulations, as a reward you may follow this link where Pimco's Paul McCulley explains what the current high oil prices might do to the economy. This little piece is an excellent example of how to get economic thoughts across to - well - anyone! I highly recommend it. Some excerpts follow:

Less technically, it's [oil price hike] similar to being told by your father-in-law that in honor of your mother-in-law's outrageously good scalloped potatoes at Thanksgiving, you will be expected to bring two bottles of fine wine this year, not one as you did last year. The price of those spuds just doubled. And you gotta have them!
[...]
Returning to the saga of the second bottle of wine you delivered to your pops-in-law, does he put it in his cellar, or do you insist on drinking it at Thanksgiving dinner? If he puts it in his cellar, then there has been a one-time shift in wealth from you to him. If you had planned to drink it before giving it to him, and are budget constrained, then there has also been a one-time downward adjustment in your consumption, a one-time blip upward in the economy-wide savings rate, a one-time upward adjustment in economy-wide inventories and, presumably, a one-time downward adjustment in the wine producers' output, since your budget constraint prevents you from replacing the wine that you would have drunk but didn't, because it is now in pops-in-law's cellar.

A fresh start to the week

2004-08-30T13:35:00.000+02:00

The end of last week saw the release of the revised GDP data for the second quarter. I was pretty pessimistic ahead of the data as I was afraid that the huge trade deficit would negatively impact the number. The impact was there all right - the deficit subtracted around 1.3% from growth!

The good news is that businesses and consumers stepped right up and did the right thing - they kept spending. Domestic spending came in at +1% which was almost enough to cancel out the negative impact of the trade deficit.

The screeching noise you hear when you're reading the report is the slowdown in corporate profits. Corporate profits were flat vs. Q1 coming in at + 0.1%. To be fair we should say that we're still looking at "good" numbers - the simple fact to keep in mind is that the numbers are just not as good as they were in Q1 (and investors ignore slowing profit momentum at their peril!).

In all it looks as if the cycle is doing its thing - we should see momentum moderating as the year progresses with the GDP numbers coming in at around the 3% level in Q3 and the heading down to a 2-point-something in Q4.

This week activity is focused on the mother of all numbers (Friday's payroll survey). I keep hearing 150k new jobs being bandied about - let's see what happens.

GDP Day

2004-08-27T11:07:00.000+02:00

It's GDP day today in the US and expectations have been creeping ever lower. The negative trade deficit data should negatively impact the number. If you consider the positive data such as construction spending you should be looking for a revision of Q2 growth to somewhere around 2.4 to 2.7 from 3%.

TAPPI - the place to be!

2004-08-25T19:55:00.000+02:00

Do you catch yourself thinking "I should really be in the decorative laminates business?" If you don't you might think twice now that senior Fed officials use the annual "TAPPI Decorative and Industrial Laminates Symposium" as a forum to present their views.

No, I'm not kidding. Atlanta Fed President Guynn spoke at said symposium and mostly reiterated standard Fed verbiage. Guynn even asked the 64k question:

"In light of recent reports, I would concede that it's fair to question what's ahead. You might ask if the economy is getting bogged down for an extended stretch of eroding growth. Or are we just going through another brief soft patch on our way to sustainable recovery?"

Now what do you think the answer was? Yes - the "soft patch theory" is still intact. The answer to the question posed above is

As a result, Guynn felt the pause would prove fleeting and the "likelihood of solid and sustainable growth looks good". But he stressed the Fed was not ignoring events.

Nice to know that the folks at the monetary helm are not asleep. No way Jose! Now the only problem is that reality keeps intruding on the Fed's view of the world. And yes, even the Fed can be surprised by events

"It's important to keep in mind that we can all be surprised by output and price developments as they unfold..."

True. I hope that these surprises don't keep piling up in a negative way. I don't really want to imagine what kind of policy response a future would bring in which (oil) prices keep rising while growth keeps getting softer and softer.

Last thought: I'm pretty sure that you all thought that the Fed was hiking rates because growth is robust. Well think again. The Fed is mostly hiking because rates were low. Huh? ~~Survey~~ Article said:

Guynn stressed the Fed was not raising rates because it felt the economy was growing too fast, but rather because with interest rates so low, an accommodative policy was not appropriate amid a widening economic expansion.

Ok - I'm pretty sure that I've convinced you to get into the laminates business - where else can you get Fed speak with your lunch? For more information visit TAPPI!

Endnote: Why does my spell checker want to change "Guynn" to "Guano"?

Emerging Markets

2004-08-24T19:28:00.000+02:00

I just came across a Reuters article with a headline that screams "Emerging mkts attractive via ETFs -Morgan Stanley". Now I don't know if emerging markets are really that attractive but I do suspect that ETFs are not really the best investment vehicle you can use to increase you exposure to these markets.

ETFs or Exchange Traded Funds are mutual funds which usually track indices and which can be traded just like stocks. They have a pretty low expense ratio because they are not actively managed. The article says:

"Exchange Traded Funds, which are traded like equities, but track an index without the investor having to buy all an index's components, increasingly offer a simple and cheap way for investors to get an exposure to sometimes challenging emerging markets, Deborah Fuhr, ETF strategist at Morgan Stanley said."

Well yes, but the problem here is that indices in emerging markets are not the thing I would really want to invest in. Why? Well, there are a lot of countries in which the index is dominated by two or three companies - South Korea comes to mind here. If I'm not totally mistaken then the three top companies there account for 25% of the market - so why buy the index if you're only getting Samsung, SK Telekom and Posco?

Indices in Emerging Markets tend to be highly concentrated and usually consist of just a couple of sectors (Energy, Banking, Telecoms and IT come to mind). That is why I believe that such markets are really more suited to an active investment strategy. ETFs seem to me to be a hassle-free kind of ways to invest in developed markets - not in markets where a fund manager might actually add value.

For discussion: why might Morgan Stanley think that ETFs are a great idea?

Side note: My favorite definition of emerging markets: "Emerging markets are markets that are difficult to emerge from in an emergency"

Birthday

2004-08-24T18:29:00.000+02:00

It is Harry Markowitz's birthday today. Congratulations!

Locusts and Tourists

2004-08-23T10:19:00.000+02:00

I was watching the news on the weekend and saw a feature on the horrible locust plague that has been ravishing northwest Africa. This bit of news reminded me of something I saw at about this time last year in a wholly different location.

I was on holiday on the Greek Island of Mykonos with my wife last year. Mykonos town is a very scenic little place with a pretty relaxed feeling about it during the off season. While we were idly sipping a frappe we noticed that the activity level around us started rising.

Shopkeepers opened up boarded-up shops, street "artists" went back to their warehouses to stock up on folk art and waiters went into that kind of trance which usually signifies that an onslaught of guests is imminent.

While we were wondering what was going on the invasion took place. The little streets of Mykonos town were thronged by masses of people that a cruise ship had disgorged down at the harbor. The passengers exhibited symptoms of serious shopping-withdrawal and stared buying anything in sight. It was an incredible sight that was only matched by looking at a swarm of locusts devastate a grain field.

The entire episode lasted for about two hours. After that blissful calm settled back on the island. Before anyone gets bothered: I do recognize that we are talking about a wholly different situation with regard to the impact on the local population.

Oil

2004-08-20T11:59:00.000+02:00

Most of the work issues that have been impeding my blogging are resolved so I've finally found the time to return to posting my weekly "Postcards from Old Europe" column over at Angry Bear's place. This week's installment looks at the effects that continuing high oil prices might have on the US economy.

Conventional wisdom has it that the oil price is in a bubble-like phase. Therefore any reduction in geopolitical uncertainty (now how likely is that) should lead to a rapid fall in prices. I'm pretty sure that price gains are being exacerbated by investors who are buying into the oil market to hedge themselves against any further price hikes (thereby bidding up the price today) and by speculative longs.

I suspect that the reason that oil prices are so high is that oil prices were so low in the past. Companies didn't have much of an incentive to explore for new capacity at sub $20/barrel prices. The market will now work its magic and ensure that more capacity will become available in the future. The problem is that this will take time. Anyway, high oil prices are not what the world economy needs right now - with the recovery coming off the boil in the US and a very fragile expansion in Europe we don't really need higher energy prices.

One down...

2004-08-19T18:05:00.000+02:00

...one to go. The Index of Leading Economic Indicators was down 0.3% in July. The index is compiled by the Conference Board and is made up of 10 separate gauges. Four of these were up with the rest coming in softer. This is the second month that the index came in weaker. Conventional wisdom has it that three declines in a row signify danger (well OK, not really danger but a more moderate rate of economic growth) ahead.

Looks like Google finally managed to crawl to market with the first price somewhere around 100 USD. A look at the screen tells me that the Philly Fed index is out at an underwhelming 28.5 which is very much below the consensus estimate. Market reaction seems muted - I don't think that anybody was really all that surprised by this weak showing.

No News is, well, no news.

2004-08-19T10:34:00.000+02:00

No major data releases yesterday to write about. The focus is firmly on today's numbers with the Philly Fed being the most important. After the lower than expected NY Fed survey economists have been busy revising their estimates downwards. Leading indicators and initial jobless claims are out as well today so we shouldn't complain about the lack of economic input.

Nothing much else happened - oil is still expensive, Iraq is still violent and the Olympics are moving along. More later.

Inflation

2004-08-17T17:45:00.000+02:00

Remember the good old days of several months past? The Fed was thought to be woefully behind the curve with regard to inflation and everyone just knew that rates had to go up. And of course the CPI was a sham - especially core CPI - who can live without food and energy after all?

Now we learn that headline prices actually fell in July - imagine that. Lower gasoline prices did the trick. The much maligned core number was up by a whisker with some categories such as cars showing price declines. This nicely shows what the Fed means by price hikes being "transitory" - not that I expect the return of disinflation. Core CPI should continue to expand throughout the rest of the year with Inflation leveling out at around 2%.

This in turn means that I firmly expect one more rate hike next month to 1.75%. What happens then is very much a function of tomorrow's data. What do you think?

News? What news?

2004-08-17T10:02:00.000+02:00

The NY Fed survey came in way below expectations yesterday. Economists were expecting a number around 30 and we got a 12.6 which equates to a drop of 23 points. My mantra that the expansion is losing momentum was again underlined by weak new orders and shipments data. The positive news was that the employment index was up. The only problem with this is that it is a result of ever more companies saying that they are not going to cut jobs - the mechanics of a diffusion index turn this stagnation into a positive.

Nobody really seemed to care about this number - the inundation by bad news has probably numbed market participants to such an extent that this data point didn't have any real effekt on sentiment.

Today will see the release of many analysts favorite bugbear, the CPI. I think that we will see a very modest gain in this number - nothing to raise the spectre of rampant inflation.

Confused about P/E ratios?

2004-08-16T11:51:00.000+02:00

Don't you love watching talking heads ruminate about how the market is valued? There is a virtual guarantee that someone will cite price earnings ratios to demonstrate that the market is cheap (or expensive or just right).

The reason why this number can be used to justify almost any standpoint is nicely presented in this article which draws upon work by Cliff Asness. The problem is of course not in the price part of the the P/E but in the earnings bit.

One widely used definition relies on analysts' projections of what companies will earn over the coming year, while another focuses on what companies actually earned over the previous four quarters.

So we can either use real earnings of lala-land earnings. Then we just have to mix and match numbers (reported/estimated, today/yesterday, ...) until we get the result we are looking for. Or as the article puts it

Consider the statement, often repeated these days on Wall Street and in investment newsletters, that the market's current P/E ratio is not abnormally high. The argument, as Mr. Asness hears it from fellow money managers, goes like this: "Currently the S.& P. 500's price-to-earnings ratio is in the mid-teens. Comparing that to an historical average of about 15 shows the market to not be more expensive than average."

But that argument relies crucially on a "sleight of hand," Mr. Asness says. The market's current ratio is in the mid-teens only if it is calculated by using projected operating earnings. Yet the long-term average ratio is as high as 15 only if it is calculated by using trailing reported earnings. It is bogus to compare the two figures.

Decomposing Fed Speak

2004-08-16T11:39:00.000+02:00

HSBC economist Stephen King (no, he doesn't write scary novels on the side) does a great job of dissecting the recent Fed statement. He contends that it is a mixture of fact, assertion and faith. Let me reproduce his key points here:

"...Output growth has moderated..." That's a fact.
[...]
"This softness likely owes importantly to the substantial rise in energy prices." We are now moving into the world of assertion.
[...]
"The economy nevertheless appears poised to resume a stronger pace of expansion going forward." This third strand of the statement is no more than an expression of faith, but it's been thrown into the mix partly to justify the Fed's overall desire to get short-term interest rates back to something approaching "neutrality". But if energy prices have been so important in explaining the recent softness of activity, why should it be that the economy will expand more strongly? After all, oil prices have risen further since June and July, so if oil prices are to blame, it seems more likely that the data for August and September will be weaker than we have seen over the past two months.

Quite. Now go and read the whole thing.

As the World Turns

2004-08-16T11:13:00.000+02:00

Watching capital markets is like a race with no finish line. Analysts chase after every data point and then quickly their sights on another economic figment as soon as the first one comes over the wire.

This week the investing class will focus on a series of US activity gauges such as today's New York Fed survey and the Philly Fed survey on Thursday. Last week ended with that serial shocker, the trade deficit.

From the statement:

The Nation’s international deficit in goods and services increased to $55.8 billion in June, from $46.9 billion (revised) in May, as exports decreased and imports increased.

Imports are gaing in sectors which were thought to be very robust. Take the rise in imports of computers. This would seem to indicate that production is shifting ever more to the Pacific Rim - no wonder that US tech firms are looking soggy in the equity markets.

In all the high trade deficit could take some of the shine off of future (and past via revisions) GDP growth numbers as demand is being met by imports. Please keep in mind that a high trade deficit means that there are lots of dollars flowing out of the country to pay for all these doodads people are buying.

This means that those pesky foreigners who are holding all these dollars had better be partial to investing the greenbacks in US assets. Otherwise we might just see quite a few people who decide to sell their dollars for something else. This then boils down to a (cough) supply/demand imbalance and a consequent price adjustment to clear the market.

Now back to this week. After consumers said on Friday that they are still pretty confident but are adjusting their expectations for the future downwards, the manufacturers will tell us about their expectations today. Economists are expecting the NY Fed index to come in at around 30 which is still consistent with expansion. In all the backdrop is just to dark right now. People are afraid of terror, oil prices, collapsing equities and a whole raft of other things. It will take very many positive data points to counteract this kind of negativity.

Painting yourself into a corner?

2004-08-13T11:05:00.000+02:00

This article from the WSJ (via the Australian Financial review) has a nice take on what a bind Sir Alan might be in. Some gems:

For two years, Alan Greenspan has stood on the deck of the American economy under a banner reading "Mission Accomplished".
[...]
Dr Greenspan and the Fed have boxed themselves in. After a few strong payroll reports and some inflation numbers that topped expectations earlier this year, the Fed's pledge of "patience" went out the window. The Fed then went on its current measured course to raise rates to maintain price stability and seemingly won't be deterred, even in the face of a sputtering economy.

As they say: rtwt!

Slowdown anyone?

2004-08-13T10:49:00.000+02:00

Well it seems as if the consensus is slowly coming 'round to the idea that the US economy is in the process of slowing down. No real news there - it really is pretty uncontroversial to admit that the economy won't continue to grow at the heady pace we saw last year.

The problem is that some investors are now getting pretty nervous. People are asking themselves: "What if the slowdown turns out to be more violent than everybody thinks?" Add in serious headwinds by rising oil prices and the ever-present threat of terrorist action and you get a scenario in which perception is everything.

In this kind of scenario good isn't good enough. Normal economic and profits growth might lead to very negative market reaction. This year has been charaterized by a taking off of the rose-tinted glasses and a subsequent re-rating of market prospects. Lucky thing that there enough excuses out there (to steal a line from Barry Ritholz "Geopolitical tensions ate my portfolio").

Back again (but only for a while)

2004-07-27T14:06:00.000+02:00

I just managed to get rid of most of the urgent stuff on my desk so I finally have time to blog a little.

Not much has changed from last week - Fed officials are still singing the praises of a recovery which - at least in my opinion - is losing steam month after month. Federal Reserve Bank of Kansas City President Thomas Hoenig stuck to the official hymn sheet yesterday and reaffirmed the view that we'll see a very strong economy this year by saying:

I think the economy is really doing well and improving and I think it will continue to improve. ... We are looking at a more positive economy, we are seeing business fixed investment pick up

Well yes. Fixed investment is probably still feeling the boost from the accelerated depreciation which is still possible until the end of the year. No guarantee though, that we'll continue to see this kind of strength in 2005.

Some leading indicators are looking pretty soft. Last week saw the release of the index of leading U.S. economic indicators which came in 0.2% weaker - the first drop in over a year. No need to get overly excited - this kind of indicator needs a couple of back-to-back negative readings to actually get anybody all hot and bothered but the writing may be on the wall.

Equity markets have been weak across the board - market action was pretty lackluster as no real impetus to price action surfaced.

Update

2004-07-22T18:20:00.000+02:00

Not much blogging for the past couple of days - work is really stressing me. Not to worry though - I really hope that I'll be able to dig myself out from under my workload shortly. Thank you.

Straight from the core

2004-07-19T10:30:00.000+02:00

Friday's CPI data had something for everyone. While inflation hawks focused on the larger than expected rise in the headline number the doves looked at the lower than expected rise in the core data. The cost of energy was again the culprit in the headline number while the price of food which managed to rise an astonishing 0.9% in May was almost flat. I guess this is good news because it is probably easier to drive than than to stop eating.

The recent rate of fluctuations in the oil price - and thus in the price action in the energy category - is a pretty good argument for the use of core data. Critics of core data say that we should use an overall measure of inflation as prices are obviously rising so it would be sophistry to eliminate energy price hikes as people are actually paying more.

This is true - it just doesn't help from a policy perspective. If geopolitical tensions are causing gyrations in the oil market a rate hike isn't really going to help contain price inflation. Or do we think that militants will stop bombing pipelines etc. because the Fed raises the Fed Funds rate?

Pre Weekend update

2004-07-16T11:56:00.000+02:00

Lots of data out yesterday - the problem with it was that we still don't have a very clear picture of what is on the cards for the economy. Producer prices were lower instead of higher with the headline number way below expectations and the core number pretty much in line. This gives me some hope that today's CPI data will come in on the soft side.

The New York and Philly Fed surveys were pretty upbeat with the crucial "hiring intentions" part looking positive in both. The other data was somewaht mixed with the New York data weaker than the Philly data (especially new orders and pricing power).

Reality was a little less kind: June industrial production dropped by 0.3% and capacity utilization fell as well.

In all this is a not too hot, not too cool kind of picture which gives the Fed wiggling room with regard to interest rates. Inflation hawks should slowly begin to tone down their rhetoric as the current expansion loses steam in the second half and inflationary pressures abate.

The truth?

2004-07-14T19:56:00.000+02:00

An old saying goes something along the lines of "If you want to demonstrate that there is a linear relationship between two variables it helps to work with only two points of data". Prof. Tufte examines the cavalier way economists work with data in his excellent post which is succinctly titled "Uh Oh". Let me give you a taste:

1) economists publish papers with results that are not replicable, and 2) few make enough effort to notice

As they say, read the whole thing. If I'm not totally mistaken, I think that the Economist had an article which made many of the same points a couple of weeks ago with regard to the use of statistics in the social sciences. Is there anyone out there who can confirm this?

By the way, when you've finished reading the article on Prof. Tufte's "private" site, go visit his other Blog. You're thinking "why should I"? Easy, Tufte's Economics Classes Blog is a great experiment - the good Professor is using a blog to get his macroeconomics students to write about (mostly) economic issues. Students get "points" by writing and commenting. Now how cool is that? So I encourage all of you to go there and use the comments feature - you can then take pride in helping people learn about econ-stuff (how about Prof. Tufte calls all commentators "Deputized Tutors").

Supersize my earnings

2004-07-14T18:10:00.000+02:00

I just can't resist! McDonalds managed to "supersize" reported earnings. This particular Happy Meal offered 27% more profit! The market said I'm lovin' it and went into buying mode. The rest of the US is in eating mode with 2 out of every three adults overweight (as in fat, not as in holding much of one stock).

Retail sales

2004-07-14T15:45:00.000+02:00

US retail sales fell 1.1% in June - worse than the consensus was expecting. It is a little worrying that the core data (ex cars) came in at a disappointing -0.2%. I was looking for some strength in this particular number. EUR/USD jumped higher after the news and broke through the 1.24 level.

We should be wary of reading too much into single points of data - the trend matters and it is much to early to say that John Q. Public is starting a spending strike. It could well be that consumers are just taking a breather from shopping - but we better hope that the news (payrolls!) doesn't turn sour. If fiscal incentives taper off without something there to replace them, a retrenchment might not be far off.

A little note of caution (mostly to myself): "do not underestimate the US consumer".

Odds and Ends

2004-07-14T12:39:00.000+02:00

More noise coming out of the Fed with regard to the transient nature of inflation - Dallas Federal Reserve Bank President Robert McTeer said

The American people, including American workers, in my opinion, will be able to enjoy rapid noninflationary growth for the foreseeable future

A little to grandiloquent for my taste but his meaning is clear. When pressed on the subject of inflation he added

I think it is most likely a blip. It's going to come back down one way or the other, on its own or with a little nudging from us

This sentiment was echoed by Federal Reserve Bank of Kansas City President Thomas Hoenig who is on record thusly

How that (inflation rise) plays is a very important consideration. My own view is that we will have inflation numbers that remain in the 2 percent range

Looks like the entire Fed is singing from the same hymn-sheet.

In other news: markets are looking for a weak retail sales number today. The consensus seems to think that we'll see a decline of around 0.7% for June. Declining auto sales and high gas prices (...it's too expensive to drive to WalMart every day...) seem to be the main culprits. My recommendation is to ignore the car-sales influenced headline and focus on the underlying retail sales trend - it might even surprise on the upside. But what will the future bring?

The National Retail Federation thinks that spending growth will continue to be strong in the second half (they look at GASF = general merchandise, apparel, sporting goods, home appliances and furniture - no cars in the list). Being a smart bunch of people they hedge their bets by noting that the phasing out of tax benefits will firmly shift the brunt of new spending on disposable income derived from traditional means (such as a paycheck!). They say

Therefore we are counting in the improvement in the labor markets and increase in wages and salaries to provide the financial wherewithal for consumers to keep on spending. If employment growth stumbles, we could see consumer spending soften

How true!

Prices again

2004-07-13T10:29:00.000+02:00

Philly Fed President Santomero weighed in on the inflation outlook yesterday and noted that prcing power may yet evaporate. This is pretty much the view that I've come around to.

Bond time?

2004-07-09T11:13:00.000+02:00

The recent weakness in equity markets has shown that the torrid love affair with the market some people have restarted over the past year may yet turn out to be a form of fatal attraction.

Recent economic data in the US has been negative and may point to a slowdown in growth over the next couple of months. Consumers have been profiting from enhanced incomes courtesy of tax cuts, refinancing debt and - at least in some cases - new jobs. Alas, the time of tax cuts seems to be over just as interest rates have started to rise. This leaves the burden of the recovery firmly on the back of the "real economy".

Against this backdrop expectations for earnings growth are still very robust. You will probably not be surprised that I don't share this view. The stimulus provided by fiscal and monetary measures is ebbing, thereby revealing that many of the excesses of the bubble have not been worked off. Capacity is still high while utilization is still relatively low - the absence of stimulus may lead us right back on a path of slow growth going forward.

In the event that the recovery fizzles and rate expectations get slashed, we may yet kick ourselves that we didn't buy bonds!

Postcard

2004-07-09T11:10:00.000+02:00

My weekly column, Postcards from Old Europe, is up over at Angry Bear's place.

Bull run!

2004-07-07T19:50:00.000+02:00

No, not in the markets. The bulls are on the rampage here.

The beauty of real estate...

2004-07-07T17:27:00.000+02:00

...is that it's safe! You don't believe me? I found a nice article on how people are flipping unbuilt condos which not only has gems such as

Wealthy investors are buying and selling beach-front condominiums on Alabama's Gulf Shores before they ever get built and are turning fancy profits on the rapid-fire deals. The practice, known as "flipping," has become so widespread that real estate companies are promoting it, along with their more traditional ads aimed at people wanting second homes.
[...]
At Wireman's Caribe Resort, some units have sold four or more times.

But also tells us that you don't need to tie up much money in the process. The great thing about this is that it works like trading a future - you only need a little cash to control a very expensive condo. The magic lies in giving the developer a letter of credit which will usually only cost you around 1% of the notional sum. The article provides an example

For example, say that an investor bought a $500,000 condominium at its initial offering two years before closing and chose to provide the 20%, or $100,000, down payment in the form of a letter of credit. If that investor's bank sold such notes at 1% a year, the investor would pay just $2,000 to control the condo for two years until the building was finished.

Then, if at some point before closing, the investor sold the unit for $600,000, he would reap a $98,000 profit on his $2,000 investment.

Fantastic! The best thing is that this is really safe! Really, I'm not kidding. Just listen to the experts. The article cites a certain Chuck Norwood who is a real estate broker and therefore fully unbiased who tells us

The last time he heard so much talk about easy money was right before the bubble burst on tech stocks. The good news, Norwood said, is that with condos, unlike the stock market, "you won't wake up in the morning and lose half your value."

How about he tells that to people who invested in Japanese real estate in 1988?

Economic Orkut

2004-07-06T20:12:00.000+02:00

Hello everyone, welcome to experiment time! As social networking is all the rage and economics is a social science, how about we inject some economics into Orkut?

So, I'll send anyone who is interested in economics an Orkut invite - let's see if we can take our blog-subject into another format. If you're interested, just send me an email (karsten.junge(at)gmail.com) or leave your name and email somewhere in the comments.

ISM Services

2004-07-06T16:31:00.000+02:00

The ISM Services Index came in at a still expansionary 59.9% albeit below the 65.2% level we saw last month. This was below Wall Street forecasts but still not as awful as one might think. Employment was still looking robust and new orders didn't look half bad. But we still have to concede that the momentum of the current cycle is slowing - the 64k question is "how much momentum will we lose?"

The always popular Challenger Survey came out today as well. Challenger Gray & Christmas is an outplacement firm which conducts a private survey of business hiring and firing intentions. This month's report shows that job cut intentions are at a 12 month low (the good news) but hiring intentions are around 30% lower than last month (the bad news).

Reports like this are like little mosaic stones which serve to assemble a picture of very cautious companies who tread carefully around subjects such as hiring and investment. No irrational exuberance here!

The kindness of strangers - or - who paid for your tax refund?

2004-07-06T10:01:00.000+02:00

One of the things that distinguishes a professional commentator from your host at CurryBlog is that the pro is able to convey an old story in an interesting and accessible way without rambling on forever.

This is the case with a Washington Post column by Allan Sloan who writes about the foreign ownership of the US public debt. While political pundits lambast many foreign countries for not helping in the war against terror they forget that very many of these countries have been fighting the war against recession (and financing the anti-terror campaigns) in the US. From the article:

The statistics show that foreign and international investors account for the entire increase in privately owned Treasury securities since George W. Bush took office. Issuing those securities is how the Treasury covered federal budget shortfalls.
[...]
Now, a little math. Privately owned debt, as you can see, was up by $620 billion since the Bush administration started -- but foreigners' holdings were up by $680 billion. This means that foreigners accounted for the entire increase in privately held debt -- and then some.

Well imagine that! As US consumers boycott French products some Pierre or Francois may just have been buying a T-Bond. This bond then may have financed some of the goodies people bought with their refund checks! It may even have provided money to finance the war against terror! Oh my, I wonder if there is a way to check where individual refund money came from...

ISM again, other random thoughts

2004-07-06T09:32:00.000+02:00

After last week's batch of economic releases we have only one noteworthy report out this week. Today will see the release of the non-manufacturing ISM survey for June. This particular index fell in May and the consensus is looking for another small fall in today's release.

As there is not much other economic data out, markets will focus on the companies that traditionally kick off earnings season (Alcoa, Yahoo,...). Expectations for earnings are still very positive and we should see some strong reports come in. Regular readers know that I'm not all that optimistic about the US economy's prospects going forward, so you won't be that surprised if I tell you that I see any gains on the back of strong earnings as a chance to reduce exposure to the stock market.

While the US economy has been handing us negative surprises lately, the Japanese economy is still looking pretty good. The index of leading indicators has now been in expansionary territory for nine months and this months reading crept higher to 66.7. The real good news is that the Japanese are opening their wallets and spending at a faster rate - the government released a report today that showed household spending rose 4.8% in May. This is good news for the entire Pacific Rim as Japanese demand is one of the key factors which determines the region's economic well-being.

The good news is also especially important for Japanese Prime Minister Junichiro Koizumi who faces an election on Sunday. Recent polls have shown that the ruling LDP is having a difficult campaign. This news is weighing on sentiment vs. the Yen as markets are factoring in the possibility of Koizumi having to resign on the back of an election defeat.

Good morning!

2004-07-05T10:10:00.000+02:00

Last Friday saw the release of the payroll data for June and the result was not pretty. While the consensus was looking for a gain of around 250.000 jobs reality only delivered about half of the projected number. Even more worrying was the fact that all the supporting data such as hours worked was negative as well.

This number was a wake-up call for those market participants who were extrapolating recent strength into the future. If the June data does not turn out to be some kind of aberration the overly optimistic analysts will have to rethink their forecasts for the second half. Just a week ago everyone was fretting over inflation and employment was just a afterthought - everyone knew that the jobs machine was just purring along.

The first part of the rethink is already in progress - the futures market is now pricing in a 2% Fed Funds rate by year end - not the 2.25% we were looking for previously. The Fed's use of the word "transitory" with regard to inflation may prove to be prescient.

Stupid German Money?

2004-07-02T12:31:00.000+02:00

The fabulously intricate German tax law has encouraged local investors to invest in a whole raft of assets that they would never have thought of without the tax incentive. The term "stupid German money" was coined to describe the cash flooding into Hollywood to finance movies on the back of a German tax loophole which made it possible to write off the entire investment in the current tax year. Some people estimate that

about 20% of Hollywood's entire production budget is financed through German media funds

Another favorite investment has been the purchase of US real estate because foreign rental income is more or less tax free in Germany. This is the reason that the Chrysler Building, Chelsea Market, 666 5th Avenue in New York or the AMA Building in Chicago to name but a few, belong to German private investors.

And what are they doing? Well, they're selling. One of the largest fund companies, Jamestown, has decided that the time is right to cash out and started to sell some of its properties. The CEO has also publicly declared that they won't place any more funds until the real estate market quiets down. Maybe the stupid German investor has learned something?

New postcard

2004-07-02T12:29:00.000+02:00

My column "Postcards from Old Europe" is up over at Angry Bear's place.

ISM

2004-07-01T16:15:00.000+02:00

The June Manufacturing ISM Report On Business is out today and it came in just a whisker away from the 60 I was looking for yesterday. Well, to be honest I was much more pessimistic than the consensus which was looking for a number of 61.6 or so, but at least I got the direction right. Again: not much real content to this report - activity is still expanding albeit at a reduced pace. Same story as the Chicago PMI yesterday.

All eyes now shift to the employment data out tomorrow. The jobs number will very much make or break the week as it really is a big data point and there is much more uncertainty surrounding payrolls than - say - the Fed rate decision.

Fed

2004-07-01T09:48:00.000+02:00

Alright, I'm pretty sure that everyone has by now realized that the FOMC increased the Fed Funds Rate by 25bp. This comes as no surprise - or rather: it was a surprise for some that things turned out to be exactly the way the consensus called it.

The Fed acted somewhat like a driver who starts signaling his turn miles ahead. The people in the following cars would probably think that this particular driver is being overly cautious. As the exit approaches some might start to wonder if the leading driver really wants to leave the highway. He might have switched on the turn signal by accident after all! All breathe a collective sign of relief when he does exactly what he communicated from the start.

The FOMC statement is consistent with recent Fed rhetoric. The Fed will continue at a "measured pace" while giving themselves some breathing space by commenting that "the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability". Speaking of which: the FOMC shares CurryBlog's view that the inflation we are seeing right now is "transitory" and that the rate of price increases will probably moderate in the coming months.

What should we look for policy-wise? I posit that we'll see a sequence of small (25bp) hikes at the next meetings. I'm certain that any large loss of economic momentum in the second half will cause the Fed to be very cautious with regard to hiking. It is not a foregone conclusion that we'll see a 2% Fed Funds by year-end.

As usual you can find the FOMC statement below. Your humble correspondent has highlighted the changes from May.

The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 1-1/4 percent.

The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. The evidence accumulated over the intermeeting period indicates that output is continuing to expand at a solid pace and labor market conditions have improved. Although incoming inflation data are somewhat elevated, a portion of the increase in recent months appears to have been due to transitory factors.

The Committee perceives the upside and downside risks to the attainment of both sustainable growth and price stability for the next few quarters are roughly equal. With underlying inflation still expected to be relatively low, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.

The windy city index

2004-06-30T17:10:00.000+02:00

The Chicago Purchasing Managers Index was released today and the data spooked quite a few market participants. Why the shock? Well...

The Chicago Purchasing Managers "Business Barometer" dropped from 68 to 56.4, showing a pullback from the thirteen months of continued growth.

Ooops. Well, maybe not all that ooops. The Chicago index is usually much more volatile (windy anyone?) than the ISM. And the ISM was a little softer last month as well. So instead of getting all upset we should note that the reading is still in expansionary territory and that all we are seeing is a loss in relative momentum.

This gibes nicely with my view that we are headed for a deceleration in the rate of economic growth over the coming 12 months and that the Fed (remember them?) will probably not have to raise rates as much as many - or even most - people are thinking. Having said that I should add that we shouldn't read all that much into one point of data. The ISM is out tomorrow and we should see it somewhere around 60. Some pundits are making much out of the fact that prices paid was the only component of the index that rose - I'm not so sure that this is really news. It is very possible that we are seeing the lagging effects of rising commodity prices which have since declined.

Alright, rate decision this evening. Will probably only be able to comment tomorrow because of time zone shift so I'll see you then.

Morning roundup

2004-06-29T09:38:00.000+02:00

Although tomorrow's FOMC meeting is still the firmly in the focus of most investors there have been other bits of financial news worth looking at. The price of oil declined to a two month low as Norwegian oil workers quit their strike and power was transferred to the nascent Iraqi government. The more interesting question is what gas prices will do ahead of the July 4 holiday weekend. Always keep in mind that the fabled guzzler of commodities, China, is but an oil-consuming minnow when compared to the SUV driving US whale.

Speaking of China: State Statistical Bureau spokesman Yao Jingyuan has been quoted as saying that the economy is cooling and on target for a soft landing in the second half. To this I say "fine, but who can really say what the Chinese economy is doing?" There is still much sentiment out there which argues that the soft landing has turned into a rout and that this will in turn lead to China gladly floating the yuan (which will then tank vs. the USD thereby giving exports a shot in the arm).

Is it just me or is the media really running lots of stories on "what will happen to indebted consumers when we get a rate hike"? A cursory look finds this, this or this. I always find it strange that people start to consider the effects of a regime switch only when it is staring them in the face. Oh well, I'm sure that everyone who financed their home via a short-term ARM is expecting a hike in income to compensate for the higher costs of borrowing.

Let's finish off with the FOMC meeting. In a nutshell: consensus is looking for a rate hike of 25bp - the big question that remains is what the wording of the accompanying statement will look like. Regular readers know that I'm not all that optimistic about the US economy going forward, so a measured pace of rate hikes (aka "Chinese water torture") is fine with me.

Thank You

2004-06-29T09:35:00.000+02:00

CurryBlog was thrilled to welcome its 10.000th visitor yesterday. A hearty "thank you" goes out to everyone who dropped in over the past months!

Step right up!

2004-06-28T16:23:00.000+02:00

That's right - be first in line to enjoy a week chock full of data and decisions. We have the FOMC meeting and payrolls this week! But that's not all folks - stay tuned for the ISM, Consumer Confidence and Personal Income and Outlays to liven up your week.

The data on Personal Spending is out already. Spending grew by around 1% with around half of the gain being accounted for by inflation. Personal income rose by 0.6% - about equal to the number we saw in April. The PCE price deflator - a measure the Fed likes to watch - rose 0.5% which is consistent with the "low but rising" inflation picture the consensus is favoring right now.

You can be sure that inflation hawks will see impending doom in this number - but hey, do we really want 0% inflation?

Anyway, I still think that the high rate of demand we've been seeing over the past quarters has caused companies to adjust prices upwards to (re)capture some pricing power. This trend was exacerbated by the fact that firms were hesitant to increase production (i.e. hike supply) - they preferred to draw down inventories. It could be that we see increased supply come online over the next couple of months which might serve to dampen the rate of price appreciation.

CA Update

2004-06-25T13:39:00.000+02:00

The post on the Current Account Koan led to a number of comments which I encourage you to read. I still believe that the question is not if the deficit is sustainable or not - I would suggest that we look at how long the things will hold up until something gives. The risks inherent in the current situation (almost a pun!) wre nicely laid out in this Bloomberg column.

The deficit is more than 5 percent of gross domestic product, double or more the level economists say could be maintained indefinitely. At the very least, trimming it to a more manageable size will take several years during which consumption will stagnate and high long-term interest rates may hurt housing and business investment.

This is mostly the point I keep trying to make - nobody here is saying that the sky will fall but there is a real possibility that deflating the deficit will mean consuming less and/or paying more for the stuff you are buying.

There's life in the old dog yet.

2004-06-25T09:59:00.000+02:00

If you were to talk to the housing bubble, it would tell you that the rumors of it's death were very much exaggerated. The market for homes just keeps powering on even as mortgage rates are rising. Interesting bit of news: prices are moderating somewhat as builders seem to be reducing prices as mortagege rates rise to keep housing relatively affordable.

Status Update

2004-06-23T19:07:00.000+02:00

A heavy workload is preventing me from posting on a regular basis right now. I hope that I'll be able to resume regular service by Friday. Not that you're missing much - markets are pretty much range-bound as everyone is waiting to see what Sir Alan will pull out of the proverbial hat come the FOMC meeting.

Current Account Koan

2004-06-21T09:52:00.000+02:00

Last Friday saw the release of the newest data on U.S. International Transactions or as some people like to put it: "the shocking truth about the current account deficit which will become ever larger and finally displace all life on earth."

I have the nagging suspicion that this data has achieved a metaphysical quality so I'd like to propose an economic Koan

If the current account deficit rises and nobody takes note, does the deficit really exist?

The current account deficit hit a new record level of around $145bn in the first quarter. The reason for the large gain can be found in the data on trade and especially in the higher costs for energy imports.

The markets were unimpressed by the data and they are right (at least in the short term). As long as the rest of world perceives the US to be an interesting investment opportunity and is therefore content to hold the US currency everything equals out. This is the situation we are in right now. Capital inflows into the US have been as large (and at some points larger) than the current account deficit.

This reflects the activity of some central banks such as the Bank of Japan who are trying to manage the value of the yen by selling their own currency for dollars. Capital inflows are also provided by private entities who decide to invest in the US for reasons of their own. As Alan Greenspan said in his Senate Confirmation hearings

There is an unquenchable demand to hold assets of claims against American residents largely because they are presumed to be safe and they're presumed to have significantly higher rates of return adjusted for risk than most other areas of the world

This nicely sums up today's situation. Private investors choose to hold dollar assets because they think that the US is a good investment right now. As economic growth is strong and inflation is still low their investment case seems intact. Many foreign (i.e. non US) companies choose to hold dollars because the US currency is still the financial lingua franca in most of the world. They have no reason to exchange the greenback for anything else right now.

So should we be wholly unconcerned about the current account deficit? Well no. Nobody can realistically force private investors to continue giving the US their money. If the economic backdrop in the US should change for the worse, private entities could start pulling their money out of the country. The same goes for companies who might want to sell the dollars in their cash registers - thereby putting pressure on the price of the greenback. This scenario would again put central banks in the spotlight as they would then have the fate of the US currencies in their hands.

Random thoughts

2004-06-18T13:09:00.000+02:00

I was out to dinner with a mutual fund manager the other day and was mostly able to refrain from talking about business except for a few general comments on the economy. He said something which I found very intersting regarding some of the strong data we've been seeing in ISM-type indices. It seems that many of those questioned were genuinely surprised by the strength of the recovery and have belatedly switched to the optimists camp. Their positive answers are what we've been seeing over the past couple of weeks although some of the economic momentum may have already been lost - simply put: many of those questioned are "behind the curve".

This is making these diffusion indices look pretty good although I still suspect that we could be in for a slowing economy in the second half. This will then give the Fed pause in rapidly raising rates.

I leave you to your weekend diversions with a reference to my post over at Angry Bear's place which looks at policy traction in the US and the Eurozone.

An eye on the CPI

2004-06-16T10:50:00.000+02:00

The (core) CPI came in pretty much in line with market expectations at a pretty modest 0.2% yesterday. The bond markets seemed to have been expecting a higher inflation rate and managed some price gains in the aftermath of the number's publication. A rebound in consumer confidence (the Iraq torture stories have run their course and gas is a little cheaper) couldn't convince market participants that the Fed will hike by a huge amount in a short time span.

I'm happy to say that the consensus is shifting towards the CurryView - the rate hikes will be measured and we will see a succession of 25bp hikes going forwards. The difficulty is that consumer's inflation perceptions are being influenced by high gas and food prices so the Fed will have to remain vigilant that perception doesn't turn into reality.

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