We do not really care about inflation. Those are the seven words the Federal Reserve can’t say – or any other central bank for that matter. The seven words they can and did say, however, was that the “uncertainty about the inflation outlook remains high.” U.S. import price inflation for every major category is now running faster than domestic inflation, which has the potential to intensify U.S. inflation. Moreover, oil prices have kept headline inflation stubbornly high. So, while visions of stagflation dance in investors’ heads, the Fed this week said that they continue to expect “inflation to moderate later this year and next year.” In fact, total inflation for consumer goods in the PCE index was running 3.1% as of May, down from the 3.5% pace it ended 2007 with. The core PCE inflation measure that the Fed likes to look at was at 2.15% y/y as of December 2007 and 2.14% as of May 2008 – nary a smidgen of new inflationary pressures. And, the six month trend in core PCE inflation is now sitting at 1.99%, just inside the 1.5%-2.0% range the Fed is comfortable with. Importantly, the experience in the U.S. over the last decade is that headline inflation converges to the core rate, not the other way around. There is no evidence this dynamic has changed, but the Fed is right to be cautious.
The worst may be yet to come - the seven words to describe our U.S. outlook. The Fed acknowledged that downside risks to growth have “diminished somewhat,” and GDP growth for the first quarter was revised up this week to 1.0% q/q. In the second half of 2007, housing was the only component of U.S. GDP to contract. Data on home prices and new and existing sales this week confirm this is likely to continue through 2008; however, a nosedive in consumer confidence highlights the large downside risk for consumer spending. Moreover, there is a sizeable - and, in our opinion, too little discussed - risk that business investment will become increasingly weak as we move forward. Changes in core capital goods orders - a measure for business investment - have been reasonably good at predicting Fed interest rate moves. U.S. core capital goods orders fell 0.8% m/m in May, and while they are still up 2.6% on a year ago basis, the credit crunch has yet to fully make itself felt.
[I]Steve Chan, Economist, TD Bank Financial Group[/I]
[B]Weekly Bank Research Center 06-30-08
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[B][B][B][B][B] High Transport Costs to ‘Un-Flatten’ the World [/B][/B][/B][/B][/B]
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[I] Stephen Roach, Head Economist, Morgan Stanley [/I]
The rather unique and extraordinary trade model in Asia – buoyant intra-regional trade, leveraged on the different comparative advantages of various Asian countries – is predicated on (i) product specialisation in the Ricardian sense nd (ii) a low cost of transport. Asia exports raw and intermediate goods to China, and China, in turn, applies the final phase of production before shipping manufactured goods overseas. This process has made Asia a rather cooperative trade zone with little horizontal competition but a lot of vertical synergy. But with sharply higher and still rising transport costs, this Asian trade model will likely be stress-tested, unless cost savings can be found elsewhere. The net impact is that the ultra-positive long-term outlook many investors may have on Asia should be tempered somewhat. We remain net-net structurally positive on Asia, but recognise that many of the factors and favourable global conditions that have made Asia such a brilliant growth story in the past years are turning – ironically, partly due to Asia’s ascent itself – and will help to temper the familiar Asian story. This does not mean that Asia’s outlook is necessarily dim, but higher transport costs will further pressure Asia to become less reliant on exports as the main engine of growth. In the initial stages of this transformation in Asia, high costs of transport will ‘help to un-flatten’ the world and act as a temporary headwind for many Asian currencies.
Full Story
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[B] Dismal Maybe, Boring Never [/B]
[/B] [/B] [/B] <em> Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank
If you have ever wondered why economics is regularly referred to as “the dismal science”, just cast a glance over the data of the past week. We are currently witnessing an unheard of collapse in consumer confidence (in Denmark, consumer confidence fell to its lowest level since 1999, in the US to the lowest level since 1992, in New Zealand to the lowest level since 1991, and in France to the lowest level since 1987 - to name just four). At the same time, purchasing mangers’ expectations (PMI and ISM) show that industry is now contracting in the US, Euroland, the UK and Japan. Further, US housing market indicators this week show that the situation here continues to deteriorate. On top of all this comes a jump in inflation. This is perhaps most visible in countries such as Vietnam (consumer prices up 26.8% y/y this week), Iceland (12.7% y/y) and South Africa (11.7% y/y), but inflation is also making its mark closer to home: Belgian inflation is running at 5.8% y/y, the highest rate since the mid-1980s. Central banks are, of course, under pressure from rising inflation, and Norway, Poland, Rumania, Mexico and Taiwan all hiked in the past week.
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[B] Fed Leaves Funds Rate Unchanged in Midst of Economic Uncertainty [/B]
[/B] [/B] [/B] [I] E. Silvia, Ph.D. Chief Economist, Wachovia[/I]
In an uncertain economic sea the Fed struck its sails and went neutral. Economic fundamentals on growth, inflation, and credit markets suggest a high degree of sensitivity to the next set of indicators. At this razor’s edge the call for bold action appears too risky -- better to wait for a clearer vision of the horizon. Looking ahead, we also expect the Federal Reserve to maintain the current two percent Federal funds target at the August and September meetings. Below trend economic growth is our expectation for the rest of this year. While rebates will temporarily boost consumer spending in the third quarter, we expect growth of one to two percent for the next three quarters. Any strength will come from exports and federal government spending. Meanwhile, inflation, as measured by the core PCE deflator, is expected to remain above the Federal Reserve’s perceived two percent target ceiling. Therefore, the balance of the growth/inflation outlook suggests that the Federal Reserve will remain on hold for the rest of this year.
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[B][B][B][B][B] The Inflation Scare [/B][/B][/B][/B][/B]
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[I] Steve Chan, Economist, TD Bank Financial Group [/I]
We do not really care about inflation. Those are the seven words the Federal Reserve can’t say – or any other central bank for that matter. The seven words they can and did say, however, was that the “uncertainty about the inflation outlook remains high.” U.S. import price inflation for every major category is now running faster than domestic inflation, which has the potential to intensify U.S. inflation. Moreover, oil prices have kept headline inflation stubbornly high. So, while visions of stagflation dance in investors’ heads, the Fed this week said that they continue to expect “inflation to moderate later this year and next year.” In fact, total inflation for consumer goods in the PCE index was running 3.1% as of May, down from the 3.5% pace it ended 2007 with. The core PCE inflation measure that the Fed likes to look at was at 2.15% y/y as of December 2007 and 2.14% as of May 2008 – nary a smidgen of new inflationary pressures. And, the six month trend in core PCE inflation is now sitting at 1.99%, just inside the 1.5%-2.0% range the Fed is comfortable with. Importantly, the experience in the U.S. over the last decade is that headline inflation converges to the core rate, not the other way around. There is no evidence this dynamic has changed, but the Fed is right to be cautious.
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[B][B][B][B][B] Credit Crunch Taking Second Place to Worries About Inflation… [/B][/B][/B][/B][/B]
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[I] Trevor Williams, Chief Economist at Lloyds TSB Financial Markets [/I]
With the credit crunch now taking second place to worries about inflation, interest rate futures are pointing to significantly higher official UK interest rates in the next two years. This is a sharp turnaround from a few months ago when they were looking for deep cuts. But the rise in consumer price inflation to 3.3% in May and the prospect that it will peak at well over 4% this year has led to a sharp change in sentiment in the financial markets. Moreover, UK consumers seem immune to the pressure from rising inflation, higher mortgage borrowing costs, falling house prices and lower confidence. Retail spending refuses to fall, rising by 3.5% in May to stand 8.1% higher in volume terms than in the year before. Our view is that employment growth is the key to this and as some people give up on owning a home, or moving near term, and spend instead, leading to lower savings and strong growth in sales. With inflation rising, there is a clear risk that the MPC may be forced to raise official interest rates significantly higher, despite weaker overall growth. Because of this, we have calculated two scenarios, one where interest rates move in line with financial market expectations, as suggested by forward sterling interest rates, and a second where Bank rate is 2% higher than in our base case. The base case assumes only one increase in UK official interest rates, in early 2009 when the effects of the credit market crisis are fading and the implications of higher consumer price inflation for the economy are clearer. The results of this exercise are shown in the following charts. And the outcomes are clear: the Bank of England must be careful not to raise interest rates too much too soon. Such an outcome could make the unfolding economic slowdown too excessive, and lead to consumer price inflation undershooting the official 2% target in 2010. At the same time, our analysis shows that some increase in official interest rates seems necessary for inflation to hit the 2% target. But for that to happen, a period of below trend growth (2.3-2.6%) this year and next is inevitable.
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[B][B][B][B][B] Other Pre-screened Independent Contributors[/B][/B][/B][/B][/B]
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[I] J-Chart [/I]
J-Chart is an innovative charting and bias-neutral market analysis tool. Based on its proprietary theoretical concept and display of market price action, J-Chart provides a much clearer and unique insight into the market than conventional charting methods. This innovative charting and market analysis tool is designed to visualize market price action that constructs unique price patterns called “Equilibriums”. Based on its “non-fixed time frame” concept and “Kinetic Equilibrium” application, J-Chart users are able to forecast markets’ future movements with high accuracy.