Subscribe: RSS Feed | Twitter | Facebook | Email
Home | Contact Us

Posts Tagged ‘prospects for stagflation’

Dollar Devaluation, Stagflation, and How “You’re Getting Screwed”

Posted by Larry Doyle on April 29th, 2011 8:12 AM |

“Remain calm, all is well!!”

Such would seem to be the message put forth this morning by The Wall Street Journal’s lead headline, Officials Unfazed by Dollar Slide,

In recent days, the nation’s top two economic policy makers—Federal Reserve Chairman Ben Bernanke and Treasury Secretary Tim Geithner—have publicly expressed their desire for a strong dollar. But there is little indication of a change in policy from either the Fed or Treasury—or in underlying economic conditions—that would alter the currency’s downward course.

When thinking of Bernanke and Geithner, who do you think of first, Abbott and Costello or Laurel and Hardy? I am more in the former camp. “Hey, Abbbbbotttttt!!”  (more…)

Front End Springs a Leak

Posted by Larry Doyle on June 5th, 2009 4:57 PM |

In a manner of speaking, the management of our economy has been nothing short of a major overhaul of a tired old ship. When the tide went out, the base of our ship was exposed as being filled with holes.

Little did we know at the time, but through many of those holes a number of “pirates” were running off with a whole lot of booty. In the process, many market participants riding along on the main deck were thrown overboard by the economic storm that hit our economy and markets over the last two years.

We do not have the luxury of bringing our ship into port for an overhaul. We have had to continue to sail this ship while trying to repair it. In that spirit, by necessity we have had to add significant ballast (liquidity) in our hull. In so doing, we need to recognize that the ballast can itself be inflammatory if the engine generates a spark.

In purely economic terms, this morning’s non-farm payroll number of -345k jobs  was a hint of a spark. While various sectors of the market gyrated today, the front end of our ship, that is the front end of our yield curve, sprung a serious leak. How so? Interest rates on short term Treasury notes increased a DRAMATIC 35 basis points. Why?

Traders are already pricing in an expectation that the Federal Reserve will be forced to increase the Fed Funds rate prior to any hint of inflation or even the expectation of inflation gains a foothold. Bloomberg sheds color on this likelihood, Traders Begin to Speculate Fed Will Need to Tighten:

Traders are beginning to price in expectations the Federal Reserve will raise interest rates this year as the recession shows signs of abating.

Federal-funds futures contracts on the Chicago Board of Trade show a 70 percent probability the central bank will lift its target rate for overnight bank borrowing to at least 0.5 percent by November after a report today showed the U.S. economy shed the fewest jobs in May in eight months. Rate-increase odds were 27 percent yesterday.

The Fed cut the target rate to the record low range of zero to 0.25 percent in December as the economy lapsed into the worst recession in decades. President Barack Obama and Fed Chairman Ben S. Bernanke have committed $12.8 trillion to thaw frozen credit markets and ramped up government spending to revive growth. The Fed last raised borrowing costs in June 2006, when policy makers pushed the rate to 5.25 percent.

Fed governors and Fed chair Bernanke now face a serious quandary. Economic data will remain decidedly weak. Unemployment will continue to increase. Consumers are going to remain strapped. Corporations will face challenges. Municipalities will encounter an ongoing decline in tax revenues. Nobody is going to truly feel like the economy is improving to the point that the Fed should even think about increasing interest rates. Then why is the market starting to price that reality into the market? Let’s go back into the hull.

The bowels of our ship are flush with liquidity and given any sort of traction in the economy, the velocity and growth in the money supply will drive inflation.

What is Big Ben and team to do? The market is raising interest rates on him rather than his raising interest rates on the market. In the process, a very fragile economy will now be forced to deal with higher interest costs along with anemic growth.

What do I see on our economic horizon? In my opinion, today’s price action took us in the direction of the island known as Stagflation.

Please share your thoughts and comments.

LD

Inflation, Deflation, or Stagflation?

Posted by Larry Doyle on June 1st, 2009 11:06 AM |

I am an eternal optimist and, as such, I never want to see people’s spirits waver. I encourage people not to allow the current economy to “deflate” their hopes for better days. By the same token, I am a pragmatist and caution people not to view the recent bounce in our equity markets as reason for an overly “inflated” sense of optimism. In this same spirit, though, we need sufficient optimism along with practical analysis to avoid the perils of “stagflation.” Let me expound.

The debate between analysts touting prospects for inflation versus deflation is ongoing. Those concerned with deflation highlight increasing levels of unemployment pressuring wages, falling asset valuations, and slack consumer demand. Those concerned with inflation point toward the unprecedented levels of liquidity injected into our system via all of the government programs. The inflation hawks maintain the economy merely needs a small spark and inflation will spread in an uncontrollable arson-like fashion.

I actually believe there is a very real chance we get developments from both camps leading to the scourge known as stagflation. How may this play out?

Many respected analysts are promoting the concept of a new “normal” economy. This scenario entails an economy operating with enormous government deficits, an elevated level of unemployment, and little to no shadow banking system (securitization of loans and other assets).

In this new “normal” economy, GDP may only eke out small positive growth given these heightened pressures. Pimco’s Mohamed El-Erian writes of A New Normal:

This reflects a growing realization that some of the recent abrupt changes to markets, households, institutions, and government policies are unlikely to be reversed in the next few years. Global growth will be subdued for a while and unemployment high; a heavy hand of government will be evident in several sectors; the core of the global system will be less cohesive and, with the magnet of the Anglo-Saxon model in retreat, finance will no longer be accorded a preeminent role in post-industrial economies. Moreover, the balance of risk will tilt over time toward higher sovereign risk, growing inflationary expectations and stagflation.

Even as we come out of this recession, our economy will run increased risks of slipping into another recession given the lack of cushion provided by a strong consumer, the burdens of heavy government debts, and inability to easily access credit.

El-Erian adds:

For the next 3–5 years, we expect a world of muted growth, in the context of a continuing shift away from the G-3 and toward the systemically important emerging economies, led by China. It is a world where the public sector overstays as a provider of goods that belong in the private sector. (As one of our speakers put it, we have transitioned from a world where the private sector provided public goods to one where the public sector provides private goods.) It is also a world in which central banks and treasuries will find it difficult to undo smoothly some of the recent emergency steps. This is particularly consequential in countries, such as the U.K. and U.S., where many short-term policy imperatives materially conflict with medium-term ones.

As our global economy transitions to this new “normal,” I believe the likelihood of stagflation is quite high. For those who recall the perils of our economy in the early 1980s, stagflation is not a pretty picture. How does one manage investments and personal finances in an environment of stagflation?

Let’s deal with the component parts. Given sluggish growth, limited credit, and lessened opportunities, it is of paramount importance to cut expenses and minimize debt as much as possible. Servicing debt will be an ongoing challenge and increasingly problematic. Be proactive at this point in time in adjusting your finances to this reality.

Where will the inflation come from and how does one address it? In my opinion, the inflation “train” will arrive sooner than we think. Some of the savviest investors, including Financial Pacific Advisors’ Bob Rodriguez and noted Black Swan author Nassim Nicholas Taleb, are already positioning themselves for it. (The WSJ reports, Black Swan Fund Makes a Big Bet on Inflation).

How can people protect themselves from the inflation monster? Increase exposure to the following:

  – precious metals and commodities

  – critical infrastructure (power plants, agriculture, water, transportation)

  – necessary life items (drugs, medicines, food)

  – stronger and more fiscally prudent foreign markets

Decrease exposure if not get outright short

  – longer maturity (5yr and and longer) Treasury bonds

This stagflation story will have many chapters and I will be writing extensively on it. Please share your thoughts, opinions, and recollections of the early 80s economy so we can all move forward most effectively in navigating the economic landscape.

LD

May 2009 Market Review

Posted by Larry Doyle on May 29th, 2009 11:23 PM |

Welcome to the Brave New World of the Uncle Sam economy! Let’s review the price action across the market, add some analysis as we look behind the numbers, contrast these returns with developments in the economy, and chart our path forward as we navigate the economic landscape!!

may-2009-market-review2

Market Returns:

Equities: while market analysts continually measure the market from March 6th, unless one purchased the market on that date and at that point, it is much more intellectually rigorous to measure returns on a YTD (year-to-date) basis. Although I will incorporate short term movements, focusing solely on the short term increases the risk that we “miss the forest for the trees.”

The equity markets posted solid returns for the third month in a row. Although the returns in May were positive, they were not as largely positive as the prior two months. Year to date, the DJIA is slightly below unchanged while the S&P 500 is slightly positive. The tech heavy Nasdaq continues to outperform and is solidly positive (+12.5%) on the year. Why? Many tech companies have significnatly less debt burden and refinancing risks.

Bonds: the high yield sector continued to outperform (+9.7% MTD, +24.3% ytd). The mortgage and municipal sectors largely marched in place. The front end (shorter maturities) of the U.S. government bond market held steady as the Federal Reserve indicates they will keep the Fed Funds rate at 0-.25% for an extended period. The long end (intermediate to long maturities) of the government bond market sold off dramatically (+35 basis points on the 10 yr) under the weight of very heavy supply.

Currencies: the U.S. dollar had a very difficult month relative to almost every other major currency. The greenback gave back almost 4% relative to the Japanese yen, although it remains within the trading range for the year. The dollar particularly suffered versus the Euro on concerns of a potential downgrade of U.S. government credit due to the ongoing fiscal deficit. 

Commodities: this is where the real action occurred this month. Commodities, in general, posted their largest monthly gain in 34 years. Oil was up 30.1% on the month and 55.6% on the year. Gold rallied 11% on the month and is up a like amount for the year. 

Looking Behind the Numbers . . .
As I view the monthly and annual numbers, I am drawn to a comparison of a football pass thrown in a game. That is, when the football is thrown, three things can happen and two of them are not good. The pass can be completed, fall incomplete, or be intercepted.

Similarly, our economy can gradually improve with credit lines opening, housing and employment stabilizing, and markets improving – much like a completed pass.

Our economy can stumble under the weight of a surge in delinquencies and foreclosures in the residential space, a wave of commercial real estate defaults, and a double digit unemployment situation – much like an incomplete pass.    

Our economy can stabilize with enough traction to create velocity in the growth of the money supply. Given the trillions of dollars injected both directly and indirectly, a hint of velocity will likely spark a sharp increase in the expectation of inflation even prior to actual signs of inflation. The price action in the commodity and currency space are sending warning signals on this front. This development is akin to an intercepted pass. 

Economic Review . . .
As I look back on the wealth of economic data, I am continually struck by the downward revisions to prior months’ numbers. Although consumer confidence has increased, in my opinion, virtually every other statistic both here and abroad shows ongoing caution signs. These numbers include retail sales, housing, employment, and industrial production. Overseas the export data is decidedly weak.

Perhaps the markets are discounting an expectation of improved economic data due to the $780 billion Stimulus Bill starting to kick in later this year. The major money center banks have clearly been stabilized, although it took a fabrication in their accounting (via a relaxation in the mark-to-market) to do so.

The movement in commodities is clearly indicating a sign of improved economic activity and/or heightened inflation, or both. It is not inconceivable that our economy does get inflation sooner than later combined with minimal credit flow due to ongoing writedowns on delinquent or foreclosed loans. Combine these two components and we have a very real chance of stagflation over the next few years.   

The Path Forward . . . 
The steepening of the yield curve (rates on short term maturities relative to long term maturities) is very positive for our banking industry. The banks can continue to borrow money at extremely low rates and earn significant interest on almost any sort of lending that occurs. That said, new loan demand is not strong while demand for refinancing is quite strong.

My concern currently is not with the major money center banks. I am VERY concerned with the non-bank banks (Freddie Mac, Fannie Mae) and the Federal Home Loan Banks (FHLBs). Given the ongoing surge and expected high levels of residential loan defaults, these institutions will bleed money. The insurance sector, despite some recent improvements in their stock prices, also concerns me given their commercial real estate holdings primarily.

I do believe longer term interest rates will continue to work their way higher under the weight of supply of global government debt, and expected ongoing heavy demand (May was a very heavy issuance of both bonds and stocks) by municipal and corporate issuers. Do not be surprised to see our 10 yr Treasury note get to 4% and 30yr fixed rate mortgages get to 6%.

The deleveraging process will continue as the economy adjusts to life without a vigorous securitization business (remember the securitization business on Wall Street provided 40-45% of total credit to our economy).

Add it all up and I think the following will occur:
   – equity markets will now move sideways in range bound fashion;
   – the bond market will move lower in price, higher in rates; 
   – the dollar will gradually decline;
   – our economy will be filled with more stops than starts.

Please share your thoughts and comments!! Thanks.

LD

Ticking Time Bomb

Posted by Larry Doyle on April 23rd, 2009 11:43 AM |

If a picture speaks a thousand words, then please take a look at the graph from the St. Louis Federal Reserve highlighting the recent growth in our domestic money supply:

None other than esteemed Harvard University economist, Martin Feldstein, is warning us about the impending threat of inflation. Some analysts view deflation as the near term threat, but it is not inconceivable that our economy has an initial bout of stagflation given the prospects of a sluggish economy. If and when the economy turns, we will then likely experience a rapid rise of inflation with a real threat of hyperinflation.

Bloomberg recently discussed these topics with Feldstein and reports, Harvard’s Feldstein Sees U.S. Inflation Danger After 2010.  

How do we prevent inflation from occurring? Picture Ben Bernanke and Tim Geithner trying to gracefully and smoothly manage a decline in the money supply from what appears on the above graph to be a likeness of the cliffs of Mount Kilimanjaro.

As Feldstein warns:

the Federal Reserve will have a challenge in heading off inflation because of how it’s conducted monetary policy during the crisis.

Instead of expanding the central bank’s balance sheet by purchasing easy-to-sell Treasuries, the Fed has snapped up mortgage securities that are likely to be tougher to use as a tool to soak up cash, Feldstein said.

In an earlier interview with Bloomberg Television, Feldstein said he didn’t anticipate a lending boom from banks judged to have passed U.S. regulators’ stress tests on their balance sheets.

In light of this threat, I think global interest rates may move sharply higher over the course of the next 1-2 years.

LD






Recent Posts


ECONOMIC ALL-STARS


Archives