Retail Sales and the Bear / CPI And The 5-Legged Calf - The Week Ahead

The US consumer has been driving a 4-speed and he’s just shifted up, now in 3rd. That gear won’t handle what’s just ahead.

We predicted vigor in consumer spending long before most other observers (thank you very much). Now these who missed the trail all want to camp with us. But there’s a bear about in the form of $5 gasoline so we’re long gone.

Spending just ahead will slow; it will not stall but will certainly slow and this is naturally tied to oil. Thus, assume the Apr/13 release for Mar Retail Sales exceeds estimates. The market crowd will be cheered. Don’t be.

Next, March CPI is to be released on Apr/15, Friday. Since Federal Reserve chair Uncle Art Burns convinced the BLS to ex out most of what counts (at Nixon’s urging, with the ’72  election in mind) CPI presents little problem to Bernanke.

Headline CPI jumped in Feb primarily due to energy prices. Imagine what headline Apr CPI will do! But to the Fed, no problem. Energy prices are about 15% above year ago levels (as of Feb) yet core consumer prices (ex food & energy) are up only 1.1%, yr to yr.

How convenient.

This reminds us of Abe’s story about the calf. During a Congressman’s boasting about a supposed McClelland “victory,” Lincoln brought up the story about the 5-legged calf. Seems there was a boy who when asked how many legs his calf would have if he called its tail a leg, replied, “five,” to which the response was that calling the tail a leg would not make it a leg.


Robert Craven

Time To Sober Up - The Week In Review

The Street have come to understand that the US economy is at escape speed, all now looking in that direction. Sure enough, events this week illustrated that unemployment is still improving (Claims), that consumers are visiting department stores like crazy.

Mark Twain reminded us, “Whatever new thing a consensus coppers (colloquial for ‘bets against’) bet your money on that very card and do not be afraid.” Well, it’s not quite that easy, but you get the idea.

We were cheerleaders for the US economy when there was no one else in the stadium. Now the stadium is near capacity.

But those fans have yet to appreciate the impact of a new game rule - Mid Eastern tension and impact on US GDP by the way of crude prices.

Consider this week’s so-called Chain Store Sales result (which represent perhaps 10% of all retail sales but provides a pretty good litmus test). Results are reported Yr to Yr. Yesterday’s numbers seemed encouraging, folks buying like crazy. Now can any reasonable observer believe that results like these will continue with $5 gasoline? No.

The situation in the mid east will prove to be corrosive. This should not be a surprise. The surprise will be the extent of damage. Gas prices are heading higher than most even now appreciate.

Federal Reserve officials warn us that higher oil will not spark inflation. Thank you very much. That was never the real risk.

We have the worst, top-side impact of higher energy at 1% of GDP.


Robert Craven

Those Pesky Offshore Events - The Week in Review

The US economic engine - just when she’s on the way to sparking on 6 of 8, one of those dog gone pesky offshore events threatens to throw a wrench into her works. Let’s take a look.

But first, let’s review the US economy. Our clients received a major heads up Q4. Forecasters were looking in the wrong direction. We predicted that when they sobered up, they would suddenly revise their US GDP estimates, much higher. This was the result. That pattern is closed.

Now to the present. This week was packed with key releases. We predicted strength in jobs, factory activity and vehicle sales. Factory activity was little changed, jobs cooperated nicely; Mar vehicles sales have yet to come in, this writing. We also predicted on Mar/24 after that day’s better than expected Claims print that the number of unemployment claimants would head even lower. Thursday’s number did just that.

Looking ahead , vigor will continue (aside from pesky offshore events) but key for our clients - most forecasters have finally caught on, depriving us of that major leg up which comes with early discovery.

Developments in the European Union appear to many to be a threat to the US economy but are not. A Special edition on this topic is in the works.

Developments in Japan have cooperated nicely with our anchor. Past a day or two of panic, markets there and in neighboring countries have recovered. There have been pipeline stoppages, delivery delays, but nothing not now priced in. A rescue package is near completion. Repatriation has so far been limited; Japan will instead issue bonds and although the Bank of Japan denies it, we expect them to at least partially finance this effort.

The yen is now at pre-quake levels vs the $. The horse is long gone from the barn. Even Warren Buffet agrees with us. It counted a great deal to understand this reality on Mar/14; it’s not worth much now. This pattern is closed.

Events tied to the tragedy will not throw a wrench in the works, will not act as a retardant on US GDP but will act as either a wash or modest spark. Eventually, observers will come to understand this reality.

Finally, we borrow copy from our Mar/4 post on the Mid East: During the weeks ahead we suggest investors and planners adhere to our anchor and acknowledge the glaring risk associated with this region. Course of least resistance for crude prices to remain higher over the intermediate term. It is foolish to believe otherwise.

Higher crude is not so much an inflation threat as a retardant and a powerful one if maintained through Q2. Clients can expect forecasters to begin to shave their US GDP forecasts, linked to this event. They just don’t know that yet.


Robert Craven

Obama - Primary Retardant

In the old days folks, things were simple. Park at the Santa Fe depot and count the cars. Tour a shopping center parking lot. On a trip to Long Beach, check out port activity. That was about all there was to it. That’s all we needed to get a pretty darn good idea of consumer activity ahead. That’s worth 70% of the equation right there.

No more. As we noted the other day, you need a spook or two in the Mid East and half of Congress wired, or your without a leg up.

Well, we try to get by.

With all the noise and ruckus offshore, it is easy to forget that we’re sitting astride a US engine which was firing on 5 of 8 and is trying its best to go to 6 or 7. We’ve noted potential retardants, the Mid East key among these. But we had through ‘09 and ‘10 a very real retardant, nothing potential about it.

We were in school when Nixon convinced Burns to fire the economy on 9 of 8 cylinders, inflation be damned. Short of that event, never before has a correct sense of political reality so directly impacted economic strategy.

In fact, the single key hindrance to a recovery resides in the White House, or did. And don’t forget that Obama and his party are partly or wholly responsible for sparking the crisis in the first place (protected the twins from reform to buy black votes).

We stated in posts ahead of the Nov election that results would spark the economy. Forecasters missed this point completely; that is, the delivery of economic traction. As we predicted, both business and consumer were cheered by the result and then further cheered as the new majority in the House began quickly, more quickly than most suspected, to make repairs.

Obama’s education has represented a huge expense for all of us. He’s learned enough to act the right way to get re-elected. OK. To the extent he can refrain from further interference, the US economy will do just fine.


Robert Craven

Data Week in Review

The beginning of each week we review that week’s scheduled eco data releases, highlighting those with mkt-moving hrsp, then predicting result vs consensus. Sometimes there are other influences which may interfere, the mkt crowd otherwise occupied (a temporary state of mind). Nevertheless, ongoing, this exercise is key to value provided by this service.

Mon (Mar/14) we predicted that releases this week would indicate more vigor ahead and building price pressures. This fits our long-held view that forecasters have yet to catch up.

Headline Feb PPI on Wed rose by double the consensus, the headline at consensus. The headline and core Feb CPI results today were both slightly higher than expected. Also today Claims for unemployment benefits confirmed the improving trend in the labor mkts, falling 16M to 385M. So far, so good.

Feb Ind Production today did not cooperate, printing -0.1% when +0.5% was expected. What happened? Manuf which makes up 75% of the total and was up nicely but utility activity tanked. It’s a mystery to us. It’s also a blip. Expect stronger readings ahead.

Finally, the key Philly Fed business outlook survey has been, over the many years we have monitored it, a reliable lead for US manuf sector trends. The Mar read today blew through expectations, making crow bait of St forecasts. The read also indicated that price pressures - “prices paid” - are rising rapidly. This of course cooperates very nicely with client anchors set earlier.


Robert Craven

Anchors

Anchors are key these days. Let’s review.


Japan - Visited in the past two blogs, we stated that the mkt crowd has over-reacted to this crisis, underestimating Japanese powers of resuscitation. Sure enough, the Nikkei recovered about half its Tues losses today. The major unknown right now is the extent of repatriation, what one observer called the “snap back in capital flows,” in Japanese offshore wealth, this being a sort of bank or fund for such a crisis. We can’t judge that factor. In isolation of that factor, the situation in the Mid East, not Japan, provides the key potential retardant to US growth.

Mid East - Nothing has changed. Turmoil will continue, likely accelerate. We are going to a place that means more manageable energy for the West but it will be no fun in getting there. These folk embody the meaning of intolerance but we’re stuck with them. Simply witness the Christian / Muslim conflict in Egypt, the current Sunni / Shiite conflict in Bahrain. Still, a gradual move to consensual gov’t represents reality for this region, and this in spite of Obama’s voting “present.”

US - The US economy can be expected to continue to accelerate into Q4. This will be lead by job creation and expanded domestic spending. Any impact from slower Japanese demand will be small. And of course, crude prices will remain a threat Q2 and Q3. And if the event in Japan means the end of the nuclear renaissance, we must factor this in too.

Fed cheerleaders - Bernanke & Co. said yesterday that inflation effects of increased commodity costs, “will be transitory.” How “transitory”? Witness today’s Feb PPI, the headline number double expectations, the largest jump in two years. Sure, it is true that companies don’t have much pricing power to pass these costs along, just yet. But if the Mid East situation extends in Q4 and higher crude with it, this will either dampen growth, of spark inflation, or more likely - both. So why “transitory”? The truth is, the Fed is without a clue, slippery as ever.


Robert Craven

The Week Ahead

This week we have two key price numbers: Feb PPI on Wed and Feb CPI on Thursday. Also on Thursday we have Claims, Feb Ind Production and the Mar Philadelphia Fed manuf outlook survey. There are other releases but only these five carry potential mkt-moving hrsp. As we approach these numbers we will review each in more detail but all in, they are likely to indicate more vigor ahead, and building price pressures.


The tragedy in Japan remains a key near-term consideration. We suggest objectivity, which requires a distancing from the headlines.

Having the advantage of working closely with Japanese institutions, past years, we can confidently advise our clients to look for more rapid resuscitation than is now priced in.

Recall the Kobe quake of Jan/95 which killed 6400 people and caused damage observers put at 2% of GDP. Kobe is a key container port. Recovery was so fast that, according to Alan Wheatley of Real Clear World although Japan’s Ind Production fell 2.6% in Jan it rose 2.2% in Feb and again in Mar. GDP rose 3.4%, Q1 ‘95.

The “experts” put the Kobe recovery at a decade. But as we are reminded by the late George Horwich of Purdue, Kobe’s manufacturing was at 98% of pre-disaster levels in 15 months.

Japan not only has abundant resources, physical and human capital but the social and economic infrastructure to utilized resources in a hurry, including those contributed by the US and others. And - KEY - the current disaster is in a region far less populated and far less an economic factor than Kobe.

Finally, the word “meltdown” is a gift from heaven for the world press, very useful for bottom line purposes. It’s application is made by the media not only to single power units, but to the world industry. We must be cautious in this regard. Conventional wisdom has it that the renaissance in nuclear power is now finished. Perhaps not. The plants in question are very old.

We spoke this weekend with a nuclear engineer assigned to PGE’s Diablo Canyon nuclear plant. He advises that new back up systems likely would not have suffered the same fate - loss of power. He adds that the key now is to observe success +/- in Japan’s shut down process..

Caution is in order before leaping to oil and coal sectors; don’t write the obituary for nuclear just yet.


Robert Craven

The Middle East - Update

During the weeks ahead we suggest investors, planners adhere to our anchor and acknowledge the glaring risk associated with this region. Course of least resistance for crude prices to remain higher over the intermediate term. Higher crude is not an inflation threat, it is a retardant, and a powerful one if maintained through Q2.

We have seen the beginning of a movement which will swing the entire region. For us it’s a birth we predicted (prematurely) 4 years ago. The little infant’s a tad late but just as welcomed nevertheless.

Pessimism re this region comes easy for world observers. Many confidently await a reversal. As Thomas Sowell maintains, “There is very little sign of tolerance in the Middle East, even among fellow Muslims with different political or religious views, and all too many signs of gross intolerance toward people who are not Muslims.”

This time will be different. “Today’s rebellions are animated, above all, by a desire to be cleansed of the stain and the guilt of having given in to the despots for so long,” Fouad Ajami reminds us. Protests have been more orderly than most expected, devoid of any radical political agenda. Yes, thugs still abound; one is killing his own people and we just this moment heard of violence in Alexandria; yet, subsurface there is a maturity to this movement, a demonstrated sense of responsibility that we have not seen before. The people have shown courage, character and a deep yearning and appreciation for consensual gov’t.

Yes, this time will be different but still fraught with awful risk. This is why we said earlier that any investor would be just plain nuts to listen to authority figures who assure them they are looking at a blip. We set the upside on WTI at about 120. Of course we don’t know for sure and hope we’re wrong but you’re a whole lot more likely to see a 120 print before you ever see 75 again.



Robert Craven
The Craven Report

It Won't Go Away

Most observers have yet to come to understand the dynamics of the situation in the Mid East.

Bernanke was a cheerleader for the economy today, saying the recent surge in oil prices is unlikely to have a major effect on growth or inflation as long as higher prices do not become sustained. Well ya but the clear risk is that they will be sustained for goodness sake, not indefinitely, but over the intermediate term.

We are witnessing nothing less than the birth of a new Mid East. We don’t know just how tumultuous that adjustment may be but we know the course-of-least resistance is for more turmoil, for more violence, for more interruptions in the flow of crude.

This is the risk as we highlighted earlier. Investors would be well advised to work this into the equation while heeding the words of Fouad Ajami, fellow at the Hoover Institution, “In the tyrant’s shadow, unknown to him and to the killers and cronies around him, a moral clarity had come to ordinary men and women.”

It won’t go away, not this time.


Robert Craven

Data Week in Review

We predicted on Monday that this week’s data would show that 1) core price pressures remain contained (because that which is not “contained” is ex’d out), that 2) consumer activity will continue to grow and 3) that manufacturing is booming. Let’s take a look.

Core CPI rose 0.2% vs consensus of 0.1%; core PPI rose 0.5% vs expectations of 0.3%. Core consumer prices are 1.0% above their year ago level, one of the slowest paces in the 52 years of data collection. Fine and dandy, and of course when transportation, apparel and medical care prices begin to spark, suppose we can ex those out too. And eventually, growing price pressures at the producer level will filter through.

Next, consumer activity continued to grow alright, but a tad slower than the St expected, given forecasters are now used to consumers broaching expectations. Some blame it on weather. But the weather was no secret. We’ll see. Retail sales rose 0.3% in Jan vs expectations of 0.5%. The consumer is alright, and is still shopping despite high unemployment, sluggish income growth and tight (but now loosening) credit.

Finally, manuf activity is indeed booming. We saw that activity of NY based firms improved further in February, and today, that activity in the mid-Atlantic region (Phil Fed survey) is off the charts, the survey at the highest level since Jan/04; new orders at the best pace since Sep/04; shipments at the fastest pace since July/04 and employment at its highest level since record keeping began in 1968.

(We did receive the Bloomberg consumer conf survey today and it was lower. Ignore all confidence surveys. They contain nearly zero leading characteristics, our experience.)

Bottom line: Basement price pressures are building, yet are on the radar so nothing really mkt moving yet, that is, this reality is priced in. Manuf activity and related employment was not on the radar and will cause forecasters to improve their forecasts. Finally, after our significant insight early on regarding consumer activity, we are now in neutral and will monitor this sector over the near term.


Robert Craven

Commodity Price Inflation - A Closer Look

World commodity price inflation continues to monopolize the headlines. We spotlighted this topic in January. Food inflation (and income inequality, and high youth unemployment) has sparked much of the recent violence in the developing world. A closer look is in order.

We hear that price hikes in food and energy stocks, past 12 months, are impoverishing folks in lesser developed countries. Mother nature had a hand in much of this. We just saw the worst drought in Russia and the Black Sea region for 130 years, lasting long enough to damage winter planting as well as the summer harvest. This was compounded by late rains in Canada, Nina disruptions in Argentina, plus increased US grain acreage for ethanol, so on and so on. For example, the world’s stocks-to-use ratio for corn is nearing a 30-year low of 12.8pc, according to Rabobank.

Next, we know the developing world is booming, or was. So this - world demand - adds pressure. But these conditions have existed before, even in tandem. What else is there? Why the spike? Many blame Bernanke. Let’s see.

Take China as an example.

Chinese consumers find themselves paying exorbitant prices for food stuffs. Here is the money portion of the equation: Everybody in the world wants to invest in China. The Fed’s printing a ton of “hot money” (money which does not come from an increase in wealth or consumer demand, but from the press) and since there’s no need for it in the US a heck of a lot of it headed for China. Coming on top of China’s massive trade surplus (in dollars) these inflows provide a migraine to the Bk of China. Why? A cheaper dollar makes their yuan more expensive; their exports shrink. So the gov’t mops up these dollars from exporters and banks and prints yuan for each dollar purchased. That’s a heck of a lot of yuan thrown on the domestic market.

This is fine for the chosen policy of mercantilism but tough on Chinese consumers. Their currency is depreciated; they pay more for cooking oil and wheat while their export industry prospers. The Chinese gov’t is sacrificing the consumer on the alter of trade by choosing to import US monetary policy. Other countries who cannot resort to currency management are doling out more subsidies for energy and food. This behavior runs the risk of stalling the recovery in the developing world.

So yes, if you inflate the world’s money supply by $1.5 trl nowadays, you can be pretty sure that you’ll spark prices on those global, auction-priced goods priced in $’s, such as food and energy. In the meantime Bernanke plods along, battling the deflationary ghost.


Robert Craven

Conspiratorial? Certainly Not!

We’ll see quite a little data this week folks. Some carries no mkt-moving potential. Some does, beginning with Jan Retail Sales tomorrow, then on to the Jan PPI, Housing Starts and Ind Production data, all on Wed., then finally to Jan CPI and the Phil Fed’s Regional Manuf’s Outlook survey on Thur.

By Friday we will have seen that core price pressures remain contained (because that which in not “contained” is ex’d out). We will see that consumer activity continues to grow, that manuf is booming. If longer-term interest rates where only impacted by this data, in isolation then they would be just a tad higher at the end of the week, and only a tad as the mkt crowd is told there is no inflation; they take that home with them.

We can peer offshore for just a moment however to see what would happen to US rates if the mkt view grew for inflationary pressures. The UK Gilt (10 yr UK obligation) is now 50 or so basis points (each “basis point” is .01 of 1%) higher that beginning year levels, last at 3.85%. The US 10 yr is only 30 bps higher for the same time period, last 3.66%. Measured inflation in the UK is almost double that in the US and the Fed-fueled spike in global commodity prices has had a heck of a lot to do with it (along with a weak currency). But Bk of Eng gov King won’t budge, won’t brake with a hike, parroting Benanke that inflation is near zero if one ex’s food and energy.

Well folks, we are not of a conspiratorial bent. However, if we were we might say that the Fed is going to extremes, looking for any excuse to keep rates in the cellar, because of its incestuous relationship with major St firms - the two are linked at the waist. We know from personal experience this to be a fact. Unusually and unnaturally low rates make a ton of $ for St firms; they can finance practically any inventory at a profit. There is a good part of your answer why the Fed, and maybe even the Bank of England are looking the other way.

Oh, but then we’re not conspiratorial. Forgot that.

Robert Craven

Inflation (of another sort) at the Fed

Bernanke was taken to task yesterday by Rep Paul Ryan, a well know critic. Ryan is more than a critic; he is a would-be executioner. Some at the Fed think Ryan’s elevator doesn’t go all the way to the top. Yes it does and he’s providing a real service to all of us.

Since CSPAN came along most legislators fear a confrontation with Fed policy makers. When challenged at a hearing for example Greenspan would launch a circuitous counter attack, saying nothing really but drawing on endless words and numbers which snowed his opponents, and, right in front of their constituents. Thus, most just let it go.

Ryan won’t do that. Whether we agree of not with his view, Ryan’s providing fresh air.

Bernanke’s intellectual honesty distinguished him from his predecessor. We hope it still does. Yet he is in fact a tad “cocky” as Ryan noted. What’s behind that exactly?

Being human, policy makers are often drawn in by the aura of their surroundings, by the complexity of their wares, by the fawning of the masses, their egos soon inflating to before unknown proportions. After a while they admit they’re still mortals, but just barely. Or so they pretend.

Fed presidents remain more grounded in this regard; governors less so. Presidents work their way up, actual business people; gov’s are appointed. Some like Greenspan are simply and purely politically promiscuous. For example, Worth mag noted that Greenspan when in private practice was the “worst forecaster ever.” No problem.

All of the FOMC however, every one of them carry with them a haunting, a perceived vulnerability, their own heart of darkness. That would be the very fact that they know they don’t know a whole lot more than the rest of us; they’re not seers and they’re not prophets. Policy making is a crap shoot; they know it, they’ll just never admit it. For the rest of us to know that they know it, would, or so they believe obliterate their credibility. That is why for example they had and will always fight to the death, efforts to video tape their deliberations.

They’ve got a tough job. They make it a lot tougher by pretending they’re something they’re not.


Robert Craven

Thouhts on the Fed chair before the House.

Chairman Bernanke defended his expansionary policy today. Our view is that it’s misguided.

But whatever it is, it is a stealth operation. Bernanke points to Core CPI (not the broader #) as cover for QE2, noting that Core CPI is now as low as it's been in many years. Well naturally Ben. It’s “EX” everything that’s on its way to the moon - food & energy. This is convenient for the Fed, just as it was when Art Burns decided to take food & energy out so he could fuel Nixon’s reelection. It stuck. His rationale? The Fed has no control over wheat or oil prices; these are mostly driven by weather and other acts of God.

Now of course the spike in world commodity prices is driven, not just by natural phenomena but by the Fed’s dollar-creation machine. It hits first the 40-odd countries who peg or closely peg to the $. As we noted in an earlier sketch, they either import inflation (print their local currency to buy $’s to keep the $ expensive) or they allow their currency to strengthen and tank their exports. Either way, it comes back to hit us, or a portion of it does.

Too bad for offshore folk but not to worry here in the US says Bernanke because he can exit gracefully when things become overheated. Maybe so but we don’t see how. Recall that under QE1 & 2 the Fed buys longer-term treasuries and mortgage paper through so-called recognized dealers. It pays for these bonds by crediting the banks’ account at the Fed. (If the bank wants paper $, the Mint takes care of that, and delivers the things in trucks.)

So how will Bernanke reverse? He will sell securities to this group, reversing the process by taking the money out of circulation. If he sells short-term T-bills, short term rates will move higher. If he sells longer-dated stock, longer term rates will come under pressure. They don’t own as many t-bills so we guess they’ll hammer the longer end - 2 - 10 yrs perhaps that impact all of us.

He figures he can fine tune the act but over the years we have never known the Fed to have much of a handle on anything but their traditional targets - O/N money and reserves. They are far out of their league when they try to figure the direction of longer rates.

Every prospective home buyer, corporate planner, trading operation and saver has a stake in just how they pull this off, if at all.

Robert Craven

Update

First, to spending. Last week we saw that consumer spending for Q4 ‘10 gained 4.4% (the most since Q1 ‘06 ) following a 2.4% increase Q3. We did not know at the beginning of Q4 that spending would print 4.4%, only that it would flatten St estimates. This was the result.

Look for any surprises over the near term to be to the side of more, not less vigor than forecast. This is the course-of-least-resistance for the US economy and it is especially true for discretionary spending. Thus planners in those businesses linked to such activity are to embrace the reality of more demand for their product, H2, not less.

Background: Most analysts missed recent vigor because they 1) did not fold results of Nov/2 and traction obtained into their models, 2) gave imbalances in housing and the mess in states’ finances too much weight and 3) took consumer confidence reports to heart.



Of course, there are always wild cards - those cataclysmic events which carry the hrsp to retard US growth. A closure of the Suez Canal is one. This brings to mind the current crisis.

We followed the Mid Eastern situation (including the Brotherhood from ‘06) in a separate blog. http://bobcraven.blogspot.com/

Better, see the recent article by Vic Hansen for a primer http://pajamasmedia.com/victordavishanson/whats-the-matter-with-egypt/.

After that exercise readers will understand the failure of Mid Eastern society, and, the West as the appointed scapegoat. Along comes the internet and anyone under 40 got jealous. Dictators stand in the way. Here is the cause of recent violence. The trigger however was food prices.

Some Western observers have blamed the Fed for the recent chaos and even deaths; they argue the US is an exporter of inflation expressed in the very commodity prices which triggered this deal. Let’s see what this is all about.

Sure enough, inflation in milk and flour prices triggered protests in Algeria that left 3 people dead. Then a food vendor in Tunisia set himself alight. Now Egypt is ablaze. Egyptians suffer for example because cereal grains are up 39% in the last year, oils and fat, up 55%. Going after the nearest bad-guy target - Mubarak - is understandable.

But is Bernanke also one of the bad guys? In the sense that he conducts US monetary policy without the interests of the developing world folded in, he is. But it takes two to tango and the complainer, the developing country must make the decision to import inflation to get things going!

Higher commodity prices are not just a monetary phenomena of course - witness the worst drought in Russia and the Black Sea region for 130 years, late rains in Canada, Nina disruptions in Argentina, and a series of acreage downgrades in the US. But what about money?

We know the Fed is flooding the world with $’s; the more of them the less they’re worth. And we know that an Egypt, or a China, or an Algeria or any other developing country must buy their food in $’s. But these guys are mostly exporters. What happens if the $ cheapens relative to their currency? Right, this dampens their exports (one $ buys less), their life blood. So what do their central banks do? They print their currency out of thin air and buy dollars. Why? To keep dollars expensive to the local currency. Thus, just like China is doing these countries make a choice or decision to import inflation. That is the core to their problem. At the expense of their own savers they flood their own mkt with their own currency. That’s about all there is to it.

An Egypt or China which may want to insulate itself from this food inflation has to appreciate its currency significantly. But then its exports would tank. No way they’ll do that. Or, they have to subsidize food prices - price controls. These measures always fail. Absent these two drastic measures, countries have to live with the implication of US monetary policy.

Robert Craven

Update

Of the few economic releases this week none carry much mkt-moving potential. So perhaps best to reflect on other events, center stage, which may impact US growth.

Key among these is Obama’s sudden conversion from gov’t planner to free-market maven. “It’s amazing how far he has moved off his campaign promises to the left, and moved over to the center-right,” noted one St observer. Of course we and future generations have paid his tuition; the cost - outrageous. We know he is looking to the election but at least he’s become practical, perhaps even useful.

This has not been lost on major employers. For example, manufacturers have become more optimistic. These were already cheered by results of Nov/2; they are now all the more buoyant given the new business-friendly attitude in the WH. Intel’s Paul Otellini noted the other day, “In 2011, everything gets better. The economy is forecast to improve.” Otellini like so many others had been a critic of Obama’s past fetish for throwing encumbrances on employers.

There are other reasons to be constructive. Well-advertised, higher commodity prices (food, metal, oil, etc) reflect stronger demand, US and abroad. This is a good thing. The other side is the inflation threat but as Zach Pandl with Nomura notes today, “U.S. companies in aggregate aren’t as affected by the rising commodity prices because they spend far more on wages and worker benefits than they do on commodities.” Maybe. Certainly the Fed agrees. The Fed of course “ex’s out” these price pressures, preferring the core CPI measure which excludes food and energy, as their guide.

Background: Major world commodities are priced in dollars. Countries earn these dollars through trade with the US. We run a trade deficit with most of these countries so they have plenty of dollars, more than ever nowadays given the Fed’s expansionary policies. These countries - many now expanding rapidly - buy food, metals and oil with these dollars, bidding up the price. So loose policy here (core CPI as the excuse) translates to commodity inflation in countries abroad.

This leads the discussion to China. China has more of these dollars than anyone; to keep this hoard safe a good chunk is in US treasuries. So much in fact that China has a lever over US policy - if they sell, up go US yields. This is why the Chinese have in the past gotten away with linking their yuan to the dollar. This keeps Chinese exports cheap but fuels Chinese domestic inflation, and by contagion eventually that in the US, biting into household pockets. This is one reason the US has warned China to speed the appreciation of the yuan to the dollar. This too will be a major part of this week’s discussion with Chinese president Hu.

Robert Craven

Update

Today’s Dec Retail Sales print (+0.6%) was just inside of expectations. Still, much more there from the consumer than hardly anyone expected for this period, back a few months ago.

We also saw Dec CPI; it was non-threatening, the core up 0.1%. The headline number was up 0.5%, mainly due to energy prices. Still, the headline is now only 1.4% above the year ago level. Core prices are only 0.8% above their year ago level. As Steven Wood reminds us, this is one of the slowest paces in the 52 years of data collection.

Today’s data throws some slack to the Fed. We don’t need the liquidity but they’re intent on providing it, so fine. With tame price numbers, longer-term yields will allow them get away with it for a little longer.

Week In Review

How did events this week support or amend our anchor, that of surprising vigor ahead, especially in payrolls and discretionary spending?

Well, it’s been fun folks. Obama quit his attack on the rich, triggering the F word from one of his fellow Dems. In fact, these loonies should have praised the guy. The tax bill, as it is this pm is not much. We get a two year break but are nailed with a $57 bln, 13 month extension of unemployment benefits that’s not paid for. So not much here to support our anchor, won’t hurt much either, perhaps a wash.

Real sector data was encouraging. Consumer Sentiment rose to its best level since June. Sentiment fell sharply in July, but has now regained all of that decline. Exports rose 3.2% for Sep and are now 15.9% above their year ago level. Jobless claims dropped by 17M for the week ended Nov/27. After being little changed for most of the year, claims for benefits have broken to the downside past 5 weeks. All of this data supports our constructive view.

The Fed continues to disappoint with this QE II business. We don’t need any more liquidity. The charge, from us and others, that the Fed is merely an extension of the administration continues to gain support.

And Nobel laureate Joseph Stiglitz reckons US banks will simply put the $ offshore, investing in so-called emerging credits, driving up these currencies, triggering all sorts of mayhem, including asset bubbles. May be. A Wild card? Stiglitz knows more about these things than we do.

But this week’s rout in the bond markets (yields spiking, prices dropping) may be the investment world’s way of issuing an inflation warning. Much more of that and we’ll have to moderate our view. Balance sheets, especially housing will not be happy campers.

Finally, and of course key - momentum continues to build in Washington to repair damage done earlier by BO, his making a bad economic situation much worse. Nov/2 was about stopping the destruction. Next year is about rebuilding. We’ll start with the health heist. The future costs of this statist president’s social agenda are no longer a given. This has greatly cheered employer and consumer alike.


Robert Craven

Too Big For Its Britches?

The Federal Reserve system was created under Wilson in 1913. Originally tasked with protecting the value of the currency its mandate was expanded in the 70's when the Federal Reserve Act was amended to promote the goals of, “maximum employment, stable prices, and moderate long-term interest rates,” (Section 2A).

“Stable prices,” means protecting the value of the $. The Fed is armed to do this by expanding or contracting the supply of $’s available - too many and they are worth less, too few and they are worth too much.

“Moderate long-term interest rates,” are not something the Fed controls very well, if at all. “Maximum employment,” are the two words however that can get the Fed in a lot of trouble.

At the moment critics claim that through the pursuit of this “maximum employment” mandate the Fed has been reduced to an extension of the administration, that is, Bernanke more the politician than the central banker.

We’ve all heard of QE2. This means that the Fed is buying practically everything under the sun in an attempt to quick start a recovery. The idea is to get medium-to-longer term rates lower, the dollar just a tad weaker in order to spur exports, all of this with employment in mind. This is not equivalent to addressing a crisis, to preventing a melt down. (Without the Fed’s emergency action Q4 ‘08, we’d all be paupers.) No, it is a completely discretionary, non rule-based activity and a mistake, one which first will have little to no impact on the pace of recovery and two, is corrosive to Fed independence, a necessary item, the heart of monetary control.

It is this trend at the Fed toward discretionary actions that is alarming to so many and who see this, correctly we believe, as just an attempt to bail out BO’s failed fiscal policy.

A group of 23 economists, money managers and former government officials issued an open letter to Bernanke on Nov. 15 saying the central bank’s planned bond purchases “risk currency debasement and inflation” and won’t boost employment.

Another critic is Fed governor Kevin Warsh, who noted recently that, "The Federal Reserve is not a repair shop for broken fiscal, trade, or regulatory policies.”

Apparently, Bernanke is not listening. We need only recall Hayek’s “Fatal Conceit” to know that a few individuals, no matter how gifted cannot replace in their judgement the complexities of a free functioning market. This applies to the FOMC as well as to Obama’s wanna-be planners.

We have followed the Fed closely for 20 years; never has it come so close to shedding its independence. Let us hope the new Congress re-writes the Fed’s mandate to confine its activities only to those of price stability.

Robert Craven

Wild Cards

We remain optimistic re US growth, believing that it will exceed expectations, especially employment numbers. But we noted earlier the existence of “wild cards,” events presently off radar.

The business of the future is to be dangerous. So let’s take a look at the odds of significant damage; that is, the odds of an event that has not been priced in and which would retard US growth.

A strike on Iranian nuclear facilities is such a wild card. This event would spike crude prices, at least by 50%. That’s a retardant folks. The Iranians would strike both Saudi oil fields and the Israelis, and attempt to blockade the Straits. Odds for such an event - 40%.

Another wild card is related to the present crisis of peripheral European credits. At the moment Ireland may soon loose her sovereignty; Portugal is in miserable shape, Spain not far behind. This turmoil has been partially priced in. The EU has an emergency fund but more prosperous credits like Germany aren’t anxious to contribute (attesting to the stupidity of the EU in the first place and the accuracy of Thatcher’s prediction). The wild card here is not that Ireland or Portugal become EU protectorates, like Greece, but is for contagion on a grander scale - an EU/Euro collapse and then the bank pandemonium that may follow. From Jeremy Warner in today’s Telegraph, “There must come a point where bailing out the fringe threatens the creditworthiness of the core. We are not there yet, but it's plainly not beyond the bounds of possibility.” Odds - 35%.

Another wild card is a sudden strike by the Chinese on US debt. Odds - 25%.

Another, with the same result, is a rapid blow back of inflation/weak $ tied to recent Fed antics, requiring a sharp contraction by the Fed and/or a full blown currency/trade war. We put this one at 25%. (This is not to say that the Fed’s recent actions are constructive in any way; they aren’t and they’re damaging to the integrity of the Fed to boot.)

Another, contributed to this piece by our friend Christian de Ryss, is traction by the way of muslim thuggery, perhaps a lucky strike at major infrastructure in the UK or Germany; perhaps even in the US and the paralysis that follows. We don’t dare print the odds, even if we had a clue.

No doubt THE key wild card is there, right now, beyond our grasp, waiting in the sidelines for a trigger.

Cross the fingers.

Robert Craven