Showing posts with label Inflation. Show all posts
Showing posts with label Inflation. Show all posts

Thursday, May 13, 2021

13/5/21: BRIC Composite PMIs April 2021: Recovery Fragile, Inflation Heating Up

April PMIs for BRIC economies show continued strengthening in the recovery in China and Russia, moderation in the recovery momentum in India and deepening collapse in the recovery in Brazil.

Since we are into the first month of the new quarter, there is not enough data to go about to meaningfully analyze quarterly dynamics. Hence, I am only looking at Composite PMIs:


PMIs in April run stronger, compared to 1Q 2021 averages for Russia (Services only), and China (Services and Manufacturing), while Brazil and India recorded deteriorating PMIs in both Manufacturing and Services, and Russia posted weaker Manufacturing PMI.

BRIC as a group underperformed Global PMIs in April in both Services and Manufacturing, although BRIC Services PMI in April was running ahead of Services PMI for 1Q 2021, and there was virtually no change in Manufacturing PMI for BRIC group in April compared to 1Q 2021 average. 

Global Composite PMI in April was 56.3, which is much higher than same period Composite PMIs for Brazil (44.5), Russia (54.0), China (54.7) and India (55.4).

Notable price pressures were marked in:

  • China: "At the same time, inflationary pressures remained strong, with input cost inflation hitting its highest since January 2017, while prices charges rose solidly".
  • India: "Supply-chain constraints and a lack of available materials placed further upward pressure on inflation. Input prices facing private sector companies rose at the sharpest pace in close to nine years. The quicker increase was seen among goods producers. Prices charged by private sector firms increased at the fastest pace since last November, but the overall rate of inflation was modest and much weaker than that seen for input costs."
  • Russia: "The rate of input cost inflation slowed in April to the softest for three months. That said, firms continued to pass on higher costs to their clients, as charges rose at the fastest pace since January 2019".
  • Brazil: "Meanwhile, input costs continued to increase sharply. The rate of inflation was the second-fastest since composite data became available in March 2007, just behind that seen in the previous month. Goods producers noted a stronger rise than service providers for the fifteenth straight month. Prices charged for Brazilian goods and services rose further, stretching the current sequence of inflation to nine months. The upturn was sharp and the fastest in the series history. The acceleration reflected a quicker increase in the manufacturing industry".

Monday, May 10, 2021

10/5/21: Ireland PMIs for April: Rapid Growth and Inflation Signals

Ireland's PMIs have accelerated across all two key sectors of Services and Manufacturing in April, while Construction Sector continued to post declining activity (through mid-April).

Irish Manufacturing PMI rose from 57.1 in March to 60.8 in April as larger multinationals boosted their activities and increased pass-through for inflation. This marks third consecutive month of increasing PMIs for the sector. Meanwhile, Irish Services PMI rose from 54.6 in March to 57.7 in April, marking second consecutive month of above 50 PMIs readings. 

In line with the above developments, official Composite PMI rose from 54.5 in March to 58.1 in April. 

Irish Construction Sector PMI, reported mid-month, was at 30.9 (significantly below 50.0, signaling strong rate of contraction in activity) in mid-April, a somewhat less rapid rate of decline relative to mid-March reading of 27.0. All in, Irish Construction Sector PMI has been sub-50 for four consecutive month now.

In contrast to Markit that publishes official Composite PMI, I calculate my own GVO-shares weighted index of economic activity across three sectors: my Three Sectors Index rose from 55.0 in March 2021 to 58.3 in April. 


In terms of inflation, Services PMI release states that "Cost pressures remained strong in April, linked by survey respondents to labour, insurance, fuel, shipping and UK customs. The rate of input price inflation eased slightly from March's 13-month high, however. To protect profit margins, service providers raised their charges for the second month running. The rate of charge inflation was the strongest since February 2020, albeit modest overall." The indications are that Irish services firms are operating in less competitive environment than their global counterparts, with stronger ability to pass through cost increases into their charges. However, this feature of Irish data most likely reflects the accounting complexity within major multinationals trading through Ireland. 

Similar situation is developing in Manufacturing: "Supply chains remain under severe pressure, with longer delivery times owing to new UK Customs arrangements, transport delays and raw materials shortages. These factors, combined with strengthening demand, are leading to a heightening of inflationary pressures. Input prices increased at their fastest pace in ten years, while output prices rose at a series-record pace."

All in, we are witnessing signs of continued inflationary pressures across a number of months now, with even multinationals - companies using Ireland as primarily a tax and regulatory arbitrage location for their activities - feeling the pressures. This is an indication that inflation is building up globally and, as time drags on, starting to feed through to final prices of goods and services.


Thursday, April 8, 2021

8/4/21: No Inflation Cometh?

 

Having written about strengthening signals of rising inflation globally and in the U.S. in particular before, here is today's note from Markit on the matter: https://ihsmarkit.com/research-analysis/global-price-gauge-hits-new-high-as-input-cost-inflation-accelerates-sharply-Apr21.html 

To quote: global inputs inflation pressures are at their highest since 2008:


By sector:


Factory gate prices are scaling up:

Manufacturing supply shortages at nearly historical highs:
Prices of all, but financial services and consumer services are up through the roof:

Profit margins are being demolished:

And consumer goods prices are going through the roof:

Which means that targeting 2-3% inflation at current monetary policies is plain bonkers. Unless Central Banks are willing to entertain inflation at +5-10 percent above current, the rates must go up. Keep leveraging, everyone. Credit cards, margin trades and mortgages are about to get 'uncertain'... 

Wednesday, April 7, 2021

7/4/21: Ireland PMIs for March: Growth and Inflation Pressures

 

Ireland PMIs for 1Q 2021 are out this week, so let's take a closer look at monthly activity data. 

  • March services PMI came in at a surprising 54.6 - up on 41.2 in February and 36.2 in January. Given the country is in a phase 5 lockdown, and there has been little change on that in recent months, the new reading is a bizarre one. Per Markit: "Three out of four monitored sub-sectors registered higher business activity in March. The strongest rate of expansion was in Financial Services, followed by Business Services and Technology, Media & Telecoms respectively. Activity in Transport, Tourism & Leisure declined for the eighth month running, but at the slowest rate since last August." A lot of hope-for vaccines and 'getting back to normal' as well as exports rise behind these figures. Services PMI is now at its highest reading since February 2020.
  • March Manufacturing PMI also performed well, rising to 57.1 from 52.0 in February. Manufacturing index has been more volatile in the pandemic than Services, so this rise is less of a surprise, given the global economic recovery and demand for Irish exports.
  • We do not have full March data for construction sector PMI, which is reported mid-month, so all we do have is mid-March reading of 27.0. 
Official Composite PMI published by Markit was pretty upbeat in march 2021, rising to 54.5 - signaling strong growth, having previously posted 47.2 in February and 40.2 in January 2021. My own, Three Sectors Activity index - a weighted average of three sectors PMIs based on their share of gross value added - rose even more sharply: from 41.8 in January and 45.0 in February to 55.0 in March. If Construction sector PMI were to come in on-trend mid-April, the Three Sectors Index will be closer to 55.1-55.2 range.


As an aside, it is worth noting that Irish economic activity is showing similar trend to global activity when it comes to inflationary pressures (see: https://trueeconomics.blogspot.com/2021/04/5421-heating-up-inflationary-risks.html). Per Markit: "March data indicated soaring cost pressures. The Composite Input Prices Index posted a record one-month gain and signalled the fastest rate of inflation since July 2008. Cost pressures were much stronger at manufacturers than service providers." In other words, even small open economies with massive distortions coming from the multinationals' financial and tax engineering sides are now showing signs of heating up inflation. 

Tuesday, April 6, 2021

5/4/21: Heating up inflationary risks

 

No, hyperinflation and, in fact, high inflation, ain't coming, yet. But the concerns with both are rising... 


Both, input prices and output prices have accelerated in March, compared to February in Markit's Manufacturing PMIs. 

Headline Markit statement says: "Conditions in the global manufacturing sector continued to brighten at the end of the first quarter, despite the potential for growth to be stymied by rising cost inflationary pressures and supply-chain disruptions." (Emphasis is mine).  And more: "Demand outstripping supply also contributed to a marked increase in purchasing costs during March. Input price inflation surged to a near-decade high, the pass-through of which led to the steepest rise in output charges since data on selling prices were first tracked in October 2009."

The same is happening in the U.S.: "Supplier lead times lengthened to the greatest extent on record. At the same time, inflationary pressures intensified, with cost burdens rising at the quickest rate for a decade. Firms partially passed on higher input costs to clients through the sharpest increase in charges in the survey's history."


Saturday, October 3, 2020

3/10/20: Eurocoin Leading Growth Indicator 3Q 2020

 

Eurocoin, a leading growth indicator for the euro area published by CEPR and Banca d'Italia posted another negative (recessionary) reading in September (-0.31) after marking peak growth contraction of COVID19 pandemic period in August (-0.64). This puts Eurocoin in negative territory for the 6th consecutive month since March 2020. 


Current forecast for 3Q 2020 growth remains at -3.5 percent q/q. Deflationary pressures are also building up. Euro area's 12 months average HICP forecast for 3Q 2020 stands at around 0.6 to 0.5.


As the chart above shows, Eurozone remains deeply in a recessionary territory based on Eurocoin forecasts and inflation dynamics. Longer term growth averages are shown in the chart below:


Overall, as noted above, one must take all leading indicators and forecasts with some serious warnings attached: we are in an environment where past models for forecasting economic aggregates become severely challenged.


Thursday, September 17, 2020

17/9/20: Eurocoin Leading Growth Indicator 3Q 2020

 

Eurocoin, CEPR & Banca d'Italia leading growth indicator for Euro Area economy is pointing to renewed weaknesses in the Eurozone economy in August, falling to its lowest levels in the COVID19 pandemic period:


As the chart above shows, Eurocoin fell from -0.5 in July to -0.64 in August, its lowest reading since June 2009. The forecast September indicator is at -0.30. Through August, we now have five consecutive months of sub-zero readings. Based on July-August data and September forecast, we are looking at a GDP contraction of 3.5 percentage points in 3Q 2020. This is mapped out in the chart below:


As the chart above shows, average annual growth rate in the Eurozone for 2020 is now sitting at -6,33 percent, far worse than the previous low of -0.575 in 2009. In quarterly readings, we now have two actual and one forecast quarters of 2020 all performing worse than the peak of the Global Financial Crisis / Great Recession contraction (see green entry in the chart above).


As before the COVID19 crisis, Eeurozone economy is performing woefully. On no time horizon did Euro area manage to achieve average annual growth of 2% (chart above).



Sunday, February 23, 2020

23/2/20: Fake Data or Faking Data? Inflation Statistics


As economists and analysts, almost all of us are trying - at one point or another - make sense of the, all too often vast, gap between the reality and the economic statistics. I know, as I am guilty of this myself (here's a recent example: https://trueeconomics.blogspot.com/2020/02/18220-irish-statistics-fake-news-and.html).

An interesting and insightful paper from Oren Cass of the Manhattan Institute dissects the extent of and the reasons for the official inflation statistic failing to capture the reality of the true cost of living changes in the U.S. over recent years (actually, decades) here: https://www.manhattan-institute.org/reevaluating-prosperity-of-american-family). It is a must-read paper for economics students, analysts and policymakers.

His key argument is that: "Economists and families see three things differently:

  • Quality Adjustment. Products and services that rise substantially in price but in proportion to measured quality improvements can become unaffordable, while having no effect on inflation.
  • Risk-Sharing. New products and services can increase costs for the entire population yet deliver benefits to only a very small share, while having no effect on inflation.
  • Social Norms. Society-wide changes in behaviors and expectations can alter the value or necessity of a good or service, while having no effect on inflation."
In other words, over time, official inflation starts to measure something entirely different than the real and comparable across time consumption expenditure. As the result, you can have a paradox of today: low inflation is associated with falling affordability of life. 

An example: "In 1985, ... it would require 30 weeks of the median weekly wage to afford a three-bedroom house at the 40th percentile of a local market’s prices, a family health-insurance premium, a semester of public college, and the operation of a vehicle. By 2018, ... a full-time job was insufficient to afford these items, let alone the others that a household needs."

To address some of the shortcomings of the inflation measures, Cass offers a different metric, called COTI - Cost of Thriving Index - which basically amounts to the number of weeks that a given line of expenditure requires in terms of median income. Or "Weeks of Income Needed to Cover Major Household Expenditures". Two charts below illustrate:



And here is a summary table:

Excluding food, other necessities and looking solely at Housing, Health Insurance, Transport and College Education, the number of weeks of work at an overall median wage required to cover the basics of the necessary expenditure is now in excess of 58.4 weeks. For female workers' median wage, the number is 65.6 weeks. 

Which means that even before you consider other necessities purchases, and before you consider taxes, you are either dipping massively into debt or require a second income to cover these. 

Note: these do not account for income taxes, state taxes, property taxes, dental insurance. These numbers do not cover payments for water, gas, electricity. There is no mandatory car insurance included. No allowances for deductibles coverage savings (e.g. HSAs). No childcare, no children expenditures, no food purchases, and so on.

And even with all these exclusions, median income cannot afford the basics of living in today's America. 

A word from Fed, anyone?

Monday, December 16, 2019

16/12/19: There is no Inflation, folks... none...


There is no inflation, folks. This is what the Fed been telling us for some time now. And the CPI figures, on aggregate, say the same.


Unless it is if you need health services or health insurance, or if you happen to *want* education. These discretionary items of spending, avoidable by choice of a prudent consumer, are, of course, exceptions to the rule...

Note, of course, the standard inflation measurements of price changes in healthcare are a bit obscure too, as they average-out effects of private insurance inflation by adding old-age and low-income insurance purchases by the state:


But, never mind, as I said above, these are purely discretionary spending items, so we should not let them cloud out the net official results that show 'no inflation'.

Wednesday, June 12, 2019

Tuesday, September 11, 2018

11/9/18: Slow Recoveries & Unemployment Traps: Hysteresis and/or Secular Stagnation


The twin secular stagnations hypothesis (TSSH, first postulated on this blog) that combines supply-side (technological cyclicality) and demand-side (demographic cyclicality) arguments for why the world economy may have settled on a lower growth trajectory than the one prevailing before 2007 has been a recurrent feature of a number of my posts on this blog, and has entered several of my policy and academic research papers. Throughout my usual discourse on the subject, I have persistently argued that the TSSH accommodates the view that the Global Financial Crisis and the associated Great Recession and the Euro Area Sovereign Crisis of 2007-2014 have significantly accelerated the onset of the TSSH. In other words, TSSH is not a displacement of the arguments that attribute current economic dynamics (slow productivity growth, slower growth in the real economy, reallocation of returns from labour and human capital to technological capital and, more significantly, the financial capital) to the aftermath of the structural crises we experienced in the recent past. The two sets of arguments are, in my view, somewhat complementary.

From this later point of view, a research paper, "Slow Recoveries & Unemployment Traps: Monetary Policy in a Time of Hysteresis" by Sushant Acharya, Julien Bengui, Keshav Dogra, and Shu Lin Wee (August 2018 https://sushantacharya.github.io/sushantacharya.github.io/pdfs/hysteresis.pdf) offers an interesting read.

The paper starts with the - relatively common in the literature - superficial (in my opinion) dichotomy between the secular stagnation hypothesis and the "alternative explanation" of the slowdown in the economy, namely "that large, temporary downturns can themselves permanently damage an economy’s productive capacity." The latter is the so-called 'hysteresis hypothesis', "according to which changes in current aggregate demand can have a significant effect on future aggregate supply" which dates back to the 1980s. The superficiality of this dichotomy relates to the causal chains involved, and to the impact of the two hypotheses.

However, as the authors note, correctly: "While the two sets of explanations may be observationally similar, they have very different normative implications. If exogenous structural factors drive slow growth, countercyclical policy may be unable to resist or reverse this trend. In contrast, if temporary downturns themselves lead to persistently or permanently slower growth, then countercyclical policy, by limiting the severity of downturns, may have a role to play to avert such adverse developments."

The authors develop a model in which countercyclical monetary policy can "moderate" the impact of the sudden, but temporary large downturns, i.e. in the presence of hysteresis. How does this work?

The authors first describe the source of the deep adverse shock capable of shifting the economy toward long-term lower growth rates: "in our model, hysteresis can arise because workers lose human capital whilst unemployed and unskilled workers are costly to retrain". This is not new and goes back to the 1990s work on hysteresis. The problem is explaining why exactly such deep depreciation takes place. Long unemployment spells do reduce human capital stock for workers, but long unemployment spells are feature of less skilled workforce, so there is less human capital to depreciate there in the first place. Retraining low skilled workers is not more expensive than retraining higher skilled workers. In fact, low skilled workers seek low skilled jobs and these require only basic training. It is quite possible that low skilled workers losing their jobs today are of certain demographic (e.g. older workers) that reduces the effectiveness of retraining programs, but that is the TSSH domain, not the hysteresis domain.

One thing that does help this paper's hypothesis is the historical trend of growing duration of unemployment, e.g. discussed here: http://trueeconomics.blogspot.com/2017/07/27717-us-labor-markets-are-not-in-rude.html and the associated trend of low labour force participation rates, e.g. discussed here: http://trueeconomics.blogspot.com/2018/06/8618-human-capital-twin-secular.html. I do agree that unskilled workers are costly to retrain, especially in the presence of demographic constraints (which are consistent with the secular stagnation on the demand side).

But, back to the authors: "... large adverse fundamental shocks can cause recessions whose legacy is persistent or permanent unemployment... Accommodative policy early in a recession can prevent hysteresis from taking root and enable swift a recovery. In contrast, delayed monetary policy interventions may be powerless to bring the economy back to full employment."

"As in Pissarides (1992), these features [of long unemployment-induced loss of human capital, sticky wages that prevent wages from falling significantly during the downturns, costly search for new jobs, and costly retraining of workers] generate multiple steady states. One steady state is a high pressure economy: job finding rates are high, unemployment is low and job-seekers are highly skilled. While tight labor markets - by improving workers’ outside options - cause wages to be high, firms still find job creation attractive, as higher wages are offset by low average training costs when job-seekers are mostly highly skilled." Note: the same holds when highly skilled workers labour productivity rises to outpace sticky wages, so one needs to also account for the reasons why labour productivity slacks or does not keep up with wages growth during the downturn, especially when the downturn results in selective layoffs of workers who are less productive ahead of those more productive. Hysteresis hypothesis alone is not enough to do that. We need fundamental reasons for structural changes in labour productivity that go beyond simple depreciation of human capital (or, put differently, we need something similar to the TSSH).

"The economy, however, can also be trapped in a low pressure steady state. In this steady state, job finding rates are low, unemployment is high, and many job-seekers are unskilled as long unemployment spells have eroded their human capital. Slack labor markets lower the outside options of workers and drive wages down, but hiring is still limited as firms find it costly to retrain these workers." Once again, I am not entirely convinced we are facing higher costs of retraining low skilled workers (as argued above), and I am not entirely convinced we are seeing the problem arising amongst the low skilled workers to begin with. Post-2008 recovery has been associated with more jobs creation in lower skilled categories of jobs, e.g. hospitality sector, restaurants, bars, other basic services. These are low skilled jobs which require minimal training. And, yet, we are seeing continued trend toward lower labour force participation rates. Something is missing in the argument that hysteresis is triggered by cost of retraining workers.

Back to the paper: "Importantly, the transition to an unemployment trap following a large severe shock can be avoided. If monetary policy commits to temporarily higher inflation after the liquidity trap has ended, it can mitigate both the initial rise in unemployment, and its persistent (or permanent)
negative consequences. Monetary policy, however, is only effective if it is implemented early in the downturn, before the recession has left substantial scars... [otherwise] ...fiscal policy, in the form of hiring or training subsidies, is necessary to engineer a swift recovery."

The paper tests the model in the empirical setting. And the results seem to be plausible: "allowing for a realistic degree of skill depreciation and training costs... is sufficient to generate multiple steady states.... this multiplicity is essential in explaining why the unemployment rate in the U.S. took 7 years to return to its pre-crisis level. In contrast, the standard search model without skill depreciation and/or training costs predicts that the U.S. economy should have fully recovered by 2011. ...the model indicates that had monetary policy been less accommodative or timely during the crisis, leading to a peak unemployment rate higher than 11 percent, the economy might have been permanently scarred and stuck in an unemployment trap. Furthermore, our model suggests that the persistently high proportion of long-term unemployed in the European periphery countries may reflect a lack of timely monetary accommodation by the European Central Bank."

Fraction of Long-term unemployed (>27 weeks) in select countries. 
The figure plots five quarter moving averages of quarterly data. 
The dashed-line indicates the timing of Draghi’s “whatever it takes” speech. 


Source: Eurostat and FRED.

This seems quite plausible, even though it does not explain why eventual 'retraining' of low skilled workers is still not triggering substantial increases in labour productivity growth rates in Europe and the U.S.

One interesting extension presented in the paper is that of segmented labour markets, or the markets where "employers might be able to discern whether a worker requires training or not based on observable characteristics - in particular, their duration of unemployment... [so that, if] skilled and unskilled workers searched in separate markets, the economy would still be characterized by hysteresis, but it would take a different form. There are two possibilities to consider. [If] ... the firm’s share of the surplus from hiring an unskilled worker, net of training costs, is large enough to compensate firms for posting vacancies in the unskilled labor market, ...after a temporary recession which increases the fraction of unskilled job-seekers, it can take a long time for these workers to be reabsorbed into employment. Firms prefer to post vacancies in the market for skilled job-seekers rather than the market for unskilled job-seekers in order to avoid paying a training cost. With fewer vacancies posted for them, unskilled job-seekers face a lower job-finding rate and thus, the outflow from the pool of unskilled job-seekers is low. In contrast, the skilled unemployment rate recovers rapidly - in fact, faster than in the baseline model with a single labor market... [Alternatively], the segmented labor markets economy could experience permanent stagnation, rather than a slow recovery, [if] unskilled workers are unemployable, since firms are unwilling to pay the cost of hiring and training these workers. Thus unskilled workers effectively drop out of the labor force."

We do observe some of the elements of both such regimes in the advanced economies today, with simultaneous increasing jobs creation drift toward lower-skilled, slack in supply of skills as younger, educated workers are forced to compete for lower skilled jobs, and a dropout rate acceleration for labour force participation. Which suggests that demographics (the TSSH component, not hysteresis component) is at play at least in part in the equation.


In summary, a very interesting paper that, in my opinion, adds to the TSSH arguments a new dimensions: deterioration in skills due to severity of a demand shock and productivity shock. It does not, however, contradict the TSSH and does not invalidate the key arguments of the TSSH. As per effectiveness of monetary or monetary-fiscal policies in combatting the long-term nature of the adverse economic equilibrium, the book remains open in my opinion, even under the hysteresis hypothesis: if hysteresis is accompanied by a permanent loss of skills twinned with a loss of productivity (e.g. due to technological progress), adverse demographics (older age cohorts of workers losing their jobs) will not be resolved by a training push. You simply cannot attain a catch up for the displaced workers using training schemes in the presence of younger generation of workers competing for the scarce jobs in a hysteresis environment.

And the Zero-Lower Bound on monetary policy still matters: the duration of the hysteresis shock will undoubtedly create large scale mismatch between the sovereign capacity to fund future liabilities (deficits) and the longer-run inflationary dynamics implied by the extremely aggressive and prolonged monetary intervention. In other words, large enough hysteresis shock will require Japanification of the economy, and as we have seen in the case of Japan, such a scenario does not lead to the economy escaping the TSSH or hysteresis (or both) trap even after two decades of aggressive monetary and fiscal stimuli.

Sunday, September 9, 2018

9/9/18: Populism, Middle Class and Asset Bubbles


The range of total returns (unadjusted for differential FX rates) for some key assets categories since 2009 via Goldman Sachs Research:


The above highlights the pivot toward financial assets inflation under the tidal wave of Quantitative Easing programmes by the major Central Banks. The financial sector repression is taking the bite out of the consumer / household finances through widening profit margins, reflective of the economy's move toward higher financial intensity of output. Put differently, the CPI gap to corporate costs inflation is widening, and with it, the asset price inflation is drifting toward financial assets:


This is the 'beggar-thy-household' economy, folks. Not surprisingly, while the proportion of total population classifiable as middle-class might be stabilising (after a massive decline from the 1970s and 1980s levels):

 Incomes of the middle class are stagnant (and for lower earners, falling):

And post-QE squeeze (higher interest rates and higher cost of credit intermediation) is coming for the already stretched households. Any wonder that political populism/opportunism is also on the rise?

Thursday, September 7, 2017

7/9/17: Deutsche Mark Euro?.. ECB, Taylor rule and monetary policy


In our Economics course @MIIS, we are covering the technological innovation contribution to the break down in the wage inflation, unemployment, and general inflation (Lecture 2). Here is fresh from the press data showing the divergence between actual monetary policy and the Taylor rule in Germany:

Saturday, June 10, 2017

10/6/17: Cart & Rails of the U.S. Monetary Policy



So, folks, what’s wrong with this picture, eh?



Let’s start thinking. The U.S. Treasury yields are underlying the global measure of inflation since the onset of the global ‘fake recovery’. Both have been and are still trending to the downside. Sounds plausible for a ‘hedge’ asset against global economic stagnation. And the U.S. Treasuries can be thought of as such, given the U.S. economy’s lead-timing for the global economy. Except for a couple of things:
  1. U.S. Treasury is literally running out of money (by August, it will need to issue new paper to cover arising obligations and there is a pesky problem of debt ceiling looming again);
  2. U.S. Fed is signalling two (or possibly three) hikes over the next 6 months and (even more importantly) no willingness to restart buying Treasuries again;
  3. U.S. political risks are rising, not abating, and (equally important) these risks are now evolving faster than global geopolitical risks (the hedge’ is becoming less ‘safe’ than the risks it is supposed to hedge);
  4. U.S. Fed is staring at the prospect of potential increase in decisions uncertainty as it is about to start welcoming new members ho will be replacing the tried-and-trusted QE-philes;
  5. Meanwhile, the gap between the Fed policy’s long term objectives and the reality on the ground is growing: private debt is rising, financial assets valuations are spinning out of control and 


So as the U.S. 10-year paper is nearing yields of 2%, and as the premium on Treasuries relative to global inflation is widening once again, the U.S. Fed is facing a growing problem: tightening rates is necessary to restore U.S. dollar (and U.S. Treasuries) credibility as a global risk hedge (the key reason anyone wants to hold these assets), but raising rates is likely to take the wind out of the sails of the financial markets and the real economy. Absent that wind, the entire scheme of debt-fuelled growth and recovery is likely to collapse. 


Cart is flying one way. Rails are pointing the other. And no one is calling it a crash… yet…

Saturday, April 15, 2017

15/4/17: Thick Mud of Inflationary Expectations


The fortunes of U.S. and euro area inflation expectations are changing and changing fast. I recently wrote about the need for taking a more defensive stance in structuring investors' portfolios when it comes to dealing with potential inflation risk (see the post linked here), and I also noted the continued build up in inflationary momentum in the case of euro area (see the post linked here).

Of course, the current momentum comes off the weak levels of inflation, so the monetary policy remains largely cautious for the U.S. Fed and accommodative for the ECB:

More to the point, long term expectations with respect to inflation remain still below 1.7-1.8 percent for the euro area, despite rising above 2 percent for the U.S. And the dynamics of expectations are trending down:

In fact, last week, the Fed's consumer survey showed U.S. consumers expecting 2.7% inflation compared to 3% in last month's survey, for both one-year-ahead and three-years-ahead expectations. But to complicate the matters:

  • Euro area counterpart survey, released at the end of March, showed european households' inflationary expectations surging to a four-year high and actual inflation exceeding the ECB's 2 percent target for the first time (February reading came in at 2.1 percent, although the number was primarily driven by a jump in energy prices), and
  • In the U.S. survey, median inflation uncertainty (a reflection of the uncertainty regarding future inflation outcomes) declined at the one-year but increased at the three-year ahead horizon.
Confused? When it comes to inflationary pressures forward, things appear to be relatively subdued in the shorter term in the U.S. and much more subdued in the euro area. Except for one small matter at hand: as the chart above illustrates, a swing from 1.72 percent to above 2.35 percent for the U.S. inflation forward expectations by markets participants can take just a month in the uncertain and volatile markets when ambiguity around the underlying economic and policy fundamentals increases. Inflation expectations dynamics are almost as volatile in the euro area.

Which, in simple terms, means three things:

  1. From 'academic' point of view, we are in the world of uncertainty when it comes to inflationary pressures, not in the world of risk, which suggests that 'business as usual' for investors in terms of expecting moderate inflation and monetary accommodation to continue should be avoided;
  2. From immediate investor perspective: don't panic, yet; and 
  3. From more passive investor point of view: be prepared not to panic when everyone else starts panicking at last.

Friday, February 24, 2017

Monday, April 18, 2016

18/4/16: Demographics, Ageing & Inflation


In my Investment Theory & ESG Risk course, a week ago, we were looking at Asset Price Models extensions to incorporate inflation risks. One discussion we had was about the possible correlation between inflation and investor behaviour / choices, linked to behavioural anomalies.

A recent Bank of Finland working paper by Mikael Juselius and Elod Takats, titled “The Age-Structure – Inflation Puzzle” (2016, Bank of Finland Research Discussion Paper No. 4/2016: http://ssrn.com/abstract=2759780) sheds some light on this link via demographic side of investor / economic agent impact on inflationary expectations.

Specifically, the authors uncovered “a puzzling link between low-frequency inflation and the population age-structure”.

This link is pretty simple: due to asymmetric relationship between consumption, savings and investment across the life cycle, “the young and old (dependents) are inflationary whereas the working age population is disinflationary”.

In other words, risks of higher inflation are demographically tilted against markets / economies with either high young age dependencies, old age dependencies or both.

According to authors, “the relationship is not spurious and holds for different specifications and controls in data from 22 advanced economies from 1955 to 2014.”

And effects are large: “The age-structure effect is economically sizable, accounting e.g. for about 6.5 percentage points of U.S. disinflation from 1975 to today’s low inflation environment. It also accounts for much of inflation persistence, which challenges traditional narratives of trend inflation.”


Crucially, “the age-structure effect is forecastable” in so far as we can see pretty accurately long term demographic trends, “and will increase inflationary pressures over the coming decades”. In other words, deflationary environment today is expected to become inflationary environment tomorrow:


Hence, the rising demand for real assets and structural support for new levels of gold prices.

It’s all in the long run game.

Sunday, February 28, 2016

28/2/16: Every Little Hurts: U.S. Consumers and Inflation Perceptions


I have written quite a bit about the wobbles of time-space continuum in the U.S. economic growth universe in recent months. But throughout the entire process, the bedrock of U.S. growth - consumer sentiment - appeared to be relatively stable as if immune to the volatility in the fortunes of the broader economy.

This stability is deceptive. Here is a chart plotting sub-series in the University of Michigan surveys of consumer confidence:


The above shows several things, some historical, others more current.

Firstly, the impact of the crisis of 2008 and subsequent second dip in the economic crisis fortunes in 2011. These were sizeable and comparable in terms of the magnitude to the abysmal late 1970s-early 1980s period.

Secondly, a steady decline in inflationary pressures on households since the early 2012. A trend bending solidly the Fed narrative of well-anchored inflationary expectations post-QE. A trend that accelerated since mid-2014 to flatten out (without a solid confirmation) toward the end of 2015.

Thirdly, a longer view of the things: despite low by historical standards inflation, the share of U.S. households still concerned with its impact on their well being is... err... high and sits well above the average for 1993-2004 golden years of the first 'Great Moderation'.

All of which, in my view, continues to highlight the utter and complete failure of traditional fiscal-monetary policies mix deployed since 2008 by the U.S. Fed and richly copied by the likes of the ECB. It also reflects a simple fact that inflation (even at near-zero bound) remains a concern for households who experience decades of weak income growth.

If, per Tesco adds, every little helps, then, when it comes to the household wealth destroying economic policies, every little also hurts...

Sunday, January 31, 2016

31/1/16: Why is Inflation so Low? Debt + Demand + Oil = Central Bankers


One of the prevalent themes in macroeconomic circles in recent months has been what I call the “Hero Central Banker” syndrome. The story goes: faced with the unprecedented challenges of dis-inflation, Heroic Central Bankers did everything possible to induce prices recovery by deploying printing presses in innovative and outright inventive ways, but only to see their efforts undermined by the falling oil prices.

Of course, the meme is pure bull.

Firstly, there is no disinflation. There is a risk of deflation. Let’s stop pretending that negative growth rates in prices can be made somewhat more benign if we just contextualise them into a narrative of surrounding ‘recovery’. Dis-inflation is deflation anchored to an invented period duration of which no one knows, but everyone assumes to be short. And there is no hard definition of what 'short' really means either.

Secondly, there is no mystery surrounding the question of why on earth would we have ‘dis-inflation’ in the first place. Coming out of the Global Financial Crisis, the world remains awash with legacy debt (households) and new debt (corporates and governments). This simply means that no one, save for larger corporations and highly-rated governments, can borrow much in the post-GFC world. And this means that no one has much of money to spend on ‘demanding’ stuff. This means that markets are stagnating or shrinking on demand side. Now, the number of companies competing for stagnant or shrinking market is not falling. Which means these companies are getting more desperate to maintain or increase their market shares. Of these companies, those that can borrow, do borrow to fund their expansions (less via capex and more via M&As) and to support their share prices (primarily via buy-backs and further via M&As); and the same companies also cut prices to keep their effectively insolvent or debt-loaded customers. slow growing supply chases even slower growing (if not contracting) demand… and we have ‘dis-inflation’.

Note: much of this dynamic is driven by the QE that makes debt cheaper for those who can get it, but more on this later.

Thirdly, we have oil. Oil is an expensive (or used to be expensive) input into producing more stuff (more stuff that is not needed, by the companies that can’t quite afford to organically increase production for the lack of demand, as explained in the second point above). So demand for oil is going down. Production of oil is going up because we have years of investments by oil men (and few oil women) that has been sunk into getting the stuff out of the ground. We have falling oil prices. Aka, more ‘dis-inflation’.

Note: much of this dynamic is also driven by the QE which does nothing to help deleverage households and companies (supporting future demand growth) and everything to support financial sector where inflation has been all the rage until recently, and in Government bonds continues to-date.

Fourth, when Heroic Central Bankers drop policy rates and/or inject ‘free’ cash into the economy. Their actions fuel  borrowing in the areas / sectors where there either exists sufficient collateral or security of cash flows to borrow against or there is low enough debt level to sustain such new borrowing. You’ve guessed it:

  • Financials (deleveraged using taxpayers funds and sweat with the help of the "Heroic Central Bankers" and protected from competition by the very same "Heroic Central Bankers") and 
  • Commodities producers (who borrowed like there is no tomorrow until oil price literally fell off the cliff). 
When the former borrowed, they rolled borrowed funds into public debt and into financial markets. There was plenty inflation in these 'sectors' though they didn't quite count in the consumer price indices. For a good reason: they have little to do with consumers and lots to do with fat cats. However, part of the inflows of funds to the former went to fund ‘alternative’ energy projects - aka subsidies junkies - which further depresses demand for oil (albeit weakly). Both inflows went to support production of more oil or distribution of more oil (pipelines, refineries, export facilities etc) or both.

Meanwhile, inflows from the financial institutions to the markets usually went to larger corporates. Guess where were the big oil producers? Right: amongst the larger corporates. Thus, cheap money = cheaper oil, as long as cheap money does not dramatically drive up inflation. Which it can’t because to do so, there has to be demand growth at the household level, the very level where there is no cheap money coming and the debts remain high.

Now, take the four points above and put them together. What they collectively say is that the risk of deflation in the euro area (and anywhere else) is not down to oil price collapse, but rather it is down to demand collapse driven by debt overhang in the real economy (corporates and households and governments). And it is also down to monetary policy that fuels misallocation of credit (or risk mispricing). Only after that, risk of deflation can be assigned to oil price shock (in so far as that shock can be treated as something originating from the global economy, as opposed to from within the euro area economy). And across all these drivers for deflation risks up, there are fingerprints of many actors, but just one actor pops up everywhere: the "Heroic Central Banker".

A recent paper from the Banca d’Italia actually manages to almost grasp this, albeit, written by Central Bankers, it just comes short of the finish line.

Antonio Maria Conti, Stefano Neri and Andrea Nobili published their “Why is Inflation so Low in the Euro Area?” in July 2015 (Bank of Italy Temi di Discussione (Working Paper) No. 1019: http://ssrn.com/abstract=2687105). They focus on euro area alone, so their conclusions do treat oil price change as an exogenous shock. Still, here are their conclusions:

  • “Inflation in the euro area has been falling steadily since early 2013 and at the end of 2014 turned negative. 
  • "Part of the decline has been due to oil prices, but the weakness of aggregate demand has also played a significant role. …
  • "The analysis suggests that in the last two years inflation has been driven down by all three factors, as the effective lower bound to policy rates has prevented the European Central Bank from reducing the short-term rates to support economic activity and align inflation with the definition of price stability. Remarkably, the joint contribution of monetary and demand shocks is at least as important as that of oil price developments to the deviation of inflation from its baseline.” 


Do note that the authors miss the QE channel leading to deflation and instead seem to think that the only thing standing between the ECB and the return to normalcy is the need to cut rates to purely negative nominal levels. In simple terms, this means the authors think that unless ECB starts giving money away to everyone, including the households (a scenario if nominal rates turn sufficiently negative) without attaching a debt lien to these loans, there is no hope. In a sense, I agree - to get things rolling, we need to cancel out household debts. This can be done (expensively) by printing cash and giving it to households (negative nominal rates). Or it can be done more cheaply by simply writing down debts, while monetising write-offs to the risk-weighted value (a fraction of the nominal debt).

I called for both measures for some years now.

Even "Heroic Central Bankers" (for now within the research departments) now smell the rotten core of the QE body: without restoring balancesheets of the households and companies, there isn't much hope for the risk of dis-inflation abating.