Friday, 29 February 2008

Japanese consumer prices rise, industrial production falls

The Japanese economy's weaknesses appear to be dissipating. Unfortunately, so are its strengths.

Bloomberg reports today that Japan stayed out of deflation in January.

Japan's consumer prices rose for a fourth month in January, matching the fastest pace in more than nine years, as companies passed on higher costs of oil, wheat and soybeans.

Core consumer prices climbed 0.8 percent from a year earlier, the same rate as December, the statistics bureau said today in Tokyo...

Tokyo's core prices, a harbinger of the nationwide index, climbed 0.4 percent in February from a year earlier, the same pace as January...

And consumer spending grew.

A separate report today showed household spending climbed 3.6 percent in January from a year earlier, as consumers bought new-model cars. Retail sales climbed 1.5 percent, in part because higher oil prices boosted revenue at gas stations, the government said yesterday.

Also, the job market did not deteriorate in January and housing starts fell at the slowest pace in seven months.

But manufacturing in Japan appears to be deteriorating. From Reuters:

The NTC Research/Nomura/JMMA Purchasing Managers Index, which gives an early snapshot of the health of manufacturing, declined to a seasonally adjusted 50.8 in February from 52.3 in January, a four-month low...

The PMI's new export orders index hit a three-year low of 49.5, down from 52.1 in January and falling below the 50 mark for the first time since December 2004...

The PMI's new orders index, a barometer of future demand that combines goods orders from both home and abroad, stayed above the 50 threshold for the fourth straight month in February, but showed a sharp drop to 50.4 from 53.5 from the previous month...

The output index, which approximates industrial production, also fell to the lowest level in four months to 50.9 from 52.3 from January, reflecting a slowdown in new orders...

The government said on Thursday that Japan's industrial production fell 2.0 percent in January from December, twice as much as expected, heightening concern that the country's economy may slow down or even contract in the first quarter of 2008.

Thursday, 28 February 2008

US dollar falls as euro and gold set new highs

MarketWatch reports:

The greenback cracked against its European counterpart Wednesday, as investors braced for more U.S. interest rate cuts to prop up the sagging economy even as inflation rears its head.

After the euro broke through key technical levels late Tuesday, it continued to charge higher and set new historical records since the European currency began trading in January 1999. The 15-nation currency was last up 0.7% to $1.5117, after earlier rising as high as $1.5144...

The dollar index, which measures the greenback against a basket of six major currencies, was at 74.540, down from 74.712 late Tuesday. The index earlier hit a record low of 74.070.

Central bankers' comments yesterday fed the move.

Federal Reserve chief Ben Bernanke told Congress Wednesday that the Federal Open Market Committee will remain on course toward implementing additional interest-rate cuts, at least in the near term, although the journey has become more treacherous as prices are rising. Downside risks to economic growth, rather than inflation, still remain the key focus of Fed policymakers. Read the Fed...

Bernanke's remarks were in stark contrast with comments earlier Wednesday from Axel Weber, a hawkish European Central Bank Governing Council member and president of the German Bundesbank, which gave a tailwind to the united currency's updraft.

"Interest rate expectations for the euro zone don't reflect the monetary policy assessment of a central bank that is committed to price stability," Weber said, according to Dow Jones Newswires.

As did economic data.

The Commerce Department said new orders for durable goods fell 5.3% in January after a burst of orders in December, another sign that the economy is slowing. Economists surveyed by MarketWatch had anticipated a 5.1% drop. See Economic Report...

Other Commerce Department data showed sales of new homes nationwide fell by 2.8% in January despite a record drop in prices. See Economic Report.

Meanwhile, money supply growth in the euro area is slowing but gradually. Bloomberg reports:

Money-supply growth in the 15-nation euro region slowed less than economists forecast in January, limiting the European Central Bank's scope to cut interest rates.

M3 money supply, which the ECB uses as a gauge of future inflation, rose 11.5 percent from a year earlier, after gaining 11.6 percent in December, the Frankfurt-based central bank said today. Economists expected a rate of 11.3 percent, the median of 38 forecasts in a Bloomberg News survey showed.

Gold also rose yesterday, touching a record US$967.70 an ounce in the process. However, crude oil fell below US$100 a barrel after a government report showed a bigger-than-expected buildup in US crude inventories.

Wednesday, 27 February 2008

US consumer confidence falls, German business confidence rises

The theme of weaker growth, higher inflation continues to play out in the US economic data. Bloomberg reports the latest data.

U.S. consumer confidence fell to the lowest level in five years and wholesale inflation picked up, limiting the Federal Reserve's room to maneuver as it tries to avert a recession.

The Conference Board's index of confidence dropped to 75.0 in February, lower than forecast, from 87.3 in January, the New York-based group said today. The Labor Department reported that producer prices rose 1 percent last month. Excluding food and energy, expenses climbed 0.4 percent, the most in almost a year...

Over the past 12 months, producer prices rose 7.4 percent, the most since October 1981. Wholesale prices excluding food and energy advanced 2.3 percent in the year through January.

However, higher inflation hasn't generally extended to asset prices recently.

Home prices in 20 U.S. cities fell in December by the most on record, a separate report showed today. The S&P/Case-Shiller home-price index dropped 9.1 percent from a year ago, after a 7.7 percent decrease in November. Home Depot Inc., the world's largest home-improvement retailer, today said fourth-quarter profit fell and forecast earnings below analysts' estimates.

Fed officials continue to focus on weaker growth rather than on inflation

... Fed Vice Chairman Donald Kohn, speaking today ahead of Chairman Ben S. Bernanke's Congressional testimony tomorrow, signaled the central banker is willing to keep interest rates low to revive the economy...

"I do not expect the recent elevated inflation rates to persist," Kohn said in the text of a speech to the University of North Carolina, Wilmington. "The adverse dynamics of the financial markets and the economy have presented the greater threat to economic welfare in the United States."

Growth is also slowing in Germany, with household spending falling 0.8 percent in the fourth quarter and dragging overall GDP growth down to just 0.3 percent compared with 0.7 percent in the previous quarter. However, business sentiment unexpectedly rose in February, reports Bloomberg.

German business confidence unexpectedly rose for a second month in February, strengthening the case for the European Central Bank to leave interest rates at a six-year high.

The Munich-based Ifo institute said its business climate index, based on a survey of 7,000 executives, increased to 104.1 from 103.4 in January. Economists forecast a drop to 102.9, according to the median of 45 estimates in a Bloomberg News survey.

Tuesday, 26 February 2008

Bank of Israel cuts interest rates, Singapore inflation hits 25-year high

Yesterday, the Bank of Israel decided to cut interest rates. And it did so in the face of data showing accelerating inflation. From Bloomberg:

The Bank of Israel lowered its benchmark lending rate by half a percentage point, the biggest cut in more than a year, saying that a strengthening shekel and slowing economy will bring inflation back into the target range.

The rate the central bank charges commercial lenders will fall to 3.75 percent on Feb. 28, a spokeswoman for the Jerusalem- based bank said today...

Inflation accelerated to 3.5 percent in January, the second consecutive month it exceeded the government's target range of 1 percent to 3 percent.

There was a similar tone to the story in Singapore, which reported yesterday that its annual inflation rate hit a 25-year high in January. Channel NewsAsia reports:

Singapore's annual inflation rate hit a 25-year high of 6.6 percent in January, according to Department of Statistics (DOS) data released on Monday...

From a month earlier, consumer prices in January rose 1.5 percent on a seasonally adjusted basis, the DOS said.

However, inflation is expected to moderate later in the year.

The Ministry of Trade and Industry (MTI) issued a statement along with the DOS data, saying the year-on-year jump in inflation in January was due to one-off factors such as a housing value revision and that it was in line with the official inflation forecast of 4.5-5.5 percent for 2008.

The MTI said inflation would start to ease in the second half of the year. In December, the annual rate was 4.4 percent.

But you don't have to be a small country surrounded by Muslim neighbours to think that inflation will moderate. In yesterday's post, I wrote that policy-makers in the US and Europe also think inflation is likely to moderate later in the year.

Paul Kasriel explains why.

... [I]nflation is a lagging economic variable. That is, first, real GDP growth slows and later, inflation peaks...

But is the current stagflation of the same type as that of the 1970s? I think not... [I]n the mid and late 1970s and early 1980s, there were sharp contractions in the global production of crude oil. Although there was a small contraction in crude oil production in 2006 (the latest complete annual data available), this contraction paled in comparison to that of earlier periods...

Back in the 1970s and early 1980s, labor unions were much more powerful than they are today. Cost-of-living wage increases were the rule. Now, they are the exception...

Richard Berner also thinks stagflation is unlikely. While acknowledging that there are secular and cyclical inflationary pressures,

... In my view, the time-honored forces of increased slack brought about by recession will cause inflation to slowly move lower. In that context, I expect that rising costs will soon have an impact on profit margins instead of prices, as companies are less able to pass them through to consumers.

Monday, 25 February 2008

As economic growth weakens, look for inflation to moderate

Global inflation is rising. With economic growth, particularly in the United States, slowing, it looks like a case of stagflation -- weak economic growth combined with high inflation. However, this condition is unlikely to last.

In the US, the Labor Department reported last week that consumer prices rose 0.4 percent in January, the same rate of increase as in December. Food and energy were big contributors to the rise but even excluding these items, prices were up 0.3 percent compared to 0.2 percent in the previous month. Over 12 months, overall consumer prices were up 4.3 percent while prices excluding food and energy rose 2.5 percent.

As further evidence of the underlying inflationary trend, other measures of core inflation also showed acceleration last month. The 16-percent trimmed-mean consumer price index monitored by the Cleveland Federal Reserve rose 0.4 percent in January, higher than the 0.2-percent increase in the previous month, while its median consumer price index rose 0.3 percent, maintaining the pace of the previous four months.

CPI less food & energy0.
16% trimmed-mean CPI0.
Median CPI0.

The 12-month rate of consumer price inflation now shows an accelerating trend according to all the four main measures monitored by the Cleveland Federal Reserve.

CPI less food & energy2.
16% trimmed-mean CPI2.
Median CPI2.

Inflation is not just a US trend. It is very much a global one.

In Europe, reports last week showed the same trend. Producer prices in Germany rose at an annual rate of 3.3 percent, the highest in 13 months. Based on EU-harmonised standards, French consumer prices rose at an annual rate of 3.2 percent in January, up from 2.8 percent in December, while Italy's consumer prices rose at a 3.1 percent rate in January compared with 2.8 percent in December.

Even China, whose exports many believe helped keep inflation elsewhere down in the 1990s and early 2000s, is facing inflationary pressures of its own. Last week, it reported that consumer prices were up 7.1 percent in January from a year ago, the highest rate of inflation in 11 years.

So is inflation running out of control? Officials at the Federal Reserve do not think so, at least in the US.

According to the minutes of the Federal Open Market Committee meeting on 29-30 January released last week, Fed officials have been disappointed by the inflation readings of recent months. They have raised the projection for inflation in 2008 based on the personal consumption expenditures PCE price index to between 2.1-2.4 percent from the previous range of 1.8-2.1 percent. Projection for 2008 inflation in the price index excluding food and energy was also raised to 2.0-2.2 percent from 1.7-1.9 percent. The latter is essentially the same as the actual rate seen in the fourth quarter of 2007, indicating that Fed officials think that inflation at what it believes is the core level will remain stubborn through the year.

However, the minutes also show that Fed officials believed that slower economic growth anticipated for the first half of this year would produce enough slack in resource utilisation as to result in an easing of price pressures. The projection for economic growth was reduced to a range of 1.3-2.0 percent from a previous range of 1.8-2.5 percent.

Fed officials have publicly stated on various occasions that they do not expect a recession. An outright recession, though, is precisely what would make a significant dent on inflation. At least that has been the case in the past, as the accompanying chart shows.

The economic reports last week, however, have not clearly indicated that the economy is in recession or will be in one soon, although they do underline how weak it is. The Federal Reserve Bank of Philadelphia's index of manufacturing activity fell this month to -24 from -20.9 in January. The National Association of Home Builders/Wells Fargo housing market index edged up from 19 in January but to only 20 in February. Housing starts edged up in January too but building permits fell 3 percent.

Leading indicators are pointing in the same downward direction. The Conference Board's US leading index decreased 0.1 percent in January and has now fallen 2.0 percent over the last six months, with only two out of ten components having advanced over the period. The Economic Cycle Research Institute's weekly leading index fell to 132.3 in the week of 15 February from 133.1 in the prior week and its annualised growth rate deteriorated to -10.2 percent from -9.2 percent, reaching its lowest reading since the week of 26 October 2001.

So if weaker economic growth does create the slack in resource utilisation that the Federal Reserve envisages, there may indeed by hope for inflation in the US to moderate later in the year.

Europe's economy is projected to develop along similar lines. According to the European Commission's latest forecast of the economy released last week, growth is expected to slow to 2.0 percent this year in the European Union, 0.4 percentage point less than forecast in November. Inflation this year is expected to average 2.9 percent in the EU, half a percentage point more than the previous forecast. However, it is expected to recede to just above 2.5 percent by the end of the year.

So cyclical factors driving up inflation today are widely expected to diminish over the next year or so.

Beyond that, however, the aggressive interest rate cuts by the Federal Reserve over the past few months should eventually reflate the US economy. Unless the economy weakens more severely than most economists expect, inflation is likely to become a concern again for policy makers before too long.

In fact, at the last FOMC meeting, according to the minutes, Fed officials had noted that inflation expectations had risen in recent months and some officials suggested that once prospects for growth improves, a reversal of the recent monetary easing, possibly even a "rapid reversal", might be appropriate.

Inflation may not be as virulent as some think, but it is probably not going to be easily buried either.

Saturday, 23 February 2008

Japan's government downgrades economic assessment

This is not unexpected. From AFP/CNA:

Japan's government downgraded its assessment of Asia's largest economy Friday for the first time in 15 months, saying the recovery was losing steam due to slowing US growth.

A monthly report from the Cabinet Office acknowledged that exports and industrial output are cooling while consumer spending is sluggish.

"The economy is recovering at a moderate pace," the report said, tweaking its previous assessment that the economy "is recovering, while some weaknesses are seen."

BoJ governor Toshihiko Fukui also spoke yesterday.

Japan's central bank chief warned Friday that uncertainties were growing in the world's second largest economy in light of a downturn in the US economy.

"A slowdown of the US economy is intensifying, while global financial and capital markets continue to be unstable," Bank of Japan governor Toshihiko Fukui told a parliamentary committee.

But he added: "Japan seems to have stronger resilience against external shocks than previously. Thus, I continue to believe that the chances are high that a gradual recovery will be sustained."

Meanwhile, Europe's economy appears to be holding up relatively well. From Bloomberg:

Growth in Europe's service industries accelerated more than economists forecast in February, prompting investors to reduce bets on European Central Bank interest-rate cuts.

Royal Bank of Scotland Group Plc's index of services, industries including banks, consultancies and airlines, rose to 52.3 from 50.6 in January, according to a preliminary estimate today...

Royal Bank's composite purchasing managers' index, which combines services and manufacturing and accounts for about half of the economy, rose to 52.7 from 51.8. A gauge of manufacturing slipped to 52.3 from 52.8, in line with economists' forecasts.

Friday, 22 February 2008

US data throw up more recession warnings

Yesterday brought yet more signs that the US economy is falling into recession. From Bloomberg:

The U.S. moved closer to a recession as manufacturing in the Philadelphia area shrank the most in seven years, while a measure of the economy's future performance declined for a fourth month.

The Federal Reserve Bank of Philadelphia's general economic index fell more than forecast this month to minus 24, showing the margin by which more firms reported a decrease in activity instead of an increase. That was the lowest figure since February 2001, weeks before the last downturn began. The Conference Board's index of leading indicators dropped 0.1 percent in January, matching December's decline...

Last month's drop in the Conference Board's index brings the decline for the last six months to 2 percent, which the Conference Board says can be one of the "reasonable criteria for a recession warning"...

The Labor Department reported today that the number of Americans remaining on unemployment benefit rolls climbed to the highest since October 2005 as faltering economic growth prompted companies to cut payrolls.

The number of people continuing to collect benefits rose to 2.784 million in the week ended Feb. 9, from 2.736 million a week earlier, the Labor Department said today in Washington. First-time jobless claims decreased by 9,000 to 349,000 in the week ended Feb. 16, from a revised 358,000 a week earlier.

It is not looking much better in Europe, as Bloomberg reports.

The European Commission cut its forecast for euro-area economic growth and predicted inflation will accelerate to the fastest pace since the single currency's debut, highlighting the dilemma facing the region's central bank.

Inflation will average 2.6 percent this year, the Brussels- based commission said today, increasing its previous estimate by 0.5 percentage point. The economy of the 15 nations that use the euro will expand 1.8 percent, it forecast, below the 2.2 percent predicted in November and the weakest since 2005.

Japan's economy, however, is once again being boosted by exports. Again from Bloomberg:

Japan's export growth unexpectedly quickened in January, as rising demand for cars and steel from China and Russia made up for falling U.S. sales.

Exports, the engine that drove almost half of the economy's expansion last quarter, rose 7.7 percent, from December's 6.9 percent gain, the Finance Ministry said today in Tokyo. The median estimate of 18 economists surveyed by Bloomberg was for a 6.6 percent increase...

Imports climbed 9 percent from a year earlier on surging oil costs. Rising imports, combined with a New Year holiday that erased three business days for Japanese shippers, caused the trade deficit to widen to 79.3 billion yen.

Thursday, 21 February 2008

Housing slump, inflation hump

Yesterday's reports did not show much change in the direction of the US economy in January. Inflation remains high, housing remains weak. Bloomberg reports:

The two-year housing slump pushing the U.S. economy toward a recession hasn't alleviated inflation pressures, reports today showed.

Consumer prices rose 0.4 percent from December, with costs excluding food and energy climbing 0.3 percent, the most since June 2006, the Labor Department said. Builders started work on 1.012 million homes at an annual rate in January, close to a 16- year low, the Commerce Department reported in Washington...

Building permits, an indication of future construction, fell 3 percent to a 1.048 million rate, the lowest level since November 1991, today's Commerce report showed.

The Federal Reserve has recently appeared more concerned with the weak growth rather than with inflation, expecting the latter to moderate eventually.

Fed policy makers last month judged that low interest rates "were appropriate for a time," according to minutes of the Jan. 9 and 21 conference calls and Jan. 29-30 meeting reported today. And, while some officials considered that a reversal of the rate cuts may be needed once the economy stabilizes, "members agreed that inflation was likely to moderate in coming quarters."

This is despite the fact that Federal Reserve forecasts were revised to show both lower growth and higher inflation.

The Fed also lowered its growth forecast and boosted its expectations for the pace of increase in consumer prices. It now expects the economy to expand 1.3 percent to 2 percent in the fourth quarter from the same period a year before, compared with 1.8 percent to 2.5 percent projected in October. Consumer prices will rise 2.1 percent to 2.4 percent compared with 1.8 percent to 2.1 percent.

Wednesday, 20 February 2008

Commodities surge, China's inflation at 11-year high

The renewed surge in commodity prices recently doesn't bode well for global inflation. Bloomberg reports:

Commodity prices surged to a record, as oil jumped above $100 a barrel and copper rallied, on signs that increased global demand for raw materials and the weakening dollar are fueling inflation.

The UBS Bloomberg Constant Maturity Commodity Index gained as much as 3.1 percent to a record 1,447.015. Crude oil, platinum, soybeans and gasoline touched their highest prices ever, and copper jumped 5.5 percent, the most of any commodity futures.

China's inflation accelerated at the quickest pace in more than 11 years last month, the government said today...

Chinese consumer prices rose 7.1 percent in January from a year earlier, the statistics bureau said today, after gaining 6.5 percent in December. Inflation in the world's fastest- growing major economy has soared since last year partly because of food and fuel costs.

Perceptions of inflation is taking on crisis proportions in China. That seems to be the cue nowadays for monetary policy innovation. From Bloomberg:

China's central bank said it will increase innovation in monetary-policy tools after a report showed that inflation surged to an 11-year high.

China's economy faces "prominent" problems such as imbalanced international payments and excess liquidity, the People's Bank of China said. The comments were in a five-year plan for the finance industry released today on the central bank's Web site.

"We will further improve monetary policy controls, continue to use quantitative measures, widen usage of price- related policy tools and increase innovation in monetary policy measures," the central bank said in the report, without elaborating...

The government will "better coordinate domestic and exchange-rate policies" and use "multiple" tools to control bank lending, the central bank said in the report.

According to other Bloomberg reports, there are other central banks that are also concerned with inflation. For example, Australia.

Australian inflation may accelerate to almost 4 percent as a labor shortage worsens, central bank official Malcolm Edey said, driving up the nation's currency on speculation policy makers will raise borrowing costs again in March.

"The striking thing is the contrast between domestic and international conditions," Assistant Governor Edey told business leaders in Sydney today. "The Australian economy to date has stayed robust and the main domestic challenges are those of strong demand, tight capacity and inflationary pressures."

And Poland.

The National Bank of Poland needs to raise interest rates further after accelerating economic growth pushed inflation to the fastest in three years, two central bankers said.

Policy maker Andrzej Wojtyna said in an interview in Warsaw today that he saw room for at least one quarter-point interest rate increase "in the near future," while fellow rate setter Halina Wasilewska-Trenkner said an increase in borrowing costs may come as soon as this month.

But inflation is not accelerating everywhere. For one, inflation in Canada appears to be cooling.

Canada's annual inflation rate excluding volatile items such as gasoline was the slowest since July 2005 last month, contained by a sales-tax cut and lower car prices, giving central bankers room to lower interest rates.

Core prices rose 1.4 percent in January from a year earlier, slowing for the seventh straight month and below the central bank's target for a fourth month, from 1.5 percent in December...

The year-over-year all-items index slowed to 2.2 percent, the smallest gain since August, from 2.4 percent in December, matching economists' forecasts. On a monthly basis, prices fell 0.2 percent in January and the core index gained 0.1 percent.

And as the Guardian reports, Sweden's case shows that central bankers can sometimes act prematurely based on inflation forecasts.

Swedish consumer prices rose by an annual 3.2 percent in January, undershooting forecasts and leading analysts to say the central bank may be able to reverse last week's quarter-point interest rate hike later in the year...

The statistics office said a CPI basket revision took 0.2 to 0.3 percentage point off the annual rate and 0.5 point off the monthly figure. The CPI fell a monthly 0.8 percent in January.

Monday, 18 February 2008

US and China on inflation watch this week

There are two important reports on inflation in January this week. One is for the United States, due out on Wednesday. Before that, however, we are due to get the inflation report from China on Tuesday.

According to a Bloomberg survey, the consensus estimate for US inflation sees consumer prices rising 4.2 percent in the year to January. Consumer prices excluding food and energy are expected to have risen 2.4 percent over the same period.

This suggests that the moderation in inflation in the US that began around the middle of 2006 has stalled for the time being. In fact, it may even be re-accelerating.

Nevertheless, most economists think that inflation will head downwards again at some point in the near future. This is based on expectations of an economic slowdown in the US over the coming months.

However, aggressive interest rate cuts in recent months by the Federal Reserve could be setting the stage for an upturn in inflation again further out into the future. A measure of expectation for inflation over the next ten years using the difference in yields between nominal Treasury notes and Treasury inflation-protected securities shows that expected inflation has been rising in recent months.

A report on import prices on Friday also gave a hint of the underlying inflationary pressures around the globe. The Labor Department reported that import prices rose 1.7 percent in January. This was largely due to petroleum imports, but even excluding the latter, import prices were up 0.6 percent from the previous month.

What also seemed noteworthy from the Labor Department report was that prices of imports from China rose 0.8 percent, the largest monthly increase since the index was first published in December 2003, and were up 3.3 percent over January 2007. China has often been seen as a source of disinflation for the rest of the world. If so, however, its role in curbing global consumer price inflation may be coming to an end.

One reason for the rising inflationary pressures from China is that China itself is facing inflationary pressures of its own. According to a Bloomberg survey, China's consumer prices are estimated to have risen 7 percent in January from a year earlier.

Other recent data highlight the inflationary pressures in China. Last week, the People's Bank of China had reported that M2 money supply rose 18.9 percent from a year earlier, accelerating from December's 16.7 percent rise. Today, the National Bureau of Statistics reported that producer prices rose 6.1 from a year earlier in January, again an acceleration from a 5.4 percent rise in December.

Therefore, the PBC will probably have to raise interest rates further this year.

Additionally, the renminbi will have to bear its share of the tightening burden and is likely to see further appreciation. In fact, with the Federal Reserve's rate cuts putting downward pressure on the US dollar, the renminbi may have to appreciate at a faster rate to offset the weakening US currency.

And the renminbi certainly has scope to rise against other currencies. As it is, while the Chinese currency has appreciated against the US dollar over the past few years, it has depreciated against the euro such that its exchange rate with the latter is now roughly back to what it was before it was depegged from the US dollar in 2005.

Saturday, 16 February 2008

BoJ holds rates as US economy weakens further

It looks like normalisation of interest rates in Japan has been put off indefinitely. From Bloomberg:

The Bank of Japan kept interest rates on hold amid concern that slowing global economic growth will cut demand for exports and costlier energy and materials will damp spending at home.

Governor Toshihiko Fukui and his colleagues left the overnight lending rate at 0.5 percent, the lowest among major economies, the central bank said today in Tokyo. Fukui, who has called for gradual rate increases since 2006, will probably finish his term on March 19 by leaving credit costs unchanged.

The decision looks justified based on the economic reports out yesterday from the US. Practically all were negative, although you'd have a hard time telling from the way US stock indices closed yesterday. From MarketWatch:

U.S. stocks on Friday closed with weekly gains...

Down nearly 100 points during the session, the Dow Jones Industrial Average fell 28.8 points, or 0.2%, to end at 12,348.2, giving the blue chips a weekly climb of 1.4%...

Lower until the final moments of trade, the S&P 500 reversed course to gain 1.13 points, or nearly 1%, to 1,349.99, giving it a weekly rise of 1.4%, while the Nasdaq Composite declined 10.74 points, or 0.5%, to 2,321.8, leaving the technology-laden index with a gain of 0.7% from a week ago...

Ahead of the opening bell, the Labor Department said the cost of goods imported into the country climbed 1.7% in January, powered largely by rising energy prices. See Economic Report...

The Federal Reserve of New York's Empire State Manufacturing Survey pointed to declining conditions this month, with the gauge falling nearly 21 points to stand at a negative 11.7, its first drop into the red since May 2005 and far worse than the fall that analysts predicted. Read more...

Having less of an impact on the equities market was word from the Federal Reserve that U.S. industrial production climbed 1% in January, matching the expectations of economists surveyed by MarketWatch.

A survey released by the University of Michigan and Reuters had consumer sentiment darkening further in February, with an index falling to 69.6 mid-month from 78.4 in January. See full story.

China did report a strong trade performance for January though. From Bloomberg:

China's trade surplus jumped more than economists estimated in January, a sign that the world's fourth-biggest economy may keep powering global growth as a recession looms in the U.S.

The gap widened 23 percent from a year earlier to $19.5 billion, the customs bureau said on its Web site today. That was more than the $17 billion median estimate of 19 economists surveyed by Bloomberg News...

Exports rose 26.7 percent from a year earlier to $109.7 billion. Imports increased 27.6 percent, the largest gain in almost two years, to $90.2 billion.

But January -- and February -- data from China are always difficult to interpret.

China's biggest annual holiday, Lunar New Year, may have helped to boost the increase in the trade surplus because it started earlier in February this year than it did last year.

"Exporters were pushing to get stuff out the door," said Stephen Green, senior economist at Standard Chartered Bank Plc in Shanghai. "February exports will be lower."

Friday, 15 February 2008

US stocks end rally

The rally in US stocks ended yesterday. Bloomberg reports:

U.S. stocks fell for the first time this week after Federal Reserve Chairman Ben S. Bernanke warned that a scarcity of credit will restrain economic growth and analysts said Intel Corp. may be hurt by slower computer sales...

The S&P 500 decreased 18.35 points, or 1.3 percent, to 1,348.86. The Dow Jones Industrial Average slid 175.26, or 1.4 percent, to 12,376.98. The Nasdaq Composite Index lost 41.39, or 1.7 percent, to 2,332.54. About five stocks declined for every one that rose on the New York Stock Exchange.

But the US economic data out yesterday weren't too bad. Bloomberg reports:

The U.S. trade deficit shrank more than forecast in December and showed the first annual drop since 2001 as the faltering economy eroded demand for imported autos and Chinese-made consumer goods.

The gap narrowed 6.9 percent from November to $58.8 billion, the Commerce Department said today in Washington. Imports fell 1.1 percent, while exports increased 1.5 percent, aided by stronger growth abroad...

A separate report from the Labor Department showed claims for unemployment benefits fell for a second week, while staying in a range consistent with a slowing job market.

Initial jobless claims decreased by 9,000 to 348,000 in the week ended Feb. 9, from 357,000 a week earlier. The four-week moving average of claims, a less volatile measure, rose to the highest level since October 2005.

Treasuries didn't generally benefit from the flight from stocks yesterday. From Bloomberg:

Treasury 10-year notes fell for a third straight day as Federal Reserve Chairman Ben S. Bernanke told Congress the central bank is ready to cut interest rates again, reinforcing concern inflation will accelerate.

The decline pushed 10-year yields to the highest level compared with two-year notes since July 2004 on signs credit markets remained strained...

Ten-year note yields rose 7 basis points, or 0.07 percentage point, to 3.81 percent at 4:22 p.m. in New York, according to bond broker Cantor Fitzgerald LP. They touched 3.86 percent, the highest since Jan. 11...

The yield on the 30-year bond rose 9 basis points to 4.64 percent after reaching 4.69 percent, the highest since Nov. 1. It's the biggest gain in a week. An increase in the price of two-year notes pushed the yield down 2 basis points to 1.89 percent. It touched 1.83 percent on Jan. 23, the lowest since April 2004...

Shorter-term Treasuries may be supported on indications of widening stress in credit markets, traders said.

Elsewhere, growth in Europe has cooled, Bloomberg reports.

Gross domestic product in the euro region rose 0.4 percent from the third quarter, when it increased 0.8 percent, the European Union's statistics office in Luxembourg said today. Economists expected growth of 0.3 percent, according to a Bloomberg News survey of economists. From a year earlier, the economy expanded 2.3 percent.

But in Japan, fourth quarter growth greatly exceeded expectations. AFP/CNA reports:

Japan's economy grew at a much faster than expected 3.7 percent annualised pace in the fourth quarter of 2007, helped by solid exports and business investment, official figures showed Thursday.

Quarter-on-quarter, gross domestic product (GDP) expanded by 0.9 percent, accelerating sharply from a revised growth rate of 0.3 percent in the three months to September, the Cabinet Office reported.

Thursday, 14 February 2008

Hawks linger in Europe, Fed still seen slashing rates

The economic reports yesterday were mostly unfriendly to bond investors.

In Europe, Sweden's central bank decided to raise interest rates again. Bloomberg reports:

Sweden's central bank unexpectedly raised its benchmark interest rate to 4.25 percent, the highest since November 2002, after inflation surged to a 14-year high last year on plunging unemployment and rising food costs.

The rate was raised by a quarter point and will remain "at roughly the same level over the coming year," Governor Stefan Ingves said at a press conference in Stockholm today. All 24 economists surveyed by Bloomberg expected an unchanged rate.

In the UK, although house prices fell in the three months to January and earnings rose less than expected in the three months to December, the Bank of England appears unlikely to cut interest rates aggressively. From Reuters:

British interest rates won't fall as sharply this year as financial markets have predicted, the Bank of England signaled on Wednesday, although at least one more cut in borrowing costs is probably still on the cards.

The BoE's quarterly inflation report showed inflation way above the central bank's 2 percent target in two years if rates fell as far as 4.5 percent by the end of 2008. But inflation would probably fall below 2 percent if they stayed at their current 5.25 percent.

In the US, where the Federal Reserve has cut rates aggressively, retail sales were actually up in January. Bloomberg reports:

Retail sales in the U.S. unexpectedly rose in January, easing concern that the world's largest economy has already slipped into a recession.

The 0.3 percent increase was led by spending on autos, clothes and gasoline, the Commerce Department said today in Washington. The figure followed a 0.4 percent decrease the previous month. Purchases excluding automobiles and gasoline were unchanged from December.

The retail sales figure hasn't changed the view that the Fed will continue to cut rates. From Bloomberg:

Treasury two-year notes yielded the least compared with benchmark 10-year debt since 2004 on speculation credit-market losses will widen.

Yields on three-month Treasury bills, viewed by investors as a haven in times of turmoil, dropped for the first time in five days. Reluctance by banks to risk capital by buying unsold auction-rate municipal bonds increased demand for the relative safety of the shortest-term government securities...

Interest rate futures on the Chicago Board of Trade showed a 32 percent chance the Fed will reduce the 3 percent target rate for overnight lending between banks by three-quarters of a percentage point at its March 18 meeting, compared with 20 percent odds yesterday. The rest of the bets are for a half- point cut. The Fed has cut the target lending rate five times since September to prevent the world's largest economy from falling into a recession.

Wednesday, 13 February 2008

Buffett buffs up market

Warren Buffett has waded into the bond insurance mess. MarketWatch reports:

Warren Buffett's Berkshire Hathaway on Tuesday came off the sidelines in the mortgage-market crisis, unveiling a plan to reinsure $800 billion of municipal bonds currently guaranteed by three of the world's largest bond insurers...

Berkshire proposed to take on the liability for the bonds in exchange for a payment from the current insurers of 1.5 times the premium they've received. See a copy of Berkshire's proposal...

Buffett's offer would cover municipal bonds but not the billions of dollars worth of complex securities known as collateralized debt obligations (CDOs) that Ambac, MBIA and FGIC have also guaranteed.

Investors initially took this as good news for the bond insurers.

Shares of some bond insurers initially gained ground on the news, lifting the broader market on hopes the plan will relieve one of the main pressure points in the current credit crisis.

How naive can investors be? This MarketWatch report probably comes closer to the true situation.

"He's calling the bond insurers' bluff," said Bill Ackman, head of Pershing Square Capital Management LP, a hedge fund firm that's been shorting, or betting against, shares of MBIA and Ambac...

"If they really believe that they won't have any losses on CDO books, they should take this deal," Ackman said during a presentation on Tuesday. "But I think the bond insurers know that they don't have enough capital for their structured finance obligations without the muni side of their business."

Jim Chanos, head of short selling hedge fund firm Kynikos Associates LP, agreed that the bond insurers are unlikely to accept Buffett's offer.

"It's interesting, but no one in their right mind will take that for obvious reasons," Chanos said during the same presentation. "They can't afford to."

Buffett is trying to show that "the emperor has no clothes," while he builds a bond insurance business of his own, Chanos added.

Now that's more like the Buffett we know.

Ambac shares eventually fell 15 percent yesterday while MBIA fell 15 percent. However, the rest of the stock market managed to finish higher, the S&P 500 gaining 9.73 points, or 0.7 percent, to 1,348.86.

European stocks saw even bigger gains yesterday. The FTSE 100 gained 3.5 percent while the FTSEurofirst 300 index gained 3.4 percent. Apart from the Buffett plan, lower-than-expected inflation in the UK provided a little bit of good news.

Tuesday, 12 February 2008

A bottom in equities?

The US stock market managed to recover from early losses to post a gain yesterday. Bloomberg reports:

U.S. stocks rose as a rally in oil prices boosted energy shares, outweighing concern that financial companies face more writedowns after American International Group Inc. said it understated losses in some assets...

The Standard & Poor's 500 Index added 7.84 points, or 0.6 percent, to 1,339.13 after earlier falling as much as 0.8 percent. The Dow average gained 57.88, or 0.5 percent, to 12,240.01, erasing a drop of as much as 113 points and rebounding from the worst week in almost five years. The Nasdaq Composite Index increased 15.21, or 0.7 percent, to 2,320.06. About nine stocks advanced for every seven that fell on the New York Stock Exchange.

"You've had some measure of indiscriminate selling such that you can find real attractive value opportunities,'' said Christian Andreach, who helps manage more than $15 billion at Manning & Napier Advisors Inc. in Fairport, New York...

Barton Biggs probably agrees with that last statement, and thinks we may be approaching an important bottom in equities. From Bloomberg:

Barton Biggs, co-founder of hedge fund Traxis Partners LLC, said he's "gradually increasing" his holdings of U.S. equities because he doesn't expect a recession and shares are "very, very cheap."

Biggs, the former global investment strategist for Morgan Stanley, said in a Bloomberg Television interview that the market is "at or very close to an important bottom" and may be led higher by banks and brokerages when a rally occurs...

But before you act on that, note that Paul Krugman does not think that the current problems can be resolved so quickly.

... [T]he recessions of [the 70s and 80s]...were caused, basically, by high interest rates imposed by the Fed to control inflation...

Since the mid 1980s...recessions haven’t been deliberately engineered by the Fed, they just happen when credit bubbles or other things get out of hand.

And while they haven’t been as deep as the older type of recession, they’ve proved hard to end (not officially, but in terms of employment), precisely because housing — which is the main thing that responds to monetary policy — has to rise above normal levels rather than recover from an interest-imposed slump.

That’s why I think our current problems will last a long time. [Calculated Risk] says 2009; I say 2010.

Monday, 11 February 2008

US recession, dollar crisis and bond market meltdown

Fears of a recession in the United States and interest rate cuts by the Federal Reserve have pushed the yield on the 10-year Treasury below the rate of inflation. With the US economy looking likely to deteriorate further, the party for bond investors could continue for a while more, but there are dangers further out into the future.

Most of the recession talk surrounding the US economy have been based on the fall in employment in January and the decline in the nonmanufacturing index from the Institute for Supply Management (ISM) to 41.9 percent in January from 54.4 percent in December.

Manufacturing, in contrast, has provided a surprising pocket of strength. Factory orders rose 2.3 percent in December and the ISM's manufacturing PMI edged up over the 50 mark to 50.7 in January.

Nevertheless, the US economy is likely to see further weakness. The Federal Reserve's quarterly survey of senior loan officers in January found tighter lending standards, weaker demand for bank loans and a deterioration in the outlook for loan quality.

In the wake of the collapsing housing market and credit market turmoil of the past months, the findings from the Federal Reserve's survey certainly come as no surprise. Over the past few months, credit spreads have surged. The spread between Moody's Baa bond yield and the 10-year Treasury yield has doubled in the past year to over 300 basis points, a rise usually associated with recessions.

Such is the concern generated by such reports that policy-makers are already moving to provide stimulus to the economy. Last week, Congress passed an economic stimulus package while the Federal Reserve monetary easing recently accelerated with 125 basis points of interest rate cuts towards the end of January.

It is far from certain though that the Federal Reserve will continue to cut rates as aggressively in the coming months. Indeed, the past week saw several Federal Reserve officials, notably Dallas Federal Reserve President Richard Fisher, Richmond Federal Reserve President Jeffrey Lacker and Philadelphia Federal Reserve President Charles Plosser, say they remained concerned about inflation.

"The Fed has to be very careful now to add just the right amount of stimulus to the punch bowl without mixing in the potential to juice up inflation once the effect of the new punch kicks in," Fisher told the Instituto Tecnologico Autonomo de Mexico on 7 February.

Federal Reserve officials generally think a recession can be avoided. Wolfgang Munchau at the Financial Times is doubtful but nevertheless still skeptical of the benefits of further interest rate cuts by the Fed.

On 20 January, in an article entitled "America’s recession will be hard to shift", he warned that rate cuts could be counter-productive and cause long-term interest rates to go up instead of down "if bond markets start to distrust the Fed’s commitment to maintain a low rate of inflation".

Yesterday, in an article entitled "A repeat of the Great Depression is unlikely", he wrote that "the Fed is...seeking insurance against the possibility of a deflationary depression", but doubts that such an outcome is likely anyway.

"During the Great Depression, the US wholesale price index fell by 33 per cent," he wrote. "Such a price fall is not likely in our globalised economy."

The view of John Hussman, president of Hussman Investment Trust, is also interesting because he thinks that although asset prices are likely to be hit in a recession, losses in output and employment on the whole are not likely to be severe.

In an article entitled "A Writeoff Recession and a Dollar Crisis", Hussman pointed out that among the components of gross domestic product, downward pressure is likely to fall on housing and fixed investment. Consumption, in contrast, is usually stable and is likely to remain so. Furthermore, some of the contraction in demand would be absorbed by "a flattening out of the US current account". Meanwhile, because inventories are already "very lean", there is not likely to be much further retrenchment there.

"Rather, the current economic downturn is likely to focus its damage on asset prices," he wrote. Asset prices are likely to decline simply because they are "too achieve an acceptable rate of return".

Losses in real economic output, however, "are unlikely to be dire".

And he may be right. In fact, the yield curve indicates that the outlook for the US economy may already be stabilising. The spread between the 10-year Treasury and short-term interest rates, negative for much of 2006 and 2007 and signalling a potential recession, has surged back into positive territory. This may be suggesting that even if the economy falls into recession, we can already see light at the end of the tunnel.

Or alternatively, it could be a sign that investors are pricing in higher inflation in the 10-year Treasury, just as Munchau feared.

In either case, it looks like the Federal Reserve needs to be wary of further aggressive rate cuts.

Indeed, both Hussman and Munchau see risks from an environment of depressed interest rates.

Hussman wrote that the low yields on Treasuries discourage capital inflow. That could trigger a US dollar crisis in view of the large current account deficit.

Munchau put it more starkly in his article yesterday. He wrote that if there is one thing that could produce a 1930s-style deflationary depression, it is a large-scale financial meltdown. In such a situation, lower central bank rates would not be very helpful.

On the other hand, if the recession turns out to be shallow and short, the 10-year US Treasury yield, now only about 3.7 percent and below the rate of consumer price inflation, might well shoot up to 6 or 7 per cent.

So if the Federal Reserve tries to insure against deflation, it might well risk "a bond market meltdown, your quintessential financial crisis".

Saturday, 9 February 2008

Japan's core machinery orders fall

It is becoming increasingly questionable whether Japan can shrug off a US recession.

On Wednesday, the government reported that its index of leading economic indicators rose to 40.0 in December from 18.2 in November but remained below the 50 mark.

Yesterday, Reuters reported additional evidence of weakness for the Japanese economy.

Japan's core machinery orders fell more than expected in December and an index that gauges service sector sentiment declined to a six-year low, adding gloom to the outlook for the world's second-largest economy...

Core private-sector machinery orders, a highly volatile series known as an indicator of capital spending in the coming six to nine months, fell 3.2 percent in December from the previous month.

That was a bigger fall than economists' consensus forecast for a 0.9 percent drop and followed a 2.8 percent decline in November.

Manufacturers surveyed by the government forecast that core orders will show a 3.5 percent rise in January-March from the previous quarter after a 0.9 percent rise in October-December...

A survey of service sector workers, called "economy watchers" for their proximity to consumer and retail trends, produced an index of 31.8 in January, down from 36.6 in December and the lowest since December 2001.

Meanwhile, though, bank lending and money supply continued to grow.

Separate data on Friday showed that Japanese bank lending rose 0.4 percent in January from a year earlier, with the pace of growth picking up from a 0.1 percent rise in December, according to the Bank of Japan.

The most widely watched measure of money supply -- M2 plus certificates of deposit -- rose 2.1 percent in January from a year earlier, in line with economists' consensus forecast, other BOJ data showed.

Friday, 8 February 2008

BoE cuts, ECB moving closer too

The hawks are still flying east.

The Bank of England cut rates yesterday, much as most economists had expected. It lowered its key rate by a quarter percentage point to 5.25 percent.

The more interesting development was with the European Central Bank. Reuters reports:

The European Central Bank left interest rates on hold on Thursday and markets spied more scope for rate cuts this year after President Jean-Claude Trichet stressed the risk of slower growth alongside inflation pressures.

Unlike the last two meetings, policymakers did not discuss raising rates and although they did not consider a rate cut either, markets and analysts saw the ECB opening the door to reducing its benchmark from the current six-year high of 4 percent by mid-year...

A Reuters poll showed most economists still expect a 25 basis point cut to 3.75 percent by June, unchanged from last week, but analysts brought forward the timing of a second cut to the third quarter from the fourth. They gave a 66 percent chance of a rate cut by mid-year, compared to 55 percent last week, and 85 percent of a cut by year-end, from 75 percent.

Meanwhile, the Czech central bank proved more hawkish, following its Romanian counterpart's one-percent move on Monday with a quarter-point hike of its own yesterday. In between, on Tuesday, Australia had also hiked rates by 25 basis points.

The world may be round but some strays notwithstanding, the hawks are not likely to make more than token appearance out in the far west in the US, where data yesterday confirmed ongoing economic weakness, as Reuters reports.

Pending sales of previously owned homes fell by 1.5 percent in December and were off a sharp 24 percent from a year ago, the National Association of Realtors said.

Separately, the Labor Department said new claims for unemployment aid edged down from a two-year high last week, but the number of workers remaining on the benefit rolls has hit a level not seen since October 2005 in the aftermath of Hurricane Katrina.

On the retail front, a spate of reports from key chain stores like Wal-Mart Stores Inc and Target Corp showed consumers have pulled back on spending. Sales in January were below expectations and were down at some key retailers.

Wednesday, 6 February 2008

Stocks plunge as service sectors deteriorate

US stocks plunged yesterday, and it's not because the Reserve Bank of Australia raised interest rates by 25 basis points to 7 percent.

From MarketWatch:

Stocks plunge Tuesday, with the Dow industrials tumbling to their biggest drop in nearly a year, after a key service sector gauge contracted in January -- possibly signaling that the U.S. economy is already in recession.

The Dow Jones Industrial Average tumbled 370 points, or 2.9%, to 12,265, with all of its 30 component stocks in negative territory. It was the worst percentage decline for the Dow since February 2007, when the index fell 3.3%. It was also its worst point drop since August...

The Institute for Supply Management (ISM) said its nonmanufacturing index fell to 41.9% in January from 54.4% in December, well below the 53.0% expected by economists. Readings below 50% indicate most firms are contracting. See full story.

European stocks plunged too. Bloomberg reports:

The Dow Jones Stoxx 600 Index retreated 3.2 percent to 318.73, extending its decline after the report on U.S. service industries, which reflect almost 90 percent of the economy, unexpectedly shrank in January...

Europe also had its share of poor economic data yesterday. From Bloomberg:

Europe's service industries grew at the slowest pace in more than four years and retail sales dropped the most since 1995 after stock markets slumped, the U.S. economy faltered and inflation accelerated.

Royal Bank of Scotland Group Plc said its purchasing managers' index for services dropped to 50.6, the lowest since July 2003, from 53.1 in December. A reading above 50 indicates growth. Retail sales in the euro region declined 2 percent from a year earlier, a record, the European Union's statistics office in Luxembourg said today.

The UK service sector, however, bucked the trend, with its PMI edging up to 52.5 in January from 52.4 in December. More in keeping with the worldwide downbeat tone yesterday was Nationwide's UK consumer confidence index, which fell to a record low of 81 in January from 85 in December.

Tuesday, 5 February 2008

Chinese stocks in record surge but US stocks tumble

China may have been hit by a severe bout of cold weather but there was nothing cold about the performance of its stock markets yesterday. From Bloomberg:

China's benchmark stock index rose by a record 8.3 percent after the government allowed the sale of new stock funds and increased efforts to restore power supplies and transport links after the worst snowstorm in more than 50 years.

The US stock market did not pick up the baton though. Again from Bloomberg:

U.S. stocks declined for the first time in three days after analysts told investors to sell American Express Co., Wells Fargo & Co. and Wachovia Corp. on concern a recession will worsen defaults among consumers...

The Standard & Poor's 500 Index fell 14.6, or 1.1 percent, to 1,380.82 after rallying 4.9 percent last week. The Dow Jones Industrial Average decreased 108.03, or 0.9 percent, to 12,635.16. The Nasdaq Composite Index retreated 30.51, or 1.3 percent, to 2,382.85. Almost seven stocks declined for every four that advanced on the New York Stock Exchange.

Perhaps investors just need to digest last week's gains, or feel that it was a bit overdone. After all, notwithstanding the 2.3 percent increase in factory orders in December, the economy is facing a real problem in tighter lending conditions, as Bloomberg reports.

The Federal Reserve said it became tougher for U.S. companies and consumers to get loans in the past three months, particularly to buy real estate.

Most lenders anticipate more delinquencies and losses this year, assuming "economic activity progresses in line with consensus forecasts," according to the central bank's quarterly survey of senior loan officers released today in Washington.

Monday, 4 February 2008

In the Year of the Rat, will the US economy fall into the sewer?

China celebrates the beginning of a new lunar year this week. On the opposite side of the world, we may be seeing the beginning of the end of the economic expansion of the past few years.

The past two weeks have been very eventful for those following the United States economy. The highlights must surely be the two Federal Reserve interest rate cuts on 23 and 30 January by 75 basis points and 50 basis points respectively and the latest report on Friday that US employment shrank in January. Volatility in markets also added to the excitement.

For China and many other countries in East Asia, another form of excitement is approaching. On 7 February, they will be celebrating the beginning of a new year in the Chinese lunar calendar. According to the Chinese calendar, this coming year is the Year of the Rat.

Feng shui master Raymond Lo says on his website that this coming year is symbolized by two elements: earth sitting on top of water. He says in his remarks on the economy in 2008 that in the absence of the fire element, "investors will play cool and conservative".

Lo says that the industries that will perform well in the coming year will be industries related to the earth and metal elements, such as property, hotel, mining, insurance, machinery, engineering, health, computer and high tech industries. The sectors that will not do so well will be those related to water, such as shipping, communication and drinks, and fire, such as the stock market, finance, energy, electricity and entertainment.

Lo adds that it will be "a year of cooling down after the heated economic atmosphere in 2006 and 2007".

At the moment, though, the start to the Year of the Rat in China is looking much too cool for comfort. Cold weather and snow storms have caused deaths and disrupted electrical power and transportation in much of the country. It is not exactly a great time to celebrate.

Economically though, the draught may hit the United States first. The US economy, the engine of global growth for the past few years, is looking shaky and may fall into recession, dragging down China and the rest of the world economy.

Last week's data provided ominous signs for the US economy. On Wednesday, the Commerce Department reported that the US economy grew at an annual rate of just 0.6 percent in the fourth quarter, weaker than most economists had expected. Then on Friday, the Labor Department reported that non-farm payrolls in the US fell by 17,000 in January.

To keep things in perspective, though, note that these do not provide conclusive proof that the economy is in or even necessarily close to a recession. Remember that the non-farm payroll number is likely to be revised in subsequent months. Furthermore, the household survey did show an increase in employment in January and the unemployment rate dipped slightly to 4.9 percent from 5.0 percent in December.

Nevertheless, employment growth in the US is clearly in a weakening trend.

Perhaps more significantly, the Institute for Supply Management (ISM) reported on Friday that its manufacturing PMI rose to 50.7 in January from 48.4 in December, indicating that manufacturing is not yet contracting. In fact, according to the ISM, a PMI in excess of 41.1 percent generally indicates that the overall economy is expanding.

Nevertheless, over the longer term, the PMI, like the employment numbers, is also on a declining trend, indicating a weakening economy.

The weak trend was corroborated on Friday by the Economic Cycle Research Institute (ECRI). The ECRI's Weekly Leading Index (WLI) fell to 131.1 in the week to January 25 from 135.7 in the prior week and its annualised growth rate fell to minus 7.1 percent, a six-year low, from minus 6.0 percent.

Some analysts have noted that the yield curve, another oft-cited leading indicator of the economy, has been steepening in recent months, which could be positive for the economy. For example, the spread between the 10-year Treasury and the 2-year Treasury, negative for much of late 2006 and early 2007, is now well in positive territory at about 1.5 percent.

However, this particular indicator has a very long lead time. Its rise perhaps indicate that there is light at the end of the tunnel for the economy.

For an indication of where the economy is headed over the next few months, however, the spread between the 2-year note and the federal funds rate may be a better indicator. This indicator, though, is showing a very different picture.

Over the past few months, the spread between the 2-year note and the federal funds rate has dived. It fell to nearly -2 percent last month before the fall was arrested by the Federal Reserve's two interest rate cuts over the past fortnight amounting to 125 basis points.

In the past twenty years, there have been two other times when the spread between the 2-yr Treasury yield and the federal funds rate fell sharply into negative territory on a similarly sustained basis. One was in late 2000 and early 2001, just before the last confirmed US recession. The other was in 1989, just before the prior recession in 1990.

On both those occasions, this spread continued to fall even as the spread between the 10-year and the 2-year was turning positive after its own sojourn into negative territory. The divergence in both those instances was driven by a fall in the 2-year yield, just as it is now.

Although this also does not prove that a US recession is imminent, Lakshman Achuthan, managing director at ECRI, probably said it correctly when he released the institute's WLI: "While the economy and employment did continue to grow through the end of 2007, the window of opportunity to avert a US recession is about to slam shut."

Saturday, 2 February 2008

US employment falls, global manufacturing picks up

Plenty of US economic data yesterday. Most were negative.

The greatest pessimism was generated by the closely-followed nonfarm payrolls report. MarketWatch reports:

Perhaps providing the smoking gun indicating that the nation's economy has entered a recession, government data released Friday showed a net reduction in U.S. nonfarm payrolls for the first time in more than four years.

As employers cut back their hiring, nonfarm payrolls fell by an estimated 17,000 in January, the Labor Department said. This is the first decline since August 2003.

Also falling in January was auto sales.

Belt-tightening by uneasy consumers took a heavy toll on January U.S. auto sales, with most of the industry reporting numbers Friday that confirmed what the industry already suspected: It's going to be a rough year.

According to AutoData Corp., overall car sales fell last month to a seasonally-adjusted annual rate of just 15.2 million vehicles. That puts the industry on the weakest pace since wrapping up a period of heavy discounts at dealerships in late 2005.

Construction spending in December was poor too.

Spending on U.S. construction projects fell by 1.1% in December as outlays on private residential construction took another tumble, government data showed Friday.

But the University of Michigan's consumer sentiment index rose in January from December.

The index rose to 78.4 in January from 75.5 in December. Economists surveyed by MarketWatch had expected a result of 79.0. The mid-January reading was 80.5...

As did manufacturing activity.

The ISM index rose to 50.7% from 48.4% in December, the ISM said...

The new orders index remained below 50%, but improved by 2.6 points to 49.5%, indicating a slower pace of decline.

The rise in the ISM index helped the JP Morgan Global Manufacturing PMI rise to 52.3 in January from 51.6 in December but at the cost of higher inflationary pressures, with the global input price index jumping to 71.2, its highest level since July 2006, from 67.2 the previous month.

Apart from the US, manufacturing in the euro area also picked up slightly, with the RBS/NTC final Eurozone Manufacturing PMI for January rising to 52.8 from 52.6 in December, but the UK manufacturing PMI fell to 50.6, the lowest since August 2005, while even China's manufacturing cooled in January along with its weather.

Friday, 1 February 2008

US stocks jump despite weak economic data

The US economy continues to show signs of weakness but you wouldn't have guessed just looking at the net change in stock prices yesterday. From MarketWatch:

U.S. stocks rallied Thursday, but still ended January with substantial losses, as a shaky market swung down on MBIA Inc.'s losses only to reverse higher when the bond insurer said it did not believe its triple-A rating was in jeopardy...

Down more than 100 points earlier on, the Dow Jones Industrial Average climbed 207.5 points, or 1.7%, to 12,650.4, giving it a monthly loss of 4.6%, its worst percentage decline for a January since 2002, when it fell 4.3%...

The turnaround came after bond-insurance giant MBIA offered assurances that it had enough cash to ride out the meltdown in the mortgage market, with the company's shares finishing up 11%.

I suspect William Ackman of Pershing Square Capital Management has some doubts about the latter.

Meanwhile, the economic reports from Europe have also been looking somewhat worrisome of late. Yesterday's were no exception. Bloomberg reports:

An index of sentiment in the euro area dropped to 101.7 this month, the lowest since January 2006, from a revised 103.4 in December, the European Commission in Brussels said today. The inflation rate rose to 3.2 percent, the highest in 14 years, a separate report showed.

But unlike in the US, employment hasn't shown any sign of deterioration yet.

[E]uro-area unemployment remained at a record low 7.2 percent in December, according to other data released today. In Germany, Europe's largest economy, the jobless rate fell to the lowest level in 15 years this month, the country's statistics office said today.

In Japan. there was some good news yesterday with the NTC Research/Nomura/JMMA Purchasing Managers Index holding up at 52.3 in January, unchanged from December. But on the whole, Japan isn't lacking in negative news, duly reported by Bloomberg.

Japan's wages fell at the fastest pace in more than three years in December as bonuses plunged, dimming prospects that consumers will help the economy overcome slowing overseas demand.

Monthly wages, including overtime pay and bonuses, dropped 1.9 percent from a year earlier, the Labor Ministry said in Tokyo today...

Deteriorating sentiment among small and midsized companies, which employ 70 percent of Japanese workers, is another reason wages aren't rising, according to Shunichi Ando, head of the Labor Ministry's statistics division. Sentiment among small firms fell to a five-year low in January, state-owned lender Shoko Chukin said today...

A separate government report today showed that housing starts fell 19.2 percent in December, the sixth monthly decline, matching economist estimates.