Posts Tagged ‘Output Gap’

Canada Market Radar (April 23, 2012)

Sunday, April 22nd, 2012

 

Canada Market Radar (April 23, 2012)

 

Major TSX Groups – One Year


Source: StockCharts.com

Major TSX Groups – Year-to-Date


Source: StockCharts.com

Major TSX Groups – Month Ending April 20


Source: StockCharts.com

Strengths


Carney Says Canadian Economy Almost Back to Full Capacity – Bloomberg

Carney, speaking in an interview with the Canadian Broadcasting Corp., said the country’s underlying inflation rate has firmed in the last several months and the central bank expects the economy to grow at “above trend” rates in 2012 and 2013.

http://www.bloomberg.com/news/2012-04-21/carney-says-canadian-economy-almost-back-to-full-capacity.html

Canada should be firing on all cylinders by next year, report says – The Globe and Mail

The report pointed ominously to a “persistence” of excess supply of labour – in recent months, and for the near future.  And that’s in spite of a monster job creation month in March, when 82,300 jobs were added. Indeed, the economy has now recovered all of the 430,000 jobs lost in the recession and added an additional 180,000.  But Scotia Capital economist Derek Holt said the monthly “body count” of jobs is less important than what’s happening to paycheques. He said Canadians are barely keeping up with inflation.  “People are not making anything beyond putting gas in their car, filling their grocery carts and heating their homes,” he said.  Bank of Canada Governor Mark Carney expects the so-called output gap to close sometime early next year.

http://www.theglobeandmail.com/report-on-business/economy/canada-should-be-firing-on-all-cylinders-by-next-year-report-says/article2406874/

Weaknesses


Canada in the minority opposing more IMF firepower – The Globe and Mail

Mr. Flaherty fought the creation of that international firewall until the end – and kept on fighting after the matter was settled at meetings of G20 finance ministers and central bank governors on Thursday and Friday. At a press conference Friday evening, Mr. Flaherty kept up his months-long attack on the bigger members of the euro zone, repeating that they haven’t done enough on their own to deserve international help.  “They need to step up to the plate and overwhelm this issue with their own resources,” Mr. Flaherty said. “There are adequate resources in Europe to address these issues and they ought to be employed.”

http://www.theglobeandmail.com/report-on-business/international-news/canada-in-the-minority-opposing-more-imf-firepower/article2409991/

Opportunities

Investors are the casualties in a booming oil patch – The Globe and Mail

Confidence in Canada’s energy sector is being shaken by a host of issues making investors unsure about the payoff from Alberta’s boom. The reasons for worry are many and varied, but they collectively point to a deeper issue. Faith in Canada’s energy business is eroding. Those who once viewed the oil sands in particular as a glittering money factory suddenly have important new reasons to be skeptical. Despite the vast sums pouring into Alberta and Saskatchewan oil fields, the earning power of the sector is being strained, and its ability to fund its growth while also spinning big profits is now under question. That challenge is critical, since success for the energy sector’s development is key to Canada’s overall economic performance

http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/investors-are-the-casualties-in-a-booming-oil-patch/article2409657/

Threats

Canada Dollar Rises Most in 7 Weeks on Carney Statement – Bloomberg

Canada’s dollar appreciated by the most since March against its U.S. counterpart as the prospects for higher interest rates attracted buyers.  The Canadian currency had its largest gains versus the yen and Brazil’s real after Bank of Canada Governor Mark Carney said the removal of economic stimulus may be “appropriate,” given stronger growth and inflation.

http://www.bloomberg.com/news/2012-04-21/canada-dollar-rises-most-in-7-weeks-on-carney-statement.html

Canada March Consumer Price Index Report – Bloomberg

Consumer prices rose 1.9% between March 2011 and March 2012, following a 2.6% increase in February. This 0.7 percentage point difference was largely the result of slower year-over-year increases in prices for food and energy.  Food prices rose 2.2% in the 12 months to March, following a 4.1% increase in February. This slower increase was the result of a month-over-month decline in food prices in March 2012, while a year earlier food prices had been on the rise.

http://www.bloomberg.com/news/2012-04-20/canada-march-consumer-price-index-report-text-.html

High oil prices threatened by … high oil prices – The Globe and Mail

The fivefold increase in oil prices over the past decade has created boom times in Alberta, in North Dakota and in crude-producing regions across the globe, but the era of $100-a-barrel oil may be sowing the seeds of its demise.  Oil-consuming nations, such as the United States and China, have become preoccupied with security of supply, amid predictions of “peak oil” in which the global energy industry will have trouble keeping pace with rising demand.

http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/high-oil-prices-threatened-by-high-oil-prices/article2409670/

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Goldman’s Economists Score 7 Out Of 10 For 2011 (Retrospective)

Thursday, December 22nd, 2011

Since the 2012 Outlooks have now slowed to a drip, its appears retrospectives are the stocking-filler of choice for the week. Goldman’s economist group reflects on their ’10 Questions for 2011′, released at the end of December 2010, and finds they were correct seven times. The tricky thing about judging the ‘score’ is the magnitude of the error – or more importantly the magnitude of the question’s impact on trading views. Jan Hatzius and his team have had their moments this year, for better or worse, in economic sickness or health but they have largely been accurate at predicting Fed policy (or should we say ‘directing/suggesting’ Fed policy), but were significantly off (along with emajority of the Birinyi-ruler-based extrapolators from the sell-side) on growth (high) expectations and inflation (low) expectations. Nevertheless, the lessons learned from over-estimating the speed of healing from the credit crisis and the disin- / de-flationary effects of a large output gap (which BARCAP would argue is not as wide) when inflation is already low and inflation expectations well anchored are critical for not making the same overly-optimistic mistake into 2012.

 

US Daily: A Retrospective on “10 Questions for 2011″

Today’s comment reviews the 10 key questions for 2011 that we posed a year ago, our answers at the time, and what actually happened.

It has been a mixed year. On the positive side, our views on Fed policy have proven accurate. On the negative side, we were too high on growth and too low on inflation. Adverse supply shocks, including the upheaval in the Middle East and the Japanese earthquake in March, explain part of these misses. But we also overestimated both the speed of healing from the credit crisis and the disinflationary effects of a large output gap when inflation is already low and inflation expectations are well-anchored.

In the last US Economics Analyst of 2010, published on December 31, we posed “10 Questions for 2011.” In today’s comment, we review each of the questions, our answers at the time, and what actually happened.

Question 1: Will we finally see a “real” economic recovery?

Our answer: Yes.

Verdict: Incorrect. Ultimately, 2011 felt much like 2010. A strong performance in the winter was followed by a sharp slowdown in the spring, renewed recession worries in the summer, and some signs of reacceleration in the fall. From the perspective of our forecasts, the main difference was that we predicted the slowdown of 2010 but failed to predict the slowdown of 2011. In fact, we thought that growth would accelerate to a 3.5%-4% annualized pace in the course of 2011.

However, real GDP grew just 1.2% in the first three quarters of 2011 and our current activity indicator (CAI)–an alternative measure of growth that takes into account a broader range of data–grew 1.9% in the first eleven months of 2011. Depending on which of the two measures we use, this implies that growth has fallen short of our forecast by 2 to 2-1/2 percentage points.

What explains this miss? We see three factors:

1. Adverse supply shocks account for a 3/4-point miss. We estimate that the nearly 30% increase in seasonally adjusted gasoline prices between November and April–largely due to increased supply worries in the wake of the “Arab spring”–shaved 1-1/2 percentage points from real disposable income growth in the first half of the year. With little change in the saving rate at the time, most of the real income hit fed through into weaker consumer spending growth. In turn, with little change in net trade, most of the consumption hit fed through into real GDP. (Note that this implies a real GDP hit of about 1 percentage point, since the level of consumption is about two-thirds that of GDP.) The supply-chain disruptions following the East Japan earthquake of March 2011 also weighed on growth for a while. For the first three quarters of 2011, we believe that adverse supply shocks may have subtracted 3/4 percentage point from growth.

 

2. Fiscal retrenchment accounts for a 1/2-point miss. When Congress extended the 2001-2003 tax cuts for another two years and passed the temporary fiscal measures–especially the payroll tax cut–at the end of 2010, we thought that this meant a roughly neutral fiscal stance in 2011, with slight net stimulus from the federal government offset by slight net restraint from state and local governments. However, we now believe that fiscal policy has subtracted about 1/2 percentage point from growth in 2011 so far. The official GDP data show that a reduction in government spending, concentrated in the state and local sector, has subtracted 1/2 percentage point from growth; meanwhile, there seems to have been little change in overall tax rates after accounting for income, payroll, and sales taxes. Overall, this suggests that fiscal policy subtracted 1/2 points more from growth than we expected.

 

3. A longer “hangover” may account for the remaining 1-point miss. The preceding two points explain perhaps 1-1/4 points of disappointment, but this still leaves approximately another 1 percentage point. An obvious candidate explanation is the European crisis, which has intensified beyond most people’s expectations (including ours) this year. But we think that this explains only a small part of the miss. Instead, a more plausible story is that the “healing” in private domestic demand has simply progressed more slowly than we had expected at the end of last year, when measures of underlying final demand had started to pick up at a fairly impressive speed. In other words, the “hangover” from the bubble seems to be lasting even longer than we thought.

 

Question 2: Will the housing market recover meaningfully?

Our answer: No.

Verdict: Correct. Although housing starts and home sales did rise slightly through 2011, the increase has fallen short of what we would call “meaningful.” Moreover, house prices have fallen on net, and some measures show a reacceleration in the pace of decline in recent months. We expect a somewhat better performance in 2012, with starts and sales growing more noticeably and home prices stabilizing late in the year.

Question 3: Will the trade deficit shrink substantially?

Our answer: No.

Verdict: Correct. The trade deficit has been essentially unchanged in 2011, as both exports and imports have grown at impressive 10%+ rates through the year. We expect more of the same in 2012.

Question 4: Will the unemployment rate fall?

Our answer: Yes.

Verdict: Correct (but partly for the wrong reasons). The unemployment rate fell from 9.8% in November 2010 to 8.6% in November 2011, which is actually somewhat below the 9% we expected a year ago. The larger-than-expected decline occurred despite weaker-than-expected GDP growth, as the labor force participation rate fell by another 1/2 percentage point to 64.0%, the lowest since 1983. Going forward, we expect the unemployment rate to move sideways to higher as growth stays sluggish and participation stabilizes.

Question 5: Will inflation move back toward 2%?

Our answer: No.

Verdict: Incorrect. Both core and headline PCE inflation rose significantly in 2011 and now stand at 1.7% and 2.7%, respectively. Part of our error was due to the bigger-than-expected increase in the prices of oil and other commodities, as well as the surge in automobile prices following the Japan earthquake. But we also underestimated the upward pressure on rents in an environment of still high but gradually declining excess supply of housing; in particular, our expectation that excess supply in the owner-occupied sector would also hold down rents in the renter-occupied sector (via an arbitrage relationship between the two sectors) proved incorrect. More broadly, we probably overestimated the disinflationary effects of a large output gap at a time when inflation is already very low and inflation expectations are well-anchored. All that said, inflation now does seem to be slowing again, and we see the core PCE deflator back at 1.3% by the end of 2012.

Question 6: Will profit margins rise further?

Our answer: Yes.

Verdict: Correct. When measured as after-tax profits as a share of GDP, profit margins rose from 6.8% in the third quarter of 2010 to 7.3% in the third quarter of 2011. When measured as S&P 500 earnings per share in percent of revenue per share, margins rose from 8.3% to 9.0%. Going forward, we expect margins to flatten out both on a top-down and bottom-up basis.

Question 7: Will QE2 end on schedule, i.e., in June 2011 with total holdings of $600bn?

Our answer: Yes.

Verdict: Correct. Fed officials did stop the program on schedule at $600bn. Since then, they have embarked on “operation twist,” whose effects on financial conditions are similar to QE in our view, and we expect them to return to QE in the first half of 2012.

Question 8: Will Fed officials start to “exit” from their current policy stance by raising the funds rate or shrinking their balance sheet?

Our answer: No.

Verdict: Correct. Despite some hawkish signals early in the year, Fed officials ultimately embraced a “lower for longer” view and are currently indicating no rate hikes until “at least mid-2013.” With the short-term rate discussion settled for the time being, we moved to a view of further easing in August, which occurred in September via “operation twist.”

Question 9: Will the 10-year Treasury note yield end 2011 above the current level of 3.4%?

Our answer: Yes.

Verdict: Incorrect. Despite our bullish call at the front end of the yield curve, we predicted an increase in rates at the longer end (albeit a moderate one that was below the forwards at the time of our “10 Questions” note). At least part of this was due to the worse-than-expected domestic growth performance and the greater “flight to quality” in the wake of the intensifying European crisis.

Question 10: Will the state and local budget crisis derail the recovery?

Our answer: No.

Verdict: Correct. The widespread fears about state and local finances at the end of 2010 did not materialize. Municipal governments have not defaulted in large numbers, and municipal bonds outperformed most other sectors of the fixed income market in 2011. While continued fiscal tightening was responsible for much of the improvement, the negative impact on GDP growth from state and local spending has actually diminished a bit in the last few quarters and should continue to do so in 2012.

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When Even John Taylor Says Bernanke’s Interpretation Of The Taylor Rule Is Wrong

Thursday, March 3rd, 2011

Something funny transpired over the the past two years in the Fed’s interpretation of the critical Taylor rule, which Bernanke refers to in every testimony before Congress or the Senate:  John Taylor, the creator of the rule, and Zero Hedge’s nomination for Fed chairman (inasmuch as we need a Federal Reserve) said Bernanke is wrong in his interpretation of the rule, and if he had a proper interpretation the Fed Chairman should already be hiking rate. Yet leave it to Bernanke to believe he knows better what the rule is supposed to mean….than even its creator. From the WSJ: “Stanford University professor John Taylor, an outspoken critic of the Federal Reserve in recent years, has a new complaint: He says Fed Chairman Ben Bernanke is misrepresenting Mr. Taylor’s eponymous rule on interest rates.” A brief reminder on the Taylor rule, which has been presented numerous times on Zero Hedge before: “The Taylor Rule offers a simple formula that economists often use as a guide for the appropriate level of the federal funds rate. The formula provides changes in interest rates depending on the level of inflation and the output gap, which is the difference between actual gross domestic product and the economy’s potential output. Depending on how you define the rule (for instance if you give the output gap a lot of weight in the formula or just a little, or if you use a projected inflation rate or actual inflation) you can come up with different interpretations of whether interest rates should be high, low or even negative in a theoretical world.” And an odd dilemma appears when one uses the original version of the Taylor rule as presented in 1993 or its 1999 revision: they provide totally different results: the first one says the Fed is wrong, the second one validates QE. Yet here is Taylor himself: “I did not propose or prefer an alternative rule in that 1999 paper, and it is hard to see how one could interpret the paper that way.” So is the entire US monetary policy based on a rule derivative that is not even endorsed by its creator? The answer is a resounding yes.

From the WSJ:

Mr. Bernanke said Tuesday that the Taylor Rule suggested that short-term interest rates, if they could be, should be pushed way below zero. That, in turn, helped to justify the Fed’s $600 billion bond-buying program, he said.

When Sen. Pat Toomey, Republican from Pennsylvania, challenged him on whether Mr. Taylor himself believed that, Mr. Bernanke asserted even Mr. Taylor has come up with variations of his own rule. The one he originally formulated in 1993 doesn’t support the Fed’s current policy, but Taylor’s revision to it in 1999 does support the Fed’s current policy, Mr. Bernanke said.

“There’s no particular reason to pick the one that he picked in 1993. In fact, he preferred a different one in 1999 which, if you use that one, gives you a much different answer,” Mr. Bernanke said in an exchange Tuesday with Sen. Toomey.

Taylor’s 1999 paper (read it here) does point to alternate versions of his rule. But Mr. Taylor says he never stood behind any alternatives to his original 1993 rule. Instead he says he was citing alternatives that others proposed, including the Fed. The 1993 version of the rule calls for a federal funds rate of around 1%, not close to zero as it is now. He charges Mr. Bernanke with misrepresenting his preferences.

“I did not propose or prefer an alternative rule in that 1999 paper, and it is hard to see how one could interpret the paper that way,” Mr. Taylor says in a blog post today.

WSJ’s Hilsenrath explains why this is such a material issue:

If this were just two academics feuding over a formula, it wouldn’t be very interesting. But it’s more than that. Mr. Bernanke is the Fed chairman. Mr. Taylor is one of the most influential voices in monetary economics and he’s saying the Fed chairman is distorting his views to justify a controversial policy.

“It is important to correct the record because the ‘others have suggested’ rule has a much larger coefficient on the GDP gap and is therefore more likely to generate negative interest rates and be used to rationalize discretionary actions such as quantitative easing,” he says on his blog.

And below is the full transcript of the exchange between Bernanke and Toomey:

MR. BERNANKE: I think that many of the monetary or nominal indicators that somebody like Milton Friedman would look at did suggest the need for a monetary stimulus. For example, nominal GDP has grown very slowly. Growth in the money supply is in fact — I’m not talking about the reserves held by banks which are basically idle — but if you look at M1 and M2, those have grown pretty slowly. The Taylor Rule suggests that we should be, in some sense, way below zero in our interest rate, and therefore we need some method other than just normal interest rate changes to —

SEN. TOOMEY: Do you know if Mr. Taylor believes that?

MR. BERNANKE: Well, there are different versions of the Taylor Rule, and there’s no particular reason to pick the one that he picked in 1993. In fact, he preferred a different one in 1999 which, if you use that one, gives you a much different answer.
SEN. TOOMEY: My understanding is that his view of his own rule is that it would call for a higher Fed funds rate than what we have now.

MR. BERNANKE: There are, again, many ways of looking at that rule, and I think that ones that look at history, ones that are justified by modeling analysis, many of them suggest that we should be well below zero. And I just would disagree that that’s the only way to look at it. But anyway, so I think there are some — there is some basis for doing that.

Which begs the question: is the broken US monetary system so institutionalized that the only person willing to speak up against the faulty usage and interpretation of a rule, is its own creator? What would happen should the Fed follow the Taylor-endorsed rule is that QE2 would immediately have to be ended. But of course this will never happen: after all it is now clear the Fed’s policy was never to actually control inflation or maximize unemployment: the whole point was always just to get stocks as high as possible. And when the bubble pops, which it will, it will be time to point fingers, and we are confident that the Fed will resort to blaming Taylor himself. Luckily by then there will be no Fed, as the monetary system will have finally reverted back to its one sustainable form, backed by either precious metals or some other non-dilutable instrument.

The fiat experiment has taken enough casualties.

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I Love Gold, But …

Wednesday, October 6th, 2010

by David Rosenberg, Chief Market Economist, Gluskin Sheff

I LOVE GOLD, BUT….

….The recent surge is the same chart as in March 2008, November 2009 and May 2010 … followed by meaningful corrections … that were to be bought. This market is long overdue for a near-term pullback, in our view.

It would seem as though investors are putting down their money on a big inflation bet.

  • Gold is up 20% this year alone.
  • The gap between the long bond yield and the 10-year note yield has widened to an eight-year high of 129bps from 92bps just six-months ago. This is the third highest spread in the past three decades.
  • Since the end of August, 10-year TIPS breakevens have risen from 1.5% to 1.8%.

There is no doubt that we have commodity prices firming, a weaker U.S. dollar and a monetary policy that seems aimed at reloading the gun. These are inflationary tailwinds. But we also have contracting bank credit, a 6% (and rising) personal savings rate, a 6.5% output gap and core inflation already south of 1%. These are warning signs, and the Treasury market refuses to sell off, which has thus failed, to ratify the great inflation trade.

There are now, according to the latest Commitment of Traders report, 79,796 short contracts on U.S. Treasuries on the Chicago Board of Trade, and there are 78,361 long contracts. So how is that a bond bubble exactly?

There are now 70,638 speculative long contracts on the Chicago Mercantile Exchange for the euro, versus 35,308 net short positions. Come again? There are twice as many bullish positions on this piece of you-know-what as their bearish contracts? Yikes! The dollar is hugely oversold here.

And there are now 297,272 net speculative long positions in gold on the COMEX compared with 39,623 net shorts. This has become a very crowded trade, my friends. Silver is far less on the radar screen.
There are also nearly twice as many speculative bulls as there are bears with respect to copper. The global boom trade is on.

This note is an excerpt from today’s Breakfast with Dave. A free and worthwhile registration is required.

Copyright (c) Gluskin Sheff

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“Deflation?!” (Saut)

Monday, August 9th, 2010

This article is a guest contribution by Jeffrey Saut, Chief Investment Strategist, Raymond James.

“With Treasury bond yields at, or near historically low levels on one hand, but with commodity prices near 8 month highs; and, with the personal feeling that outside of a home, a computer and a flat screen TV, the cost of living seems to only go higher on the other hand, here is another perspective on the inflation/deflation debate. Since June 1981, when Volker started to lower interest rates from 20% as high inflation rates started to fall, the absolute level of CPI rose 142% to the high in July ’08 (90.5 to 217). Deflation is defined as a decrease in the general price level of goods and services; but, to quantify the current fall in prices, the CPI has fallen just 1% from its all time high. This tiny price move, notwithstanding we are still near an all time high in the daily cost of living, has led to talk that the Fed needs to do more to avoid deflation at all costs and thus create inflation via more QE (quantitative easing ). An example, oil goes from $50 to $85 in one year and the next year falls 1% to $84.15 and we’re told there is deflation and deflation is bad.

“The view is that with excess capacity and a lack of demand combining for softer prices, we must have even lower interest rates to spur more borrowing and thus more economic activity to increase demand and thus reduce the large output gap. Think about this, policy makers think we should raise the cost of goods and services in order to cure a lack of demand. The law of supply and demand says lower demand must be met by lower prices in order to get to the proper equilibrium. What the Fed really wants to do is create inflation in order to not deal with an overleveraged economy in the most responsible way, either paying debt off or writing it down. They want us to pay off the debts with inflation. Inflation is a hidden tax on every single one of us and thus the corollary to deflation is a tax cut. Inflation is good for those who are highly indebted as those debts get paid back with inflated money while deflation or flat prices are good for those who save and have little debt and vice versa. ”

“In the state of deleveraging the US is in, where the low cost of money doesn’t matter much to an individual or a business in making spending and investment decisions, artificially low rates mostly spur just refinancing and higher commodity prices. While maybe, or maybe not, higher commodity prices make their way into government consumer price statistics, the commodity inflation is still there and has to be eaten by someone. Food for thought.”

…Peter Boockvar of Miller Tabak


Click here to enlarge

I read Peter Boockvar’s prose after reading a debate between two top economists. One is in the deflation camp and the other is not (http://www.nytimes.com/2010/08/06/business/economy/06deflation.html?_r=1&src=busln). To be sure, I was quite impressed with Peter’s cogent comments against deflation. Indeed, deflation has always been a “bad bet,” except for the 1930s. Currently, however, deflationary concerns are swirling on the “street of dreams;” and, I don’t believe them. I think the present-day policies will actually prove inflationary. While it’s true transfer payments to middle/lower-income recipients are not going to be all that simulative (or inflationary) given falling housing prices, that still does not spell deflation. In such an environment recipients will probably not spend the transfer payments, but rather save them to offset the negative wealth effect of lower housing prices. A better strategy would be making “transfer payments” to a program like the WPA of the 1930s. Recall, the Work Progress Administration was crafted in 1935 to employ the unemployed with the objective of putting people back to work by building infrastructure projects. Such operations have a far greater “multiplier effect” (for every $1 spent you get a $2+ impact) in the economy. Accordingly, given the current economic policies, the nascent economic recovery is likely to be slow, but with no double dip. And, that what’s happening as the recent economic reports have softened, punctuated by last Friday’s ugly employment numbers. Nevertheless, the economy will recover with inflation (not deflation) likely to follow.

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The Ten Commandments of Fiscal Adjustment in Advanced Economies

Thursday, July 1st, 2010

This article is a guest contribution by Olivier Blanchard, Chief Economist, IMF (on leave from MIT) and Carlo Cottarelli, IMF, via VoxEU.org.

The G20 communiqué stresses the difficulty of balancing fiscal stimulus and fiscal consolidation. This column – written by one of the world’s leading macroeconomists, Olivier Blanchard, and his co-author – sums up the research-based policy analysis of the issue.

Advanced economies are facing the difficult challenge of implementing fiscal adjustment strategies without undermining a still-fragile economic recovery. Fiscal adjustment is key to high private investment and long-term growth. It may also be key, at least in some countries, to avoiding disorderly financial market conditions, which would have a more immediate impact on growth through effects on confidence and lending. But too much adjustment could also hamper growth, and this is not a trivial risk. How should fiscal strategies be designed to make them consistent with both short-term and long-term growth requirements?

We offer ten commandments to make this possible. Put simply, what advanced countries need is clarity of intent, an appropriate calibration of fiscal targets, and adequate structural reforms – with a little help from monetary policy and their (emerging market) friends.

  • Commandment I: You shall have a credible medium-term fiscal plan with a visible anchor (in terms of either an average pace of adjustment, or of a fiscal target to be achieved within 4–5 years).

There is no simple one-size-fits-all rule. Our current macroeconomic projections imply that an average improvement in the cyclically-adjusted primary balance of some 1 percentage point per year during the next four to five years would be consistent with gradually closing the output gap, given current expectations on private sector demand, and would stabilise the average debt ratio by the middle of this decade. Countries with higher deficits/debt should do more; others should do less. Such a pace of adjustment must be backed up by fairly specific spending and revenue projections and supported by structural reforms (see below).

  • Commandment II: You shall not front-load your fiscal adjustment, unless financing needs require it.

For a few countries, frontloading may be needed to maintain access to markets and finance the deficit at reasonable rates – but, in general, a steady pace of adjustment is more important than front-loading, which could undermine the recovery and be reversed. Nonetheless, a non-trivial first installment is needed; promises of future action will not be enough.

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The Dow-Gold Relationship (Rosenberg)

Wednesday, June 16th, 2010

This article is a guest contribution from David Rosenberg, Chief Market Economist, Gluskin Sheff.

THE DOW-GOLD RELATIONSHIP

That is what the chart below displays … and: (i) if this ratio ends up retesting the two fundamental lows that it has achieved in the past; and, (ii) if we are correct in our assertion that gold goes to $3,000/oz, then what we would be talking about here is a Dow 5,000 trough at some point down the road.

FED ON HOLD FOR A LONG, LONG TIME

“Many predict that the economy will take years to return to full employment and that inflation will remain very low. If so, it seems likely that the Fed’s exit from the current accommodative stance of monetary policy will take a significant period of time.”

That was the conclusion from the just-published San Francisco Fed newsletter – titled The Fed’s Exit Strategy for Monetary Policy. Indeed, when you go to the rule-of-thumb that reveals statistically the relationship between the funds rate, inflation and the output gap, we estimate that the equilibrium policy rate right now is -5%. Yet it is 0.25% and we have many a Fed bank president clamouring for rate hikes. And remember, bonds do not go into bear markets unless either the Fed is tightening monetary policy or threatening to do so.

A CALL TO ARMS — PART II

A few Fridays ago, I blasted out a ‘Call to Arms’ diatribe and I apologize for ruining anybody’s weekend with it. So, I thought I would send out Part II. If truth be told, a weekend with Gary Shilling, Nouriel Roubini, Marc Faber, and Fred Hickey does one thing – it sharpens one’s wits and at a personal level it gets my wheels spinning prompting me to get more of my macro and market thoughts down on paper.

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Rosenberg vs. Russell: Bull or Bear on Long Bonds?

Friday, April 16th, 2010

I recently penned two bearish posts about the outlook for US Treasuries, namely US bonds – the end of a 30-year bull market and Government bonds – what’s up? Let’s now turn to two other analysts for additional perspectives on this very pertinent issue.

Firstly, David Rosenberg chief economist and strategist of Gluskin Sheff & Associates, remains bullish on bonds (and bearish on equities) and argues as follows: “People are allowed to have their opinions but not their own facts. While the bearish view on bonds is predicated on the supply outlook for Treasuries – deficits only have a 39% correlation with the direction of bond yields. Commodities have a 33% correlation. In fact, headline inflation has a 64% correlation.

“What does have the best correlations? Try monetary policy – the ‘carry’ – which has an 88% relationship. And core inflation – the one everyone laughs at for excluding food and energy (then again, oil only has a 25% correlation with bond yields) commands a 75% historical relationship. Here are the correlations:

- Fed policy 88%

- Core CPI inflation 75%

- CPI inflation 64%

- Core PPI inflation 58%

- PPI inflation 40%

- Budget deficits 39%

- CRB Index 33%

- Oil prices 25%

- ISM 12%

“Where is inflation going? Down. Fully 87% of the time in the past, going back more than five decades, U.S. core inflation was lower in the year after the recession ended. Not only that, but 75% of the time, core inflation was down two years after the recession ended. This is because even as the economy moves off the bottom, the output gap lingers and exerts downward pressure on inflation. The problem is that core inflation has hardly ever been as low as this cycle when the recession ostensibly ended last summer – when the YoY pace was 1.7% (and now down to 1.3%).

“On average, the core inflation rate is down 154 basis points in the first year of recovery and if that were to happen again it would mean it will go as low as 0.2% by mid–2009. But here is the real kicker – core inflation historically declines a further 63 basis points in the second year of the expansion, which would then put core inflation in never-never land of -0.4%. Now you can see why we are bullish on the bond market.”

But bond bears abound. One of them is long-timer Richard Russell (Dow Theory Letters) who said: “David Rosenberg is an excellent analyst. But his thesis that bonds are headed higher because of baby boomers’ desire for yield is a very risky and theoretical scenario. Personally, I prefer to follow the market, which means the charts. The chart below (from The Chart Store) tells an entirely different story I showed this chart just before the bond market cracked. Here we see a huge head-and-shoulders BOTTOM pattern with an upside breakout, which means interest rates are now heading higher. Please show this chart to Mr. Rosenberg.”

Source: The Chart Store (via Dow Theory Letters)

My viewpoint remains that we are on the verge of entering a secular bear market in bonds. Whether we see more ranging for a while longer is difficult to know, but I will not be a buyer at these levels.

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Get Ready for a Little Emerging Markets Inflation

Friday, March 12th, 2010

Today I was thinking about tightening cycles in emerging markets, and more specifically about those in China. Because let’s face it, China matters. China matters to the rest of Asia via competition for export income. China matters to Europe via competition for jobs. China matters to Brazil via domestic production via imports. China matters.

The inflation pressures are building in key emerging economies, especially in the BIICs (Brazil, India, Indonesia, and China) – see this previous post regarding my new acronym, and this article at the Curious Capitalist (curiously posted just shortly after my post), which leaves my omitted “R” but relays the intuition behind the second “I”.

Although the inflation is not prevalent in any BIIC except India, really, I wanted to comment about why it will build…quickly.

First round, the construction of consumer prices is heavily weighted towards food and energy costs across the BIICs. Indonesia, India and China are highly susceptible to food price shocks (either driven by shortages or demand growth). Expect this as a first-round driver of inflation as the global economy recovers further. It’s already  happening.

Second round, the BIICs are growing quickly and nearing, or are already at, potential. Annual industrial production growth has recovered or surpassed its pre-crisis rate in China, Brazil and India – 19%, 16% and 17%, respectively. This is expected, given the drop-off in world trade (an illustration can be found from this May 2009 post), but unsustainable as the output gap closes.

rw1203

Third round, interest rate differentials. This year, the BIICs’ central banks are expected to raise policy rates. In fact, Brazil, China and India have already boosted reserve requirements. But with US rates expected to stay low for an “extended period”, international interest rate differentials will change and monetary flows will shift. Capital inflows can lead to inflation if not properly sterilised.

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To date, inflows have not been properly sterilised, as evidenced by the ongoing accumulation of reserves and rising money-supply growth (again, I refer you to my previous post on M1 growth rates.

rw1203b

The chart above illustrates the one-year-ahead nominal interest rate differential between the two-year forward government rate for each respective BIIC country versus the two-year forward US Treasury rate. The forward differentials for China and India are on a steady upward trajectory, while those for Brazil and Indonesia are simply steady. I believe this appropriately represents the sterilisation efforts and monetary policy management on the part of the BIICs’ central banks: more managed in Brazil and Indonesia, not as much in China and India.

So where does this analysis leave us? With a very interesting policy mix in the emerging-market space. In fact, in my view this is the riskiest part of the emerging-market cycle: the recovery. If policymakers get this wrong, we could see a lot of price action, final goods and assets alike, on the horizon.

Source: Rebecca Wilder, News N Economics, March 11, 2010.

* Rebecca Wilder is an economist in the financial industry. She was previously an assistant professor and holds a doctorate in economics.

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David Rosenberg: BoC’s Bullish Decision

Wednesday, October 21st, 2009

David Rosenberg shares his thoughts on the Bank of Canada’s decision to leave its policy interest rate at 0.25% possibly until next summer. This seems like a common sense move, considering the detrimental effect that a prolonged strengthening of the Loonie would have on Canada’s export and manufacturing sector.

BoC POLICY ANNOUNCEMENT — BULLISH FOR RATES; TAD BEARISH FOR THE CAD

For a country that is a play on the global economy, what struck me about the Bank of Canada’s latest policy announcement on the global outlook were the words “significant fragilities remain.” Quite a bit different from what Caterpillar (CAT) had to say in its 2010 guidance.

The Bank of Canada took a knife and cut its 2011 real GDP growth forecast, to 3.3% from the earlier view of 4.7% (2010 seen at +3.0%), though it acknowledged what the data has made clear of late is that “a recovery is also under way.” The BoC also pushed out, by a quarter, to 2011 Q3, its expected timing of when the output gap closes. The expected return of inflation to the 2% target was also pushed out one quarter, to 2011 Q3. Note, the Bank reiterated that even with the recession behind us, “the overall risks to its inflation projection are tilted slightly to the downside.” In other words, a BoC rate hike is not coming for a long, long time — the tone of this press statement seemed to deliberately part ways with the Reserve Bank of Australia.

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CAVEAT EMPTOR

The only thing we really learned in this extremely flashy, seven-month, 60%, nine-point multiple expansion-led rally, is that momentum investing never did become extinguished this cycle. It is really a fascinating commentary on human behavior that so many “investors” are lamenting about how “the train has left the station” without them. Please, give us a giant break! The train has left the station countless of times in the last 10 years but obviously none of these trips lasted very long because the reality is that equities have failed to generate any positive return over this time interval.

As for the here and now, there is another reality. Price gains in the stock market have generally occurred with low volume. There are limited buyers — hedge funds and flash traders — but no sellers (not yet, anyway). And, we saw in yesterday’s decline that volume climbed across the board, and the number of high-volume selloffs is a major red flag that should not be ignored. See the front page of the IBD for more.

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