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June 30, 2006
A Happy Reaction To A Not-So-Great PCE Inflation Report
I guess it's because it was only as bad as everyone expected. From Reuters:
Prices on U.S. core consumer goods rose mildly in May, while consumers' inflation worries eased and their economic outlook improved in June, according to private and government data released on Friday.
The core price index on personal consumption expenditures rose 0.2 percent in May, matching analysts' forecast. The core PCE gauge, which excludes food and energy prices, was up 2.1 percent from a year earlier in May, matching April's advance, the Commerce Department said.
The Federal Reserve's preferred inflation measure suggested that core inflation remains contained...
The Federal Reserve's preferred measure? Pretty broad statement, that. If what was me, I might want to see the data cut a few more ways. I might want to see, for example, the "trimmed mean" calculations from the Federal Reserve Bank of Dallas, or "Market-Based PCE" statistics:
OK. I'll call the May report a draw. Unless you really want to attach yourself to one measure or another, there isn't much evidence to support the view that underlying inflation trend is increasing -- or decreasing. And this picture, showing the distribution of price changes is not a lot more comforting than what we have been observing in the CPI:
The majority of prices in the PCE market basket, when weighted by expenditure share, are still increasing at annual rates in excess of 3 percent. That can't be good.
UPDATE: Calculated Risk notes that the Personal Income and Outlays report that contains the PCE data also shows that the personal "savings rate continued its downward trend." Mark Thoma welcomes the newest Federal Reserve governor with the PCE report. Both The Skeptical Speculator and the Nattering Naybob summarize the economic news of the last several days, and the latter warns:
Investors need to have a reality check & wake up call. When the market rallies +200 points because the Fed says the economy is weakening, there's big trouble in store. This knee jerk rally is a head fake, in the near term, the markets are headed further South.
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Post-FOMC Market Update
The pudding, from the Financial Times..
“Traders probably sense from the statement that the Fed is proceeding cautiously, even reluctantly, in terms of future tightening,” said Alan Ruskin, strategist at RBS Greenwich Capital. “It seems like it may have caught the market off guard.”
Futures traders priced in a reduced probability of an August rate rise – still about 65 per cent cent, but down from about 90 per cent the day before.
... along with some more proof in pictures:
That change is not quite as dramatic as the numbers quoted from the Financial Times -- a result of using options rather than futures alone in the calculations of the probabilities -- but the story remains more or less the same. The details and data will be available later this morning on the Cleveland Fed website, where you will also find the first hint of what the market thinks September will bring:
UPDATE: Meanwhile, in the global blogger village: The Capital Spectator observes that the decision was "a surprise to no one", but the statement was "anything but routine." (CS also digs up an analyst willing to muse "If we get a bad consumer price index report, for instance, the Fed might do something the next day".) The Nattering Naybob reads the statement as "status quo" (and puts the decision in the broader context of the day's news, as does The Skeptical Speculator.) But The Prudent Investor is not buying the dove interpretation. William Polley thinks "another one or two quarter point steps are probably in the cards." Hypothetical Bias reminds us that "the Fed has a history of overdoing tightening regimes" and suggests that to "demonstrate his inflation-fighting credentials, Bernanke may continue this pattern." A full parsing of the Committe' statement is available at Economist's View and at The Mess That Greenspan Made.
The New Economist has some links that I missed.
Sort of related: Contango has an interesting panel of Morgan Stanley economists discussing whether monetary policy has defnitely turned restrictive. (Answer: Yes.) Greg Mankiw relays (with some skepticism) an attempt to resurrect the reputation of Arthur Burns.
UPDATE II: Michael Shedlock has many thoughts, all of which lead to the conclusion that "the recession of 2007 is looming ever larger."
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June 29, 2006
A Kinder Gentler FOMC?
US dollar mixed Sydney morning; potential Fed pause weighs
US futures dealers sense rate pause on dovish FOMC
Fed signals pause in US rate rises
Dollar Set for Quarterly Loss as Fed Near to End of Rate Rises
Stocks surge as Fed raises rates but softens its stance slightly
Fed Raises Rates, but Scales Back Talk of Inflation
Just in case I have not yet beat you senseless with the point, the Wall Street Journal's always excellent round-up of professional commentary begins this way:
Both the structure and language of the statement are more dovish... Ian Shepherdson, High Frequency Economics
What grabbed the attention of many was the shift from this language from the May meeting..
The Committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information
... to this language from today's press release:
Although the moderation in the growth of aggregate demand should help to limit inflation pressures over time, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.
Nonetheless, not everyone was convinced that the change in language means all that much. Returning to the commentary collected by the Wall Street Journal:
We look for the Fed to raise rates to 5.5% in the third quarter and then maintain rates at this level for a long period of time. -- John Ryding, Bear Stearns
We continue to look for the fed-funds target to peak at 6.00% near mid-2007... -- Joshua Shapiro, MFR Inc.
And there is this useful reminder:
... as was the case at the time of the May meeting, basically what the Fed does on Aug. 8 depends on the core inflation data. We have one month's data, the June figures for both CPI [consumer price index] and PCE [price index for personal consumption], between now and then. It feels like a 0.2% increase in core inflation accompanied by a trend-or-below second-quarter GDP reading might allow for a pause, whereas another high reading for core inflation will probably force another move. -- Stephen Stanley, RBS Greenwich Capital
Things do change, and change pretty quickly. Which will bring us immediately to tomorrow's PCE report.
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June 27, 2006
Existing Home Sales: Stumbling, Not Tumbling
The good and the bad, from Bloomberg:
Sales of previously owned homes in the U.S. fell less than expected in May, suggesting a gradual slowdown in the housing market...
Resales were expected to decline to an annual rate of 6.6 million from April's originally reported 6.76 million, according to the median estimate of 58 economists in a Bloomberg News survey. Forecasts ranged from 6.43 million to 6.88 million...
The supply of homes rose 5.5 percent to 3.6 million, bringing inventories up to 6.5 months' worth at the end of May.
The median price of an existing home rose 6 percent in May from a year earlier to $230,000, the Realtors group said.
The story in pictures, by region:
The commentariat in blogland was unimpressed. The Capital Spectator says:
Yesterday's latest release of new home sales renewed talk that the much-discussed slowdown in housing has been greatly exaggerated. Don't believe it.
Existing Home Sales are a trailing indicator. The sales are reported at close of escrow, so May sales reflects agreements reached in March and April.
Usually 6 to 8 months of inventory starts causing pricing problem - and over 8 months a significant problem. Current inventory levels are now in the danger zone.
You have been warned.
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» Existing Home Sales from TruePress
Calculated Risk and Macroblog take a look at residential real estate trends. Macroblogs headline seems to reflect what has generally happened in the market to date, Stumbling, Not Tumbling, and does not make the situation appear t... [Read More]
Tracked on Jun 28, 2006 4:12:23 PM
June 26, 2006
The Chinese Saving Glut
Stephen Roach... certainly believes that the big US external deficit is a problem. He just doesn’t think the RMB/ $ has much to do with the US external deficit, or with China’s surplus.
Roach’s argument is that the US would save too little (and China too much) no matter what the RMB/ $.
Perhaps. But it sure seems to me that the availability of easy financing from the Chinese central bank (and a host of oil investment funds) is one reason why the US saves so little. Roach views the US savings deficit as a product of US policies alone, I don’t...
All in all, I see far stronger links between China’s currency policy and low US savings than Roach does. I don’t think the US would be saving as little without a credit line from the PBoC. And it sure seems that China’s savings boom is correlated with its export boom, even if the channels linking a rise in China's trade surplus to a rise in Chinese savings are a bit more murky than the channels linking Chinese reserve growth to low US savings.
... A stronger RMB is not all that is needed to bring about a more balanced world. China does need to do more to stimulate internal consumption, and the US does need to do more slow the pace of demand growth (i.e. raise savings).
Not going to happen just yet. From Reuters, via China Daily:
China's Ministry of Finance said on Monday it would issue the country's first ever savings bonds, worth up to 15 billion yuan (US$1.9 billion), offering Chinese citizens a new investment option.
The tax-free three-year bonds, to be sold from July 1 to 15, would bear an annual coupon of 3.14 percent, the ministry said in a statement published on its Web site (www.mof.gov.cn).
The coupon compares with 3.24 percent for three-year fixed yuan deposits, but interest from the savings bonds is not subject to the 20 percent income tax for bank savings.
The non-tradable bonds would be sold through a pilot computer system linking big commercial banks to allow individuals to purchase, manage and redeem the forthcoming savings bonds electronically, the ministry said.
That will help in the long-run, as the web of existing capital controls is dismantled...
But they are largely forbidden from investing outside China, and their domestic options are limited to savings accounts and stock, bond and real estate purchases.
... but it doesn't exactly sound like a pro-consumption policy. And here is an sometimes under-appreciated reason Chinese saving rates are so high:
Chinese citizens hold $1.8 trillion yuan in bank deposits, due in part to an underdeveloped social welfare system that pushes many to save for medical care and old age.
That one is not going to be fixed by capital-market and currency reform alone. As for RMB revaluation, feel free to take a breath. From Bloomberg:
China's yuan fell after central bank Governor Zhou Xiaochuan said the nation will move "gradually'' to make the currency more flexible, disappointing some investors expecting greater gains to help slow the economy...
"We can be reasonably safe to assume that the pace of appreciation is going to be very, very gradual and it's probably going to be the scenario for next year,'' said Jan Lambregts, head of research at Rabobank Groep in Singapore. "China may feel like it's gotten away with it so far, so it's going to keep a very gradual track.'
All of which explains why Chinese trade surpluses aren't going away any time soon.
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June 23, 2006
Durable Goods Orders: Sounds Bad, Looks Good
Led by a big drop in orders for aircraft, U.S.-made durable goods fell 0.3% in May, the second decline in a row, the Commerce Department said Friday.Orders have been up and down for the past few months.
Cause for concern? Apparently not.
"Underlying trends, however, remain solid," said Joshua Shapiro, chief economist for MFR."The outlook for capital spending remains positive," said Bart Melek, an economist for BMO Nesbitt Burns.
Excluding transportation, The Commerce Department said durable goods orders -- items meant to last three years or more -- rose 0.7 percent, slightly more than the 0.6 percent rise economists had forecast...
"I would look past the fact that orders declined and point to ex-transportation, which was up," said Ken Mayland, president of Clearview Economics LLC in Pepper Pike, Ohio. "Manufacturing continues to be in darn good shape. Business is good in manufacturing."
And there is more. Back to MarketWatch:
Morgan Stanley economists David Greenlaw and Ted Wieseman said their firm cut its forecast for second-quarter gross domestic product to 2.5% from 2.8% based on the lower trajectory for capital spending seen in shipments for core capital equipment."Despite the likely slowdown in capital spending in the second quarter, forward-looking indicators in this report point to a significant pickup in future months," said Greenlaw and Wieseman said in a note.
In a potentially positive sign for future production, unfilled orders for durable goods rose 0.6 percent after a 1.5 percent increase in April, to the highest level since the data have been gathered in current form beginning in 1992. Unfilled orders have climbed in 12 of the last 13 months.
"Although the pipeline is full, productive capacity is already stretched thin and with the economy set to cool further, it is unlikely that production will be ramped up in the second half of the year," said economists at Moody's Economy.com. "The risk of excessive inventory levels is becoming more palpable."
"The headline number was a negative surprise, there's just no getting around that, and you had a downward revision the previous month," said Michael Woolfolk, currency strategist at the Bank of New York. "Leading indicators yesterday suggest a slowing of the economy over the next three to six months, and this report fits in line with that."
But much of the commentary waxed hopeful, as in this take, from the Wall Street Journal:
"The strength of investment spending is good news for the durability of this expansion, with consumers facing increasing pressures from a slowing housing market and high gasoline prices," wrote Nigel Gault, U.S. economist at Global Insight, a Waltham, Mass., consulting company. "Businesses can help to keep growth going even as consumer spending and residential construction slow."
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June 22, 2006
Advice From The King
Bank of England governor Mervyn King compared the UK's monetary policy arrangements favourably with those operating at the US Federal Reserve and the European Central Bank.
In his annual Mansion House speech to the City of London's great and good, King noted that the Fed and ECB have found it 'far from straightforward to convey the likely trajectory of future interest rates'.
Hmm. As I noted the other day, it does seem that the Fed has, in general, been pretty succesful in conveying the likely trajectory of future interest rates, certainly when judged by this criterion...
'Markets appear to have been rather successful in drawing conclusions because our decisions on interest rates have not, by and large, surprised them,' he added.
A number of Bank watchers had been expected a 6-2 vote in favour of unchanged rates, with the MPC gearing itself up for an August rate hike.
Still it's hard to argue with this point...
Financial markets have grown increasingly confused in recent months about when the Fed will bring its monetary tightening to a halt and at what speed the ECB intends to raise interest rates. Fed chairman Ben Bernanke, in particular, has faced widespread criticism for not conveying a clear message.
... and Mr. King is very clear about what he thinks works: An explicit objective and a window to how policymakers are assessing progress toward meeting those objectives.
'Knowledge of our objective and our analysis is all that markets need from us to form judgements about the future path of interest rates,' said King.
'Changes in our analysis, and the range of views within the Committee, may well affect the conclusions that financial markets draw about the likely path of interest rates,' he added.
The implication is that it would be so much easier to figure out what the Fed is up to these days if the FOMC was an inflation targeting institution. To that, I like this:
I think that being more explicit about our inflation objective could help us to be successful in maintaining price stability, but my expectations are modest.
... and I'm not so sure the Bank of England has been totally immune to the uncertainty bug:
Today's minutes to the June 8 MPC meeting diminished expectations that the central bank will raise the cost of borrowing in August by a quarter point to 4.75 pct. They showed that seven members voted for an unchanged base rate of 4.50 pct, with David Walton once again the only one voting for a hike.
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June 21, 2006
DutchBook Partners' Stan Jonas alerted to me to an excellent article on "Alternative Guages of Underlying Inflation." The piece was written by Goldman Sachs' Ed McKelvey, and appears as the June 20 issue of the GS US Daily Financial Market Comment. If you have access to the publication, I highly recommend McElvoy's deconstruction of alternatives to the "excluding food and energy" variants of the Consumer Price Index and Personal Consumption Expenditure Index that are often used to assess underlying trends in inflation.
I don't have permission to quote from the article, so I won't, but it did remind me of one measure of "core" inflation I haven't really highlighted on this blog: the market-based PCE index. What it's all about, from the Bureau of Economic Analysis:
... BEA now prepares supplemental personal consumption expenditures (PCE) price and quantity indexes that are based on market transactions for which there are corresponding price measures.
... It excludes most imputed expenditures, such as services furnished without payment by financial intermediaries except life insurance carriers, but imputed space rent for owner-occupied nonfarm housing is included in the index. (We note that its inclusion improves comparability with the CPI. Owner's equivalent rent within the CPI is measured by reweighting the renter sample of market transactions.) It excludes expenses of nonprofit institutions serving households, most insurance purchases, gambling, margins on used light motor vehicles, and expenditures by U.S. residents working and traveling abroad. Household insurance premiums, which are deflated by the CPI for tenants’ and household insurance, are included in market-based PCE; medical and hospitalization and income loss insurance, expense of handling life insurance, motor vehicle insurance, and workers’ compensation are excluded.
So what story has the market-based PCE been telling of late? Here's the history, along with the traditional ex-food-and-energy measure and the Dallas Fed's trimmed PCE:
The good news is that the market-based PCE has not exhibited the recent uptick seen in the ex-food-and-energy and trimmed PCE variants. The bad news is that it remains at levels well above the other two alternatives. Overall, I'd say no comfort there, and it appears that everyone knows what that means.
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What Is The Right Road To Budget Discipline?
Senator Judd Gregg is leading a move to force cuts in the spiraling growth of federal benefit programs.By twelve to ten vote yesterday, the Senate Budget committee approved a bill written by Gregg, the committee's chairman. It would force mandatory cuts to the deficit, enforced by across-the-board cuts to programs like Medicare, Medicaid and unemployment insurance if Congress can't meet deficit targets on its own.
The bill also revives the idea of the line-item veto which would allow the president to single out wasteful items contained in bills he signs into law, and it would require Congress to vote on those items again.
The problem with Judd Gregg's proposal is that Gramm-Rudman didn't work when we tried it in the 1980s. It, I think, made matters worse--members of congress became more eager to vote for budget-busting measures when they could claim that Gramm-Rudman placed a cap on the total deficit, and then the congress was unwilling to apply the cap medicine when the dose turned out to be unexpectedly high, and so the process died.
The Budget Enforcement Act framework seemed to work much better in the 1990s than Gramm-Rudman worked in the 1980s.
To be fair to the proponents of Senator Gregg's proposal (who may not be legion), the new variant of GRH seems to address some of the perceived weaknesses of GRH itself -- specifically the inclusion of a presidential line-item veto and the removal of shelter for entitlement expenditures. And at least in implicit in the Gregg plan is a pay-as-you go feature that was central to the Budget Enforcement Act (as enacted under G.H.W. Bush and extended during the Clinton administration).
Democrats in Congress unveiled their 2006 campaign agenda last week, laying claim to the mantle of "fiscal responsibility." The GOP's spendthrifts have handed them this political opening, which makes it all the more disappointing that Democrats are falling back on an old confidence trick.
Their ruse goes by the name of "pay-as-you-go" budgeting, which has the political virtue of sounding as if spending won't be able to exceed revenue...
That's because paygo rules apply only to new or expanded entitlement programs, not to those that already exist and grow automatically with user demand. Thus spending for Medicare, growing this year at an astounding 15% annual rate, would continue to run on autopilot. Ditto for Medicaid. So-called "discretionary" programs (education, Defense) that Congress approves each year are also exempt. Democrats somehow forget to disclose that those notorious "earmarks" stuffed into spending bills are also exempt from paygo.
Well, OK, but I'm with Brad, on the paygo issue and his broader support for the mechanisms of the Budget Enforcement Act. In my opinion, the fundamental problem with the GRH approach to budget arose from its focus on the deficit per se. To me, fiscal policy boils down to answering a few simple questions. How much do we want to spend, and what do we want to spend it on? Having answered that question, it is beyond obvious that revenues have to pay for that spending in the long run. The only remaining question, then, is how those revenues should be raised (that is, who and what do we want to tax).
I am not presuming to answer these questions. In particular, I am not suggesting that correct answer is to raise revenues to match projected spending, anymore than I am suggesting the correct answer is to lower projected spending to match revenues. What I am suggesting is that an institutional process that puts the focus squarely on the trade-off between a dollar spent on one type of government spending versus another, a dollar spent in the public sector versus one spent in the private sector, and one type of taxation versus another, is the right way to go. The Budget Enforcement Act had the great virtue of requiring explicit decisions about new spending (for the discretionary part of the budget and new entitlement programs) and forcing explicit consideration of the inevitable trade-offs when anyone wanted to deviate from the program.
I'll close with an appeal to higher authority:
... For about a decade, the rules laid out in the Budget Enforcement Act of 1990 and in the later modifications and extensions of the act helped the Congress establish a better fiscal balance...
Reinstating a structure like the one formerly provided by the Budget Enforcement Act of 1990 would signal a renewed commitment to fiscal restraint and help restore discipline to the annual budgeting process. Such a step would be even more meaningful if it were coupled with the adoption of provisions for dealing with unanticipated budget outcomes. As you are well aware, budget outcomes have often deviated from projections--in some cases, significantly--and they will continue to do so. Accordingly, well-designed mechanisms that facilitate midcourse corrections would ease the task of bringing the budget back into line when it goes awry. In particular, the Congress might want to require that existing programs be assessed regularly to verify that they continue to meet their stated purposes and cost projections. Measures that automatically take effect when a particular spending program or tax provision exceeds a specified threshold may prove useful as well. The original design of the Budget Enforcement Act could also be enhanced by addressing how the strictures might evolve if and when reasonable fiscal balance came into view.
I do not mean to suggest that the nation's budget problems will be solved simply by adopting a new set of budgeting rules. The fundamental fiscal issue is the need to make difficult choices among budget priorities, and this need is becoming ever more pressing in light of the unprecedented number of individuals approaching retirement age.
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June 20, 2006
The Housing Market Shows Signs Of Life -- Except Where I Live
I'm not sure it means all that much, other than the data just refuses to provide any support for the full-blown crash scenario. From Bloomberg:
Housing starts rose a greater-than-expected 5 percent to an annual rate of 1.957 million, the Commerce Department said today in Washington. Building permits, a sign of future construction, fell 2.1 percent to the lowest level since November 2003.
While the increase in starts doesn't change the outlook for a cooling housing market, the number may reassure investors and Federal Reserve policy makers that the slowdown won't become a rout. Atlanta Fed President Jack Guynn and Dallas Fed President Richard Fisher yesterday predicted a moderate softening in the industry.
"There's no question housing is slowing down, but it's not falling off a cliff,'' said Ken Mayland, president of ClearView Economics LLC in Pepper Pike, Ohio ...
By region, the clear laggard last month was the midwest...
... illustrating of the proposition that the winners in April will be later to lose -- or something like that:
Given such month-to-month variation, it's a good idea to take a look at the trend over a slightly lnger period of time. From the beginning of the year, say:
How does that stack up to last year's performance?
I'll leave it to you to decide if that is a big change or not.
If you like the pretty pictures, they are a mere click away:
(Thanks to Brent Meyer for supplying me with those templates.)
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