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Friday, September 30, 2011

With A Whimper?

Let's see: I stayed up late to catch the Markit PMIs for China and Japan. They weren't good. Chinese manufacturing is still in contraction with input price increases accelerating(!!!!) and Japanese manufacturing fell to 49.3 from 51.9 in August. The report notes weakness in Chinese orders as one of the causes of the fall in Japanese new orders. Japanese retail sales in August fell hard. Falling retail sales plus falling manufacturing presents a pretty difficult growth picture! So I then grumped my way off to bed.

This morning, I got a big fat stinking three-day-dead mackerel in the face in the form of Personal Income and Outlays for the US, which executed a real -0.3 negative for income on the month and a real 0.0 for Personal Consumption Expenditures (PCE) on the month. I thought from Treasury Receipts that nominal incomes (reported a 0.0) should be higher for August, although the high inflation is still cutting into real incomes. I will go back and look at receipts as soon as I have time. Maybe I missed something, but my first impulse is to say that this will be revised up (although still not to a real increase).

The preliminary benchmark revision for the establishment survey is out. This is still not real-time - it is picking up pulses from when the economy was stronger and employment was picking up in March - but it is certainly closer to current figures. This revision is deployed in February of 2012. See the release for more details.

Let's see - we have some other goodies here in the economic report grab bag. Eurozone inflation was reported to have jumped from 2.5% in August to 3.0% in September. This seems likely to delay any ECB move to cut rates, but most people think that the ECB will cut rates before the end of the year. It depends partly on inflation IMO. German retail sales were reported down 2.9% on the month. German unemployment keeps falling - it is currently below 7%!!!!! That's got to be the lowest since reunification. But Germans are experiencing increasing inflation, so it is reasonable perhaps that they are spending less in real terms. Unlike US retail sales, Germany reports inflation-adjusted retail sales.

The Euro is dropping and this may add to inflation. Normally you fight that with rate increases, not decreases. I think if I were the ECB I'd raise rates, because lower rates overall won't get through to the debt-troubled countries, and if the Euro drops more German unemployment will keep dropping, but everybody may just keep spending less. With a weakening market for exports, eventually that will tail off anyway. If you raise rates and cut inflation, there may be more spending oomph overall in the Eurozone. Just a thought. At this point a lower Euro is helping economies like Germany's, but it will over time still feed consumer inflation.

I think Germany's current fall in retail is cyclical and highly related to heating oil purchases for winter. So I expect this to improve later in the year. Or do I just hope for change? Well, anyway I expect the first shock to wear off and more Germans to hit the stores by November.

New Zealand got downgraded. This will not shake world markets. However the blinding fall in coffee on commodity markets shows what kind of downdraft we can expect in pricing. Part of the reason for the fall were reports that warehousing for green beans was quite well stocked indeed, and harvests were looking pretty good. But the truth is that earlier in the year no one cared about these stats, and now they do, which shows a change in trading methodology. These sorts of shifts generally last for at least six months, so risks are on the downside for all such commodities.

I also believe that while prices will adjust, they will not adjust quickly. There is too much money out there looking for a home, and with the equity markets doing poorly, especially in Asia, there is no other home. Therefore we are still not in a trading economy at which prices are adjusting on trade flows and supply, but rather still in a financial economy at which prices are adjusting for changes in money flows and supply. Given the choice of accepting a negative real rate of return on bonds and being chained to the fate of one currency, accepting a possible negative real rate of return with the option of being able to shift currencies smoothly still makes commodities look somewhat appealing even with high downside risks. Personally I would not do this, but I think producers will continue to stockpile supplies and so there is some near-term support for use commodities.

Such trading schemes generally produce nasty, sudden disruptive adjustments that hurt real trading of goods, so I expect the current sorrowful trend to continue. I also think that trading in such commodities has a much higher downside risk than the market believes. Oil now has no real support at almost any price level; I don't THINK it will go much below $45, but it could. It could go below $20 in a year, and that's more than a 5% probability. It all depends on how fast the global economy can adjust. I do think we have some slow adjustments in order for a while, because oil has a high psychic comfort level at this point. Note that abruptly the high copper stockpiles have emerged as a pricing factor; this is an example of the same evolution.

I do not think the Chinese manufacturing figures are quite as bad as they seem. As far as I can tell, Chinese manufacturing output is being dragged down by the inability to finance large buys of input costs. So manufacturers have shifted toward caution and lower output levels in order to try to retain the ability to finance new production runs on received orders. This does imply that there is further trouble ahead. I have to believe that part of the problem is construction and development companies that are borrowing money in the 15-25% range. This surely must shut out a lot of self-financed industrial investment!

Cripes! I thought you'd been expecting oil in the $60s.

Thanks for the global tour. Again.
I do expect it to get there at about a 90% probability. But I do not necessarily expect it to STOP there.

People are running out of things to buy!
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