February 2008

Let see if I’ll be right or wrong. Two big elephants just entered the room:

  • Bucky is cracky, just broke support and is trading at 73.72
  • The 30-year mortgage rate is reported to break the October heights

It seems to me that those are problems that Feds are forced to address. In the last two days they are pumping like mad and the reason is simple – the Treasury dept is on the market with a huge tin cup to borrow $46 bln.

Tomorrow they will fill the tin cup for whatever price it takes and then next week Feds will be forced to attack the inflation expectations. I guess the way to do that is to drain funds and tank the markets, both equity and commodity. This Fed already demonstrated back in January that they can throw the stock market under train if they need to. Now they need to.


Today morning I heard quite a smart guy at Boomberg radio (not sure what his name was). He made several interesting points on inflation:

1. Historically, inflation usually peaks during second half of the recession

What does it mean? If this recession indeed started in December and will end in December of ’08 it is totally normal to expect the inflation to peak somewhere in late Summer or even Autumn period.

2. When the recession starts inflation takes care of itself

It doesn’t matter what Feds do after the recession already had started, the inflation eventually fade. The hyperinflation scenario (1970s) happens because of the Feds actions before the recession

3. Feds made a huge bet that we are or soon will be in recession

The greatest risk in Feds aggressive rate cuts is not that it may fail to prevent a recession. Just in opposite. The greatest risk to the economy happens if after those aggressive rate cuts we do not fall into recession, because in that case the inflation will not take care of itself. Then Feds will be forced to raise rates to the moon and the hell will break lose.

That could explain why Feds were very tight back in January. They tried to force the economy into recession, because this is the optimal outcome. In the past few weeks they got enough evidence that we are in recession and now they can finally relax the monetary policy.

This economy needs a recession badly and, fortunately, we are in recession. All goes well, or at least according to plan 🙂

Can you measure inflation pain? Probably not, but I have an interesting chart (click):


The green line is the consumer price index, which is measuring the price of the basket of the average consumer (your mileage will vary as, for example, I spend 2% of my income on gasoline, but some people spend 15%). This measure compares apples to apples, i.e. the basket is more or less the same.

The red line is chained consumer price index, which is using PCE-adjusted basket, i.e. is comparing apples to oranges. How? For example, if price of the oranges is growing too fast comparing to the price of apples, many consumers are switching from oranges to apples, so the weight of oranges in the index is declining.

The red line is always below green one, which is quite natural – people are switching between apples and oranges to minimize the impact of the inflation. But what is interesting is the delta between those line – I think this is a simplest proxy to measure the inflation pain. When people don’t care much that the price of oranges is growing they don’t switch to apples and the lines are close. But when they just can’t stand the pain of expensive oranges and are running into safety of apples the lines are falling apart.

It seems that inflation pain was especially big in late 2000, then it was better and then the pain was back in most of ’06, then we had a mid-cycle slowdown in late ’06 – early ’07 and then the pain reached the 6-year maximum in late ’07 and is at maximum now.

The inflation pain is a negative feedback loop – when consumers are able to boycott the most expensive items (we know that many department stores are losing customers to Walmart and I heard that Walmart is planning for quick colonoscopy exams right at the checkout, taking customers away from expensive doctors) the pricing power is fading.

Please note that the periods of maximum pain are always followed by the decline of absolute inflation numbers

Today was what I think could be counted as a pretty good confirmation of the existence of PPT (plunge protection team) and they way it works.

I always suspected that PPT is not involved in direct market manipulation because the Uncle Sam is pretty short in cash in those troubled times. But it takes some art to move the markets in the most critical moment the most effective way without spending a dime on that.

Look at today chart:


Today afternoon the market clearly broke down the triangle formation which was pretty sufficient to trigger a quick ride back to January lows next week. Then, just half an hour before the market closed the rumor surfaced that Ambac will be rescued. They didn’t give any details before the marked closed, so the intriguing news sent the shorts to the run and the chart was saved.

Do you remember that every time the markets were about to plunge something always happened. Usually it was some kind of a plan (that later was proved to be ineffective) or some kind of rumor (that later was proved to be wrong or not important) or some familiar faces pop on TV saying that they have some magical solution to all problems. Whatever works, but you can’t undo the market – once shorts stampede to cover the plunge is over. This tactics must be familiar to those who follows the political roots of current elite. Remember, when Bush was campaigning against McCain back in 2000 the rumor surfaced that McCains is adopting a black bastard child. Of course that was wrong and the origins of the rumor were not proven, but it worked! And whatever works must be used.

How convenient is that Buffett has a policy to never comment on rumors that he’s buying something?

I’m sure this is already posted everywhere, but anyway:

From 1984 through 2006, only 13 auctions failed, typically because of changes in the credit of the borrower, according to Moody’s Investors Service. There were 31 failures in the second half of 2007, and 32 during a two-week period beginning in January. That compares with more than 480 failures yesterday alone, according to figures compiled by Deutsche Bank AG, Wilmington Trust Corp. and Bank of New York Mellon Corp.

We are witnessing something unprecedented in all aspects. As you know that I always was a supporter of Kondratieff wave theory and so I’m ready to see many 75-year old records, in whatever form they will come

P.S. About jobless claims today. Great economist David Rosenberg said that by his calculations the break-even number for NFP growth is at 350k of weekly jobless claims. Right now the 4-week average is at 361k, i.e. negative NFP number is guaranteed.

Another interesting point (from briefing.com): 4-week average at start of 1990 recession was 362K, 2001 recession was 373K. In this recession jobs are not falling as fast as before and this fooled everyone. But in fact the “Sudden Debt” blog explained that due the reduction in relative employment in manufacturing this time the jobless numbers will not grow as fast as in previous recessions. He predicted this few months ago and he’s proven to be right

Today’s inflation surprised to the upside. I see almost no bright spots, inflation rose across the board, and only one component, recreation, has a trailing 3-month annual-adjusted rate below 2% – recreation price is growing at only 1.6% annual rate. On the other side transportation cost is growing at 22% annual rate.

Do we need a better illustration that people spend money on what they need and cut on things that they want but don’t need? Recreation business has absolutely no pricing power.

Whenever we speak about inflation we need to recall what great economist David Rosenberg said:

Inflation is first and foremost a lagging indicator

It means that today inflation is echo of last year economy. Today’s state of the economy has no effect on inflation whatsoever.
Inflation is impossible without solid growth of real income and/or borrowing. Nobody has any damn interest what the producer cost is, the only thing that matters for inflation is do people have money or not.

While income growth was good but not great the borrowing was still exceptional. Look at personal consumption expenditures: growth was choking in October and December. Look at the compensation cost data: the rate of growth is getting slightly slower. Look at MEW: people continued to tap the home equity at alarming rate in Q4’07.

Based on above my prediction about inflation is following. Take this graph of MEW from CR post:


Once this graph falls into normal historic range of 2%-3%, few months later all the inflation will be gone. Completely.

Another angle to look at the inflation is like that: inflation means money get cheaper. Look at today Russ Winter blog: the main topic of this post is that price of money is going up. Mortgage rate is up, the cost to insure mortgage bonds is up, cost to finance the car is up – i.e. there will be less money in the economy once all borrowers will have to scale down on how much they can afford to borrow.

I give inflation another year, and I think I’m very generous

Of course, if our government manages to completely debase the currency the inflation will not only increase but it will turn into hyperinflation. When I see that happening I will change my mind

Today Hovnanian and Standard Pacific’s credit ratings got downgraded.

By itself, it’s no big deal, companies got downgraded all the time. But this time it could be different. Remember, I’ve said that banks have $2.5 trillion of commitments in credit lines and they would be happy to use any formal excuse to cut the credit line for a particular client if they can?

I think there is a very big chance that at least one creditor will pull the credit line from at least one of those homebuilders. If they want to clean the book before the Q1 ends they could do it soon.

I think it’s about time, too many walking skeletons around

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