Energy and Economic Growth
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Inflation worries are heating up around the world and jolting financial markets in the process.
On Tuesday, China's stock market was the latest to feel the blow, with the benchmark Shanghai Composite Index tumbling by 7.7%, to its lowest close this year. The drop came after the government announced steps to remove cash from the financial system in an attempt to tamp down inflation.
.....Also Tuesday, officials in Vietnam effectively devalued their currency in a step aimed at easing market pressures related to soaring inflation rates. (See related article.)
And in the U.S., investors sold off U.S. Treasury securities, one day after Federal Reserve Chairman Ben Bernanke warned that the run-up in oil prices is adding to upside risks for inflation. The price of the two year Treasury note, most sensitive to the Fed's moves, has fallen sharply (and its yield has risen) as investors grow convinced that the central bank may have to raise rates this autumn to contain inflation. On Tuesday, the two-year note's yield was 2.9%, up from 2.4% on Friday, marking a major jump in that rate.
Meanwhile, the Bank of Canada surprised markets Tuesday by holding off on an expected interest-rate cut; the central bank said the risk of inflation, driven by high energy prices, had grown too great to allow for further rate cuts. The European Central Bank is also considering interest rate increases to fend off inflation.
European Central Bank board member Juergen Stark damped speculation of a series of interest-rate increases, saying policy makers have signaled only that they may raise borrowing costs in July.
``The markets have understood the Governing Council's signal,'' Stark, 60, said in an interview in Chatham, Massachusetts, late yesterday. ``However, we are not talking about a series of rate increases.''
ECB President Jean-Claude Trichet said last week the bank may raise its benchmark rate by a quarter-point to 4.25 percent in July to curb inflation, which is running at the fastest pace in 16 years. Investors responded by increasing bets on higher borrowing costs. They expect the ECB to lift the key rate twice this year, taking it to 4.5 percent, according to Eonia forward contracts.
Oil prices above $130 a barrel and rising food prices pushed inflation in the 15-nation euro region to 3.6 percent in May, well above the ECB's 2 percent limit. Central banks around the world are changing rate policy in response to surging inflation.
Global Policy Shift
Vietnam, Brazil, Chile, the Philippines and Indonesia all lifted borrowing costs this month. The Bank of Canada yesterday unexpectedly kept its benchmark rate unchanged after four straight reductions. U.S. Federal Reserve Chairman Ben S. Bernanke has also signaled the Fed is done cutting rates, saying this week he'll ``strongly resist'' any surge in inflation expectations.
Inflation has remained high, largely reflecting sharp increases in the prices of globally traded commodities. Thus far, the pass-through of high raw materials costs to the prices of most other products and to domestic labor costs has been limited, in part because of softening domestic demand. However, the continuation of this pattern is not guaranteed and future developments in this regard will bear close attention. Moreover, the latest round of increases in energy prices has added to the upside risks to inflation and inflation expectations. The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as for inflation.
Geithner also said containing global inflation risks will probably require tighter monetary policy. The Fed has cut U.S. interest rates sharply to 2 percent since September, though markets expect it to raise them later this year.
U.S. Treasury Secretary Henry Paulson on Tuesday said he stood by comments made a day earlier in which he said he would never rule out currency intervention as a potential policy tool.
"I'll let my comments stand," Paulson said in an interview with Bloomberg Television. "I never like to say never, but my focus is on long-term fundamentals."
Saudi Arabia's oil output increased by almost 500,000 barrels a day this quarter, to 9.54 million barrels, sources in the Saudi Oil Ministry told CNBC.
World oil demand will rise at its slowest pace in six years during 2008 as a raft of fuel subsidy cuts in Asia erodes consumption, the International Energy Agency said on Tuesday.
But the adviser to 27 industrialized economies also sharply lowered its projection for supply outside the Organization of the Petroleum Exporting Countries, increasing consumers' reliance on the exporter group.
In its monthly Oil Market Report, the IEA said global oil demand will rise by 800,000 barrels per day (bpd) this year, 230,000 bpd less than its previous forecast.
Before turning to those issues, however, I would like to provide a brief update on the outlook for the economy and policy, beginning with the prospects for growth. Despite the unwelcome rise in the unemployment rate that was reported last week, the recent incoming data, taken as a whole, have affected the outlook for economic activity and employment only modestly. Indeed, although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so. Over the remainder of 2008, the effects of monetary and fiscal stimulus, a gradual ebbing of the drag from residential construction, further progress in the repair of financial and credit markets, and still-solid demand from abroad should provide some offset to the headwinds that still face the economy. However, the ongoing contraction in the housing market and continuing increases in energy prices suggest that growth risks remain to the downside.
Renewed banking trouble Monday sent investors scrambling to buy low-risk government debt, with shorter-dated maturities making the biggest gains.
The two-year note rose 8/32 point, or $2.50 for every $1,000 invested, to yield 2.512%. That is down from 2.641% Friday as bond yields fall when prices rise. The yield on the benchmark 10-year note fell below the 4.0% mark again -- a level just breached last week. It was yielding 3.971% Monday.
The advances helped government debt gain back some ground after suffering a rout in the past few weeks amid rising inflation worries, speculation over higher interest rates and a recovery in risk appetite.
But risk aversion returned Monday after British mortgage lender Bradford & Bingley warned about the outlook for 2008, and two major U.S. banks, Wachovia Corp. and Washington Mutual Inc. made management changes. That reminded investors that the credit-market crunch, while improved from the worst levels in March, is far from over.
Standard & Poor's downgrades of the counterparty ratings on three major U.S. brokers added to investors' worries, as the ratings firm said it expects Merrill Lynch & Co., Lehman Brothers Holdings Inc. and Morgan Stanley to make additional writedowns.
"You are seeing a flight-to-quality bid into Treasurys again," said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG's private wealth-management unit in New York. "The credit market crisis isn't over. This is just a reminder of that. The market is repricing risk."
Crude oil spiked to new records around $139 per barrel, deepening a stock market sell-off and driving flows out of riskier assets into safe-haven Treasuries. However, a sustained acceleration of inflation pressures even in a period of weak economic growth could later prove negative for bonds, analysts warned.
Federal Reserve Chairman Ben S. Bernanke said policy makers will ``strongly resist'' any surge in inflation expectations, delivering his clearest message yet the central bank is done lowering interest rates.
Bernanke played down the biggest jump in the unemployment rate in 22 years in May and said the risk of a ``substantial downturn'' receded in the past month. Policy makers will need to pay ``close attention'' to make sure the increase in commodity costs doesn't pass through to broader consumer prices, he said in a speech to a Boston Fed conference late yesterday.
The Fed chief's remarks spurred investors to bet that officials will raise rates later this year and sent two-year note yields to their highest level since January. Bernanke and his colleagues are raising the alarm on inflation after oil costs doubled in the past year and companies from Dow Chemical Co. to tire-maker Titan International Inc. raised prices.
U.S. gasoline rose to $4 a gallon at the pump for the first time, threatening to further shake the confidence of consumers whose spending makes up two-thirds of the economy.
``The fact that confidence has gone down as inflation expectations are going up indicates gasoline has been an important driver because it's one of the reasons expectations are rising,'' Nigel Gault, chief U.S. economist at Global Insight Inc. in Lexington, Massachusetts, said.
Consumers are already rattled by falling home values and a weakening job market, prompting them to curb spending and threatening to halt the six-year expansion. Consumer confidence in May fell to a 28-year low, as inflation expectations rose to their highest in more than two decades, according to last month's Reuters/University of Michigan sentiment survey.
Oil prices are likely to hit $150 a barrel this summer season, the global head of commodities research at Goldman Sachs said on Monday, as tighter supplies outweigh weakening demand.
"I would suggest that the likelihood of that happening sooner has increased tremendously ... sometime in summer," Jeffrey Currie told an oil and gas conference in the Malaysian capital, referring to oil at $150 a barrel.
Goldman Sachs, the most active investment bank in energy markets and one of the first to point to triple-digit oil more than two years ago -- a once unthinkable level -- said last month oil could shoot up to $200 within the next two years as part of a "super spike."
The cause for optimism: the U.S. has called in the economic cavalry, which has responded in textbook fashion. The Federal Reserve has aggressively cut interest rates, bringing the Federal Funds rate down from 5.25 percent last September to 2 percent. Earlier this spring, Congress and President Bush, in a rare moment of bipartisan accord, passed a stimulus package, which will shove nearly $100 billion into the pockets of American consumers by mid-July.
But this downturn is likely to last longer than the eight-month-long recession of 2001. While the U.S. financial system processes popped stock bubbles quickly, it has always taken longer to hack through the overhang of bad debt. The head winds that drove the economy into this dead calm— a housing and credit crisis, and rising energy and food prices—have strengthened rather than let up in recent months. To aggravate matters, the twin crises that dominate the financial news—a credit crunch and the global commodity boom—are blunting the stimulus efforts. As a result, the consumer-driven economy may not bounce back as rapidly as it did in the fraught months after 9/11.
it has always taken longer to hack through the overhang of bad debt
Total debt outstanding -- that is personal, corporate and government debt outstanding -- is $31.758 trillion. Total US GDP is $14.196 trillion. That means that there is 2.23 times the amount of debt in the US relative to the total value of the US economy.
Total household debt is $13.960 trillion. That means total household debt as a percentage of GDP is 98.33%. Disposable income at the national level is $10.502 trillion. That means that total household debt is 132.92% of disposable income at the national level.
The head winds that drove the economy into this dead calm— a housing and credit crisis, and rising energy and food prices—have strengthened rather than let up in recent months
May 27 (Bloomberg) -- Home prices in 20 U.S. metropolitan areas fell in March by the most in at least seven years, pointing to weakness in the housing market that will constrain economic growth.
The S&P/Case-Shiller home-price index dropped 14.4 percent from a year earlier, more than forecast and the most since the figures were first published in 2001. The gauge has fallen every month since January 2007.
Prices continue to slide as record foreclosures put more homes on the market and stricter lending standards make it harder to get loans. Falling home values are slowing consumer spending, threatening to halt the six-year expansion.
``There is excess supply, weakening demand, prices are falling and will continue to fall,'' said Kevin Logan, senior market economist at Dresdner Kleinwort in New York. ``Housing sales are still trending lower.''
Lehman unloaded at least $120 billion of holdings in the second quarter, said people with direct knowledge of the matter. At least $18 billion of the assets were tied to mortgages and leveraged-buyout loans that plummeted in value, said one of the people, who declined to be identified because the figures haven't been disclosed.
``They're doing all the right things, such as de-leveraging aggressively, but these are stressful times, and they don't always get the credit they deserve,'' said UBS AG analyst Glenn Schorr, who has a ``neutral'' rating on Lehman. ``Although Lehman is very different than Bear, there's one similarity, and that's what could undo all the other positives: perceptions can become reality.''
Fund manager BlackRock expects the global credit crisis to last another two to four years as a weakening U.S. economy triggers more writedowns by banks, its chief investment officer for equities said on Monday.
"The credit crisis will be with us for a long time," said Bob Doll, CIO and also vice chairman of the U.S. money manager, which managed $1.36 trillion in assets at the end of March.
"The deleveraging of the financial system, which is the outgrowth of the credit crunch, will likely last a couple of more years -- two, three, four," he said.
Financial institutions around the globe such Citigroup and UBS have suffered more than $300 billion of write-downs and credit losses during a credit crisis triggered by the collapse of the U.S. subprime mortgage market.