Tuesday, March 29, 2005
a new era
espcially entertaining, as it was in 1999, is the new era hype:
In Miami, Ron Shuffield, president of Esslinger-Wooten-Maxwell Realtors, predicted that a limited supply of land coupled with demand from baby boomers and foreigners would prolong the boom indefinitely.with core consumer inflation data rising to 3%, inflation is becoming a serious concern. (raw cpi data here.) more spectacularly, however, inflation in the pipeline seems to be building. the widely-reported core producer price index (ppi) -- prices paid by manufacturers for the goods they use -- has risen to 4.7%. the difference between ppi and cpi rates comes out of profits for manufacturers. while companies can choose to take a dent in the bottom line, they are obviously more inclined to pass along inflation to the consumer.
"South Florida," he said, "is working off of a totally new economic model than any of us have ever experienced in the past."
moreover, while the well-known ppi focuses on finished goods, it is often led by the ppi for intermediate and crude goods -- elements of finished goods and raw materials, respectively. crude goods were running in mid-2004 at annual inflation rates of over 20% -- thanks in part to the declining dollar -- which has spilled over into intermediate goods, which have been inflating for almost a year at 7-9%, the highest levels since the stagflation of the late 1970s-early 1980s.
employment too is doing very well. the unemployment rate is 5.4%, and initial unemployment claims have fallen to a 4-week average of 321,750. while great news for the now, these numbers are too low for the good of the future -- when claims get into the area of 300k, it indicates a tight labor market that will spur wage inflation and limit growth in coming quarters.
the squeeze on profitability (already being seen by the economist) that comes with pipeline price and wage inflation pressures will result over the next few quarters in higher consumer prices (cpi inflation), more borrowing, slower growth and hiring (higher unemployment) or profit warnings -- or any combination of the four and quite possibly all. and that prospect is surely behind the steady rate raising over at the fed as well as the handwringing by some fed governors to starting taking more drastic measures; the fed's mandate is cpi stability, and it is duty bound to squelch borrowing and therefore economic activity with interest rate increases to try to keep a lid on inflation.
surprisingly, in spite of all this evidence for higher future rates and a slowing economy, the sensitive 30-year bond yield remains low, flattening the yield curve. how long will it remain so? i suspect that inflation surprises may lie ahead -- the ten-year treasury today yields 4.58%, while the ten year TIPS bond yields 1.86%, giving an approximate annual cpi forecast of 2.7%. this indicates that the market expectation for inflation over the next ten years is even less than the current cpi. this is primarily a function of asian central bank purchasing suppressing rates -- when it slows, as it eventually will, treasury yields will rise with inflation expectations and the dollar's fall.
what does it all mean? that expected inflation is probably too low -- that inflation may be surprisingly strong and difficult to counteract, meaning more aggressive fed action than we've seen and higher than expected rate increases. higher rates mean more expensive mortgages, of course -- and perhaps the end of the housing bubble.
the fed's handiwork to this point is having its effect in the economy -- consumer confidence data is weakening. while the february headline number looks encouraging, what is not is the most relevant measure to economic forecast -- future expectations (95.7) less present situation (a strong 116.4) equals -20.7. whenever this figure reads negative, it forewarns of a coming recession with an long lead time (often years). it first began to flirt with the zero line in early 2004, and has in recent months dropped several points. more considerable recessions often are preceded by a reading of less than -50. (the most recent report is here.)
the economist makes the case for watching the leading economic indicator published by ecri, which declined steadily into november 2004, but has rallied since. with something like a six-month lead on actual economic conditions, this would indicate slow business activity until midyear -- and that only if the leading index continues to rise.
so a recession in 2005, probably accompanied by sharply higher interest rates, looks increasingly likely. the difficulty is in assessing the risk of the imbalances (including consumer debt and current account deficits and government debt) built up around the american economy act to take the situation beyond the control of the fed. the possibilities of a hard landing are discussed by nouriel roubini and brad setser in their recent paper and roubini's guest blogging appearance at wsj online.