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Wednesday, June 18, 2008

 

deflation now in evidence in the UK


there have been a rash of disaster calls among analysts -- what i would take normally as a contrarian setup. on top of both the BIS and AIG's analyst, bob janjuah royal bank of scotland calls s&p 1050 within three months.

but there is something more afoot it seems. as expectations of rate increases get built into the market following manifest central bank inflationary concerns, reiterated by yet another fed governor (this time william poole) yesterday, bond yields have risen and the curve has flattened dramatically -- there is de facto tightening of liquidity in the bond market already.

and it is coming in spite of the first verifiable and overt signal of deflation in the UK. it's picked up by the telegraph, via ft alphaville:

The M4 monetary supply in particular, is plummeting. The headline number - a growth rate of 11.1 per cent - masks a precipitous decline when crisis-driven interbank market factors are stripped out. The M4 growth rate is down year-on-year 16 per cent according to the BoE. That contraction in lending could have a huge impact on the economy - and makes inflationary-killing rate hikes less of a sure path to take for the Old Lady.


i've not seen anyone run a similar stripped-down series of monetary aggregates for the united states, but i would expect exactly the same phenomena is underway here as well (though perhaps not so pronounced, thanks to the policy rate cuts of the federal reserve earlier this year). the upward bent of both the dollar (in a now nascent rally against the euro) and sterling would seem to tentatively corroborate as much. per the telegraph itself:

The M4 money data - which includes a wide range of bank accounts as well as cash - often gives advance warning of major shifts in the economy.

Leading monetarists such as Professor Tim Congdon from the London School of Economics warned three years ago that surging M4 growth would lead to a property bubble and inflation.

This is exactly what occurred, although a surge in global food and oil prices have been a crucial factor.

Mr Congdon say the risk has now inverted as the credit crisis eats into bank lending.

"The money supply is plummeting. This is potentially serious," he said.

... The Bank of England says the overall M4 figure - growing at 11.1pc - is distorted by strains in the interbank markets. Once this effect is stripped out, the M4 growth rate is down 16pc a year ago to 4.5pc in the first quarter.

The money markets have already begun to price in two to three rate rises this year, so some degree of tightening is already happening.

"A rate rise is out of the question. The Bank may soon need to start cutting," said Mr Ward.

The Bank's Governor, Mervyn King, pays close attention to M4 data. This might explain why he has played down the surge in inflation to 3.3pc in May, the highest since the Labour era began.


official optimism at junctures like these is essentially meaningless without rigorous evidenciary support -- i pay little mind to the proclamations of monetary and banking authorities now, given that duress has palpably stressed these folks, however well intentioned they may be, and what james montier calls a "conspiracy of optimism" must be their charted course.

in reality, evidence indicates that -- for all the debt-deleveraging and credit constriction we've already seen -- more is coming, for big banks and smaller banks alike. the effect of monoline downgrades is still in front of us, and liquidity problems are apparently returning to credit markets. the effect on the historically overleveraged consumer is predictable, but the intensity is surprising virtually everyone:

[I]n November ... executives were assuming Americans would buy ... only about 15.5 million [vehicles in 2008]. ... [S]o far in June ... J.D. Power and Associates and Citigroup are seeing a sales pace that is almost 20% lower -- only 12.5 million vehicles per year.

"This is the lowest sales level in 16 years and indicates a significant and continued softening of the U.S. automotive market," Nardelli wrote.
...
If J.D. Power's forecast for June -- an annualized rate of 12.5 million sales -- continues for long, Erich Merkle of IRN Inc. said, it would be "Armageddon. Doomsday."


under such circumstances, it is exceedingly difficult to commit to a position directly contrary to the most recent institutional converts to market doomsaying.

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