The Money Map Advantage
Monday, April 17, 2006
By Horacio Marquez
Email – #38
** Fed Gov. Kohn’s Curve Ball And How Globalization Leads To Well-Behaved Inflation
Let me start by sending my warm regards to all of those who celebrated Jewish and Christian feasts last week. May they continue to bring peace and joy to you and your loved ones.
In our last update, I mentioned that as the long bond was almost maxed-out in yield, many market participants were preparing themselves for the coming bond rally. In effect, as other comments from Fed governors were indicating that we are almost there in terms of Fed tightening, and that the current rates are “at the top end of neutrality,” many agree that that the Fed is almost done.
In fact, a very wide survey of economists last week revealed that the Fed should do less rather than more, given the very large leverage (especially that of consumers) in the economy. The same survey estimated the 10-year rate finishing the year at 5.04% after reaching that level by mid-year.
In contrast, Fed Governor Kohn’s speech last week threw a curve ball to the bond market, which – in the light trading of a shortened week and ahead of a week where very significant economic data is going to come out – chose the path of least resistance. Bond yields climbed to the highest levels since June of 2002, and closed the week at 5.04%. Dr. Kohn’s “prognosticator’s always-murky lens” (his own words, which might not be shared by other committee members) painted a picture of risks still on the side of inflation picking up. I excerpted some key remarks:
Supporting our long-held view of accelerating global growth:
“a firming of activity abroad and the associated increases in demand for our exports”
“the expansion of output has become more firmly established in both Japan and the euro area”
“growth continues at a solid pace in the United Kingdom and Canada”
“economic growth in most of the emerging economies of Asia has been robust”
Supporting our view of well-behaved inflation:
“the rise in energy prices has apparently had only a limited negative effect on the national economy. Energy costs are not nearly as important today as they once were.”
“the underlying rate of inflation has remained moderate”
“the run-up in the prices of energy and other commodities appears to have had only a modest effect on prices for non-energy goods and services”
“(PCE) price index, has been running a bit under 2%, only about a half percentage point above its rate two years ago before the spurt in energy prices began”
And, to date, inflation expectations have been well anchored.
But his punch line was not supportive of our view: “The capacity utilization rate and the unemployment rate have recently reached zones that on occasion in the past have been associated with the beginnings of upward pressure on inflation.” Yet, inconsistent with this statement, he goes on to say: ” …I believe that underlying inflation should remain roughly stable.”
While acknowledging that inflation has been well-behaved and that inflation expectations are well-anchored, in what I referred to as his punch line, he hints that inflation might accelerate from here: “the economic climate appears to be one in which further increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures.”
The culprit that might precipitate such acceleration might be the rising prices of commodities and the level of resource utilization (labor and plant capacity). Yet, he also confesses that there are many variables that are difficult to measure and understand today, such as:
the likely course of housing prices and their effect on consumption and saving patterns;
the ongoing effect of technological improvement and the effect on increasing labor productivity; and local and international competitive forces that are holding end prices down.
He finally summarizes what he views as the opposing forces in play right now that predicate the Fed’s actions:
“Maintaining economic growth around this pace will likely reflect a balancing of opposing forces. The rise in interest rates we have experienced will tend to restrain demand, offsetting the effects of sustained economic expansion in our trading partners and the reduced drag on U.S. growth from oil prices, assuming that those prices roughly flatten out as participants in futures markets seem to expect.”
“Inflation: Where Art Thou?”
Nowhere. The reality is that turning points in markets and in economic activity are very difficult to time. And this is also true for Fed Governor Kohn and his colleagues in the Federal Reserve. However, my experience in analyzing emerging markets and the current phenomena of globalization leads me back to my long-held thesis (which has delivered outstanding profits so far) maintaining that the forces of globalization, together with technological and other efficiency gains and constrained by a very high-leveraged and price-conscious consumer, have led – and will continue to lead – to stable inflation.
The consumer and competitive markets do not allow for end prices to rise. And in my opinion, the Fed would err if it kept raising rates, with no inflation in sight and a weakening economy.
In addition, the U.S. economy will inevitably slow down from here, as the Katrina and Rita rebound effects in the first quarter of this year fade away and the brisk rise in both short- and long-term interest rates destroy speculation and contain consumer spending. And with this, lower levels of job creation and capacity utilization will end up allowing the Fed to actually ease monetary policy at the end of the year. This week will allow us much more evidence of the current state of the economy, which I expect will continue revealing the scenario that I just described.
With the 10-year Treasury above 5% already, giving us a pretty high 3% real rate (especially considering the low level of nominal interest rates), I maintain that the Fed will stop raising rates at 5%. This implies that our scenario for continued appreciation in global equities and commodities is intact. In fact, the hard commodity rally we saw last week came in as expected, and the soft commodities seem ready for launch.
Iran, Spoiling the Party
Iran failed to heed international calls for its unrealistic desires for uranium enrichment… The increasing tensions with Iran are a risk to equities, which sold off after that country’s announcement, especially ahead of a long weekend. I wrongly expected that the widespread pressures from the international community would bring Iran into reason. It is not too late and Condoleeza Rice indicated that strong initiatives in the United Nations will be the next steps. I hope and pray, as I am sure everybody does in the world, that the last resort of an efficient surgical bombing strike does not become necessary and that Iran comes back to reason soon.
While I am ready to pull the trigger on new positions based on current market prices and prospects, this week’s loaded economic calendar and the Iran situation warrant some further examination before I do so.
Enjoy and profit,
Horacio Márquez
If you have any questions, feel free to call one of our VIP Trading Services representatives at 888.570.9830 (toll-free) or e-mail: viptrader@oxfordclub.com, or contact Pillar One Advisor Rick Pfiefer at 800.438.3040 or 407.667.4729.
Stock & Symbol
Current Price
Comments
Unibanco (NYSE: UBB)
$73.58
Buy. Sell stop is $59.58.
Peabody Energy (NYSE: BTU)
$50.90
Buy. Sell stop is $35.
IShares Brazil Fund (Amex: EWZ)
$40.65
Buy. Sell stop is $33.79.
BHP Billiton (NYSE: BHP)
$43.16
Buy. Sell stop is $32.70.
Banco Bradesco (NYSE: BBD)
$35.34
Buy. Sell stop is $29.45.
Petrobras (NYSE: PBR)
$88.84
Buy. Sell stop is $75.47.
Mitsubishi UFJ Finan. (NYSE: MTU)
$15.65
Buy. Sell stop is $12.93.
iShares Japan Fund (AMEX: EWJ)
$14.48
Buy. Sell stop is $12.83.
Tenaris (NYSE: TS)
$209.72
Buy. Sell stop is $117.27.
MSCI Austria Fund (AMEX: EWO)
$31.25
Buy. Sell stop is $26.51.
Market Watch
NASDAQ
1528.95
0.00
SP 500
813.88
0.00
DJIA
7749.81
+89.84
As Of 6:12AM 3/26/2009
Attention Money Map Subscribers!
Money Map Report,
New China Trader
& Money Moves Alert
are now found at www.moneymappress.com
