Pricing Power: The Decline and Fall 11 comments
James Picerno
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Deflation may or may not be coming, but the Treasury market's forecast is clear.
After yesterday's news of a sharp drop in consumer prices, which came on the heels of something similar in wholesale prices the day before, traders in government securities took the hint. Yesterday's closing yield of 3.391% for the benchmark 10-year Treasury isn't the lowest we've seen, but it's getting close.
Back in June 2003, the 10-year briefly dipped to the then-astounding low of just under 3.10%. At the time, some observers of the financial scene said the trough would stand for generations as a low-water mark. A reasonable call at the time, based on the available information. But the forecast has been abandoned in light of recent trends, and rightly so.
The economic news of late gives reason to think that the 2003 may soon give way. In the current environment, any news of weakening demand promotes the expectation that prices generally will fade for the foreseeable future. The latest example comes in this morning's update on initial jobless claims, which jumped again last week, rising to 542,000, the highest since 1992. The message in this leading indicator is clear: The labor market will shed jobs for the foreseeable future. Unfortunately, there's a surplus of similarly discouraging trends in everything from retail sales to manufacturing activity. Pricing power, as a result, grows weaker by the day, and shift is quickly being reflected in interest rates, as recent changes in the Treasury yield curve remind.
No wonder, then, that the inflation forecast coming out of the Treasury market has crashed. As of last night's close, the 10-year forecast for inflation was an annualized 0.4%, based on the yield spread between the nominal and inflation-indexed 10-year Treasury (see chart below). As recently as October 22, this inflation outlook was over 1% and just this past July it was above 2%.
The change in the state of economic and financial affairs in the past year or so -- the past two months! -- has been extraordinary, perhaps unprecedented in the modern age in terms of the pace and depth of the reversal. The magnitude of the change suggests that the recovery will be slow in coming and even then the rebound may be weak for an extended period. The smoking gun for this prediction comes via the generally high level of indebtedness among consumers. Leading the charge is the still-sinking real estate market, which continues to pressure household finances. The burden, already heavy, will be even more onerous if and when deflation arrives in earnest.
The main threat in all of this is the fear that the financial pain becomes negatively self reinforcing. The elevated challenge of paying off debts convinces consumers to steer clear of the shopping malls, which in turn weighs heavily on economic growth, which contributes to job destruction, which pushes prices lower, which makes debt servicing tougher, and round and round we go.
How do we stop this toxic merry go round? As we've discussed, the monetary solution is spent. Effective Fed funds (a more realistic measure of actual banking transactions) is now at 0.37%, even though the more widely quoted Target Fed funds rate is 1.0%. With the central bank within shouting distance of zero, fiscal stimulus via Congress is the only game left. Accordingly, the economy's fate seems to rest ever more firmly in the hands of the politicians. That's less than encouraging on its face. Unfortunately, the U.S. is knee-deep in a government transition, which raises an additional layer of uncertainty over the usual political questions.
The silver lining in all of this is that the bargain prices for strategic-minded investors will be astonishing in the months (years?) to come -- even beyond the already rich valuations on offer as we write. The question is whether anyone will have the stomach for partaking in the plush bargains that await.
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This article has 11 comments:
(2) Locking in a 4% gain for 30 years based on price behavior during a commodity collapse? Does this seem prudent?
cyclingscholar
Nobody has seen ANYTHING yet! The market hasn't even seen one shoe drop really, really hard. It's only gotten a tap.
The fact is no government (or group of governments) has the money to fill in the black hole made by this mess.
Listen to how absolutely nervous these political leaders sound. When things REALLY come down I give this country maybe a 10 percent possibility of making it through.
I think many of these idiots in Washington have been told that when the sucker goes down they won't be able to count on their security details. They'll be off protecting their own families and who could blame them after watching what went down in New Orleans.
Nicolai Chauchesku moments anyone?
www.youtube.com/watch?...
www.youtube.com/watch?...
Anyhow, I don’t see how any country, or group of countries can turn this thing around. It will take them throwing 15 years worth of negligent spending to fill up this black hole. I bet they don’t have the resources to do it.
I think the best investments these days are Smith & Wesson, Remington Arms, etc.
They changed the way CPI is calculated in the 1980's so the U.S Government could manipulate it like they do the unemployment statistics.
I wonder if they calculate in the CPI how tiny products have become? You need a microscope to find your can of tuna these days. Since we live in a shrinking world, does the CPI take into account that the can of tuna that was 5 ozs one day and 4.2 ozs the next?
Amazing.
"Helicopter" Ben Bernanke might warn these individuals that betting on 0.4% average inflation for the next decade might be hazardous as the fed has the power to create as much money (M1) as it wants. Interest rates are just one tool in the shed - the one used for fine tuning. His famous threat to drop money from helicopters if necessary was made in 2003 to emphasize that the fed has the tools to prevent deflation. The heavy equipment is called treasury auctions, the printing press, and legislative stimulus.
For those of you who are into world markets... FINE! But REALLY make it a global market. Common currency, common exchange markets, remove all trade AND labor barriers. Then, and only then, will a stimulus package touted by our government not end up by second round in a foreign country?
If you want globalization, then do it 100 percent. If not, make the American economy whole again.
If one of these two actions doesn’t take place, the economy of the United States, as well as economies throughout the world will falter and risk total collapse.
Consumers, as the charts show, live in the REAL WORLD. These big three automakers who fly to a bailout meeting with Congress in private jets are not only stupid, but they lack a total understanding of the real world. If you are making decisions, you better make them based on the real world. Not some hype that you start to believe yourself, or manufactured statistics to make your administration look better than it is, look at the reality.
Before this is over, our government will need to buffer our people from immense suffering. They won't do it by hiding $2 Trillion, the Fed loaning money below target without a press release, or bailing-out the sick auto industry.
And we have seen the result of that... The Weimar Republic...
The closing of the gap in their earnings is not a measure of underlying inflation. It is an inverse measure of the level of fear in financial markets.
When the dollar starts to implode everyone will scramble to exit their USBond positions just as fast as they scrambled to get in. We will see an entirely different look to this spread at that time.
They may try market intervention by buying stocks directly from the stock markets to shore up their respective countries but that is going to fail too - because govts have limited buying capacity.
What is needed is INVESTORS intervention into the market. We already have a Treasuries bubble that is serving only as a parking lot to investors capital with close to zero yield. That is the bubble that needs collapsing in order to revive the economy.
Governments have no business buying stocks. It is the investors'. However, investors are not going to enter the market unless it becomes rediculously cheap. And when they get cut by the thousands, they will stop buying anything even at ridiculous prices.
Govt, such as China's or Japans', which still have some cash reserve, must do what govt must do - provide guarantee to investors on their capital investments.
Investors confidence or the total lack thereof is driving stock markets all over the world down. Likewise, stock markets are starting to destroy even resilient economies such as China, Russia and Brazil, Australia, etc.
Once a country started making guarantee on investor investments, other countries will follow immediately.
Investor capital infusion into the existing markets will immediately revive the economies all over the world. Investor investment is the tried and tested way of reviving economies and sustaining growth.
Govt stimulus packages are simply too small and too late at the current stage - too much wealth has already been destroyed and being destroyed on the daily basis. Stimulus packages, likewise, take too long to take effect while the current markets are already in a free fall.
Consumers can't possibly turn the economy around when even solvent companies start going bankcrupt all over the place due to liquidity problems.
Better use the stimulus package as cash reserves to guarantee the investors of their capital infusion into existing companies.
With additional capital, companies will hold off employee retrenchments. Consumers will not go thru a drastic cut in expenses and will start spending again as the economy starts recovering.
Otherwise, govts around the world will see their tax collections next year going down the drain. At which time they may not be able to shore up their economies but in fact will be forced to retrench govt employees and expenses because of the tax collection shortages.
This can result a new domino effect around the world wherein the stock markets driving the economies down and the economies driving the govts down, then govts driving the economies down, and the economies driving the stock markets down.
See my previous comments on where the Dow Jones is headed and what the govt can do to guarantee stock market purchases.
The big box swindle by Tracy Mitchell
seems to make a lot of sense by now. Explaining not all, but quite a lot.