Our expectations of economic growth and inflation for the remainder of the year suggest to us the Fed will remain on the sideline at next month’s FOMC meeting. Recent data on inflation has been mixed. On one hand we have seen core CPI inflation moderate since the beginning of the year. On the other hand, we have seen little relief regarding higher energy and food prices which has kept total inflation elevated. In the near term, we expect total inflation will likely remain elevated as food and energy prices continue to climb. However, we anticipate the pace of inflation to moderate towards the end of the year as commodity prices level off and take some pressure off of the headline number. So far consumers are wary. Record gasoline prices combined with rising grocery store bills are having an impact on consumers’ psyche. Several measures of short and long-term inflation expectations have edged higher which is of utmost concern to the Fed. The Fed will continue to keep a watchful eye to see if there is further deterioration in expectations.
E. Silvia, Ph.D. Chief Economist, Wachovia
Weekly Bank Research Center 05-27-08
Review and Preview
Stephen Roach, Head Economist, Morgan Stanley
After a lot of volatility along the way, particularly for such a light news week, Treasuries ended the past week close to unchanged. Early in the week, the market staged a solid rebound from the prior week’s big front-end-led sell-off, but as oil spiked higher in an increasingly disorderly manner, inflation fears drove a sharp reversal Wednesday and Thursday, before a sizable rebound off the lows in Friday’s shortened trading session to end the week. Notably, the flat performance of Treasuries on the week came despite significant losses across risk markets, breaking at what had been a consistently strong negative correlation for some time. This relationship held strongly during the early week rally, as the bond market actually received an odd lift from an ugly PPI report, responding more to the resulting stock and credit weakness than to the data themselves. It was only when the huge spike in oil hit Wednesday that broadly based weakness was seen across risk-free and risky markets. The stagflationary fears driven by out-of-control oil prices were evidently seen as bad news for most asset classes – if only for a couple of days, as Friday’s sizable Treasury market rebound was supported by significant weakness in risk markets as oil prices continued moving higher. It remains to be seen whether the broadly based weakness across markets seen Wednesday and Thursday was just an anomaly and Treasuries will continue the resumption of trading inversely to risk markets or whether all markets will again come under pressure if oil prices continue surging higher. In addition to oil, major weakness in Europe, where 2-year yields surged about 25bp in both the UK and the Eurozone, also weighed on Treasuries through the week, as investors largely gave up on the possibility of rate cuts based both on country-specific economic and monetary policy news and the generalized inflation fears that intensified across the globe.
Falling PMI but High Inflation - the ECB's Dilemma in a Nutshell
Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank
It has been an eventful week with some important indicators of economic growth in Euroland. The German Ifo index for May showed a surprising increase which largely made up for the fall in April. This means that the index has been practically horizontal since autumn 2007, but below the average for 2007 as a whole. Together with the general downward trend in the sub-index for expectations for the next six months, this confirms the impression of a German economy set to slow in the coming months. The German PMI figures confirmed this pattern. On the other hand, French consumption data for April were relatively weak, and the French PMI figures for May also pointed downwards, with the PMI now at its lowest level since 2003. For Euroland as a whole, the data indicate that growth will slow as expected in the coming months, as the strong headwinds (still strong EUR, slower global growth, high oil and food prices, and credit tightening) impact on the economy. The downturn looks set to be sharpest in southern Europe, where the as yet unpublished figures for May are likely to show further deterioration.
Fed Expected to Remain on Hold
E. Silvia, Ph.D. Chief Economist, Wachovia
Our expectations of economic growth and inflation for the remainder of the year suggest to us the Fed will remain on the sideline at next month’s FOMC meeting. Recent data on inflation has been mixed. On one hand we have seen core CPI inflation moderate since the beginning of the year. On the other hand, we have seen little relief regarding higher energy and food prices which has kept total inflation elevated. In the near term, we expect total inflation will likely remain elevated as food and energy prices continue to climb. However, we anticipate the pace of inflation to moderate towards the end of the year as commodity prices level off and take some pressure off of the headline number. So far consumers are wary. Record gasoline prices combined with rising grocery store bills are having an impact on consumers’ psyche. Several measures of short and long-term inflation expectations have edged higher which is of utmost concern to the Fed. The Fed will continue to keep a watchful eye to see if there is further deterioration in expectations.
Inflation is the Word
Steve Chan, Economist, TD Bank Financial Group
It wasn’t economic data but the minutes from the Federal Open Market Committee’s April 30 interest rate decision that spooked financial markets into retreat this week. The FOMC minutes are a bit like a trip into the minds of participants, delving into the psychology behind their current interest rate decision and setting the tone for future actions of the Bank. The minutes this time were more than explicit in laying out what the Fed would be trying to get across in the interim period between the end of April and the Fed’s next meeting in June. Their statement that, “it was unlikely to be appropriate to ease policy in response to information suggesting that the economy was slowing further or even contracting slightly in the near term, unless economic and financial developments indicated a significant weakening of the economic outlook,” gave us all the signal we needed to believe the Fed is likely to remain on hold at least in the near term. The Fed topped off their concern for inflation by raising their forecast for headline PCE inflation in 2008 a full percentage point to a range of 3.1% to 3.4% from 2.1% to 2.4% previously. Recognizing the importance of anchoring market inflation expectations, this view necessitated a more neutral stance to monetary policy at least in the near term.
High Inflation Will Slow UK Economic Growth But No Recession
Trevor Williams, Chief Economist at Lloyds TSB Financial Markets
We are more concerned about inflation than recession but a rise in inflation weakens real, or inflation adjusted, growth. To this extent, accelerating price inflation may raise the risk of recession (falling output) or a period of well below long run average economic growth. How does price inflation do this? The process is straightforward, inflation reduces real incomes and so cuts real consumer spending. With UK economic growth already weakening sharply - how much will the latest bout of rising prices damage prospects? The conclusion from the following analysis is that higher price inflation will take 0.25% off gdp growth this year but will have no impact on our 2009 forecast, if it falls back as expected. We now look for 1.8% growth this year after 3% in 2007.
Other Pre-screened Independent Contributors
J-Chart
J-Chart is an innovative charting and bias-neutral market analysis tool. Based on its proprietary theoretical concept and display of market price action, J-Chart provides a much clearer and unique insight into the market than conventional charting methods. This innovative charting and market analysis tool is designed to visualize market price action that constructs unique price patterns called "Equilibriums". Based on its "non-fixed time frame" concept and "Kinetic Equilibrium" application, J-Chart users are able to forecast markets' future movements with high accuracy.
