2 more interest rates rises in 2008 likely...

[trendsta]

it will be passed on but I'm not sure I would call that inflation per se.

we should probably distinguish between an increase in prices and problem inflation. a genuine increase in the cost of producing / importing things will show up in the headline inflation figures but is not really 'problem' inflation like we had in the past. We have to consume less of other things of course which is bad (living standard drop) to accomodate the higher prices. And the adjustment will impact the headline inflation statistics but only for a short period of time. The inflation statistics are a relative statistic - i.e. the prices of things relative to the price of things the previous month.

But when prices rise because prices are rising (month in month out) then you have an inflation problem - it is inflation based on expectations of inflation. That could be where we are heading.

hi yieldmatters,
i c your point .. however disagree with some of the views.
I think that these costs are REAL .. by taking these costs out (e.g. oil rising 400% over five years, and similar increases in other materials) the fed and various other reserves are only delaying inflationary pressure. These are persistent changes, not short term changes ... if they were minor short term trends i would agree.. but they arent.. 100% changes in basic neccessities over a period of years, used by ALL, can not simply be discounted..

I agree inflation is relative.. in physics terms you can define it as acceleration rather than speed (i.e. rate of change)..

Even if oil and other commodities, raw materials etc dont rise (stay steady), sooner or later these costs will be borne by the customer.. at the moment companies are absorbing these costs.. there hasnt been much productivity gain, hence it is impacting their margins.. so far they have been able to get away with it because china has absorbed a lot of these costs, and secondly cheap debt has allowed consumers to buy more (for companies this means more sales at lower margins)... but when china cant absorb these inflationary pressures and consumer sales start slowing (1st qrt 08) these costs are either:
a). going to hit company profits, or
b). passed on to consumer

B will result in inflation.. suddenly cost of many goods: clothing, footwear, certain electronics, fertiliser (already happening), food, meat, eggs, transport, travel, labour/wages etc will go up .. fed is taking a massive risk waiting for this to happen before acting.. and thats my point... raising rates at this point will be too late..

A will result in corporate bankrupcies etc as profits erode and it is not feasible to operate under high costs, low profits.. unemployment etc etc..

 

[Jase H]

Not a bad thing for prepared investors in the short term, either.
Alex

Very True

 

[yieldmatters]

hi yieldmatters,
i c your point .. however disagree with some of the views.
I think that these costs are REAL .. by taking these costs out (e.g. oil rising 400% over five years, and similar increases in other materials) the fed and various other reserves are only delaying inflationary pressure. These are persistent changes, not short term changes ... if they were minor short term trends i would agree.. but they arent.. 100% changes in basic neccessities over a period of years, used by ALL, can not simply be discounted..

I agree inflation is relative.. in physics terms you can define it as acceleration rather than speed (i.e. rate of change)..

Even if oil and other commodities, raw materials etc dont rise (stay steady), sooner or later these costs will be borne by the customer.. at the moment companies are absorbing these costs.. there hasnt been much productivity gain, hence it is impacting their margins.. so far they have been able to get away with it because china has absorbed a lot of these costs, and secondly cheap debt has allowed consumers to buy more (for companies this means more sales at lower margins)... but when china cant absorb these inflationary pressures and consumer sales start slowing (1st qrt 08) these costs are either:
a). going to hit company profits, or
b). passed on to consumer

B will result in inflation.. suddenly cost of many goods: clothing, footwear, certain electronics, fertiliser (already happening), food, meat, eggs, transport, travel, labour/wages etc will go up .. fed is taking a massive risk waiting for this to happen before acting.. and thats my point... raising rates at this point will be too late..

A will result in corporate bankrupcies etc as profits erode and it is not feasible to operate under high costs, low profits.. unemployment etc etc..

Agree with the outcome (profits eroded, unemployment etc) - if cheap Chinese imports now cost more then it is going to be tough.

But if these increases are real increases and not a monetary issue - i.e. it actually genuinely costs more to produce or import this stuff then there is nothing the fed can do about it. Raising rates won't help as its not a monetary issue - these things now cost more and the standard of living must drop as a result.

So the fed is looking for inflation caused by inflation expectations which is a different thing. They try to get an understanding of it by looking at core inflation. I also think the measure is a bit dodgy as its too narrow and they miss stuff but I understand why they do it. If oil goes from $20 to $100 and then stays there then inflation will take a short term hit but will then level off - it is a permanent change that will impact people's lives but it is out of the scope of the central bank's mandate.

 

[komstak]

Do you think this will happen in Australia?

http://finance.yahoo.com/real-estate/article/104024/Will-Home-Prices-Hit-Bottom-in-2008-YesBut

 

[trendsta]

Agree with the outcome (profits eroded, unemployment etc) - if cheap Chinese imports now cost more then it is going to be tough.

But if these increases are real increases and not a monetary issue - i.e. it actually genuinely costs more to produce or import this stuff then there is nothing the fed can do about it. Raising rates won't help as its not a monetary issue - these things now cost more and the standard of living must drop as a result.

So the fed is looking for inflation caused by inflation expectations which is a different thing. They try to get an understanding of it by looking at core inflation. I also think the measure is a bit dodgy as its too narrow and they miss stuff but I understand why they do it. If oil goes from $20 to $100 and then stays there then inflation will take a short term hit but will then level off - it is a permanent change that will impact people's lives but it is out of the scope of the central bank's mandate.

i see your point of view..
i have learnt something new today .. thanks..

the impact i still see though, and think you're agreeing with me here, is that things like oil (wheat, iron ore, coal, soy beans, etc etc) are primary and needed as input for a lot of things.. in their own they may not impact inflation.. but once their costs are passed on to secondary and finished goods ,that use them as raw materials, thats when you get the 'core' inflation .. it still seems risky business to me to wait till that time..

 

[yieldmatters]

i see your point of view..
i have learnt something new today .. thanks..

the impact i still see though, and think you're agreeing with me here, is that things like oil (wheat, iron ore, coal, soy beans, etc etc) are primary and needed as input for a lot of things.. in their own they may not impact inflation.. but once their costs are passed on to secondary and finished goods ,that use them as raw materials, thats when you get the 'core' inflation .. it still seems risky business to me to wait till that time..

Yes - these things are getting more expensive and it will be a big shock to the economy. Either get more productive or get poorer.

 

[Mofra]

Do you think this will happen in Australia?

http://finance.yahoo.com/real-estate/article/104024/Will-Home-Prices-Hit-Bottom-in-2008-YesBut

komstak,

There are two major differences in Australia:

a. The level of housing construction in the US that precipitated the price retraction was much higher than our current or recent past development activity. Local government restriction on land releases, and the big domestic development companies land banking only serve to artificially increase this upward pressure.

b. (Arguably) we have higher credit standards in Australia. Non conforming loans & sub prime loans are only a fraction of market share in comparison with the US.

 

[Sunfish]

The thread started with the proposition that interest rates would rise twice, soon.

Forecasts of where interest rates are headed have been notoriously wrong, usually on the high side, and I think this could be another case of the same mistake.

The US Fed seems unable to contain the sub-prime fiasco alone, as shown by other central banks being forced to join them in a "rescue bid" late last week. Like AIDS, the yanks have exported the "sub-prime" virus around the world and it will only be contained with worldwide remedial measures. These measures will have interest rate cuts as their primary weapon.

Even if we don't cut, we can't swim against the tide.

 

[willair]

Even if we don't cut, we can't swim against the tide.

Columbia Management, which is a unit of Bank of America, is shutting down its Strategic Cash Portfolio, which is an "enhanced cash fund." That means it moves out the risk curve to try and earn a little more than your average money market fund. This is a fund for institutional investors with a $25 million dollar minimum. The fund had roughly $34 billion, but it seems that some $21 billion wanted to redeem. Typically, such redemptions would be at $1 per share, just like a money market fund. But enhanced cash funds are not required to maintain a $1 per share valuation, which is why they are allowed to invest in riskier paper, like short term commercial paper from SIVs (Structured Investment Vehicles) backed by asset backed securities. So, technically B of A did not break the buck, as they were not required to maintain the value of the fund at $1.

However, the assets of the fund had fallen to less than $1. If Columbia/B of A allowed the larger investors to go at $1, then that means more losses for those who did not redeem. So, they decided to close the fund. Not an easy decision, as my guess is that the fund was generating close to $60 million in annual fees, assuming a 20 basis point management fee.

And since GE Asset Management had closed a similar fund a few weeks ago at $.94, B of A decided to follow the precedent. Sort of. The large investors in the $21 billion pool will not actually get the 99.4 cents the smaller investors will get. They are actually going to be given their share of the actual assets of the funds, called a "distribution in kind." So some state pension fund is going to be given a collection of SIV commercial paper and who knows what else and wished best of luck in getting your money. If I was an investor, I would not be very happy. Exactly what trading desk at a pension fund is going to sell those assets? And to whom and for what price? Isn't that the reason you gave the money to B of A in the first place? To let them do the management?

Giving investors their assets back "in kind" is a huge black eye for B of A. Why would they do it? My guess is that there is simply no way to value or cash out some of the portfolio, as clearly much of the portfolio is illiquid in the short term, and would have to be sold at a loss if they had to go to the market in size.

Now, maybe that's what the investors wanted to do. I don't know. But as Michael Lewitt wrote this week:

"All in all, this is nothing less than a disaster for Bank of America and Columbia Management from a reputational standpoint even if investor losses turn out to be relatively minor. It is also a sign of just how severely strained short-term money markets have become in the current credit market meltdown."

There is never just one cockroach. There are a lot of these enhanced cash funds. I called one of the smarter bond managers I know, John Woolway, and asked him for his thoughts on these funds. While he manages bond portfolios for individuals, he has had the cash portion of their portfolios in treasury funds since the summer, as he could see the problems were going to develop. And he thinks it could get worse. (I will be happy to send you John's email if you like. Just drop me a note.)

There are a lot of mutual funds which are essentially enhanced cash funds. You should check out what kind of cash fund you are in. If you are in one of these enhanced funds which has exposure to asset backed commercial paper, my suggestion would be to get out now. Maybe the fund you are in will not have problems, but you can bet the guys running the B of A fund were smart guys who thought they understood the risks. It is just not worth the risk for an extra 1%.

The risk is that there is a "run on the bank" in these funds, and that the funds sell the most liquid assets to meet redemptions, leaving the problematic assets in the fund. In theory, they are marked to market, but if there is not a market price, how do you know what the price is? Maybe those assets eventually get marked higher. Maybe not. Do you really want to be in a fund that is under pressure?

Please note that I am not suggesting that you redeem from ordinary money market funds! There is a big difference. Just the funds with exposure to asset backed commercial paper. There is a simple rule. If you want higher returns, you are going to take more risk, and I think the lengthy period of stability that we have seen lulled investors into forgetting that principle. This is a market that is re-pricing risk.

Inflation Rears it Ugly Head

http://www.gloomboomdoom.com/public/pSTD.cfm?pageSPS_ID=4210

 

[alexlee]

Australia doesn't have to cut or raise interest rates with the US: but the effects will show up in the exchange rate. If the Fed cuts and the RBA doesn't, it means the AUD will appreciate against the USD. The reverse happened a few years ago: the RBA didn't raise rates to support the dollar to avert recession even as the AUD dropped past 50 US cents.

Of course, a high dollar will cause a deterioration in the current account as imports 'cost' less (and will likely increase) and exports cost more (for overseas buyers) and we get less in AUD terms. I think the RBA will keep raising rates until inflation is controlled. Unfortunately, with some components of inflation being essentially independent of interest rate rises (such as food, which is increasing from weather conditions, ethanol production and China for example consuming more meat, oil, which is subject to geopolical concerns, and rent, which is ironically rising precisely because interest rates are rising so fewer investors are buying IPs), people will have to cut back on other things to compensate.

Actually the concerted action by the 5 central banks is precisely designed to NOT solely depend on interest rates. The facility allows the central banks to inject liquidity directly instead of just dropping rates, especially as dropping rates doesn't seem to be working because banks don't trust each other.

One possibility raised by the media about this is that it allows the Fed, for example, to raise rates if inflation gets out of hand and still inject liquidity into the market to stop it from freezing up. Bernanke knows interest rates don't have as much influence as they used to, ironically because China and the Middle East hold so much USD. Greenspan had this problem when he kept raising the official rate but it didn't get reflected in the yield curve because China et al kept shoving USD back into the system, keeping rates down. This in part made the mortgage bubble bigger. Bernanke is well aware of this.

Whether they can balance so many balls is another issue.
Alex

 

[Ausprop]

Of course, a high dollar will cause a deterioration in the current account as imports cost more and exports fall in AUD terms.

just to be picky, imports will costs less however volumes may raise... arguably. I am an advocate of a strong currency

 

[trendsta]

As predicted earlier, this fiasco will impact other companies with high debt..

Centro close to collapsing today, after reporting difficulties in funding its short term debt. Looks like even debt backed by prime commercial real estate, in a strong ecnomy like australia, isnt safe in investors eyes .. PERCEPTION of risk has gone up.. this is NOT a liquidity problem.. wish central bankers would stop treating it like one and fanning more inflation..