Thursday, November 15, 2007

[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -28.4%]

Two crisis, one sharp difference; Bank Credit Analyst & the Fed; Advance, overshoot and correct; strong economic growth in the Netherlands.

[1] Two crisis, one key difference. There is a crucial difference between the current turmoil in credit markets and the late-summer crisis: inflation breakevens. Back then, inflation expectations had all but collapsed on the back of rising credit spreads. Ten-year inflation breakevens reached a high of 246 bps on June 14, only to fall back sharply to 219 bps in eary September. [While on vacation, I wrote a quick post on August 8: MOST IMPORTANT PIECE OF NEWS: THE COLLAPSE IN INFLATION EXPECTATIONS, COURTESY OF THE INVERTED YIELD CURVE]. That's what the Fed had been expecting — and it duly acted on September 18. By the time "Helicotper Ben" eased again on October 31, inflation breakevens were back at 234 bps. Right now, rising inflation breakevens (at 240 bps), coupled with a much steeper yield curve, seem to preclude any further aggressive move by the central bank.

[2] Bank Credit Analyst & the Fed. The highly rated (and rightly so) Canadian consultants see things from a very different perspective indeed. They argue that the Fed may have fallen behind the curve in terms of policy easing: "The shift to a neutral bias by the FOMC was misplaced given the renewed rioting in the financial markets ... Rather than panic and bet on Armageddon, investors should stay focused on the rapidly rising odds of a major reflationary program, i.e. much lower rates and yields than most have envisioned. The Fed may already be easing by stealth". [Bank Credit Analyst: "Has the Fed Fallen Behind the Curve?"].

[3] Governor Warsh: "Advance, overshoot, and correct". I've always liked Governor Warsh's "watchful optimism". Credit markets may be in turmoil, but that is, perhaps, the price to pay for the ... "democratization of credit and growing access to capital"! In very Schumpeterian terms, he draws this poignant conclusion: "As in the political realm, the path to the end of history may well prove to be prone to advance, overshoot, and correct". [Kevin Warsh: "The End of History?", Federal Reserve Board].

[4] Great Moderation Watch: Dutch economic growth. Things look pretty good from Amsterdam. Yesterday, the leading local business newspaper carried a headline about the robust growth of the Dutch economy (+4.1% in Q3). Even as the euro gets stronger and the credit market turmoil deepens, exports grew at the astonishing rate of 7.5%. [Het Financieele Dagblad: "Export voert Nederlandse groei naar record hoogte"].

1 comment:

F-Trader said...

The Fed killed inflation last year by holding the FFR 0.25 higher than most economists agreed was necessary. He did this in order to have room to cut later in case he needed to reinflate per the usual malinvestments of inflationary expansionism.

Though the yield curve suggests some inflationary worries, on an absolute scale, treasury yields show that an economic slowdown is the more believed fear than inflation.