The upside? with recession looming in US/UK/EU and Asia growing more slowly, pressure on demand is not going to backfill the lack of speculation. Bottom line: commodity driven inflation will abate, it is the current spook but it is not real. In a related news, TIPS investments (inflation protected treasuries) HAD NEGATIVE REAL YIELDS AS OF YESTERDAY! meaning that the futures bet were on "NO INFLATION". Money quote from Albert Edwards:
After the biggest cost push pressures on inflation from commodity prices in decades, isn't it absolutely amazing that the best core inflation can do is hover around 2 per cent [slightly higher in the US, slightly lower in Europe and "slightly zero" in Japan]. "As commodity prices slide in this downturn, expect negative headline CPI inflation within 12 months".
I am loving it. IF this is the case, what this means is that the FED HAS A POTENTIAL SAVIOR: the bursting of the commodities bubble will give them monetary breathing room. Once that abates, they will have further leeway to print money, MAINTAIN inflation in acceptable bands and provide the liquidity.
If swapping Treasuries for mortgage securities isn't enough, 400bn of liquidity will get us to 1.5T and probably still not hit the upper band of 4%. Add less pressure on Hedges, and direct intervention in mortgage backed securities (de-securitization by Freddy and Fanny anyone?) and the US govt could even be poised to make a KILLING on oversold "toxic" mortgage securities. Done at the right time they can set a floor on those securities.
I would call the inflexion point when the commodity bubble burst and the FED follow up with liquidity/swapping/acquisition of stricken securities as they are doing. As is they still appear on the balance sheets. Which leads me to a final point. At the end of the day, all of this is handicapped by the solvency of the banks. Not liquidity, but outright solvency. No one knows, hedgies are still blowing up (3 today), and we, the larger public, really doen't know about the state of the banks. There is little the FED can do on the solvency front but give them time to make more money by extending more leverage, which would stabilize the de-leveraging.
All of this optimistic scenario can be contrasted with the bear scenario. This morning, via "Naked Capitalism", we can read that REAL inflation is 8% and that US treasury securities have basically yielded negative return for the past decade. Money quote:
But let us suppose for a moment that series is correct. If US inflation were really 8%, this would mean that interest rates in the US have been negative at all times in the last 10 years. It would mean that 10-year treasuries, which yield only a little over 4%, are massively mispriced, that a bond price crash of historic proportion would beckon, essentially wiping out a large amount of China's and Russia's wealth - countries that have heavy investors in the US. It would be a global economic catastrophe. So we are not going to switch back with ease and pleasure. There are many vested interests in not doing so.
I do not want to discuss the merit of this particular statistic - which I cannot - but I believe strongly that the Fed is absolutely wrong to target a core-inflation index (and it is not even doing that with any great conviction and success). Core inflation is supposed to be more stable, as it excludes volatile categories of food and energy, but both categories have not been volatile, but persistently rising. To exaggerate a little (well, ok, a lot): All the troublemakers are taken out of the basket, the rest is adjusted.
Oh, who do you believe. On the one hand we can see a way out by controlling inflation and on the other hand that cat has already left the bag and there really isn't any breathing room. In one scenario (low inflation and commodities burst) the fat lady is singing in 18mo. In the other, well you read Yves Smith: "Global economic catastrophe", I will play it 5 to 1.
Yesterday, Roubini and Wolf, basically argued that the FED only has ONE MORE SHOT at it... So the bad news is that it is necessary that this shot works, the good news is that it is sufficient (well... at 5 to 1 :) that this shot work.
BEN B: STEADY AS SHE GOES!!!