The ECB's Vicious Circle

Saturday, June 07, 2008

Posted by Macro Man at 8:06 AM  


==> US consumption comes crashing down ==> commodities go down again (at least in euro terms) ==> inflation again on target.
Of course this won't happen without pain for the eurozone too, but the main guest of honor on this particular party is the (not so) little piggie called US consumer. So let the festivities begin.

Anonymous said...
9:17 AM  

Wither the ECB. It may be a tad early but I think Macro Man can make some very good money being long euribor and short sterling contracts, for the very reasons you are bearish on stocks.

I don't really agree with your vicious circle, I don't think a weak dollar is the main driver of crude prices, just one of many factors. And a strong euro should help to slow the very inflation that Trichet is so worried about.

One of the major houses had a great chart yesterday, it overlaid crude onto the Shanghai index, but shifted the Shanghai stocks backward by about 7 months. The correlation of the SHIFTED prices was nearly 90%. And look out below crude, because it's right about now (in crude terms) that Shanghai started a huge move down.

I think China is the root cause of crude, at the end of the day. So to me there is solid logic for this relationship to hold, particularly if China adjusts or eliminates its energy subsidies.

From a larger perspective none of us really knows what to make of all this and so it's very tough to make money. I got my head handed to me yesterday being short crude and short EUR, with relatively small positions.

But what I do have strong conviction on is that because wages are still relatively tame, once commodities stop going up, inflation should stop in its tracks. And I think demand destruction will see to that, esp in the emerging world.

So Trichet you got me good today, but as the governor of California once said, "I'll be back."

Steve said...
11:46 AM  

$30 per barrel war risk.

Anonymous said...
12:20 PM  

The only thing that will help this would be for the rest of the world to dump their US treasury and dollar holdings and shove the inflation monster right back at the source which is the US and the dollar reserve currency. The US economy would collapse but they richly deserve that having spent more then they have produced for far to long. The empire is dying.

Anonymous said...
1:06 PM  

Seems like Trichet and the ECB are on the right side of the inflation argument.

The vicious inflation cycle is a dollar-zone phenomenon. Lower US rates stoking inflation in pegged currency countries (China/Petrostates), which feed into the US consumer complex. Kills US GDP then you need to cut more...

prophets said...
4:37 PM  

ANon @ 9.17..If the US consumer is the main issue here, than isn't ECB tightening (or not) irrelevant?

Steve, I am avoiding outright longs in Euribor and short £ like the plague, because there's too many damaged people playing those markets. Frankly, given that you have to get both the basis and the policy rate right, I am happy to give them a miss for now. I do have a curve trade on in euro $ which has worked quite well...I must be one of the few macro guys out there whose book entitled "short end" has made money (albeit modest dough) over the past few months.

I don't think the dollar is the main driver of the level of crude, but I do think it is an important contributor, particularly during periods of impulsive weakness, a la the last two days. Obviously, May was a different story, but I do think my little schematic is a pretty good summary of Thursday and Friday.

One could argue that if China were to end its energy subsidies, Chinese demand for crude would rise (assuming that consumers were charged world prices), and refiners would not have to worry about locking in negative margins, which has helped cause shortages in China for energy usage. And chalk me up as one who think Chindia demand for energy is secular and ain't going away for a long, long time.

Prophets, don't get me wrong, I think the main cause of commodity price inflation is overlay lax monetary policy in the dollar bloc...primarily by mercantilist piss takers, but strongly exacerbated by the Fed. It was only six weeks ago that I wrote Rather than asking what the ECB is smoking, Macro Man can't help but wonder what the market is smoking for thinking the ECB shouldn't hike.

Macro Man said...
5:07 PM  

Friday's crude looks alot like the end of the party from this seat. Political intervention in Europe is now absolutely inevitable - and expect it within the month, if not the week.


Anonymous said...
5:07 PM  

The U.S. is help hostage by TPTB, as per Congressman Paul's statement. It also is difficult to get out from under the "Fed's Reserve Note" aka "Dollar" if you live in the U.S.

May 14, 2008
Washington , DC - This morning at a Joint Economics Committee Hearing Congressman Ron Paul had the opportunity to question former Federal Reserve Chairman Paul Volcker on the economy and the credit crisis.

The hearing was entitled “Wall Street to Main Street: Is the Credit Crisis Over and What Can the Federal Government Do to Prevent Unnecessary Systemic Risk in the Future?”

Volcker mentioned in his opening remarks that the United States suffers from overconsumption, and that we cannot sustain the current build up of debt. He postulated that consumers could be realizing that fact and shifting spending habits accordingly.

Congressman Paul decried the ability of the Federal Reserve to now buy virtually anything as an asset to hold as collateral. In addition to mortgage-backed securities, they can also buy credit card securities, student loan securities, and car loan securities.

Congressman Paul pointed out that the roots of the current crisis are a misunderstanding of capital and debt, over-regulation rather than under-regulation, and the Federal Reserve’s distortion of the marketplace with artificially low interest rates and promises of bailouts which encourage malinvestment and irresponsible behavior among banks.

Anonymous said...
5:15 PM  

if you watched the exchange of Ron Paul and Paul Volcker carefully (which I did), you would see that Volcker didn't completely agree w/ Paul and it is LACK of regulation that let cowboys on wall street run wild, not zero regulation.

Ron Paul is way off base here.

prophets said...
8:54 PM  

From the comments no one seems to think the Fed will raise rates. . .however, I think that they will, the inflation hawks are gaining ground in the U.S., and when that happens we will see 1931 like circumstances with a disruption in capital/flows, and trade.

Ask yourselves what will happen if the Fed raises rates THIS month, and "beats" ECB to the Punch, which may be what the ECB has in mind?

peconomist said...
9:32 PM  

Steve: I couldn't find the chart you're referring to, comparison between crude and shanghai index, which ibank published it ?

Nil said...
9:38 PM  

Seems like Oil is being seen by the market as a dollar neutral T-Bill. Sort of like the classic pattern of stocks tanking and everyone running to treasuries. Treasuries are pricey and there is "other shoe" risk with the dollar so now when stocks and/or the dollar tank everyone runs to crude. Goodbye Crude the commodity, Hello crude the asset class. Probably will end in tears, I recall houses weren't supposed to go down in value either.

That is overlaid on a concern that oil supply is not going to keeps up with demand growth, wars and rumors of wars, etc. I have read that supplies are to be tight for the next 5 years or so. Hopefully a new occupant in the most exclusive real estate in D.C. will lower the geopolitical risk.

HoosierDaddy said...
2:14 PM  

This doesn't make sense. In this closed circle oil would not go up in euros, but in dollars.

Anonymous said...
2:30 PM  

Anon @ 2.30, that would only be the case if the euro and oil had the same liquidity and volatility. If I buy $50 mio worth of euros, I may move the price 2 bps. If I buy $50 mio worth of oil (370,000 barrels), I can assure you that the price will move more than that. When the price of oil goes up, it goes up against everything. Failure to understand that is one of the fatal flaws of inflation targeting.

Macro Man said...
3:52 PM  

Well, as a dummy I can still assure you all that a +12 % curde price increase in two days is not driven by true demand! Supply then ? Less likely as well...

So speculation is the answer and all speculation comes to an end sooner or later...

Anonymous said...
10:54 PM  

To "peconomist" who called for fed rate hikes in response to "inflation"

- are unit labour costs likely to rise in an enviroment of rising unemployment? - NO

- is labour predominantly unionised in the US - NO (it has one of the world's most flexible labour markets

- are we therefore likely to see a cost push wage inflation spiral in the US - NO

- have you reads Bernanke's paper (1997) "systematic monetary policy and the effects of oil price shocks" in which he argues that a large proportion of the reason why a recession followed monetary tightening was becuase of the monetary policy response (in hiking) - given your comments, doesn't look like it..

I think in 12months time, we will be worrying about deflation in the US and helicopter ben will be circling the skies - i very much believe the US will be using quantiative easing in the not so distant future...

A Thinker.. said...
12:55 AM  

and what if the US gets a price-poverty spiral?

Oil goes up. US economy tanks.

US lowers rates. Dollar crashes.

Oil goes up. US economy tanks more.

US lowers rates. Dollar Hammertimed again. US economy tanks more.

China unpegs yuan to maintain oil buying power.

Anonymous said...
4:11 AM  

Nil, it was Merrill. You can replicate it if you have a Bloomberg by cutting and pasting weekly data for CL1, for the Shanghai index, and by shifting the Shanghai index so that its peak corresponds with today's crude price. You can then graph it using Excel.

Yet another day for the financial history books today...

Steve said...
4:36 PM  
chamika said...
5:54 AM  

It looks a little bit different from the other problems facing in other countries.There will be solutions taken for this.The content which has shown here seems to be pretty interesting.
chamika vinodani
Wide Circles

chamika said...
6:10 AM  

But what I do have strong conviction on is that because wages are still relatively tame, once commodities stop going up, inflation should stop in its tracks. And I think demand destruction will see to that, esp in the emerging world.


martin said...
8:05 PM  

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