Recap 4-30-12

Main Items:

· Chicago PMI dropped to 56.2 in Apr vs 60 exp and 62.2 prev. While still strong, this represents the lowest print since Nov 2009. Time will tell how much of this was seasonal payback related.

· Dallas Fed declined to -3.4 in Apr vs 60 exp and 62.2 prev

· US Personal Income rose 0.4% in March vs 0.3% exp and 0.2% prev. Personal Spending declined to 0.3% vs 0.4% exp and 0.8% prev.

· Core PCE Deflator increased to 2.0% as exp vs 1.9% prev

· Canadian GDP declined to 1.6% YoY in Feb vs 2.1% exp and 1.7% prev

Overseas:

  • EU M3 increased to 2.8% on a 3m avg rate.
  • EU CPI Flash Est declined to 2.6% YoY vs 2.5% exp aned 2.7% prev
  • German Retail Sales increased to 2.3% YoY in March vs 0.5% exp and 1.7% prev
  • South Korea Mfg Business Survey improved to 90 in May vs 85 prev.

Upcoming Data:

  • Mon: South Korea CPI, AustraliaMfg PMI, China Mfg PMI
  • Tues: RBA, UKMfg PMI, US ISM, China HSBC Mfg PMI, US Vehicle Sales
  • Wed: Swiss Mfg PMI, Italy Mfg PMI. German Unemployment, US GDP, China Non-mfg PMI
  • Thurs: UK PMI Services, EU PPI, ECB, US ULC, Initial Jobless Claims, ISM Non-mfg, China HSBC Services PMI
  • Fri: Italy PMI Services, EU Retail Sales, US Payrolls, Unemployment

Commentary:

Hugh Hendry’s April investor letter is a good read. One of his views is that we will get bouts of deflation prior to an inflationary impetus. This actually dovetails well with a thought experiment I’ve been playing with. Namely, what happens if central banks take QE to massive levels?

For the most part, market participants have had a very poor record of predicting the effects of QE. Starting with Japan almost a decade ago, to events over the past few years, most forecasts of the macro economic effects have been incorrect. In the thought experiment below, I simply tried to show how system balance sheets change in a hypothetical economy following QE. (Cells in yellow are the fields that changed at each stage) Notes for each stage are at the bottom. Note that I do NOT think this will happen in the US – but it is possible in Japan. Ultimately, the ‘tipping point’ may be private sector confidence in the banking system. However, in the meantime, long government bonds may be the right bet. As always, comments & disagreements are welcome.

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3 thoughts on “Recap 4-30-12

  1. I wish I’d noticed this earlier. I think you’ve made a big mistake here by omitting the government and the external sector, that would start soaking up that cheap financing – like it happened to real world Japan. Also, the assumption of static government debt seems wrong to me. Finally, you assume no pick-up in private sector demand, that would start eating up the cash reserves and raising loans (don’t forget that there can easily be mismatches in the private sector and many agents would probably be left without all that cash).

    Still, this is a fun way to analyze things:)

    1. I wish I’d noticed this earlier. I think you’ve made a big mistake here by omitting the government and the external sector, that would start soaking up that cheap financing – like it happened to real world Japan. Also, the assumption of static government debt seems wrong to me. Finally, you assume no pick-up in private sector demand, that would start eating up the cash reserves and raising loans (don’t forget that there can easily be mismatches in the private sector and many agents would probably be left without all that cash).

      Still, this is a fun way to analyze things:)

  2. I tried to keep it simple, with the goal of thinking about what the end game is. But it is certainly worthwhile to think about how other sectors would adjust.

    I assumed that private sector demand would not pick up because if it did pick up sufficiently, the exponential amounts of QE would probably not be executed.

    You’re probably right that government debt will likely increase given the scenarios above, although I’m not sure if it would be a result of low interest rates as versus say deleveraging pressures. If public debt increases gradually, like in Japan, the end state may not be very different. Ultimately, the central bank would have to purchase more public debt because both the banking and private sectors are limited by how much equity they have. In other words, more QE.

    In this scenario, if coupons are low, this could go on for a long time. Public debt can continue to rise in conjunction with newly printed central bank reserves as long as public faith in the central bank / currency remains, AND loan growth at banks is limited. Assuming the later condition is satisfied due to secular forces like labor force shrinkage, things can continue until domestic investors start converting their deposits into other currencies. After all, currencies are like gold in that its value is inherently psychological.

    Note also that a depression or an extended recession could be a trigger. Ultimately, if a sufficient number of people stops using the banking system, (possibly due to economic hardship) ponzi style finance could proliferate. The resultant quick jump in leverage could also trigger inflation and/or a loss of faith in the currency.

    A final possibility is that JPY appreciation could occur quickly once its Current Account balance falls into a deficit.

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