Mish's Global Economic Trend Analysis

Trichet Backs off Rate Hikes; US Dollar Up Sharply; Currency Fundamentals
Weekly Unemployment Claims Soar to 474,000; Bogus Excuses Offered
Ponzi Financing Involving Copper Trade Gone Wild In China

Trichet Backs off Rate Hikes; US Dollar Up Sharply; Currency Fundamentals

Posted: 05 May 2011 01:39 PM PDT

ECB President Jean-Claude Trichet has backed off his usual way of signaling a rate hike, which is to use the phrase "strong vigilance". Instead, Trichet said today "the ECB will monitor inflation risks very closely".

The market interpreted this change as a pause in rate hikes by the ECB. Unlike most, I had been expecting this action by Trichet for many reasons. I gave some of those reasons in my speech last week at Saxo bank. (See Meeting with Saxo Bank Chief Economist; My Speech in Copenhagen; Images of Stockholm and Copenhagen) for a discussion and lots of digital images.

Why I expected Trichet to Curtail Rate Hikes

Strengthening Euro is hurting European exports
ECB's One Size Fits Germany Policy is not viable.
Rate hikes would exacerbate problems Spain, Greece, Portugal, Italy, Ireland, Greece, and Spain (the PIIGS)
The recovery in Europe is not on solid footing
Hiking rates to combat oil prices makes no sense if the spike in oil prices is not caused by a rise in demand

Fundamental Factors Affecting Currencies

Expected and actual interest rate actions
Direction of interest rate differentials
Actual interest rate differentials
Demand for dollars in debt deflation credit crunch
Deficits
Actions on Deficits
Trade imbalances

The top reason the Euro has been soaring was an expectation the ECB would hike three times or more and the Fed none. Trichet threw cold water on that expectation today, and the Euro promptly sank 3 cents vs. the US dollar.

Euro 15-Minute Chart

click on chart for sharper image

Minneapolis Fed Noise About Rate Hikes

Meanwhile, not that anyone believes it (I sure don't), but Minneapolis Fed President Narayana Kocherlakota says 'Modest' Rise in Key Rate Is Desirable This Year.

Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said it would be "desirable" to lift the target for the benchmark U.S. interest rate by a "modest amount" this year, based on his inflation forecast.

The Federal Open Market Committee "should raise the fed funds rate by around 50 basis points" if core inflation rises by 1.5 percent this year, he said today in remarks prepared for a speech in Santa Barbara, California. "Under my baseline forecast, it would be desirable for the FOMC to raise the fed funds target interest rate by a modest amount toward the end of 2011," said Kocherlakota, who votes on monetary policy.

Fed Won't Hike

I highly doubt the Fed seriously entertains the notion of hiking this year. I even have a December Eurodollar options bet on inaction by the Fed. I see a slowing economy and a likely collapse in commodity prices to boot.

However, the noise from Kocherlakota comes at the perfect time today to support the US dollar given the widely unexpected announcement from Trichet today.

Commodity Factor

Moreover, should commodities collapse, it is highly likely the commodity currencies such as the Australian dollar and Canadian dollar sink with it.

If the Reserve bank of Australia acts to support the Australian property bubble collapse with rate cuts (an action I expect but the market doesn't), that will pressure the Australian dollar.

Note once again points number 1-3 above regarding currency fundamentals. Although there is a huge interest rate differential between Australia and the US, if the direction of differential narrows, especially if it narrows unexpectedly, the Australian dollar will likely give up ground to the US dollar.

Finally, should there be another US credit crunch (an event I think is probable but have no specific time frame in mind), demand for US dollars to pay back debts will be high.

Few understand the role of credit and debt when it comes to debt-deflation demand for dollars.

All things considered, anti-US Dollar sentiment is so extreme and fundamentals so poor for other currencies (as compared to widely expected actions and commodity fundamentals), a rise in the US dollar could easily last for months to the absolute astonishment of the hyperinflation fanatics.

Everyone understands the problems with the US dollar. Few bother to look at problems elsewhere or other factors including reversals in extreme sentiment.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Weekly Unemployment Claims Soar to 474,000; Bogus Excuses Offered

Posted: 05 May 2011 10:18 AM PDT

The number of people filing initial unemployment claims soared to 474,000 this week, surpassing the most bearish forecast of all 46 economists in a Bloomberg economic survey.

Please consider the Department of Labor Unemployment Insurance Weekly Claims Report for the week ending April 30, 2011.

In the week ending April 30, the advance figure for seasonally adjusted initial claims was 474,000, an increase of 43,000 from the previous week's revised figure of 431,000. The 4-week moving average was 431,250, an increase of 22,250 from the previous week's revised average of 409,000.

Weekly Claims and 4-Week Average Up 3 Consecutive Weeks

Seasonally Adjusted 4-Week Moving Average of Initial Claims

Bogus Excuses Offered

Please consider U.S. Jobless Claims Unexpectedly Jump on Auto Shutdowns

The number of claims for U.S. unemployment benefits unexpectedly rose last week, pushed up by auto-plant shutdowns and other unusual events that seasonal variations failed to take into account, the Labor Department said.

A spring break holiday at schools in the state of New York prompted workers to file claims, which the seasonal adjustment factors didn't expect last week, the Labor Department official said. In addition, Oregon began a new emergency benefits program for the long-term unemployed that also pulled in some new claimants, he said. Finally, auto plant shutdowns due to parts shortages caused by the earthquake and tsunami in Japan also contributed to the increase, the official said.

Spring Break in New York? New Oregon Benefits?

From the first link...

The largest increases in initial claims for the week ending April 23 were in New Jersey (+5,326), Massachusetts (+4,027), Pennsylvania (+2,306), Ohio (+1,700), and Connecticut (+1,601), while the largest decreases were in Florida (-1,861), North Carolina (-1,662), Missouri (-1,618), New Mexico (-1,417), and Arizona (-1,138).

An Eye Test

Just to make sure that I am not blind, does anyone see either New York or Oregon in that list?

However, I must point out that was for the week ending April 23, not April 30. Then again, the Oregon extension kicked in for the week ending April 23.

This of course has me wondering what extended emergency benefits have to do with "initial" claims in the first place unless someone dropping off the list then coming back on a week later counts as an "initial" claim.

As a point of reference, also note the Spring Break in New York City was as follows: Monday April 18 Through Tuesday April 26 including Good Friday, Easter and Passover.

What kind of silly system allows teachers to file for unemployment benefits for a one-week recess? For that matter, why should they be able to file even for a whole summer?

Nonetheless, let's watch to see next week if there is some huge jump for New York or Oregon. If not, this was a huge smoke-blowing exercise.

Manufacturing Slowdown Theory vs. Service Sector Theory

There is some merit to the possibility of a manufacturing slowdown caused by Japan.

However, I have a more likely explanation. Here it is: Non-Manufacturing ISM Plunges Below Prediction of All 73 Economists, New Orders Collapse, Prices Firm; Did Rosenberg Capitulate at the Top?

Rate of growth in the service sector unexpected plunged in April. Employment is barely expanding. Given the service sector is a huge percentage of the economy, and the plunge was missed by 73 of 73 economists, I will stick with my explanation vs. the explanation of the Department of Labor unless proven otherwise.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Ponzi Financing Involving Copper Trade Gone Wild In China

Posted: 05 May 2011 12:05 AM PDT

As I have repeated numerous times, those looking for massive inflation can find it in China, not the United States. Demand for credit is so insane in China, that businesses will go to any length to get it.

Courtesy of Michael Pettis at China Financial Markets, please check out the insane way some companies in China obtain credit. Via Email, Pettis writes ...

In this week's newsletter I will argue that in spite of the rising wages, appreciating currency, and interest rate hikes we've seen in recent months, China is not actually rebalancing.　 Instead it is creating a change in the structure of the industrial base that may, unfortunately, be the opposite of what Beijing says it is aiming for.

But before getting into why, I want to bring up once again the goings-on in the commodity markets.　 Since January I've been writing about – and trying to figure out – the strange happenings in the Chinese copper market.　 The issue has been a regular topic of conversation in my central banking seminar at Peking University, where much of the most imaginative analysis I've seen has been done.　

China had been importing for many months far more copper than was needed for real use – and this in spite of a huge surge in domestic infrastructure and real estate development which has boosted the demand for copper.　 Imports continued even when London prices exceeded Shanghai prices by more than the equivalent of China's value-added tax.

Instead of being shipped to end users, it seems that copper was being stockpiled in warehouses.　 Why?　 One possibility of course was pure speculation.　 If you think domestic Chinese copper use is going to soar, and with it prices too, then it might make sense to buy copper and hoard it. But there seemed to be a lot more hoarding than normal, and anyway with London prices often above the tax-adjusted Shanghai prices, why would anyone want to speculate on foreign copper when it could be bought more cheaply domestically?

It turns out, that the copper purchases were not entirely, or even mainly, speculative.　 They were part of a financing scheme for companies that, in spite of the avalanche of new lending occurring both within and outside normal RMB lending, were having trouble accessing bank credit.　

credit-starved companies were importing copper because they could obtain trade finance or some other sort of foreign financing, and then used the physical copper (or warehouse receipts, I guess) as collateral for domestic borrowing.　 The financing was continually rolled over.　 Buying copper was just a way to borrow for companies that needed loans and were otherwise unable to get them.

As I mentioned two weeks ago, when I discussed this in February with a senior executive in a major commodities company, he responded by saying that he thought the same thing might also be happening in soya.　 Borrowers are resorting to some fairly convoluted and expensive ways of obtaining short-term credit largely because they cannot obtain financing from the local banks.

Here's how it works.　 Even when London prices are above Shanghai prices, companies eager for loans are importing copper in order to get back-door financing, whereas local traders, noticing that domestic demand isn't strong enough to justify those import quantities, and perhaps eager to arbitrage the prices, are selling copper abroad.　 The weird distortions in the banking system, where credit isn't rationed by price but by quantity and hierarchy, has turned China, at least temporarily, into a revolving door for copper imports and exports.　 This is great for copper traders, of course, but perhaps not so good for the overall economy since someone has to pay for those outsized trading profits.

I still need to find out more about this.　 I am only speculating and I don't have real data to support me, but it does fit together nicely into a pretty consistent narrative on everything we are hearing in China, both about copper and about credit.

China's share of total global demand for a selected list of non-food commodities:

China's share of total global demand for a selected list of food commodities:

What is most noteworthy about these tables, of course, is the disproportion between China's share of global GDP and China's commodity consumption.　

The tables give a very good sense of what might happen to global demand for various commodities as China rebalances.　

Take iron, for example.　 If Chinese demand declines by 10%, this would represent a reduction in global demand of nearly 5%.　 I am not an expert in the commodity markets, but I guess that supply and demand considerations are fairly finely balanced, and a 5% reduction in demand should have significant price repercussions – especially if a material part of Chinese demand represents stockpiling and this stockpiling is reversed.

Copper Weekly Chart

click on chart for sharper image

Note that those companies holding copper, especially those new to this wild financing scheme, are very vulnerable to a decline in the price of copper. Alternatively, those companies taking out loans based on copper collateral then selling the copper back to the exchanges have managed to get loans with no collateral.

Interestingly, Pettis insists that credit cannot really be considered tight in China, rather demand for credit has gone through the roof.

In my model, rapidly expanding credit is a sign of a huge inflation problem. For comparison purposes, many forms of credit are still stagnant or declining in the US.

This is supposed to end well? For who?

There is much more in Pettis' email including a more detailed discussion of China's rebalancing that is not happening, who pays for the adjustment, and currency valuations.

Under terms of agreement with Pettis I cannot print the entire email so I picked the section on commodities to excerpt. Pettis will post more on his website later.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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