<inflation/deflation battle of the titans>
I would characterize the situation thusly:
1. Very large and off side hedge funds long positions in gold, oil, and anti-USD trades, combined with a big bond shorts set the stage, for a large fund liquidation in 2005.
2. The Wizards have brought out their propaganda arm, heavy on talk. However, in the current circumstances, "talk" isn't enough, so,
3. Since Dec 8th they have backed up talk with some action, and IMO have tightened monetary conditions, which I have been tracking here.
jessel.100megsfree3.com
jessel.100megsfree3.com
This in turn has led to;
4. Funds running for cover, which in turn gives the appearance of the death of emerging inflation, and even mention of the D word.
What's really going on?
1. Resources and input goods (except food, but one poor crop away from trouble, can farmers afford big plantings this season?) are still scarce, so the consumers (especially Asia) of it are trying to more actively manage the Malthusian situation. By and large they are still doing this through MoP bluff and manipulation, and eating their young (such as water injecting oil fields). However, as the situation is now more acute, they are attempting actual slow down policies (led by the US, which is also trying to stabilize the USD). The resulting reduction in some demand is reflected of late in the Purchasing.com commentary, more of a mixed pricing bag, but to me still quite stagflationary.
purchasing.com
So I would say that the combination of two months of tighter monetary conditions and an economic slowdown has momentarily (?) taken the hard edge off of what was very close to runaway inflation in 4q, 2004.
2. The easy result has been achieved, mostly by blowing out speculators. Their trading position is no longer extreme, and closer to neutral. But the fundamental supply issue is unaltered. Friday's COT on the rate structure will be interesting, to see how much betting on higher rates is gone. The economic slowdown so far was easy to achieve, but at what cost? There are a trillion bucks of HELOC loans out there, so each 25 bps increase (on each fed funds increase) in the prime rate adds $25 billion a year to Joe Sixpacks tab. His ARMs rates are notching up month by month, with the greatest surge since November.
3. Depending on who you believe (Greenspan's magic stick approach?), the twin deficits will still be between 1.0-1.2 trillion. Higher rates actually increase capital outflows to abroad. With these financing needs (the short rate financing advantage of the US Treasury is going away, forcing them down the curve),
Message 21025262
one has to question the ability of the Wizards to continue with another month or two, of turning off the money printing? If they continue, then we could be facing a severe downturn, and possible deflationary outcomes (down the road, not immediately). However, my expectation is that they will blink at the first sign of financial trouble. With carry trade spreads evaporated, that may not be long in coming. Start looking for a new term to emerge, financial disintermediation.
4. Therefore we are in a game of chicken. If the Fed and their toadies in Asia blinks (which is what I expect, but will watch daily), we are right back into the inflationary brew and geared by a weak currency. And this one will be much worse than anything seen so far. |
