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Lower Inflation Liberates the Fed

Mon, Jun 22 2009, 05:43 GMT
by Wachovia Research Team

Wells Fargo Investments, LLC


U.S. Review

Lower Inflation Liberates the Fed

Worries about inflation have clearly gotten ahead of themselves. While we believe inflation is a monetary phenomenon over the long run, lags between stronger money growth and rising inflation are long and variable. The Fed still has plenty of time to drain the liquidity it provided in the aftermath of the financial crisis before a troublesome inflation takes hold. Bond investors will likely remain edgy until such a plan materializes, as they should.

Bond investors, policymakers, and consumers are right to be concerned about the rapid money growth. Money supply growth, both M1 and M2, is up at a 9.5 percent annual rate since November and the monetary base is up at a 53.1 percent annual rate over this period, which means money growth would be even stronger if lending actually picked up.

Of course the whole purpose of flooding the economy with reserves was to stabilize the financial markets, so that lending could revive. So the Fed’s task is now to drain the excess liquidity they provided just as the economy revives, without killing off the recovery or enraging Congress.

The Economic Environment will Make the Fed’s Task Difficult

The economic environment the Fed will likely face during this period will not make things easy for policymakers. While we see the recession ending later this year, unemployment is likely to continue rising well into 2010. The last two recessions saw the unemployment rise 15 months and 19 months, respectively, after the recession ended. If, as we expect, the recession ends this summer, and the unemployment rate rises along the lines that it did following the past two downturns, then the unemployment would peak in late 2010 or early 2011. With the unemployment rate currently at 9.4 percent, the jobless rate will almost certainly top out in the low double digits and could quite possibly rise above the post-depression high of 10.8 percent hit back in 1982.

Unemployment Rate

Politics could make the Fed’s job even tougher. Next year will mark a contentious mid-term congressional election and voters are likely to be antsy, particularly in states with high unemployment rates. The latest state unemployment figures, which came out today, show that 12 states and the District of Columbia already have unemployment rates above 10 percent, including large states, such as California, Florida, and Michigan. Even if the unemployment rate peaks sooner than it did following the past two recessions, it will still likely be uncomfortably high come election time. Draining liquidity without wrecking the recovery or upsetting Congress would require skills tantamount to pitching back-to-back no hitters.

For all the worries about inflation, the latest inflation figures show little reason to be concern. The Consumer Price Index rose just 0.1 percent in May, both on an overall basis and after excluding food and energy prices. Price increases were tame pretty much across the board. One notable exception was gasoline prices, which rose 3.1 percent in May. With the economy struggling, rising gasoline prices are having more of a dampening effect on consumer spending than they are on pushing prices higher in related industries. Prices for airfares, for example, declined sharply. Food prices are also moderating, particularly for fruits and vegetables, which are among items that are most sensitive to higher fuel costs.

Looking back further in the production pipeline there is even less reason to be concerned about inflation in the near term. The Producer Price Index rose 0.2 percent overall but fell 0.1 percent after excluding food and energy prices. Price increases were even better behaved further back in the production pipeline, with core intermediate goods prices falling 0.2 percent in May and tumbling at a 5.6 percent annual rate over the past three months.


Global Review

Is the U.K. Economy Nearing Bottom?

Real GDP in the United Kingdom dropped at an annualized rate of 7.3 percent in the first quarter, the steepest sequential rate of decline in 30 years, and recent monthly indicators suggest that the economy has continued to contract, albeit at a slower rate, in the second quarter. For starters, the labor market has continued to deteriorate. The number of unemployed workers rose by 39,300 in May, which was not quite as bad as expected. However, the unemployment rate, which has shot up rapidly since last summer, rose further. Indeed, unemployment is currently at the highest rate since the late 1990s.

Unemployment Rate

The weakness in the labor market has caused wage growth to slow sharply in recent months. Last autumn, average earnings (excluding bonuses) were growing at a year-over-year rate of 3.6 percent. In April, earnings were up only 2.7 percent. If bonuses are included, the slowdown is even worse (top chart). Because bonuses for most employees were cut significantly last autumn, total earnings in April were up only 0.8 percent.

Average Earnings

With earnings growing so slowly, it is little wonder that retail spending has slowed significantly over the past year or so. Indeed, real retail sales in May were down 1.6 percent relative to the same month last year. Another factor that may have depressed real spending in May was the rise in consumer prices during the month. Although CPI inflation has receded since last year’s spike, which was induced largely by higher energy prices, the overall CPI rose 0.6 percent in May relative to the previous month. Although the increase in petroleum prices helped to lift overall consumer prices in May, the “core” CPI was up 0.4 percent as well. With prices up, consumers have less purchasing power.

Core CPI

Recent survey data from the manufacturing sector also are consistent with continued contraction. A widely followed monthly survey indicates that the volume of output produced remained weak through June (middle chart). That said, the survey also suggests that the contraction in output in the second quarter was not as rapid as it was in the first quarter. Indeed, “hard” data that were released last week showed that industrial production in April edged up 0.3 percent relative to March, the first monthly increase in more than a year.

U.K. Manufacturing

In sum, the evidence suggests that the British economy, which has already contracted for four consecutive quarters, has not hit bottom yet. By our reckoning, real GDP will decline at an annualized rate between one and two percent in the second quarter. Although growth should turn positive in the second half of the year, we project that the upturn next year will remain sluggish as indebted consumers reduce leverage.

Signs that the U.K. economy may be nearing bottom have contributed to sterling’s rise versus the dollar over the past few months (bottom chart). The pound has come a long way in a fairly short period of time, so some retracement is inevitable. Sterling probably won’t fall back to the lows of early 2009, but a pullback seems likely in the months ahead as investors question the sustainability of the eventual recovery.

Exchange Rates

Published on  Mon, Jun 22 2009, 06:32 GMT


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https://www.wellsfargo.com/ | sam.bullard@wachovia.com

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Recently, the stock market has experienced high levels of volatility. If you are thinking about participating in fast moving markets, please take the time to read the information below. Wells Fargo Investments, LLC will not be restricting trading on fast moving securities, but you should understand that there can be significant additional risks to trading in a fast market. We've tried to outline the issues so you can better understand the potential risks. If you're unsure about the risks of a fast market and how they may affect a particular trade you've considering, you may want to place your trade through a phone agent at 1-800-TRADERS. The agent can explain the difference between market and limit orders and answer any questions you may have about trading in volatile markets. Higher Margin Maintenance Requirements on Volatile Issues The wide swings in intra-day trading have also necessitated higher margin maintenance requirements for certain stocks, specifically Internet, e-commerce and high-tech issues. Due to their high volatility, some of these stocks will have an initial and a maintenance requirement of up to 70%. Stocks are added to this list daily based on market conditions. Please call 1-800-TRADERS to check whether a particular stock has a higher margin maintenance requirement. Please note: this higher margin requirement applies to both new purchases and current holdings. A change in the margin requirement for a current holding may result in a margin maintenance call on your account. Fast Markets A fast market is characterized by heavy trading and highly volatile prices. These markets are often the result of an imbalance of trade orders, for example: all "buys" and no "sells." Many kinds of events can trigger a fast market, for example a highly anticipated Initial Public Offering (IPO), an important company news announcement or an analyst recommendation. Remember, fast market conditions can affect your trades regardless of whether they are placed with an agent, over the internet or on a touch tone telephone system. In Fast Markets service response and account access times may vary due to market conditions, systems performance, and other factors. Potential Risks in a Fast Market "Real-time" Price Quotes May Not be Accurate Prices and trades move so quickly in a fast market that there can be significant price differences between the quotes you receive one moment and the next. Even "real-time quotes" can be far behind what is currently happening in the market. The size of a quote, meaning the number of shares available at a particular price, may change just as quickly. A real-time quote for a fast moving stock may be more indicative of what has already occurred in the market rather than the price you will receive. Your Execution Price and Orders Ahead In a fast market, orders are submitted to market makers and specialists at such a rapid pace, that a backlog builds up which can create significant delays. Market makers may execute orders manually or reduce size guarantees during periods of volatility. When you place a market order, your order is executed on a first-come first-serve basis. This means if there are orders ahead of yours, those orders will be executed first. The execution of orders ahead of yours can significantly affect your execution price. Your submitted market order cannot be changed or cancelled once the stock begins trading. Initial Public Offerings may be Volatile IPOs for some internet, e-commerce and high tech issues may be particularly volatile as they begin to trade in the secondary market. Customers should be aware that market orders for these new public companies are executed at the current market price, not the initial offering price. Market orders are executed fully and promptly, without regard to price and in a fast market this may result in an execution significantly different from the current price quoted for that security. Using a limit order can limit your risk of receiving an unexpected execution price. Large Orders in Fast Markets Large orders are often filled in smaller blocks. An order for 10,000 shares will sometimes be executed in two blocks of 5,000 shares each. In a fast market, when you place an order for 10,000 shares and the real-time market quote indicates there are 15,000 shares at 5, you would expect your order to execute at 5. In a fast market, with a backlog of orders, a real-time quote may not reflect the state of the market at the time your order is received by the market maker or specialist. Once the order is received, it is executed at the best prices available, depending on how many shares are offered at each price. Volatile markets may cause the market maker to reduce the size of guarantees. This could result in your large order being filled in unexpected smaller blocks and at significantly different prices. For example: an order for 10,000 shares could be filled as 2,500 shares at 5 and 7,500 shares at 10, even though you received a real-time quote indicating that 15,000 shares were available at 5. In this example, the market moved significantly from the time the "real-time" market quote was received and when the order was submitted. Online Trading and Duplicate Orders Because fast markets can cause significant delays in the execution of a trade, you may be tempted to cancel and resubmit your order. Please consider these delays before canceling or changing your market order, and then resubmitting it. There is a chance that your order may have already been executed, but due to delays at the exchange, not yet reported. When you cancel or change and then resubmit a market order in a fast market, you run the risk of having duplicate orders executed. Limit Orders Can Limit Risk A limit order establishes a "buy price" at the maximum you're willing to pay, or a "sell price" at the lowest you are willing to receive. Placing limit orders instead of market orders can reduce your risk of receiving an unexpected execution price. A limit order does not guarantee your order will be executed -" however, it does guarantee you will not pay a higher price than you expected. Telephone and Online Access During Volatile Markets During times of high market volatility, customers may experience delays with the Wells Fargo Online Brokerage web site or longer wait times when calling 1-800-TRADERS. It is possible that losses may be suffered due to difficulty in accessing accounts due to high internet traffic or extended wait times to speak to a telephone agent. Freeriding is Prohibited Freeriding is when you buy a security low and sell it high, during the same trading day, but use the proceeds of its sale to pay for the original purchase of the security. There is no prohibition against day trading, however you must avoid freeriding. To avoid freeriding, the funds for the original purchase of the security must come from a source other than the sale of the security. Freeriding violates Regulation T of the Federal Reserve Board concerning the extension of credit by the broker-dealer (Wells Fargo Investments, LLC) to its customers. The penalty requires that the customer's account be frozen for 90 days. Stop and Stop Limit Orders A stop is an order that becomes a market order once the security has traded through the stop price chosen. You are guaranteed to get an execution. For example, you place an order to buy at a stop of $50 which is above the current price of $45. If the price of the stock moves to or above the $50 stop price, the order becomes a market order and will execute at the current market price. Your trade will be executed above, below or at the $50 stop price. In a fast market, the execution price could be drastically different than the stop price. A "sell stop" is very similar. You own a stock with a current market price of $70 a share. You place a sell stop at $67. If the stock drops to $67 or less, the trade becomes a market order and your trade will be executed above, below or at the $67 stop price. In a fast market, the execution price could be drastically different than the stop price. A stop limit has two major differences from a stop order. With a stop limit, you are not guaranteed to get an execution. If you do get an execution on your trade, you are guaranteed to get your limit price or better. For example, you place an order to sell stock you own at a stop limit of $67. If the stock drops to $67 or less, the trade becomes a limit order and your trade will only be executed at $67 or better. Glossary All or None (AON) A stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were filled or killed. Day Order A buy or sell order that automatically expires if it is not executed during that trading session. Fill or Kill An order placed that must immediately be filled in its entirety or, if this is not possible, totally canceled. Good Til Canceled (GTC) An order to buy or sell which remains in effect until it is either executed or canceled (WellsTrade® accounts have set a limit of 60 days, after which we will automatically cancel the order). Immediate or Cancel An order condition that requires all or part of an order to be executed immediately. The part of the order that cannot be executed immediately is canceled. Limit Order An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases). Maintenance Call A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity. Margin Requirement Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales. Market Makers NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. Although this article may provide information relating to approaches to investing or types of securities and investments you might buy or sell, Wells Fargo and its affiliates are not providing investment recommendations, advice, or endorsements. Data have been obtained from what are considered to be reliable sources; however, their accuracy, completeness, or reliability cannot be guaranteed. Wells Fargo makes no warranties and bears no liability for your use of this information. The information made available to you is not intended, and should not be construed as legal, tax, or investment advice, or a legal opinion.

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