Weekly Economic and Financial Commentary

Neither Deflation Nor Inflation Will Be A Problem In 2009

Mon, Feb 23 2009, 06:53 GMT
by Wachovia Research Team - Wells Fargo Investments, LLC | View company's profile

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U.S. Review

Is There A Silver Lining?

This week saw another run of rotten economic news. Housing starts plummeted, industrial production fell sharply, the Philadelphia Fed index hit its lowest level in more than 18 years, and first-time unemployment claims increased. Even the Fed minutes had a weaker tone. With this much crummy news, we wonder if there is a silver lining somewhere.

An apparent bright spot was a rise in the index of leading economic indicators. Though January marks the second consecutive monthly rise for the LEI, it does not likely mark a turn. Most of the improvement in recent months has come from the money supply and interest rate spread. Consumer expectations also improved in January. Expectations turned back down in February, however, and many other indicators also look like they will decline this month as well.

The January price data are both good and bad news. Both rose more than expected in January. Larger-than-expected rises in both indices would normally be bad news. But with so many folks worried about deflation, a little more heat in the PPI and CPI is not all that bad.

Neither Deflation Nor Inflation Will Be A Problem In 2009

January’s slightly larger-than-expected rise in the PPI and CPI does not impact our inflation outlook at all. The PPI for total finished goods rose 0.8 percent in January and prices excluding food and energy rose 0.4 percent. Most of the increase in the headline index was due to sharply higher gasoline prices, which rose 15 percent in January, following twenty percent plus plunges in each of the three previous months. The bounce back in energy prices is not that surprising given how sharply they declined last fall. Energy prices are expected to remain low for the foreseeable future, which should lead to further declines in the year-to-year PPI figures.

Prices outside the energy sector also perked up a bit, with wholesale prices for consumer goods rising 1.0 percent. Here too, prices had declined for some time and a bounce back is not totally unexpected. Consumer goods prices fell 2.5 percent in December and were down 3.2 percent in November. Even with January’s increase, prices are down at a startling 17.7 percent annual rate over the past three months. Moreover, prices continue to tumble further back in the production pipeline. Prices for intermediate goods and services fell 0.7 percent in January and are down at a 31.5 percent annual rate over the past three months. Core intermediate goods prices, which have historically shown the strongest relationship to the CPI, fell 1.1 percent in January and are down at a 22.2 percent pace over the past three months.

The Consumer Price Index rose 0.3 percent in January, which was right in line with expectations. As with the PPI, rising gasoline prices accounted for most of the increase. Prices excluding food and energy items rose a larger-than-expected 0.2 percent. The increase was broad based but once again, most of the categories posting increases had been down sharply in recent months.

Rent of primary residence and owners’ equivalent rent both rose 0.3 percent. The increases seem to fly in the face of the obvious oversupply of housing present throughout the country. The Census Bureau’s quarterly survey shows rental vacancy rates at 10.1 percent nationwide. High and rising vacancy rates, along with growing competition from single-family homes and condominiums now being put out for rent, should be driving rents lower.

January’s rise in rent of primary residence may be a statistical fluke. Many rental agreements include utilities. Since rents are usually fixed for one year terms, a drop in utility costs actually raises the computed rent. This seems to have been the case in January, when prices for fuel oil and other fuels declined 2.7 percent and prices for gas and electricity declined 0.8 percent.

Global Review

Global GDP Tanked Last Quarter

GDP data for foreign economies have trickled in over the past few weeks, and the outturns have been universally bad. As we reported previously, the British and the Euro-zone economies each contracted roughly six percent (annualized rate) in the fourth quarter. It was Asia’s turn this week and the news was even worse. As shown in the chart at the left, real GDP in Japan plunged at an annualized rate of 12.7 percent. Moreover, the 4.6 percent year-over-over contraction in Japanese GDP in the fourth quarter was the sharpest decline since records began in 1955. Japan appears to be in its worst downturn since the end of the Second World War.

The sharp drop in Japanese economic activity in the fourth quarter was due at least in part to the eye-popping 45 percent decline in exports. Japan is an important supplier of capital goods to the rest of the world, especially to other Asian economies, and the global recession that is underway is clearly having a very negative effect on the Japanese economy. Domestic spending in Japan is very weak as well. Personal consumption expenditures declined 1.6 percent at an annualized rate in the fourth quarter, and fixed investment spending dropped 11.3 percent.

Taiwan did not fare much better last quarter. As shown in the top chart, Taiwanese GDP in the fourth quarter fell 8.4 percent on a year-over-year basis, surpassing the previous record decline that was set during the “tech” collapse in 2001. As in the case of Japan, the rest of the world contributed to the weakness in the Taiwanese economy. As shown in the middle chart, the volume of exports nosedived in the fourth quarter. However, domestic demand in Taiwan, which hasn’t been very strong over the past few years, weakened even further in the fourth quarter.

Unfortunately, it appears that global economy has continued to contract at a sharp rate thus far in the first quarter. As shown in the bottom chart, the manufacturing and service sector PMIs in the Euro-zone, which both edged higher in January, set new lows in February. Manufacturing indices in the United States also weakened further in February.

Although there is not much good news at present, there are a number of forces that sooner or later will stabilize global economic activity and eventually lead to recovery. First, short-term interest rates in most countries have declined significantly. Although the usual channels of monetary transmission may be impaired somewhat at present, lower interest rates should eventually help. Most countries have also announced fiscal stimulus plans that will kick in over the course of the year. In addition, lower energy prices will help. If oil prices average $50/barrel this year (WTI is below $40/barrel at present), then roughly $1.5 trillion worth of purchasing power will be transferred from oil-producing nations, which tend to have relatively high propensities to save, to oil-consuming nations, which tend to have higher propensities to consume. This transfer of purchasing power should help to eventually stabilize global economic activity. In the meantime, however, the global economy remains mired in a very deep slump.

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Published On Mon, Feb 23 2009, 06:59 GMT

About this Report

Wells Fargo Investments, LLC

https://www.wellsfargo.com/

sam.bullard@wachovia.com

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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. 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