17 June 2008

Nominee for Best Actor in a Drama: Ben Bernanke

"The Fed is talking about raising rates to slow inflation and support the dollar... The Fed is on the fast track to destroying its own credibility."

In my view, no sooner will all of this “tough love” leave the lips of Fed governors than the Fed will be forced to announce some novel emergency “liquidity facility” to address a fresh round of credit concerns. We may even observe an emergency easing on some morning in the next few months when the markets appear likely to open up particularly weak. The simple fact is that inflation outside of food and energy is not particularly high." --- John P. Hussman, Ph.D.

WASHINGTON (Thomson Financial) - The number of foreclosures filed by US homeowners increased for the third consecutive month in May, California-based RealtyTrac reported today. Foreclosures totaled 261,255 in May, up 7 pct from April and 48 pct since May 2007. Approximately one in every 483 US households received a foreclosure filing during the month. Bank repossessions continued to surge in May -- posting a double-digit percentage increase from the previous month and more than twice the number reported in May 2007. Nevada continued to document the nation''s highest state foreclosure rate, with one in every 118 households receiving a foreclosure filing in May. That is up 24 pct over April. California posted the second highest rate, with one in every 183 households receiving a filing.”

Fed to Markets: "We Ain''t Got To Show You No Stinking Credibility"

Fed tightening can do nothing to ease the food and energy pressures short of intentionally throwing the U.S. into a deeper recession (by making adjustable-rate mortgage resets more onerous than they already are). Mortgage failures remain the predominant risk to the economy, and that risk will not go away soon.

- It is typical for commodity prices to “hang on” early into a recession and then dive as employment losses build. Whether or not we have seen the peak of the recent vertical push, the evidence of an early recession is already in from the standpoint of anything that has provided useful warning.

- Those analysts who want to wait for two quarters of negative GDP before calling a recession are perfectly welcome to do so, provided they recognize that by the time such “proof” was available in prior recessions, the damage to stocks was often complete.

- As mortgage foreclosures and writeoffs predictably increase in the coming quarters, we are likely to observe a fresh demand for Treasury bonds as a safe-haven because of their lack of default risk. That is likely to place downward pressure on monetary velocity, which will act as a major brake on inflation.

- As a side note, even during the deflation of the Great Depression, the monetary base grew at a very rapid rate, but demand for currency grew even faster (i.e. monetary velocity plunged). Deflation is always first and foremost a symptom of plunging velocity resulting from credit fears. We may not see deflation in the current cycle, but it''s probable that inflation concerns will subside very quickly as we move further into the current recession.

The Fed can certainly talk about raising rates, and might even trot out an initial hike, but every time credit trouble threatens the markets, the Fed will predictably shift to frantic attempts to calm the market with easy money.

Since the progression of foreclosures has mirrored the pattern of adjustable mortgage rate resets, mid-2008 will most likely represent the highest rate of change in cumulative foreclosures, after which they will continue to rise but at a moderating rate.

In short, mortgage foreclosures and defaults are just now hitting their stride, and we are likely to observe a second round of credit fears as those losses mount.

The U.S. dollar has enjoyed a brief rebound on tightening talk from the Fed, which is likely to quickly dissipate as soon as those credit concerns revive. Meanwhile, commodity price pressure is likely to diminish by the end of summer as the result of a continuing economic downturn coupled with a flight-to-safety which will reduce monetary velocity.

Fed chief still doesn''t get it

"Ben Bernanke''s tough talk on inflation suggests the economy may be improving. He''s wrong, and his comments will backfire. I believe the chance of Bernanke raising interest rates is essentially zero. I think the Fed''s next move will be to ease rates, though I don''t know if that will be three months or six months from now." --- Bill Fleckenstein

Deflation rather than inflation could soon be our big worry

"In a year''s time the economy will be very weak and inflation will be falling like a stone. The case for rate cuts is not that higher inflation in the months ahead does not matter but rather that it will be temporary."--- Roger Bootle, managing director of Capital Economics and economic adviser to Deloitte

We know enough about price increases in the pipeline to know that inflation is heading sharply higher... What we do not know, however, is what will happen to all those things that are not yet in the pipeline. financial markets are increasingly fearing the worst.

If inflation is to be kept low, despite these upward pressures, then the price increases of domestically produced items must be forced onto a lower trajectory. This the Bank can do through the interest rate weapon, which affects overall domestic demand.

In fact, in current circumstances, a marked slowdown in domestic demand is under way without any prompting from the Bank - thanks to the credit crisis and the weakness of the housing market.

I believe that the central banks will act strongly enough to suppress inflation through higher interest rates. Accordingly, in my view, if price pressures turn out to be stronger than I expect, then the result, ultimately, will not be higher inflation, but rather weaker output and employment.

So why have expectations of inflation picked up so much? This is frequently cited by the Bank and others as foreshadowing more general upward pressure on prices. But things may not be quite so simple.

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