Risks of disinflation are limited. Record weakness in the economy - it is 10% unemployment, a decline in production by 7% and capacity utilization below the levels of past recessions - all this indicates a downward pressure on inflation. Indeed, although the growth in energy demand has led to the return of consumer inflation, which reached 2.8%, according to the Consumer Price Index, "core" inflation, as if she was not measured, remains at or below the "comfort level" The Fed, which is equal to 1 ,5-2%. However, in our view, downside risks are limited: the ratio of weakness, inflation is less stable than in the past, a weakness in itself - is a narrowing of the economy, strong global growth has raised the prices of goods and imports, which leads to some increase in inflationary expectations. As a result, our view on inflation remains unchanged: we expect to lower core inflation in the direction of 1% over the next few months, and rise back to 2% in 2011.
Three sources of uncertainty.
There is a general belief that inflation and pricing are weakened simultaneously with the growth of the economy. Nevertheless, uncertainty remains on three issues:
1 - the measurement of inflation: measurement of core inflation measures diverge
2 - modeling of the key factors of inflation: there is uncertainty as to how to measure inflation expectations and a sluggish economy, how to determine their interaction with inflation.
3 - how the Fed's response will shape the prospects: many officials reassured the current, relatively confident expectation of inflation. However, the current stable rates may change if investors believe that the Fed, for whatever reason, will miss her arrival.
Uncertainty in the measurements. First, there is uncertainty regarding the "correct" measures for basic or core inflation. In 2009, two popular ways of measuring core inflation diverged: core inflation, as measured by the consumer price index was stable, but were less than 30 points when it is measured by the price index for personal consumption (PCEPI). Although the differences and are obtained mainly due to different approaches in measuring prices, it can create uncertainty about the direction of inflation.
Model uncertainty. There is even less certainty about the key determinants of inflation and a model that connects them with inflation. In the 30 years since the Fed has held its first conference on inflation modeling extensively used model of "allowances in excess of the value of" all proved less reliable, dependent on a supportive monetary policy, globalization, and changes in pricing policies of the firm. Indeed, our analysis shows that firms are now geared to the market, setting prices based on the conditions of supply and demand on the world market, instead of value added.
Nevertheless, both models include three key elements: a measure of inflationary expectations, the measurement of a weak economy and the factors that mean real inflation, such as changes in energy and import prices. But it seems that the ratio of weakness, inflation has become less stable over the past few years, the influence of one another also decreased. Smoothing the Phillips curve may indicate that an increase in the weakness of the economy today may not cause a significant drop in inflation, as it did in the past. Model in which prices are formed in response to the market, may also explain the phenomenon in which the company cover the costs, including currency fluctuations, are more willing to turn it into profit.
The role of the Fed. Through a long period of good monetary policy, lower and more stable inflation expectations could shift the ratio of weakness, inflation down, but not change its slope, so that empirical analysis should take into account all these factors. Indeed, studies show that inflation expectations will affect inflation and, in turn, strengthens the monetary policy expectations. The price dynamics of such models is compatible with our price-market hypothesis. However, uncertainty about future Fed may weaken the adsorbing effect, which we discuss below.
How serious is the weakness of the economy? Our inability to assess the economic downturn and inflationary expectations with any precision, inflation also adds more uncertainty. Measures measuring the weakness of the economy, such as a decline in production, invisible, and the unemployment rate measures only the weak labor market, rather than commodity markets. Fed Vice Chairman Kohn recalled a few years ago that the "erroneous assessment of potential output may have contributed errors of monetary policy 1970. This may be true even today: some fears that the financial crisis has reduced the potential growth of 1 percentage point to 2%, raising the risk of outbreak of inflation. In our opinion, they declined slightly to 2,5%, which is quite a small figure for inflation.
We believe that the Phillips curve diminished. The result is a substantial increase in economic weakness caused by a doubling of unemployment or failure in terms of production load that weighed in over the past two years for inflation, but it is not substantially affected. The good news is that the strenuous efforts of the Fed to limit the risks of deflation have kept inflation expectations from falling. The main downside risk for inflation is now coming from further slowing rental rate. Weakness in the property market weakened sharply increase in rents for tenants and owners, which is one third of the consumer price index, and about one-sixth of the basis of price index for personal consumption. We believe that reducing the risk of betting on rents is limited, and a decline in the housing market (and therefore supply) and the stabilization of demand combined, extending the weakness in the property market.
Pushing inflation above: the effects of speed, global growth and profitability. Moreover, we believe that these three factors are pushing up inflation: the weak economy and declining inflation responds to changes in accordance with its level of weakness, strong global growth increases the need for imports, inflation expectations are either steady or increased, leaving a small risk of substantial disinflation.
The idea of the effect of speed, or changes in the weakness of the economy, as well as the level of impact of inflation, are controversial and complex processes in order to bind them empirically, though it wants to do intuitively. The deepest point of falling operating rates or the peak of unemployment will change the direction of the course of business and consumers, tuned to the movement of inflation. These processes can be enhanced by the fact of cyclically-sensitive pricing, such as food, energy or other products that could start to grow in the recovery process. Consequently, such effects will be strongest for wholesale prices or from the manufacturer, and we in turn believe that this will also impact on consumer prices.
More importantly, several global factors probably contributed to inflation in the U.S. over the past few months. Among them: strong global demand and limits on supply are a growing demand for energy and food security. Demand for electricity has increased by 25,6% over the last 3 months of the year. Although this point the pace had slowed down, our team believes that they will be still higher. Meanwhile, estimated by the CPI, retail food prices also rose, although at a modest 1.3% on an annual rate from September to December. However, the strength of global demand is likely to be higher food prices. Finally, the price of imports in the U.S. will rise again. We believe that sellers ignore in some cases, higher prices, to raise them with 2-4 month delay. Together with the residual effects from the weak dollar, this price increase may also contribute to inflation in the U.S. due to increased inflationary expectations.
Inflation expectations have become higher. Estimated 5-year inflation expectations rose to 2,75-3%. Based on a review of performance measurement is also grown, in late January, the median long-term inflation expectations in the University of Michigan slowly increased to 2,9%, inflation expectations for next year rose to 2,8%. It should be noted that such studies are unstable and may be unreliable, since they are based on small samples, do not belong to any particular index, and cover a wide range of opinions expressed by households. However, to some extent, they are important for observations.
The Fed is going to change the forecast for inflation in the middle of the year. These Countercurrent will contribute to lower inflation at the moment. But by the middle of the year, we believe that investors' forecasts for inflation and the Fed will change its value and she would rush up.
At this stage the role of the Federal Reserve will be crucial in the formation of inflationary expectations. The market already concerned about the Fed's credibility, given the unprecedented cash incentives on the ground. They refer to two interrelated factors: first, most importantly, they worry that officials will not have enough strength for tightening, or they will be difficult to tighten the policy properly. In addition, some think that the Fed just made a political mistake and misleading. Against this background, policymakers should be ready to prevent inflationary expectations from excessive growth, and we think they will.
In fact, what is the cornerstone of the Federal Reserve our times: we believe that the change in inflation expectations will force the Fed to move away from zero interest rates in the second half. At the same time, given the set of global factors, potentially increasing inflationary expectations, the unresolved issues at the Federal Reserve could create uncertainty in the market, resulting in increased premiums and increased steepness of the yield curve.
Three sources of uncertainty.
There is a general belief that inflation and pricing are weakened simultaneously with the growth of the economy. Nevertheless, uncertainty remains on three issues:
1 - the measurement of inflation: measurement of core inflation measures diverge
2 - modeling of the key factors of inflation: there is uncertainty as to how to measure inflation expectations and a sluggish economy, how to determine their interaction with inflation.
3 - how the Fed's response will shape the prospects: many officials reassured the current, relatively confident expectation of inflation. However, the current stable rates may change if investors believe that the Fed, for whatever reason, will miss her arrival.
Uncertainty in the measurements. First, there is uncertainty regarding the "correct" measures for basic or core inflation. In 2009, two popular ways of measuring core inflation diverged: core inflation, as measured by the consumer price index was stable, but were less than 30 points when it is measured by the price index for personal consumption (PCEPI). Although the differences and are obtained mainly due to different approaches in measuring prices, it can create uncertainty about the direction of inflation.
Model uncertainty. There is even less certainty about the key determinants of inflation and a model that connects them with inflation. In the 30 years since the Fed has held its first conference on inflation modeling extensively used model of "allowances in excess of the value of" all proved less reliable, dependent on a supportive monetary policy, globalization, and changes in pricing policies of the firm. Indeed, our analysis shows that firms are now geared to the market, setting prices based on the conditions of supply and demand on the world market, instead of value added.
Nevertheless, both models include three key elements: a measure of inflationary expectations, the measurement of a weak economy and the factors that mean real inflation, such as changes in energy and import prices. But it seems that the ratio of weakness, inflation has become less stable over the past few years, the influence of one another also decreased. Smoothing the Phillips curve may indicate that an increase in the weakness of the economy today may not cause a significant drop in inflation, as it did in the past. Model in which prices are formed in response to the market, may also explain the phenomenon in which the company cover the costs, including currency fluctuations, are more willing to turn it into profit.
The role of the Fed. Through a long period of good monetary policy, lower and more stable inflation expectations could shift the ratio of weakness, inflation down, but not change its slope, so that empirical analysis should take into account all these factors. Indeed, studies show that inflation expectations will affect inflation and, in turn, strengthens the monetary policy expectations. The price dynamics of such models is compatible with our price-market hypothesis. However, uncertainty about future Fed may weaken the adsorbing effect, which we discuss below.
How serious is the weakness of the economy? Our inability to assess the economic downturn and inflationary expectations with any precision, inflation also adds more uncertainty. Measures measuring the weakness of the economy, such as a decline in production, invisible, and the unemployment rate measures only the weak labor market, rather than commodity markets. Fed Vice Chairman Kohn recalled a few years ago that the "erroneous assessment of potential output may have contributed errors of monetary policy 1970. This may be true even today: some fears that the financial crisis has reduced the potential growth of 1 percentage point to 2%, raising the risk of outbreak of inflation. In our opinion, they declined slightly to 2,5%, which is quite a small figure for inflation.
We believe that the Phillips curve diminished. The result is a substantial increase in economic weakness caused by a doubling of unemployment or failure in terms of production load that weighed in over the past two years for inflation, but it is not substantially affected. The good news is that the strenuous efforts of the Fed to limit the risks of deflation have kept inflation expectations from falling. The main downside risk for inflation is now coming from further slowing rental rate. Weakness in the property market weakened sharply increase in rents for tenants and owners, which is one third of the consumer price index, and about one-sixth of the basis of price index for personal consumption. We believe that reducing the risk of betting on rents is limited, and a decline in the housing market (and therefore supply) and the stabilization of demand combined, extending the weakness in the property market.
Pushing inflation above: the effects of speed, global growth and profitability. Moreover, we believe that these three factors are pushing up inflation: the weak economy and declining inflation responds to changes in accordance with its level of weakness, strong global growth increases the need for imports, inflation expectations are either steady or increased, leaving a small risk of substantial disinflation.
The idea of the effect of speed, or changes in the weakness of the economy, as well as the level of impact of inflation, are controversial and complex processes in order to bind them empirically, though it wants to do intuitively. The deepest point of falling operating rates or the peak of unemployment will change the direction of the course of business and consumers, tuned to the movement of inflation. These processes can be enhanced by the fact of cyclically-sensitive pricing, such as food, energy or other products that could start to grow in the recovery process. Consequently, such effects will be strongest for wholesale prices or from the manufacturer, and we in turn believe that this will also impact on consumer prices.
More importantly, several global factors probably contributed to inflation in the U.S. over the past few months. Among them: strong global demand and limits on supply are a growing demand for energy and food security. Demand for electricity has increased by 25,6% over the last 3 months of the year. Although this point the pace had slowed down, our team believes that they will be still higher. Meanwhile, estimated by the CPI, retail food prices also rose, although at a modest 1.3% on an annual rate from September to December. However, the strength of global demand is likely to be higher food prices. Finally, the price of imports in the U.S. will rise again. We believe that sellers ignore in some cases, higher prices, to raise them with 2-4 month delay. Together with the residual effects from the weak dollar, this price increase may also contribute to inflation in the U.S. due to increased inflationary expectations.
Inflation expectations have become higher. Estimated 5-year inflation expectations rose to 2,75-3%. Based on a review of performance measurement is also grown, in late January, the median long-term inflation expectations in the University of Michigan slowly increased to 2,9%, inflation expectations for next year rose to 2,8%. It should be noted that such studies are unstable and may be unreliable, since they are based on small samples, do not belong to any particular index, and cover a wide range of opinions expressed by households. However, to some extent, they are important for observations.
The Fed is going to change the forecast for inflation in the middle of the year. These Countercurrent will contribute to lower inflation at the moment. But by the middle of the year, we believe that investors' forecasts for inflation and the Fed will change its value and she would rush up.
At this stage the role of the Federal Reserve will be crucial in the formation of inflationary expectations. The market already concerned about the Fed's credibility, given the unprecedented cash incentives on the ground. They refer to two interrelated factors: first, most importantly, they worry that officials will not have enough strength for tightening, or they will be difficult to tighten the policy properly. In addition, some think that the Fed just made a political mistake and misleading. Against this background, policymakers should be ready to prevent inflationary expectations from excessive growth, and we think they will.
In fact, what is the cornerstone of the Federal Reserve our times: we believe that the change in inflation expectations will force the Fed to move away from zero interest rates in the second half. At the same time, given the set of global factors, potentially increasing inflationary expectations, the unresolved issues at the Federal Reserve could create uncertainty in the market, resulting in increased premiums and increased steepness of the yield curve.
Morgan Stanley
1 comment:
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