Daily Archives: January 20, 2011

Robin Harding

An important question about US inflation in the coming year or two is the extent to which rising commodity prices will feed into core inflation. As discussed in the piece that Chris and I did last week, the feed through from headline to core has been very low – in fact close to zero – in recent years.

One channel by which an impact could come is if rising commodity prices push up costs for manufacturers in the developing world and that translates to higher prices for imported manufactured goods in the US. In that regard, and in light of China’s strong GDP and high inflation figures today, this is an interesting chart:

 

Reserve requirements are so in vogue. Israel’s central bank is the latest to adjust their ratio, bringing in a 10 per cent requirement for non-residents dealing in foreign exchange derivatives, specifically FX swaps and forwards. The move will be effective January 27. The bank said:

In the last few months the volume of foreign exchange derivative transactions by nonresidents has increased markedly. A significant part of the increase in nonresidents’ transactions is in short term instruments. This measure will strengthen the Bank of Israel’s ability to achieve the objectives of its monetary, foreign exchange and financial stability policies. 

Robin Harding

There is an blogosphere flap today about a minor change to Federal Reserve accounting: it will mark its liability to the Treasury on a daily rather than annual basis and recategorise it as “Interest on Federal Reserve notes due to U.S. Treasury”.

Here is the change:

Effective January 1, 2011, as a result of the accounting policy change, on a daily basis each Federal Reserve Bank will adjust the balance in its surplus account to equate surplus with capital paid-in and, in addition, will adjust its liability for the distribution of residual earnings to the U.S. Treasury. Previously these adjustments were made only at year-end.

Adjusting the surplus account balance and the liability for the distribution of residual earnings to the U.S. Treasury is consistent with the existing requirement for daily accrual of many other items that appear in the Board’s H.4.1 statistical release.

 

Turkey’s central bank has just cut their benchmark rate 25 basis points, building upon moves last month that cut the same rate 50bp and raised reserve requirements. The two-pronged move was intended to weaken the lira, make exports more attractive and thus reduce the current account deficit – a blight on an otherwise booming economy.

The particular problem with Turkey’s bank reserves is their maturity profile, which is quite short-term, making the country vulnerable to external shocks. Rather than focusing on inflation and growth, a great deal of attention in Ankara must be focused on securing the next slice of funding. Encouraging longer-term maturities is a smart move; financial stability increases in proportion to the average maturity of deposits. 

China and Russia sold off substantial amounts of US debt during December – a month that saw the biggest treasuries sell-off since the collapse of Lehman’s. Market commentators entered denial mode: this was “not necessarily the start of any particular trend,” said one. “It’s too early to infer that China is shifting its diversification stance,” said another.

All this denial suggests the market is waiting for bad news – a theory backed up by volatility futures, which suggest a great deal of volatility is constantly expected roughly two months away. Whatever the date, Bad News is due in roughly two months’ time (these are VIX futures, and yes, you can buy a future on just about anything). Are these connected? Here’s one theory.

US borrowing costs have been kept artificially low for years, thanks to demand for US treasuries by world investors. The fact that the dollar is a reserve currency, and is considered safe, has kept demand for the debt high even when it is not a profitable investment. The normal laws of supply and demand are distorted. The people buying and the people selling are doing so for different reasons.

This asymmetry should be a cause for concern. 

Brazil has raised rates by 50bp to 11.25 per cent to try to bring inflation back to target. The central bank also introduced new reserve requirements for dollar short sellers recently, in an effort to counter inflationary pressure on the real. Prior to the rise, the selic rate had been on hold for about six months at 10.75 per cent (see chart).

Consumer price inflation ran at 5.91 per cent in the year to December, in the upper end of the target range of 4.5 per cent +/- 2 percentage points. This was the highest since at least December 2008, when the Bank’s historical series begins.