CMP Associates Regulation Blog: World Inflation Waves Policy, Financial Turbulence and Economic Slowdown

World Inflation Waves and Monetary Policy, World Financial Turbulence and Economic Slowdown

Carlos M. Pelaez

Executive Summary

I United States Inflation and Monetary Policy

IA Current Monetary Policy

IB United States Inflation

IC Conclusions

ID Quantitative Easing and Portfolio Rebalancing

II World Financial Turbulence

IIA Appendix on Sovereign Bond Valuation

III Global Inflation

IV World Economic Slowdown

IVA United States

IVB Japan

IVC China

IVD Euro Area

IVE Germany

IVF France

IVG Italy

IVH United Kingdom

V Valuation of Risk Financial Assets

VI Economic Indicators

VII Interest Rates

VIII Conclusion

References

Appendix I The Great Inflation

Executive Summary

This comment provides data on inflation in the US and relates it to the carry trades from zero interest rates to commodity futures. The carry trade fluctuates now in three waves in 2011 that are repeated in worldwide inflation. Unconventional monetary policy of zero interest rates and large-scale purchase of securities for the balance sheet of the central bank intends to lower long-term costs of borrowing to stimulate investment and consumption that can increase economic growth and employment. In practice, the central bank cannot direct the use of huge volumes of cash that can be borrowed at nearly zero interest rates to investment and consumption. Cheap cash has many alternative uses in allocations to a wide range of real and financial risk assets. Risk financial assets that can attract cheap cash include equities, emerging-market equities and fixed income, currencies, commodity futures and so on. The carry trade consists of short dollar and immediate-term fixed income jointly with long, highly-leveraged positions in risk financial assets. The carry trade is unwound during episodes of risk aversion such as the fears of repercussions in financial markets of disruption of European sovereign debt. Inflation in 2011 has been dominated by carry trades into commodity futures during periods of risk appetite that are unwound during periods of risk aversion.

The analysis of world inflation in this blog reveals three waves of inflation of producer and consumer prices. In the first wave from Jan to Apr of 2011, lack of risk aversion channeled cheap money into commodity futures, causing worldwide increase in inflation. In the second wave in May and Jun, risk aversion because of the sovereign debt crisis in Europe caused unwinding of the carry trade into commodity futures with resulting decline in commodity prices and inflation. In the third wave since Aug, alternations of risk aversion revived carry trades of commodity futures with resulting higher and lower inflation.

Table ES1 provides annual equivalent rates of inflation for producer prices indexes followed in this blog. The behavior of the US producer price index in 2011 shows neatly three waves. In Jan-Apr, without risk aversion, US producer prices rose at the annual equivalent rate of 17.3 percent. After risk aversion, producer prices increased in the US at the annual equivalent rate of 0.8 percent in May-Jul. Since Jul, producer prices have increased at the annual equivalent rate of 2.7 percent. Resolution of the European debt crisis would result in jumps of valuations of risk financial assets. Increases in commodity prices would cause the same high producer-price inflation experienced in Jan-Apr. There are seven producer-price indexes in Table ES1 showing very similar behavior in 2011. Zero interest rates without risk aversion cause increases in commodity prices that in turn increase input and output prices. Producer price inflation rose during the first part of the year for the US, China, Germany, France, Italy and the UK when risk aversion was contained. With the increase in risk aversion in May and Jun, inflation moderated as carry trades were unwound. Producer price inflation has returned since July, with alternating bouts of risk aversion.

Table ES1, Annual Equivalent Rates of Producer Price Indexes

INDEX 2011	AE ∆%
US Producer Price Index
AE ∆% Jul-Oct	2.7
AE ∆% May-Jul	0.8
AE ∆% Jan-Apr	17.3
Japan Corporate Goods Price Index
AE ∆% Jul-Oct	-2.4
AE ∆% Jan-Apr	7.1
China Producer Price Index
AE ∆% Jul-Oct	-1.8
AE ∆% Jan-Jun	20.4
Germany Producer Price Index
AE ∆% Jul-Oct	4.6
AE ∆% Jun-May	1.2
Jan-Apr	7.1
France Producer Price Index for the French Market
AE ∆% Jul-Sep	2.4
AE ∆% May-Jun	-3.5
AE ∆% Jan-Apr	11.4
Italy Producer Price Index
AE ∆% Jul-Sep	2.4
AE ∆% Jun-May	-1.2
AE ∆% Jan-April	10.7
UK Output Prices
AE ∆% May-Oct	2.0
AE ∆% Jan-Apr	12.0
UK Input Prices
AE ∆% Jul-Oct	-1.0
AE ∆% May-Jun	-8.7
AE ∆% Jan-Apr	35.6

Sources: http://www.bls.gov/ppi/data.htm

http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1110.pdf

http://www.stats.gov.cn/enGliSH/newsandcomingevents/t20111109_402764953.htm

http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Content/Statistics/TimeSeries/EconomicIndicators/Prices/Content100/kpre550bv4.psml

http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20111031

http://www.istat.it/it/archivio/43892

http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/october-2011/index.html

Annual equivalent consumer price inflation in the US in Jan-Apr reached 7.5 percent as carry trades raised commodity futures, as shown in Table ES2. Return of risk aversion in May to Jul resulted in annual equivalent inflation of 2.0 percent in May-Jul. Inflation then rose again in Jul-Oct to annual equivalent 3.3 percent with alternation of bouts of risk aversion. The three waves are neatly repeated in consumer price inflation for China, the euro zone, Germany, France, Italy and the UK. In the absence of risk aversion, zero interest rates with guidance now forever, induce carry trades that raise commodity prices.

Table ES2, Annual Equivalent Rates of Consumer Price Indexes

Index 2011	AE ∆%
US Consumer Price Index
AE ∆% Jul-Oct	3.3
AE ∆% May-Jul	2.0
AE ∆% Jan-Apr	7.5
China Consumer Price Index
AE ∆% Jul-Oct	4.3
AE ∆% Apr-Jun	2.0
AE ∆% Jan-Mar	8.3
Euro Zone Harmonized Index of Consumer Prices
AE ∆% Aug-Oct	5.3
AE ∆% May-Jul	-2.4
AE ∆% Jan-Apr	5.2
Germany Consumer Price Index
AE ∆% Jul-Oct	1.5
AE ∆% May-Jun	0.6
AE ∆% Feb-Apr	4.9
France Consumer Price Index
AE ∆% Jul-Oct	0.8
AE ∆% May-Jun	1.2
AE ∆% Feb-Apr	6.6
Italy Consumer Price Index
AE ∆% Jul-Oct	3.7
AE ∆% May-Jun	1.2
AE ∆% Jan-Apr	4.9
UK Consumer Price Index
AE ∆% Aug-Oct	5.3
May-Jul	0.4
Jan-Apr	6.5