Super Bowl Hangover

By: Michael Ashton | Mon, Feb 6, 2012
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Wow, people really did spend the day on Monday talking about the Super Bowl. Volume on the NYSE was only 644 million shares: the slowest day of the year. This is not part of a secular decline; this is a much more-abrupt falloff if it continues this way. For reference: last year, the slowest day of the year prior to the Christmas season was 655 million shares. That includes all pre- and post-holiday trading sessions. The only days in 2011 that were slower than today's total were the day after Thanksgiving and the 23rd-30th of December.

Then again, the Giants didn't win the Super Bowl in 2011, so maybe that's part of it.

Still, it is remarkable. If the market can respond to all of the news that circulated today about Greece without much trading, then I think that means that investors have reached their conclusions about the outcome. Think of what happens to an option price when the underlying market moves. If the option is "near the money", meaning that it isn't very clear whether it will end up in the money or out of the money, the option value is quite large and the probability of eventual exercise (the delta, approximately) is quite variable. But if the option is either deep in-the-money or far out-of-the-money, movements in the underlying market don't change the probability of exercise very much. The delta is near 0, or it is near 1. The gamma, which explains how much the delta changes with movements in the underlying market, is very low.

If markets are no longer moving much when another weekend comes and goes with no deal on Greek funding, when Euro officials say (as Merkel did today) that they can't understand what the Greeks could possibly need with another couple of days because "time is running out," when the big unions in Greece declare strikes and threaten violence; if this doesn't cause any ripple in the market, then I tell you that the delta has set. In principle, we don't know whether investors are assuming there will be no default or whether it is guaranteed there will be a default, but the latter case seems more likely to me. If that is the case, it also means that there will never be any less risk in the markets on a default than there is right now. Everyone is as comfortable with his strategy as he is going to be, and now everyone is just waiting to ring the bell for the actual event.


St. Louis Fed President Bullard spoke today and tried hard to justify the "Bull" in his name. In his prepared speech, which I thought might actually talk about inflation targeting, he made it clear that he considers the new statement of longer-term Federal Reserve objectives to constitute "inflation targeting" because it describes 2% PCE inflation as a "goal." That's inflation targeting in the same way that a rifleman is targeting when he talks about wanting to shoot well this afternoon. It's a target, but targeting is a process. Moreover, it's a target that has been operative for many years informally so stating it doesn't change much (like the rifleman going from just wanting to shoot well to saying that he wants to shoot well). The Fed would be inflation targeting if they named a long-run inflation or price level target and described how they would adjust policy in response to being off-target in a particular period. For example, if the Fed said "the inflation target is a compounded annual inflation rate of 2%±¼% between 2012 and 2022 and our expected policy path will adjust so that target will be hit, that would be an inflation target.

While it's not necessary that the inflation target be expressed as a number rather than as a function of aggregate growth over that period, True inflation targeting makes a growth agenda strictly second-importance at best.[1]

In his Q&A, Bullard made some remarkable statements. He said that the "European situation has calmed down substantially." Is that really what the Fed believes? If so, then they're more out-of-touch than I would have expected. Greece is discussing default and it could happen as early as sometime in the next six weeks. Portugal's 10-year bonds yield 13%; Hungary's 8.5%, Ireland's 6.9%, and Italy's 5.6%. France has been downgraded and scores of banks are only solvent because they are receiving infusions of LTRO and carrying assets at par that should be fractions of par. That is "calmed down substantially?" Bullard's forecast for 3% GDP growth in 2012 and better than 3% growth in 2013 is also pretty generous, although achievable if nothing bad happens in Europe. He remarked that the Fed must be careful to avert "a lot of inflation." Um, what about a moderate amount of inflation?

Let's just hope he was up late watching the Giants, and not on his game. Otherwise, I would have to say something uncharitable.


Several friends sent me the article "Huggies Cut Shows Why Bond Market Backs QE3" for my comments, so I thought I would share them generally. The article explains that Procter & Gamble just rolled back prices after a recent 8% increase caused them to lose 7 points of market share. The article argues that P&G found it couldn't raise prices "because wage growth remains stunted."

That's a great story, but compensation growth if anything follows inflation - it certainly doesn't lead it. The chart below shows the quarterly Employment Cost Index, which includes both wages and the value of nonmonetary benefits, compared with headline inflation. (The source of the data is and Bloomberg; the old ECI series was discontinued in 2005 so this chart contains the new series starting in 2001).

Employment Cost Index versus CPI

It is difficult from this chart to make the claim that wages lead inflation; in fact, there are several clear examples where inflation led wages. The real question is, if wages aren't rising then why did Procter & Gamble feel the need to raise prices? Margins generally (although I can't speak to P&G directly) are at the highest levels in a generation, so I doubt they were just trying to pad margins in a competitive industry like consumer products. Clearly, there are price pressures these manufacturers are feeling; it's just that this company (and the restaurants that the article also discusses) are in highly-competitive businesses where it is difficult to yank prices up 8% without a demand response.

There is no guarantee that inflation will continue to rise, but I find it remarkable how much ink is spilled these days talking about how it's almost fait accompli that it will fall.

On Tuesday, Chairman Bernanke testifies before the Senate Budget Committee. The testimony is scheduled for 10:00ET.


[1] In principle, the inflation target could be expressed as a function of compounded growth, but this gets (a) confusing and (b) complex. Should higher-than-expected growth imply higher-than-expected inflation is acceptable, reflecting the economic orthodoxy that rapid growth fuels inflation? If so, then what about the current situation, in which the Fed would like to run faster growth even at a cost of higher inflation? So the growth variable would have to be phrased in terms of the output gap...which no one agrees how to measure.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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