Not That Surprising

By: Michael Ashton | Tue, Mar 6, 2012
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As the Thursday deadline for the Greek PSI deal approaches, some trepidation is apparently developing. Stocks and commodities dropped 1.5%, while Treasuries rallied (although less than one would expect in a 'flight to quality' trade). Inflation swaps dropped 2-3bps and TIPS underperformed nominal bonds. This isn't terribly surprising; the markets have been pricing a high probability that the Greek chapter of the crisis ended with the PSI 'invitation' and LTRO2, and it would have been very hard (and out of character for this entire episode) for the chapter to close smoothly without some doubt creeping in. I'm not very confident that the PSI exchange will be completed as scheduled, but I was very confident that it wouldn't be a slam-dunk.

The only surprising thing about Tuesday's selloff was that the commodities market was approximately 100% correlated with equities. I understand that investors have been trained to focus on real demand and real supply and to project the result on nominal prices, because that's generally the same thing when inflation is very low (and incorrect if inflation is higher). But while crisis in Europe and the possible default of Greece could conceivably cause a decline in energy prices and industrial metals prices, I am unsure how a weak global economy will affect the price of Soybean Oil, Wheat, Sugar, or (certainly) Coffee.

If the dollar had powered higher today (it rallied, but not dramatically), then the fact that many of these commodities are denominated in dollars could have contributed to the 1.7% decline in the DJ-UBS index. I suspect that the more-likely explanation is that investors flushed commodity exposures wholesale in a risk-reduction move.

Since I don't usually point out particular turning-point days, I have to take credit when I occasionally call one right. So far, my observations on February 27th about the parallels between stocks in the run-up after the Bernanke 2010 Jackson Hole speech, into QE2, and the run-up into LTRO2 have worked out (although so far the bond selloff hasn't materialized - there's time, though). The good news is that the parallel would shave only another 20 points off of the S&P and then knock it around for a bit before the next up-leg began. I am not going to call zig-zags, though! I think risk here remains acutely to the downside in equities, and since so far the indications are that the PSI may not be as well-received as hoped, I am maintaining my short bias.

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I suppose it had to happen. Someone has introduced a smartphone app that allows you to track your own personal inflation. Now, be forewarned that it doesn't help you correctly weight your purchases relative to your total consumption, or make corrections for changes in the size of the packaging (e.g., for something as simple as an electric bill) or the frequency of purchase (e.g., that new computer - what do we compare that to?), or the change in item quality (Hyundai to Jaguar). But it appears that it will allow you to at least track frequent purchases, and some people will find that very interesting. The link to a discussion of the app "Sticker Shock" is here.

What I really want, though, is a U.S. version of the on-line application you can find here. This site allows you to see how your personal inflation rate may differ from the norm on the basis of your different consumption patterns. You simply set your own consumption habits, and it will show you your personal CPI based on those weights. I love it. Unfortunately, it isn't available as far I know for U.S. consumers, which is a pity. Still, you can get some idea how different consumption patterns produce different inflation experiences.

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On Wednesday, the market will digest the last rumors and threats about the PSI bond exchange, whose deadline is Thursday. Also, while it will not likely affect markets significantly, the results of the Super Tuesday primary battles will provide entertaining water cooler discussion fodder. In economic news, ADP will release its report of employment (Consensus: 215k vs 170k, with higher whispers due to good weather) as well as revisions to seasonal factors and certain other estimates that are used in computing the monthly data. I don't expect much net change in the level of ADP's figures, but it will add some noise. Indeed, the easy prediction for Wednesday is just this: sound and fury...but at least, signifying something.

 


 

Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA
E-Piphany

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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