Yield Spread Analysis 12/26 01/02
Countries heavily affected by commodity price changes, namely Australia, New Zealand (exporters) and Japan (importer), saw long term rates rise as crude oil and gold jumped last week. The gains increase inflation risks for the respective economies, and thus the probability of monetary policy tightening rises as well.
Meanwhile, the US yield curve flattened slightly as traders pushed estimates for a Fed rate cut to later in 2007. Japanese yields benefited from rumors of a January hike by the Bank of Japan, but the gains may be short lived as data does not entirely warrant immediate tightening.
Long Term** vs. Short Term*
US Fed Balanced Bias?
Though non-voters in FOMC, Mr. Fisher and Mr. Lacker both appear to be maintaining a tightening bias, no matter what the cost. The question is: how influential is their opinion to voting FOMC members? The release of the December meeting minutes may give more insight on Wednesday:
Richard Fisher, Dallas Federal Reserve Bank President
On the inflation front, the good news is inflationary pressures appear to have reached a stasis, despite the labor shortages in certain sectors?particularly in chemicals and petroleum industries and in functions requiring skilled and semiskilled workers. The bad news is that the stasis is at too high a level for party poopers like me who will have no choice but to advocate tightening monetary policy further if inflation does not ratchet downward. December 19, 2006
I would have to say that the risk of unacceptably high inflation still outweighs the risk of substandard economic growth. December 20, 2006
Jeffrey Lacker, Richmond Federal Reserve Bank President
In any event, the weakness in housing will continue to be a drag on overall economic activity into the first half of next year, with the effect gradually waning as the year progresses. But I seriously doubt it will be enough of a drag to tip the economy into recession. My doubts stem from the fact that residential investment accounts for 6 percent of GDP, while household consumption accounts for 70 percent, and the outlook for that spending looks quite strong right now. December 21, 2006
Many forecasters have been saying core inflation will moderate in the near term, and this certainly would be desirable. But such moderation is not yet evident, despite the two most recent (CPI) reports. December 22, 2006
ECB Steadfastly Hawkish
The ECB continued to talk up inflation risks and accommodative interest rates following the central banks December hike to 3.50%:
Jean-Claude Trichet, European Central Bank President
While the outlook for energy prices remains uncertain, overall inflation rates are likely to increase again in early 2007 and then hover around 2 percent in the course of that year and 2008, also reflecting the impact of higher indirect taxes. December 20, 2006
Lorenzo Bini Smaghi, European Central Bank Executive Board Member
Rates must be raised further should Euro-zone economic growth continue to accelerate. The ECB has increased interest rates because the economy has gradually strengthened. If that strengthening continues in 2007, keeping rates at the current low levels would mean creating the prospect for inflation. December 31, 2006
Erkki Liikanen, European Central Bank Governing Council Member
As economic growth is strengthening, companies' pricing power might strengthen and then the risk that higher oil prices will go through to the prices is bigger... [Further], if pay [increases in Germany] remain lower than productivity increases, there would not be inflation pressure. But if this doesn't happen, it might increase inflation pressure. January 2, 2007
Axel Weber, European Central Bank Governing Council Member
Euro zone interest rates remain low even after the European Central Bank's latest tightening move, and its monetary policy continues to be supportive to economic expansion while inflation risks remain tilted to the upside. December 22, 2006
Yves Mersch, European Central Bank Governing Council Member
The dynamism of this growth and the ample monetary liquidity raises the risk of inflation?The ECB's benchmark interest rate remains low in historical terms and monetary policy accommodative. December 28, 2006
PBOC Flexible Yuan Band. Flexible Officials?
Chinese monetary and government officials have made it clear that while they intend to allow yuan appreciation, they will only do it at a pace which benefits economic growth for China:
Zhou Xiaochuan, Peoples Bank of China Governor
The PBOC will maintain stability at the financial system...to boost a good and fast development of the national economy? 2006 saw the bank perfecting the yuan exchange rate formation mechanism, keeping the yuan exchange rate floating orderly within a reasonable range. He also stated that the bank will continue strengthening and perfecting financial macroeconomic regulations, implement a stable monetary policy, strengthen and improve foreign exchange management (and) push forward financial reform. January 2, 2006
Wu Xiaoling, Peoples Bank of China Vice Governor
The market strongly expects more interest rate hikes by China and Japan. The difference in economic trends and interest rate policies reinforces the dollar's weakening trend and the strengthening trend of the euro and Chinese yuan. This will help to balance the development of the global economy. December 28, 2006
Ma Kai, Chinese Minister of the State Development and Reform Commission
Although the economy's development is on track with our macroeconomic control initiatives (to date), the foundation of the economy is still not solid and growth is (still) too fast. It is an important task for next year to continue to strengthen controls on fixed-assets investment. The policies will aim to keep the growth rate reasonable, to adjust the structure of investment and to improve efficiency. December 22, 2006
Tang Xu, Peoples Bank of China Research Bureau Director
Slow appreciation in the market is very good for steady and sustainable development of the Chinese economy and for world economic development. You should understand that there's nothing good about the yuan rising too fast - the damage could be large. It's fine for the yuan to appreciate, but it's a problem if it rises too fast. December 21, 2006
