U.S. stocks had a tough time dealing with inflation reports from China to Europe yesterday, and the prospect that the former will continue to hike rates and the latter will be forced to fully remove their emergency-level accommodation.   Comments on the housing market by Bank of America CEO Moynihan, stating that the housing market faces “enormous challenges,” didn’t help.

This market has pushed aside many big-time negatives of late – ie. raging Mideast tensions, a Japanese quake and aftermath that will put the screws to a JIT supply-chain world, and homes prices making new lows – so it’s way too early to expect this latest challenge will derail the rally.  However, more people seem to acknowledge the quandary that has set up.  That is, central banks can’t continue to backstop risk assets without pushing inflation to destructive levels – they’re cornered and there’s no pretty way of getting out.

The areas of safety reigned as consumer staple, health care and utility shares outperformed.  Energy, basic materials and financials were the hardest hit sectors. 

Energy prices responded correctly to the supply figures for the first week I can remember.  The weekly energy report showed crude supplies jumped 3.78 million barrels (that’s a 13 billion bbl build in three weeks!) to 370.3 million bbls – 17% above the 5-yr average.  Total U.S. fuel demand fell 0.9% last week to 18.2 million bbls per day, the lowest level since June 2009 and 13% below the peak hit a few years ago.  

The price of crude fell $5 to $98/bbl, and is off another $2 this morning – what a world we’re living in when $96 oil is talked about as cheap (ok, maybe not “cheap”); crude averaged less than $24/bbl 1995-2003, now that’s cheap.  Gasoline got slammed by 26 cents to $3.12/gal – people go entire careers without seeing such moves, we’ve seen two in a week and three in four months.

Market Activity for May 11, 2011

Sector Activity for May 11, 2011

Central bankers continue to show their poor forecasting skills (or is it they just can’t stop cheerleading the economy).  We’ve seen our own Fed lower their economic forecast about three times now over the past year, while raising the outlook for inflation (which is still much too low) – not to mention the big misses, like scoffing at suggestions that the housing market was bubblicious in 2007.  Now it’s the Bank of England’s turn to look stupid (coming from someone who still has fair value on the S&P 500 at 950 that’s quite an accusation) as their economy is on the cuff of full-blown stagflation.  The BoE had to lower their growth number once again as that economy is mired, while increasing their inflation forecast – they’ve got 1.8% y/o/y GDP and 4% CPI; their retail price gauge has inflation running at 5%). 

Now, as I’ve stated numerous time, it’s unlikely that harmful levels of inflation will remain sticky, simply because developed-world economies are much too weak.  That is, the higher commodity prices will destroy demand, as we’re seeing with the aforementioned energy reports.  But anyway one looks at it, central bank forecasting can’t be taken seriously.

Mortgage Apps

The Mortgage Bankers Association reported that their applications index rose for the second week in a row as both purchase and refinancing activity contributed. 

The measure rose 8.2% for the week ended May 6 as purchase apps rose 6.7% and refinancings rallied 9.0%.  The average contract interest rate on the 30-year fixed mortgage fell nine basis points to 4.67% (fourth week of decline). 

Purchases do have a long way to go though, and even if mortgage borrowing costs continue to decline, falling prices are likely to keep buyers on the sidelines – sales won’t begin to rise in a strong and consistent manner until buyers believe prices have bottomed and those prices are still pressured by a flood of supply. 

Trade Balance

The Commerce Department reported that the trade deficit widened in March as it came in at -$48.179 billion (-$47.08 billion was expected) after the -$45.4 billion in February – that’s on a nominal basis as the key driver is the jump in oil prices.  So much for that dollar devaluation narrowing the gap; it’s past time to take your head out of the Keynesian textbooks, Mr. Fed.

So this brings the three-month average on the real (inflation-adjusted) trade gap, which is the key way to look at this figure, to -$50.063 billion – nearly $4 billion wider than in the three months that ended December.  This means the mild drag that trade was estimated to have had on Q1 GDP in the initial revision will show a meaningfully deeper drag when the revision comes out at the end of the month.   

Export growth is definitely there, which is what the weak dollar policy is meant to accomplish.  But policymakers are forgetting that a weak dollar also increases import prices (as we illustrated yesterday), which fosters a wider nominal trade deficit.  And on the price-adjusted figure, the ultra-low interest rate environment fosters increased import activity, thereby adversely affecting the trade figure that feeds into GDP. 

And as I try to state each month when these figures are released, trade’s drag on GDP wouldn’t be nearly as large if we were to produce more of our domestic energy needs.  Crude oil accounted for 35% of all of our imports in March.  I’m all for trade and surely it makes sense to import some energy, but the current policy is senseless in my view.  How much more income and high-paying manufacturing jobs could we generate with a common sense shift in policy? 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900