Research Zeitgeist: Inflation, Libor and Vintage Subprime
Fear of rising inflation gathered steam this week with worrisome developments on a number of fronts.
CIBC’s fascinating analysis of how soaring oil prices are eroding East Asia’s competitive advantage in manufacturing by boosting shipping costs was a popular topic. In China’s case the problem is exacerbated by exchange rate and labor issues, as well as increased demand for diesel fuel as a result of the recent earthquake. The Chinese government has historically intervened to ensure China’s exports remain competitive, but given the many challenges it faces, its options are limited. Even if the CFTC’s investigation finds that speculators have contributed to the current spike in oil prices as an IMF working paperargues, it will not change the longer term fundamentals that suggest continued relatively high prices. Still, not everyone agrees with Goldman’s $200 oil superspike analysis, as one of our most popular posts showed.
Meanwhile prices of agricultural commodities, are also expected to stay at high levels in the next 10 years, even after current short term factors pass and bring prices down from the highs. An interesting and worrisome parallel between oil and agricultural commodities is that in both cases, supply is not responding to higher demand in the same way as in the past.
There’s a growing a realization that tighter monetary policy is needed to keep inflation under control, as argued in another IMF working paper, but the prospect of higher interest rates is most unappetizing at a time of economic weakness and financial market instability.
The Wall Street Journal’s claim that several big banks may be contributing to the erratic behavior of Libor caused a stir. JPMorgan challenged the WSJ’s methodology via Alea, which also offered its own critique. while Felix Salmon at Portfolio.com, offers a broader defense of Libor. “What the WSJ has done is come up with a marginally interesting intellectual conundrum: why is there a disconnect between CDS premia, on the one hand, and Libor spreads, on the other? But the way that the WSJ is reporting its findings they seem to think they’re uncovering a major scandal. They’re not.”
FT Alphaville provides Morgan Stanley’s take, which finds the “critique in the WSJ is interesting, but it falls down by trying to combine generic term lending rates with the cost of idiosyncratic default protection. By doing so, it paradoxically reinforces the value of the LIBOR fixing process in producing a generic reference rate, even during stressed periods when bank risk is more heterogeneous than usual.”
Finally, the subprime crisis is not forgotten: our most popular post by far was the S&P report that securities backed by subprime and other “non-prime” loans from the 2007 vintage are shaping up to be the worst ever in terms of defaults.
Research Recap Quote of the Week
For us, the whole circus concerning analysts mentioning ever higher round numbers has seemed a very hollow one indeed. It serves little purpose to start making me-too statements just to serve as a piece of analyst bling.
Barclays Capital commodities analysts Paul Horsnell and Kevin Norrish commenting on Goldman’s $200 oil price forecast.
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August 6th, 2008 at 11:32 am
[...] the recent flap questioning the accuracy of LIBOR, no significant changes are planned in the key interest rate [...]