A Tour of Inflation . . . . . .and why the world (& the UK) is not Rosy
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Transcript of A Tour of Inflation . . . . . .and why the world (& the UK) is not Rosy
Fixed-income strategy
A tour of inflation . . .. . .and why the world (& the UK) is not rosy
March 2011
Andrew Roberts
“The rise and fall of civilizations are linked to demographic trends” (Source: CIA)
CLIENT LOGO
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Risky assets doing fine… on. Well, they were up to last week
55
60
65
70
75
80
85
90
Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11
AUD/JPY
-2000
-1500
-1000
-500
0
500
'91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11
RBS Risk appetite indicator
Risk-off
Risk-on
10
60
110
160
210
Feb-09 Aug-09 Feb-10 Aug-10 Feb-11
0
10
20
30
40
50
60
Treasury Option Volatility Estimate
VIX Index (rhs)
0
20
40
60
80
100
120
140
Jun-08 Jan-09 Aug-09 Mar-10 Oct-10
EUR FRA/OIS SPRD 3M,
4th future
GBP FRA/OIS SPRD 3M,
4th future
USD FRA/OIS SPRD 3M,
4th future
20
30
40
50
60
Feb-07 Nov-07 Aug-08May-09Feb-10 Nov-10
World Equity
0
200
400
600
800
1000
1200
1400
Feb-07 Dec-07 Oct-08 Aug-09 Jun-10
US Industrial 10-yr
Benchmark - US
Treasury 10-yr
B rated industrials
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Data surprises are already at all time highs. Worrying for equity bulls
Surprise
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
Mar-02 Mar-04 Mar-06 Mar-08 Mar-10
RBS data surprise index, sample of USA & Germany front line data.
Normalised surprise indices, monthly data to end-Feb 2011
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What about the oil effect? About to hit
6
8
10
12
14
16
18
20
'67 '69 '71 '73 '75 '77 '79 '81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11
US CPI Urban Consumers Gasoline / US hourly wage
900
1000
1100
1200
1300
1400
1500
Feb-
06
Aug-
06
Feb-
07
Aug-
07
Feb-
08
Aug-
08
Feb-
09
Aug-
09
Feb-
10
Aug-
10
Feb-
11
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
EU27 gas oilpump priceindexGerman 2-yryield
Demand driven
Demand
driven: up to
now
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The rate of change can count . . . beware sharp rises
-75%
-55%
-35%
-15%
5%
25%
45%
65%
85%
105%
125%
Dec-
1961
May-
1967
Nov-
1972
May-
1978
Oct-1983 Apr-
1989
Oct-1994 Mar-
2000
Sep-
2005
-2
-1
0
1
2
3
4
5
6
7
Oil Price YoY % change World GDP growth YoY % change (rhs)
-75.00%
-25.00%
25.00%
75.00%
125.00%
175.00%
225.00%
275.00%
325.00%
375.00%
Dec-
1961
May-
1967
Nov-
1972
May-
1978
Oct-1983 Apr-1989 Oct-1994 Mar-
2000
Sep-
2005
Mar-
2011
-3
-2
-1
0
1
2
3
4
5
6
7
8
Oil Price 2yr change World GDP growth YoY % change (rhs)
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Real wages the key in H2. Already plunging, falling further in zones with spare labour
-3
-2
-1
0
1
2
3
4
5
6
7
Mar-
71
Mar-
74
Mar-
77
Mar-
80
Mar-
83
Mar-
86
Mar-
89
Mar-
92
Mar-
95
Mar-
98
Mar-
01
Mar-
04
Mar-
07
Mar-
10
Germany, Realcompensation rate,total economy, yoy
United States, Realcompensation rate,total economy, yoy
-6
-4
-2
0
2
4
6
8
10
Ma
r-7
1
Ma
r-7
4
Ma
r-7
7
Ma
r-8
0
Ma
r-8
3
Ma
r-8
6
Ma
r-8
9
Ma
r-9
2
Ma
r-9
5
Ma
r-9
8
Ma
r-0
1
Ma
r-0
4
Ma
r-0
7
Ma
r-1
0
United Kingdom, Real compensation rate,total economy, yoy
Sweden, Real compensation rate, totaleconomy, yoy
The big theme (even though no-one is discussing it). Spare labour capacity = no wage bargaining
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Eg US unemployment is high. Extraordinarily high in some measures
Source: Courtesy of ShadowStats.com
The augmented U-6 rate includes long-term discouraged workers (defined out of
existence in 1994). U-6 only includes short-term discouraged workers
Unemployment Rate
0
2
4
6
8
10
12
Jan-50 Jan-58 Jan-66 Jan-74 Jan-82 Jan-90 Jan-98 Jan-06
% Unemployed for >6m
0
10
20
30
40
50
Jan-48 Jan-57 Jan-66 Jan-75 Jan-84 Jan-93 Jan-02 Jan-11
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EMU: where is inflation going to come from? Wages low, demands high
– Negotiated wages outlook weak. Was at weakest ever last month
– Parts of EMU approaching deflation already
– Just popped up to due to fiscal tightening = higher VAT/taxes (notwithstanding oil)
Source: RBS Euro economics
0
0.5
1
1.5
2
2.5
3
3.5
4
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
EMU Negotiated Wages, % yoy EMU Core inflation, % yoy
97-10 avg
97-10 avg
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Ger, Fra, Ita, Neth, Bel, Aut, Fin, Lux
Spa, Gre, Por, Ire, Cyp, Mal, Svn, Svk
Taxes
7
7.5
8
8.5
9
9.5
10
10.5
11
Jan-91 Mar-95 Apr-99 May-03 Jul-07 Aug-11
0
1
2
3
4
5
Eurozone Unemployment Eurostat Harmonised Index of Consumer Prices
German wage claims in 2011
Sector demand
Construction industry 5.9%
Chemicals 6-7%
Deutsche Telekom 6.5%
Food and Catering 5-6%
Public services €50 + 3%
Coal industry Real wage rise
Textiles 5%
Insurance 6%
Volkswagan 6%
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What about the UK? In poor shape, according to balance sheet
-14.0
-12.0
-10.0
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
Mar-88 Nov-90 Aug-93 May-96 Feb-99 Nov-01 Aug-04 May-07 Jan-10
Government Households
Private non-financial corporations United Kingdom to rest of the world
Household
financial balance
is negative
35
40
45
50
55
60
65
Ma
r-
06
J
ul-
06
No
v-
06
Ma
r-
07
J
ul-
07
No
v-
07
Ma
r-
08
J
ul-
08
No
v-
08
Ma
r-
09
J
ul-
09
No
v-
09
Ma
r-
10
J
ul-
10
No
v-
10
US ISM Non-Manufacturing UK Services PMI
EMU Services PMI
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Risk assets are recovering, but UK production is not
UK production hardly bounced whatsoever, despite -26% sterling trade-weighted fall
Q307 to Q408
60
70
80
90
100
110
Mar-78 Mar-82 Mar-86 Mar-90 Mar-94 Mar-98 Mar-02 Mar-06 Mar-10
-15
-10
-5
0
5
10
15Industrial Production Change (YoY)
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What about the UK? Retail sales news mixed
Retail sales (ex. auto) - Change YoY
-8
-6
-4
-2
0
2
4
6
8
Feb-
05
Jul-
05
Dec-
05
May-
06
Oct-
06
Mar-
07
Aug-
07
Jan-
08
Jun-
08
Nov-
08
Apr-
09
Sep-
09
Feb-
10
Jul-
10
Dec-
10
UK EMU US
Better? No, with BRC retail sales at -0.4%yoy
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UK fiscal tightening set to bite
Government balances (% of GDP)
-12.0
-10.0
-8.0
-6.0
-4.0
-2.0
0.0
2.0
Austr
alia
Cana
da
Fran
ce
Germ
any
Greece Ita
ly
Netherlan
ds
Portu
gal
Spain
Swed
en
Switzerlan
d
Unite
d Kingd
om
Euro ar
ea
Total
OEC
D
2010 2011 2012
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Sticky UK inflation, yes … taxes & external influences
-1
0
1
2
3
4
5
6
2004 2005 2006 2007 2008 2009 2010 2011
UK
EMU
HICP constant tax, % y/y
85
90
95
100
105
110
Feb-06 Jun-06 Oct-06 Feb-07 Jun-07 Oct-07 Feb-08 Jun-08 Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10
US Composite Leading Ind.
Total LeadingUK Composite Leading Ind.
Total LeadingEMU Composite Leading Ind.
Total LeadingJapan Composite Leading Ind.
Total Leading
Spot the odd man out: before the turmoil, UK was showing weaker momentum (data up to end-2010)
Source: OECD
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UK CPI forecasts
-2.00
-1.00
0.00
1.00
2.00
3.00
4.00
5.00
6.00
Jan-
02
Jul-0
2
Jan-
03
Jul-0
3
Jan-
04
Jul-0
4
Jan-
05
Jul-0
5
Jan-
06
Jul-0
6
Jan-
07
Jul-0
7
Jan-
08
Jul-0
8
Jan-
09
Jul-0
9
Jan-
10
Jul-1
0
Jan-
11
Jul-1
1
Jan-
12
Jul-1
2
RPI
RPI forecast
CPI
CPI forecast
il13s
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What are inflation options telling you? That the UK is seen to have an inflation problem
EMU
15
20
25
30
35
40
45
50
Feb-10
Mar-10
Apr-1
0
May-10
Jun-10
Jul-1
0
Aug-10
Sep-10
Oct-1
0
Nov-10
Dec-10
Jan-11
Feb-11
Mar-11
<1%Between 1% and 2%>3%
Probability of yoy inflation at various levels
in 10 years
UK
0
10
20
30
40
50
60
70
80
90
Feb-10
Mar-10
Apr-1
0
May-10
Jun-10
Jul-1
0
Aug-10
Sep-10
Oct-1
0
Nov-10
Dec-10
Jan-11
Feb-11
Mar-11
<1%
Between1% and 2%>3%
US
10
20
30
40
50
60
70
Feb-10
Mar-10
Apr-1
0
May-10
Jun-10
Jul-1
0
Aug-10
Sep-10
Oct-1
0
Nov-10
Dec-10
Jan-11
Feb-11
Mar-11
<1%
Between1% and 2%>3%
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Bank balance sheets not fixed. Credit to tighten for years
The knock-out punch that deleveraging delivers. 6 years of deleveraging?
Bank credit to the private sector (% of nominal GDP)
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No-one wants any credit when you are deleveraging . . .
UK: more credit available UK: that nobody wants
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UK rates already discounted a lot higher
UK rates already seen to rise significantly
0
1
2
3
4
5
6
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49
GBP USD EUR
1yr swap rates, starting at various forwards
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EMU debt sustainability
1.7
2.7 2.8 2.8 2.93.2
3.4 3.53.7 3.7
4.3
5.1
4.2
0
1
2
3
4
5
6
Gre
ece
Por
tuga
l
Hol
land
Ger
man
y
Spa
in
Italy
Fin
land
Bel
gium
Fra
nce
Aus
tria
Irel
and
US
A
UK
%
-5.9
-4.7 -4.7
-1.8-1.5
-1.1-0.8 -0.6 -0.6
-0.2 -0.1
0.5
-0.2
-7
-6
-5
-4
-3
-2
-1
0
1
Gre
ece
Spa
in
Irela
nd
Net
herla
nds
Por
tuga
l
Finl
and
Uni
ted
Sta
tes
Bel
gium Ita
ly
Fran
ce
Aus
tria
UK
Ger
man
y
%
Difference versus 2000-07IMF estimates of mean nominal GDP growth 2011-15
Growth is pivotal
Spain, Portugal & Ireland all suffer massive drops in nominal growth compared to the years 2000-2007
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Nominal growth minus long-term interest rates
-8
-6
-4
-2
0
2
4
6
Gre
ece
Ireland
Portu
gal
Spain
Italy
Finland
Net
herla
nds
Belgium
Franc
e
Ger
man
yUK
Unite
d Sta
tes
2000-2007 2008-2015
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A Fiscal Risk Index
Source: Maplecroft, February 2011
“…identify countries that will come under increasing economic pressure in
future years due to low birth rates, high life expectancy and state
commitments to look after ageing populations.
The index is calculated using eight indicators: child and old-age
dependency ratios between 2010 and 2050; labour rates of the over-65s;
GDP; debt; and public spending on pensions, health and education.”
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Uncomfortable bedfellows
Changes in public debt, 2008-2011, & 2008-2015
Source: IMF Fiscal Monitor, November 2010
Easy to differentiate between:
a) Countries that have gone beyond (?) or almost
reached the point of no return
b) Countries that have terrible metrics but are
doing what is necessary (UK)
c) Countries that are in the „bubbling under‟, next
countries to be hit category (Spain, Portugal,
France)
d) Countries that have done less easing and
should be less punished (Italy, Australia, EM)
Source: IMF World economic outlook, October 2010. Note: net debt for Japan
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UK funding needs coming down. From a high level, but falling
0
50
100
150
200
250
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16
Gilt issuance/gross financing requirement
Gross Gilt sales
As of March Budget 2010: £187.3bn
As of April 2010 revision: £185.2bn
As of June 2010 emergency budget: £165.0bn
Current: £165.2 Gilt sales
Cumulative fall in gross financing requirement
announced in June 2010 emergency Budget:
-£106bn
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UK: logically, doing what it says on the tin
Gilts have just been on one big round trip (10-yr spread to bunds)
-80
-60
-40
-20
0
20
40
60
80
100
120
Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11
(bps
)
UK 10y vs.France
UK 10y vs.Germany
The 7 Dec 2009
Budget give-
away, & capital
flight
The great Gilt reappraisal
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