Wednesday, February 9, 2011

When Do Inflation, Debt Become Bigger Worries Than Jobs?

by Joseph Schuman

So much for the jobs-jobs-jobs agenda.

The epidemic unemployment gripping the the country may still be the top priority of the Federal Reserve. But other issues loom larger for the new majority in the House of Representatives, as Fed Chairman Ben Bernanke learned this morning in his first testimony of the year before a committee that has switched hands to Republicans.

There was little change in Bernanke's outlook from his recent public comments -- an economy picking up steam, inflation that's tame and stubbornly high unemployment that's unlikely to abate anytime soon -- but his audience in the House Budget Committee was ready to shake things up.

Budget Committee Chairman Paul Ryan started with a warning that the Fed's campaign to thrust $600 billion into the economy through an eight-month bond-buying spree, its biggest effort to boost growth and generate hiring, risks sparking inflation and jeopardizes American fiscal strength.

"My concern is that the costs of the Fed's current monetary policy -- the money creation and massive balance sheet expansion -- will come to outweigh the perceived short-term benefits," Ryan said. "We are already witnessing a sharp rise in a variety of key global commodity and basic material prices, and we know that some producers and manufacturers here in the United States are starting to feel cost pressures as a result."

Bernanke stuck to his argument that while prices for gasoline and agricultural commodities have visibly risen, core inflation in the U.S. has remained historically low. And that, he said, gives the Fed room to keep buying bonds in a strategy -- called quantitative easing and nicknamed QE-2 -- that is aimed at lowering long-term interest rates and giving banks more money they can lend.

"The inflation is taking part in emerging markets because that's where the growth is, that's where the demand is and that's where in some cases the economies are overheating," Bernanke said, arguing that it is up to the central banks of those countries to keep their economies balanced.

"The increases in oil prices, for example, are entirely due, according to the International Energy Agency, to increases in demand coming from emerging markets. They're not coming from the United States," Bernanke added. "Of course, that's a serious problem, but monetary policy can't do anything about, say, bad weather in Russia or increases in demand for oil in Brazil and China. What we can do is try to get stable prices and growth here in the United States."

But the concerns aren't just coming from Republicans.

The central bank of China raised interest rates again this week to dampen rising prices in a country that also happens to be the source of many goods that eventually make their way to American consumers. On Tuesday, Brazil reported accelerating inflation in Latin America's biggest economy, which is also a key trading partner of the U.S.

European Central Bank President Jean-Claude Trichet, too, has become increasingly hawkish in warning about inflation threats to the eurozone and beyond.

Even within the Fed, there seems to be growing disagreement. Richard Fisher, president of the Federal Reserve Bank of Dallas and a voting member of the Fed's policymaking Federal Open Market Committee, said in a speech Tuesday that the QE-2 purchases make him very wary of inflation and also risk enabling the U.S. government's addiction to debt.

"Barring some unexpected shock to the economy or financial system, I think we are pushing the envelope with the current round of Treasury purchases," Fisher said. "I would be very wary of expanding our balance sheet further. Indeed, given current economic and financial conditions, it is hard for me to envision a scenario where I would not use my voting position this year to formally dissent should the FOMC recommend another tranche of monetary accommodation."

Richmond Fed President Jeffrey Lacker, a nonvoting member of the FOMC this year, voiced similar reservations Tuesday in a separate speech.

Bernanke told Ryan and others on the Budget Committee that the Fed remains "unwaveringly committed" to protecting the country from inflation, and that he and his colleagues frequently re-examine QE-2, which is set to run through June.

He also defended the program from accusations that it adds to U.S. debt, noting that the Fed is buying long-term Treasury securities it will eventually sell and that all the interest from the bonds -- totaling about $125 billion since 2009 -- goes to the Treasury.

But Bernanke, too, warned the Budget Committee that unless Congress and the president can agree to severe adjustments to the budget -- he advocated neither cuts nor new taxes -- "the unsustainable trajectories of deficits and debt" will risk a disaster for the country.

"The question is whether these adjustments will take place through a careful and deliberative process that weighs priorities and gives people adequate time to adjust to changes in government programs or tax policies, or whether the needed fiscal adjustments will come as a rapid and painful response to a looming or actual fiscal crisis," Bernanke said.

He also reiterated that a failure by Congress to raise the national debt ceiling soon would be "catastrophic."

Congressional Republicans have threatened to block such a move unless President Barack Obama first commits to massive spending cuts. But the Treasury has warned that unless the borrowing limit is raised above the current $14.29 trillion by next month, the U.S. government won't be able to pay interest on Treasury bonds.

Bernanke noted that a default would undermine trust in the U.S. among investors around the world and lead to much higher costs for all future American borrowing.

"We do not want to default on our debts," he said. "It would be very destructive."

Hang Sang Index (HSI)

By Barry Ritholtz

As seen in the chart above the Hang Sang Index failed to make new highs on its recent rally attempt last week by stalling at resistance (upper red line). The index has subsequently rolled over in the last few days and is now testing its uptrend line again (green line). China led the S&P 500 lower by correcting two weeks ahead on the S&P 500 during the S&P 500’s approximate 17.00 % peak to trough May to July 2010 correction, thus the Hang Sang about to break trend needs to be monitored closely as a leading indicator to price weakness here in the states.

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by BondSquawk


How Traders Exploit Changes in the Shape of the Yield Curve

In bond trading 101, we discussed how professional bond traders trade on expectations of changes in interest rates (referred to as “outrights”).   Bond traders also trade based on expected changes in the yield curve.  Changes in the shape of the yield curve will change the relative price of bonds represented by the curve.  For example, suppose you have a steeply upward sloping yield curve like the one below:
On this curve the 2-year is yielding 0.86% and the 30-year is yielding 4.50%- a spread of 3.64%.  This may lead a trader to feel that the 30-year was cheap, relative to the 2-year.  If that trader expected the yield curve would flatten, he could simultaneously go long (buy) the 30-year and sell short the 2-year.  Why would the trader execute two simultaneous trades rather than simply buying the 30-year or selling short the 2-year?  Because if the yield curve flattens, reducing the spread between the 2-year and the 30-year, it could be the result of the price of the 2-year falling (increasing the yield), or the price of the 30-year increasing (decreasing the yield), or a combination of the two.  For the trader to profit from just going long the 30-year, they would be betting that the flattening of the curve will be the result of the price of the 30-year going up.  Similarly, if the short the 2-year they are betting that the price of the 2-year will decline.  If they take both positions, they do not have to know in what way interest rates will move in order to make a profit.  Such trades are “market neutral” in the sense that they are not dependent on the market going up or down in order to make a profit.

In this and in subsequent lessons, we will explore ways that professional bond traders anticipate changes in the shape of the yield curve and trade on these expectations.

So what is the driving force that determines the shape of the yield curve?  As it turns out, Federal Reserve monetary policy in response to the economic business cycle determines the shape of the yield curve as well as the general level of interest rates.  Some traders will use economic indicators to follow the business cycle and try to anticipate fed policy, but the business cycle is very difficult to follow, while the Fed is very transparent about their policy decisions, so most traders follow the Fed.  Think back to our discussion in Bond Trading 102: Forecasting Interest Rates.  There we stated that when the Fed sets the level of the fed funds rate, it directly influences short-term rates, but has less of an impact the further out you go on the yield curve.  Because of this, changes to the fed fund rates have a tendency to change the shape of the yield curve.  When the Fed increases the fed funds rate short-term rates tend to increase more than long-term rates, thus flattening the yield curve.  A flattening curve means the spreads between short-term treasuries and long-term treasuries are narrowing.  In this environment, traders will buy longer term treasuries, and short shorter term treasuries.  An inverted yield curve is the result of the Fed pushing short-term rates to very high levels, but investors are expected that these high rates will soon be lowered.  An inverted yield curve is often an indication that the economy is heading into a recession.

When the Fed lowers the fed funds rate, the yield curve tends to steepen, and traders will tend to buy the short end and short the long end of the curve.  A steep positively sloped curve results from the Fed maintaining low short-term rates, but investors are expecting rates to rise.  This usually occurs towards the end of a recession and is often an indication that the economy is about to turn around.


How Traders Establish Strategic Curve Trades

Professional bond traders structure their strategic yield curve trades to be market neutral[1](also referred to as duration neutral) as they only want to capture changes in relative rates along the curve and not changes in the general level of interest rates.  Because longer maturity bonds are more price-sensitive than shorter term bonds, traders do not go long and short equal amounts of short-term bonds and long-term bonds, they weight the positions based on the relative level of price sensitivity of the two treasuries.  This weighting of the positions is known as the hedge ratio.  As was pointed out in Debt Instruments 102 in the discussion of duration and convexity, the price sensitivity of bonds changes with the level of interest rates.  Bond traders, therefore will not keep the hedge ratio constant over the life of the trade, but will dynamically adjust the hedge ratio as the yields of the bonds change.

While there are different ways to measure the price sensitivity of a bond, most traders use the measure DV01, which measures the price change that a bond will experience with a 1 basis point change in interest rates.  For example, if the DV01 of a 2-year bond is $0.0217, and the DV01 of a 30-year is $0.1563, the hedge ratio would be 0.1563/0.0217, or 7.2028 to 1.  For every $1,000,000 position the trader takes in the 30-year, he would take an opposing position of $7,203,000 in the 2-year.  As interest rates change, the trader would recalculate the DV01 of each bond and adjust the positions accordingly.

Flat or inverted yield curves provide bond traders with unique strategic curve trade opportunities, since they are not encountered very often and generally do not last very long.  They usually occur near business cycle peaks when the Fed is holding the fed funds rate at significantly high levels.  When fed funds rates are unusually high, investors at the longer end of the curve do not expect these high rates to prevail over the long term, so yields at the long end do not rise as much.  Traders will exploit this by shorting longer maturities and going long shorter maturities.

Another opportunity that does not present itself very often occurs during times of extreme economic turmoil when financial markets experience significant sell-offs.  During these periods, investors will sell their equity and lower rated debt investments and buy short-term treasuries.  This phenomenon is referred to as a flight-to-quality.  Short term treasury prices shoot up, causing a steepening of the yield curve, particularly prominent in the very short end of the curve.  Traders will often sell short the short-term treasuries while buyer treasuries further out on the curve.  The risk with this trade is that it is hard to judge how long it will take for yield spreads to adjust back to more normal levels.


Factors that influence the P & L of Strategic Curve Trades

Changes to the relative yields of the bonds in a strategic curve trade are not the only determining factor to a trades profit or loss.  The trader will receive the coupon interest in the bond that they are long, but will have to pay the coupon interest on the bond that they borrowed to sell short.  If the interest income received from the long position is greater than the income paid on the short position, the profit is enhanced, if the interest paid exceeds that which is received the profit is reduced, or the loss is increased.

When a trader goes long the short end of the curve and shorts the long end, the proceeds of the short is not sufficient to cover the long position, so the trader will have to borrow funds to purchase the long position.  In this case, the cost of carry must be factored into the P&L of the trade.  These trades that require borrowing to finance cash shortfall between the purchase and short sale are said to have negative carry, while trades that have short sell proceeds that exceed the purchase amount are said to have positive carry.  Positive carry adds to the P&L because the excess cash can earn interest.


Advanced Strategic Curve Trades

Professional bond traders also have strategies to deal with perceived anomalies of the yield curve shape.  If a trader sees an unusual convex hump in a section of the curve there is a strategy to make a bet that the hump will flatten out.  For example, if there is a hump between the 2-year and the 10-year, the trader will take a duration neutral short position in the 3-year and 10-year and buys a treasury in the middle of the range of the same duration.

  In this example the 7-year would do.  If the anomaly was a concave dip in the curve, the trader could buy the short and long-term bond, and sell short the intermediate; however this trade would entail negative carry, so the trader would have to have a strong belief that the anomaly would be corrected and that the correction would cause a considerable change in relative prices.

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Brazil not clear yet from soy sowing hangover


It is too early for Brazilian farmers to write-off the threat of setbacks from a late soybean planting season, even if rains have put them on course for a record harvest of the oilseed.
The US Department of Agriculture lifted by 1.0m tonnes to an all-time high of 68.5m tonnes its forecast for Brazil's soybean production in 2010-11, after rainfall boosted a crop whose sowings were delayed by up to three weeks by dry weather last year.
"The weather situation across Brazil has eased earlier concerns about dryness," the USDA said.
Brazil's improved prospects contrast with those of neighbouring Argentina, where rains last month arrived too late to prevent crop damage.
"About 40% of the early-planted soy was flowering during the drought conditions in December and early January, which will likely reduce potential yield," the department said, cutting its forecast for Argentina's soybean crop by 1.0m tonnes.
The corn crop was downgraded by 1.5m tonnes.
Rainfall question
However, Brazilian farmers could still suffer a delayed hangover from the late soybean sowings if so-called "safrinha" crops, largely cotton and corn, which are planted immediately the oilseed's harvest encounter adverse weather.
"Both safrinha cotton and corn in the central-west region are slightly behind with regard to their planting window because of the late start to soy planting in September," USDA analyst William Baker said.
"Due to the late planting of the safrinha cotton crop, yield will be especially dependent on the amount of rainfall received during the remainder of the summer."
Currently, Brazil appears on course for total cotton output of 8.2m bales, although the country is becoming increasingly reliant on the safrinha crop, which can account for 40-45% of output of the fibre on some farms.
The USDA made the comments as it released the February edition of its influential Wasde report, which made only minor changes to soybeans estimates – outside South America – nor to cotton forecasts.

Survivor Trading System - Trades of 8 February

I trades di Survivor System del 8 February. I risultati real-time sono a disposizione al seguente link:

Trades of Survivor System on 8 February. Real-time results are available at the following link:

Commodity Inflation Continues as Wheat Prices Surge

By Nick Nasad

A strong drought in China - the world's largest producer of wheat - will weaken the supply of wheat to the global market and has helped push wheat prices to their highest since 2008. At the same time that there is poor growing weather, there has been an increase in demand from places like Bangladesh, Iraq and Algeria, to quell pressure on governments from local unrest.

As we can see from this weekly chart, we have seen an 83% increase in wheat prices since last year and that has pushed up the cost of inflation around the world. It has led to shortages for basic staples like bread and has fermented unrest in several countries.
Here is the jump in wheat today.


"On Wednesday, the United Nations' Food and Agriculture Organization (FAO) issued a notice that severe drought in China's main winter wheat region could pose a serious threat to output, as reported in the Wall Street Journal. Some 5.2 million hectares out of the total of about 14 million hectares could be under threat from poor rainfall and low snow cover."

A lack of bread and higher bread prices have been cited as a factor in the protests that have spread through Tunisia to Egypt and others. Because of that countries are increasing their demand in order to help lower local prices.

The United Nations said that food prices reached a record last month according Bloomberg. We have seen countries trying to battle inflation by raising interest rates - the most recent example being China's hike of its benchmark lending and deposit rate.

More from Bloomberg:

The drought in China's wheat-growing regions may worsen "rapidly" as the weather gets warmer, the Ministry of Agriculture said Feb. 4. The drought affected 35 percent of wheat crops in eight provinces as of that date, it said. "On the weather front, the drought in China is at center- stage right now, as wheat is starting to come out of dormancy," Paris-based farm adviser Agritel said in a commentary today.

Chinese wheat output may have dropped to 114.5 million tons at the last harvest, compared with 115.1 million tons a year earlier, according to U.S. Department of Agriculture estimates. Macquarie expects output to drop a further 4 million tons this year. The USDA will update its outlook today.

Impact on Central Bank and Currency Markets

Higher wheat prices are a symptom of generally higher commodity prices. We have seen this higher food inflation and commodity inflation working its way into the developed countries like United Kingdom and Euro-zone, not to mention the emerging market economies, and will create some impetus for central bankers to move on interest rates. The prospect of higher interest rates and more hawkish central bankers would work to boost the EUR and GBP. For now the Fed is content with their loose policy and so the USD will be sold, especially in an environment when commodities and equities are rallying on risk appetite.

Still, part of the effect of this is higher bread prices, and this drought in China will only increase upward pressure on the price of wheat.

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The Limits of Monetary Policy: ‘Monetary Policy Responsibility Cannot Substitute for Government Irresponsibility’

By Barry Ritholtz

I am delighted to speak here in the hallowed halls of the Harvard Club of New York City. I have been a member of this club for over 35 years. I love its sturdy facilities, its history, the trophies from Teddy Roosevelt’s African expedition of 1909–10 and … its mustiness.

The thing I prize most about this facility is that the rooms here are cheap. As I did last night, I always stay in what used to be called a “dorm room,” one of the little rooms smack in the middle of this old building. These rooms are sparsely furnished, with only a sink and a bed and the smallest imaginable armoire jammed into approximately 130 square feet. I like them because there are no better-priced rooms in New York City. And because they are stone quiet.

They are the only hotel rooms I know of in the city where the occupants cannot hear the grinding noise of trash trucks … when trash is actually being collected.

I am especially honored that both the Manhattan Institute and e21 are
sponsoring this speech today.[1] Thank you, David [Malpass] for taking time out of your busy schedule to introduce me.

The Manhattan Institute and e21 are powerful proponents of the free-market capitalism that made our country the richest and the most successful democracy in the history of humankind. I took note of the institute’s claim on its website that it sponsors thinking “literally and figuratively outside the Beltway.” That’s a good thing. The Federal Reserve is structured to balance “inside the Beltway” influences with “outside the Beltway” thinking. The governors of the Fed, in Washington, are appointed by the president of the United States and confirmed by the Senate. The 12 bank presidents, like me, who operate the System in the field and also sit on the Federal Open Market Committee (FOMC) with the Fed governors, are not. Instead, we are selected by, and serve at the pleasure of, boards of directors drawn from the citizenry of our districts. In my case, the Dallas Fed serves 27 million people who populate 360,000 square miles of Texas, northern Louisiana and southern New Mexico and whose economic output exceeds Australia’s and is only slightly less than that of India.

On the policy front, the job of the Fed Bank presidents is to bring a Main Street perspective to the table. When I was asked by the Dallas Fed board to become president of the Bank, I then met with Alan Greenspan. I asked the Chairman how I could best serve the System. His answer was crisp: “Just speak to the truth,” he said.

Today, I will speak to the truth as I see it. I speak only for myself and my colleagues at the Dallas Fed and not for anybody else on the FOMC or elsewhere in the System. I suspect this will immediately become clear.

Fiscal Matters

A week ago today, a new Congress was sworn in. New leadership took office in the Lower House, with the new speaker saying, “The American people have humbled us. … They have reminded us that everything is on loan from them.”[2] The Senate retained its leadership but underwent a sea change of composition.

At the other end of Pennsylvania Avenue, the White House announced significant staff changes, among them bringing in a highly respected former administration colleague from my days as a trade negotiator to be the president’s chief of staff.[3]

The new Congress and the new staff in the White House have their work cut out for them. You cannot overstate the gravity of their duty on the economic front. Over the years, their predecessors―Republicans and Democrats together―have dug a fiscal sinkhole so deep and so wide that, left unrepaired, it will swallow up the economic future of our children, our grandchildren and their children. They must now engineer a way out of that frightful predicament without thwarting the nascent economic recovery.

I have been outspoken about the limits of monetary policy as a salve for the nation’s fiscal pathology.[4] The Fed has done much, in my words, to provide the bridge financing until the new Congress gets to work restructuring the tax and regulatory incentives American businesses need to confidently expand their payrolls and capital expenditures here at home.[5]

The Federal Reserve has held rates to nil. We have expanded our balance sheet to unprecedented levels. After much debate―which included strong concern expressed by one member with a formal vote and others, like me, who did not have voting rights in 2010―the FOMC collectively decided in November to temporarily undertake a program to purchase U.S. Treasuries that, when added to previous policy initiatives, roughly means we are purchasing the equivalent of all newly issued Treasury debt through June.

By this action, we have run the risk of being viewed as an accomplice to Congress’ fiscal nonfeasance. To avoid that perception, we must vigilantly protect the integrity of our delicate franchise. There are limits to what we can do on the monetary front to provide the bridge financing to fiscal sanity. Last Friday, speaking in Germany, [European Central Bank President] Jean-Claude Trichet said it best: “Monetary policy responsibility cannot substitute for government irresponsibility.”[6]

The entire FOMC knows the history and the ruinous fate that is meted out to countries whose central banks take to regularly monetizing government debt. Barring some unexpected shock to the economy or financial system, I think we have reached our limit. I would be wary of further expanding our balance sheet. But here is the essential fact I want to emphasize today: The Fed could not monetize the debt if the debt were not being created by Congress in the first place.

Those lawmakers who advocate “Ending the Fed” might better turn their considerable talents toward ending the fiscal debacle that has for too long run amuck within their own house. The Fed does not create government debt; fiscal authorities do. Deficits and the unfunded liabilities of Medicare and Social Security are not created by the Federal Reserve; they are the legacy of those who control the purse strings―the Congress, working with the president. The Fed does not earmark taxpayer money for pet projects in local communities that taxpayers themselves would never countenance; only the Congress does that. The Congress and administration play the dominant role in creating the regulatory environment that incentivizes or discourages job creation.

A look within the United States makes clear the overriding influence of fiscal and regulatory policy. Monetary policy is uniform across the 50 states; the base rate of interest paid on a business or consumer loan or a mortgage in Michigan, California, Ohio or here in New York is the same as that paid in Texas. Yet there is a reason that Michigan and California each lost more than 600,000 jobs over the past decade while Texas added more than 700,000 over the same period. There is a reason that the population of Ohio grew by only 183,000 residents over the past 10 years, while Texas grows by that number every five and a half months. There is a reason that with each passing census, the state of New York has been losing congressional seats and Texas has been adding them; a reason that, in the recent census, California failed to gain any while Texas gained four. There is a reason that, as reported in this morning’s Wall Street Journal, college graduates—the best and brightest of the successor generation—are leaving New York and Cleveland and Detroit and moving to Austin, Texas.[7] There is a reason Texas now houses more Fortune 500 headquarters than any other state in the union. There is an underlying reason behind the graph placed before you that charts the disparate employment growth that has taken place in the 12 Federal Reserve districts over the past two decades.
That reason has nothing to do with monetary policy. It has everything to do with the taxation and fiscal and regulatory policies of the states. The cost of capital does not explain the different economic performances of the states; the cost of doing business has everything to do with those differences. However well-meaning tax and regulatory initiatives in the laggard states may have been when they were conceived and levied, they have had unintended consequences that have led to economic underperformance and job destruction.

Similarly, the key to correcting the underperformance of the American economy and American job creation does not rest with the Federal Reserve. It is in the hands of those who make fiscal and regulatory policy.

The Fed has reduced the cost of business borrowing to the lowest levels in decades. It has seen to it that liquidity is widely available to banks and businesses. It has kept the economy from deflating and it has kept inflation under control. This has helped raise the economic tide. Recent data make clear that the risks of a double-dip recession and deflation have ebbed and that economic growth and job creation are beginning to flow. Yet the ships of job-creating investment remain, for the most part, tied to the docks—or worse, choose to sail for foreign ports where tax and regulatory conditions are more favorable, very much in the same way that Ohio, Michigan, New York and California businesses and workers have navigated to Texas.

I don’t believe this has much to do with the Fed. None of my business contacts, large or small, publicly held or private, are complaining about the cost of borrowing, the lack of liquidity or the availability of capital. All express concern about taxes, regulatory burdens and the lack of understanding in Washington of what incentivizes private-sector job creation. All are stymied by a Congress and an executive branch that have appeared to them to be unaware of, if not outright opposed to, what fires the entrepreneurial spirit. Many have begun to feel that opportunities for earning a better and more secure return on investment are larger elsewhere than here at home.

The Recent Election

Perhaps because I live so far outside the Beltway—among the Washington-skeptical, independent-minded people of the Eleventh Federal Reserve District—I was not surprised by the outcome of the recent election. As I watched it unfold, I thought of one of the better books I had read in the summer of 1998, at the recommendation of a friend, the eminent historian David McCullough. It was titled Cod: A Biography of the Fish That Changed the World, written by Mark Kurlansky, and was considered by the New York Public Library to be “one of the 25 best books of the year.”[8]

Buried in the middle of that remarkable little book is a wonderful description of the causes of the American Revolution. Kurlansky wrote that “Massachusetts radicals sought an economic, not a social, revolution. They were not thinking of the hungry masses. … They were thinking of the right of every man to be middle-class, to be an entrepreneur, to conduct commerce and make money.”[9] Referring to John Adams, John Hancock and John Rowe―everyone seemed to be named John in New England in those days―he posited that the revolution “was about political freedom.” “But,” he went on, “in the minds of its most hard-line revolutionaries, the New England radicals, the central expression of that freedom was the ability to make their own decisions about their own economy.”[10] He concluded that “all revolutions are to some degree about money,” reminding the reader that, reflecting upon France’s revolution, the Comte de Mirabeau said, “In the last analysis the people will judge the Revolution by this fact alone [sic] … Are they better off? Do they have more work? And is that work better paid?”[11]

We now have a new, younger and―in the sense depicted by Kurlansky―more radical Congress working alongside a president as they seek to craft policies more responsive to the message given by the electorate. The new Congress was elected to cast off the status quo of what many have come to feel is excessive encroachment upon the people’s freedom to make their own decisions about the economy. To do so successfully, this new, radical Congress and newly inspired president had better bear in mind Count Mirabeau’s analysis. The people of the United States will judge them not by their rhetoric, not by their declarations, proclamations and statements of intent, but by whether their policies result in a people who are better off, have more work and are better paid.

The leaders of our government cannot attempt to talk their way out of the problem like their predecessors did. They must fix the problem. Now. If they fail to do so, then the election, for all its hoopla, will prove to have been nothing more than a case of putting old, rancid wine in new bottles.

Theirs is not an easy task. We have all become used to the false comfort of having government coddle us, whether we are rich businesses receiving subsidies or poor citizens sustained by government largesse. The election tapped into a foreboding sense that the cost of that comfort now exceeds its benefits, as manifest in looming megadeficits, deep if not unfathomable unfunded liabilities, egregious abuse of fiscal powers symbolized by earmarks and other methods used by politicians to grease the skids of their reelection.
Tapping into that foreboding in the recent election was the easy part. Talk of reform is cheap. Enacting reform will be painful.

A reader of Shakespeare will recall the dialogue between Glendower and Hotspur in Henry IV. Glendower claims, “I can call spirits from the vasty deep.” And Hotspur replies, “Why, so can I, or so can any man; But will they come when you do call for them?”[12]

We shall see if the new Congress will prove worthy of the power the American people have “loaned” them, and, together with the president, actually draw the spirits of fiscal reform and sanity from the “vasty deep” to at long last implement meaningful fiscal and regulatory policy that incentivizes private-sector job creation here at home while arresting the hemorrhaging of our Treasury. If they do, then more Americans will find work and be better off, better paid and freer to make their own decisions about the economy.

If they don’t, then woe to our children, their children and the American Dream.

I am tempted to end this cheery talk by saying, “Have a nice day!” and walking off the stage. However, I would hate to leave this podium with your having concluded that I am just another central bank curmudgeon. I am professionally programmed to worry. But I am also a red-blooded American, as are all my colleagues at the Fed. I draw on the wisdom of Marcus Nadler, one of the great minds of the Federal Reserve from a period when our economy endured an even more dire test. To counter the intellectual paralysis and down-in-the-mouth pessimism that gripped the financial industry after the Great Depression, Nadler put forth four simple propositions:

First, he said: “You’re right if you bet that the United States economy will continue to expand.”
Second: “You’re wrong if you bet that it is going to stand still or collapse.”
Third: “You’re wrong if you bet that any one element in our society is going to ruin or wreck the country.”

And fourth: “You’re right if you bet that [leaders] in business, labor and government are sane, reasonably well informed and decent people who can be counted on to find common ground among all their conflicting interests and work out a compromise solution to the big issues that confront them.”

This became known as Old Doc Nadler’s Remedy, and for my part, it is spot on. Every one of us preoccupied with what ails us should keep it in mind.

It may seem like the stuff of our wildest dreams to imagine getting ourselves out of our current nightmarish predicament. But I believe we can and we will. We are Americans. I believe deep in my soul that, when put to the test, Americans rise to the occasion no matter how great the challenge. We have done it time and again. We have no choice but to do it once more.

I think I have said enough, if not too much. In the musty, time-honored tradition of central bankers, I am now happy to avoid answering any questions you might have.

Thank you.
About the Author Richard W. Fisher is president and CEO of the Federal Reserve Bank of Dallas.

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Gold Price Tsunami Ahead, Says Sprott


The gold price climbed $1.80 to $1,365.60 per ounce Wednesday as the price of gold traded firm amid selling pressure on global stock and commodity markets.  On the heels of China’s third interest rate hike in the past four months, emerging market equities fell for the fifth consecutive day.  Gold prices, which rallied nearly 1% yesterday, have been buoyed by strong physical demand out of Asia.

Despite closing at its highest closing level since January 3, the price of gold remains lower by 4.0% year-to-date.  While the gold price has underperformed cyclically-sensitive commodities thus far in 2011, its resiliency was on full display yesterday.  Gold prices powered higher despite a further tightening of monetary policy in China and weakness in oil.  The People’s Bank of China (PBOC) hiked its benchmark one-year deposit rate by 25 basis points to 3.0% to cool its surging property market and stem the tide of rising inflationary pressures.

The ability of the gold price to advance in the face of higher rates in China may be a sign that the recent correction in the yellow metal is nearing an end.  Although the price of gold has fallen in 2011, it remains within 4.8% of its $1,431.50 all-time high.  One reason for the resurgence in the gold price is that, contrary to conventional wisdom, investors are not convinced China is willing to aggressively fight inflation at the same time that the U.S. Federal Reserve and European Central Bank (ECB) keep monetary policies at crisis levels.

Eric Sprott, founder of Sprott Asset Management and a long-time gold bull, provided another Chinese-related rationale for his firm’s positive gold price outlook.  In his latest monthly letter entitled “Gold Tsunami,” Sprott and colleague David Franklin attributed the resurgence in gold to the potential for massive gold demand from China and India.  “The scale and speed with which they are accumulating precious metals IS new, and it’s driving the fundamentals,” noted Sprott, who asserted that this demand will result in higher gold prices in 2011.

As a catalyst for this growing trend, Sprott pointed to the Industrial and Commercial Bank of China’s Gold Accumulation Plan (ICBC GAP), which “speaks to the new era of gold investment within China.”  Launched in April 2010, the program allows investors in mainland China to purchase gold through a daily dollar averaging program.  Thus far, the IBCB GAP program has led to the purchase of over ten metric tons of gold.  Sprott asserted that the program’s growth prospects suggest this figure could rise to 300 metric tons per year, which would represent more than 10% of estimated annual global gold production.

If the program were to be launched in other large gold-consuming nations such as India, Russia, or Turkey, Sprott contended that the demand for gold would begin to “overwhelm” supply.  Moreover, “while the world continues to float on a sea of paper, this massive wave of physical demand silently threatens to crash into the physical gold and silver market, potentially wiping out tangible supply.”

Sprott has built a fortune for himself – and his investors – betting on the gold price and other natural resources.  If past is prologue to the future, this is not a man to bet against.

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U.S. Home Prices Fall to Pre-Bubble Levels

The drop in home values caused by the mortgage crisis has resulted in at least one positive outcome: Prices have fallen so far and so fast that home affordability is back to pre-housing boom levels , according to a new report.

After reaching a peak in late 2005, the ratio of home prices to annual income fell to its lowest levels in 35 years last September, according to data compiled by Moody's Analytics, which tracked median home prices and annual incomes in 74 markets.

By that measure, housing affordability at the end of September had returned to or surpassed the average reached between 1989-2003 in 47 of those markets, The Wall Street Journal reported, noting that most economists believe the housing boom took off in 2003.
"Based on incomes, this is as affordable as it gets," said Mark Zandi, chief economist at Moody's Analytics. "If you can get a loan, these are pretty good times to buy."

Though homes have become affordable, an increasing number of people who bought as the market was rising toward its peak are finding that their homes are now worth less than the amount owed on them, also known as being "underwater."

More than a quarter of households with a mortgage were underwater at the end of December, up from 23% in the third quarter, the Journal reported, citing data compiled by real estate website . The increase was attributable to a further decline in home prices and the temporary cessation of foreclosures by banks, which had halted the practice to correct errors in document handling.

The Truth About the Financial Crisis, Part I

By Barry Ritholtz

Jennifer S. Taub is a Lecturer and Coordinator of the Business Law Program at the Isenberg School of Management, University of Massachusetts, Amherst. Her research interests include corporate governance, financial regulation, investor protection, mutual fund governance, shareholders rights and sustainable business. Previously, Professor Taub was an Associate General Counsel for Fidelity Investments in Boston and Assistant Vice President for the Fidelity Fixed Income Funds. She graduated cum laude from Harvard Law School and earned her undergraduate degree, cum laude, with distinction in the English major from Yale College. Professor Taub is currently writing a book on the financial crisis for Yale University Press.
After reading much of the final report identifying the causes of the Financial Crisis in the United States, released last Thursday December 27, by the Financial Crisis Inquiry Commission, I have one suggestion.  But before I get to it, allow me to explain.

Awe-inspiring labor and thought went into this document including interviews with 700 people, numerous hearings, millions of pages of information reviewed and synthesized.  Those who have followed the hearings or even read popular books or other accounts of the Crisis will find little new with the framework and conclusions.   What makes the Report uniquely useful, though, is the level of detail (with nearly 100 pages in footnotes and untold amounts of exhibits and supporting materials) organized so well in one document. Undoubtedly, this effort will provide tremendous value for the long term.

However, an important near-term measure of success is whether the conclusions are both credible and also can be communicated quickly and clearly to the general public.  Can the report as delivered succeed in educating millions of Americans about the causes of the Crisis?  And, will the result of such education be encouragement of and support in 2012 for those political candidates who plan to facilitate, not impede, the legislative and regulatory reforms necessary to hold people accountable and avoid such a disaster in the future? Without an appreciation of the truth, the public will be too easily swayed by the misleading refrain propagated by the US Chamber of Commerce, that existing reform and certainly any future measures will be “job-killing” regulation.

Communicating the true causes of the Financial Crisis is a tough challenge for our times. Back in the day of the investigation led by Ferdinand Pecora into the causes of the Great Crash, there were few other media distractions. Folks were riveted by the hearings that spanned 1932 through 1934. Testimony of “banksters,” worked to show how “extravagant incentive salary arrangements” had “encouraged bank officers to engaged in unsound security-selling and unsound banking practices.” The populist anger propelled a significant overall of the financial system, including passage of the first federal laws regulating the sale of securities to the public and the creation of the FDIC.

In our era, there is much competition for our attention.  And, there are interests skilled at directing populist anger away from those who are to blame and onto those who are trying to hold the culprits accountable. In terms of competition for our attention, even regarding the Financial Crisis, there have already been numerous Congressional hearings, and investigatory bodies that delved into the same topics, interviewed some of the same witnesses, and issued reports touching on similar topics. Moreover, because the Commission report has appeared more than six months after the financial reform legislation (the Dodd-Frank Wall Street Reform and Consumer Protection Act) was signed it to law, special care should be paid to explaining why the work is indeed still relevant. On page xv, the Commission makes its ambition and relevance clear:
“Some on Wall Street and in Washington with a stake in the status quo may be tempted to wipe from memory the events of this crisis, or to suggest that no one could have foreseen or prevented them. This report endeavors to expose the facts, identify responsibility, unravel myths, and help us understand how the crisis could have been avoided. It is an attempt to record history, not to rewrite it, nor allow it to be rewritten.”
So, back to the suggestion.  In line with this agenda to “unravel myths,” perhaps, after the Commission winds up operations in February, a few staffers (or mere Commission-watchers) could create a program similar to the Discovery Channel’s popular MythBusters.  For those unfamiliar with MythBusters, it is an hour -long cable television show hosted by two former Hollywood special-effects experts and three charismatic and knowledgeable co-stars. Each episode typically includes three separate investigations into whether certain “urban myths” can be substantiated. If after testing out the myth, it proves untrue, it is “busted.” If it is accurate it is categorized as “fact.”  And, occasionally, a third category is invoked where the myth is not refuted, but where a high level of certainty is unattainable, “plausible.” By way of example, one urban myth is that drinking diet coke while consuming Mentos candy will make one’s stomach explode. This myth was busted. However the theory that playing dead will help a person survive a shark attack was confirmed as fact. What makes the show additionally useful is that viewers can send in urban myths they have encountered, for testing.

So why and how to mash-up a myth-busting television format with the Commission report? From the nonprime mortgage crisis of 2007, through the moment the credit markets nearly froze up in September 2008 up to the present, it has been difficult to become educated about what happened and why.  Some of this relates to the complexity of the subject for those unfamiliar with finance, accounting or regulation. However, even beyond that, the truth is often hard to find.  There is a mixture of truth competing with mal-intentioned-lobbyist-backed misinformation.  In this muddle, I have noticed many myths worthy of examination.  Also, I suspect that many Americans concerned about the Financial Crisis struggle not just with the truth about the broader financial system, but the reality of their own financial problems in the current challenging economy and therefore have a few myths of their own for testing.
What motivates our inquiry? Consider first, the extraordinary measures begun under the Bush Administration to commit Trillions of dollars to prop up giant failing financial firms. Add to that anger about the audacity of the chief executives of those same failed firms doling out more than $18 billion in bonuses for 2008.  Share the pain of millions of foreclosures and double digit unemployment. Then, top that with the lobbyists campaign to undo and undermine the regulatory implementation of even anemic reforms enacted under Dodd-Frank.  All of this is bewildering and infuriating.

Thus, the public is eager to understand why this happened. We wish to know whether the blameworthy will be punished (or at the least have to return their ill-gotten gains). We wonder whether those injured will be made whole. And, we fear for the future of this nation, for the prospects of equality and democracy for our grandchildren. Finally, we hope against hope that we have the courage to ensure that this type of catastrophe can be prevented or mitigated.

The prospects of getting to that place of confidence depends upon important changes to the current banking and shadow banking system. However without first clearing away the misconceptions, busting the myths, we cannot see what has happened and what is merely a smoke-screen.

Toward that end, parts ii and iii of this series shall present and debunk the top ten urban myths about the crisis.
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US to cut soybean stocks estimate 'to 35-year low'


America's soybean stocks may be shown on their way to the lowest in 35 years after US officials later on Wednesday revise crop estimates, with forecasts for corn supplies also cut, analysts believe.
Analysts on average expect the US Department of Agriculture, in its latest Wasde report on world crop estimates, to make only marginal cuts to estimates for domestic inventories at the close of the 2010-11 year.
However, analysts at Country Hedging have estimated that the estimate for domestic soybean inventories will be cut by 27m bushels to 113m bushels, representing the lowest inventories since 1976-77.
The broker added that such a figure, which comes amid resilient US exports of the oilseed, largely to China, may be reached through a number of revisions rather than in one hit on Wednesday.
Corn demand 
For corn, Macquarie came in with the lowest estimate for end 2010-11 stocks among brokers polled by Thomson Reuters, forecasting a figure of 663m bushels, 82m bushels below the current USDA forecast.
Macquarie analysts said they were more upbeat than peers over prospects for US corn exports, which in latest weekly data reached a marketing-year high of 1.2m tonnes.
"We expect the corn production losses in Argentina will put more pressure on US export demand, while we also maintain a view that China will purchase corn from the US at some point this spring or early summer," Macquarie said.
Domestic demand for the grain looks firm too, the broker added, noting strong demand from ethanol plants and upbeat comments from meat giant Tyson last week.
"There is very little sign of any livestock producer pullback in production" despite high grain prices.

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China wheat woes lift prices of futures and shares


Wheat prices soared in China, supporting further rises in Western markets, as fears for mounted the country's winter wheat crop, with talk of efforts to step up agriculture lifting shares in Shanghai-listed farm groups.
Wheat for September, the best traded lot, surged the exchange limit in Zhenghou, closing up 7.0% at 3,051 yuan a tonne.
The jump on the exchange's first day back from lunar new year holidays followed a warning by the UN Food and Agriculture Organisation on Tuesday which crystallised background concerns about dry weather in wheat-growing areas of China, the world's top producer of the grain.
In fact, the area of seedlings affected by drought may be bigger than the 5.2m hectares, in five provinces, highlighted by the FAO, which warned crops faced a "critical situation" if rain was not forthcoming.
According to state radio, 6.7m hectares of wheat in eight provinces, which together account for more than 80% of the national harvest, is suffering drought.
About 24.3m hectares, an area the size of the UK, was sown altogether.
Shares surge 
On Shanghai's stock market, expectations of extra government support following the drought helped shares in many agriculture groups sidestep broader weakness from Tuesday's 0.25-point raise in Chinese interest rates.
Shares in Heilongjiang Agriculture, China's third-ranked listed food producer, closed 8.3%, while those in many seed groups also firmed. Stock in Gansu Dunghuang Seed climbed 5.4%, with Hefei Fengle gaining 4.9%.
Farm products retailer Gansu Yasheng Industrial soared 9.8%, a performance narrowly beaten by seed-to-marketing group Hunan Jinjian Cereals Industry, whose shares closed 10.0% higher.
China's government, which also directs $15bn at supporting farmers' incomes and subsidising fuel and fertilizer purchases, is looking at extra measures to support grain output, state radio said.
Western reaction 
In Western futures markets, China's woes helped support continued strength in wheat prices, although the country's limited role in international wheat markets, and apparently healthy inventories, capped bullish sentiment,
Chicago's March lot rose 1% to a fresh two-year high of $8.84 a bushel, with Paris's March lot keeping step to reach E279.00 a tonne.
London wheat for May gained 1.4% to £212.00 a ton

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China raises rates to battle stubbornly high inflation

By Aileen Wang and Ben Blanchard

China raised interest rates on Tuesday for the second time in just over six weeks, intensifying a battle in the fast-expanding economy against stubbornly high inflation that threatens to unsettle global markets.

The timing was a surprise, coming on the final day of China's Lunar New Year holiday, but investors have long expected more monetary tightening as Beijing struggles to rein in price pressures and ward off a property bubble in an economy that grew at a double-digit pace last year.

Benchmark one-year deposit rates will be lifted by 25 basis points to 3 percent, while one-year lending rates will also be raised by 25 basis points to 6.06 percent, the People's Bank of China said. The changes go into effect on Wednesday.

Although annual inflation slowed in December, analysts polled by Reuters expect it to have picked up to 5.3 percent last month, the fastest pace in more than two years, on the back of soaring food prices.

"It is the first interest rate rise in the Year of the Rabbit, but it will not be the last," said Xu Biao, an economist with China Merchants Bank in Shenzhen, referring to the country's new year, which began last week.

"If inflation stays high in February, the central bank will be forced to increase interest rates on a continuous basis," he added. "Investor confidence will be seriously hurt by expectations of aggressive policy tightening."

Fearing that tighter monetary policy would dampen demand in a country whose growth helped lift the world out of the global financial crisis, commodity markets fell after the central bank announcement. Oil, metals and grains prices recovered later on Wednesday though as investors shrugged off the rate hike, deeming it inadequate to slow the country's hunger for raw materials.

European stocks slipped back from 29-month highs in the wake of the Chinar rate rise, with the pan-European FTSEurofirst 300 index of top shares ending off 0.1 percent at 1,176.28 points. Helped by gains in U.S. stocks though, the MSCI world equity index ended up 0.35 percent at a new 29 month high.

For now, however, Chinese officials have insisted that inflation will be controllable and domestic investors have priced in only gradual tightening.

Chinese stocks could, in fact, rise slightly when the market re-opens on Wednesday to catch up with Asian counterparts that have rallied during China's week-long holiday.


This is the third rate increase since China began a monetary tightening cycle in earnest in October. It announced the last rate rise on December 25.

Wary of raising rates too high, China has leaned most heavily on quantitative tools in its tightening, forcing banks to lock up more of their deposits as reserves seven times over the past year and also ordering them to lend less.

Beijing has also imposed a slew of measures to target property prices that have stayed stubbornly high. The country's leaders, acutely aware of public anger over unaffordable housing, have said they would not tolerate property inflation and speculation.

"I didn't think it (China's rate hike) would happen today, but it doesn't matter whether you think it will happen today or tomorrow. You know that interest rates are going up," said Mike Lenhoff, chief strategist at Brewer Dolphin in London.

Excessive cash in the economy, partly stemming from China's huge trade surplus, is a root cause of fast-rising prices, and Beijing hopes that higher rates will encourage savers to keep more of their money in banks and also weigh on demand for mortgage loans.

Anti-inflation talk from the central bank in recent months has primed investors for more policy tightening and, even with the latest move, many believe further tightening is in the cards.

Economists forecast in December that China's one-year deposit rate would climb to 3.25 percent by June.
A stronger currency would be another weapon against inflation, reducing the cost of imported goods.

But Beijing is expected to keep the yuan to its path of gradual appreciation, frustrating critics from the United States to Brazil who say an undervalued exchange rate gives Chinese firms an unfair advantage in global trade.


While tighter policy may have tapped the brakes on the Chinese economy and taken a toll on the domestic stock market, which has dropped 12 percent since hitting a 2010 high in November, analysts believe the country's slowdown will be moderate.

China's economy is likely to grow 9.3 percent in 2011, according to a Reuters poll, down from a pace of 10.3 percent last year that many feared was unsustainable. 

If anything, Beijing's move to tighten policy at a time when U.S. and euro zone interest rates are at record lows is a mark of confidence within the country that its economy, the world's second-largest, is on solid ground. 

"Global markets may begin to see the frequent rate hikes as a sign that growth slowdown in China is inevitable, which could briefly weigh on market sentiment," said Dariusz Kowalczyk, economist with Credit Agricole-CIB in Hong Kong. 

"But in the end, the move will be seen as a sign of strength, with solid growth momentum allowing policymakers to raise rates. And in the end global markets should respond positively to such moves aimed at controlling inflation," he said.

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China piling up rare earth reserves to tighten monopoly

by Commodity Online

World’s largest rare earths reserves holder, China is reported to have building up on its reserves to gain more control over prices, said Wall Street Journal.

According to WSJ, details of the stockpiling plans haven't been made public.

Storage facilities built in recent months in the Chinese province of Inner Mongolia can hold more than the 39,813 metric tons China exported last year, the newspaper said.

Rare earths are a group classified as 17 elements and sometimes are called "21st Century gold" for their importance in such high-tech applications as laser-guided weapons and hybrid-car batteries, the report said.

According to a report issued by the US Geological Survey in November, about 36 percent of the world's reserves of the metals are in China. The country currently controls around 95 percent of global supply of rare earth metals.

China controls about 95 per cent of the global trade for the 17 minerals that collectively make up the rare earth metals market.

The metals, prized for their special chemical or electromagnetic properties, are used in making mobile phones, batteries for hybrid cars, wind turbines, flat-screen televisions and other high tech products.

With the prices of rare earth metals rising on average by about 130 per cent last year, mining companies in countries such as Australia have stepped up efforts to extract the minerals.

But according to the Wall Street Journal, a new mine could take a decade to develop, so the processing of rare earth elements will remain concentrated in China for years.

Last month, China brought 11 rare earth mines under state control as Beijing consolidated the industry a move analysts said could drive up prices of the elements.

In December, China also tightened control over the metals by slashing quotas for overseas shipments by some 35 per cent for the first half of 2011, as well as hiking export taxes.

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Inflation - Retail Friend or Foe?

By IB Times Staff Reporter

Robert W. Baird forecasts inflation to upswing during the course of 2011, while inflation overall is expected to remain rather benign by historical standards. The brokerage said food and gasoline are among the items poised to see upward price pressure this year.

"With many forecasters projecting an uptick in inflationary pressures during 2011, we thought it would be useful to look at how retail stocks have performed during past periods of rising inflation," said Peter Benedict, an analyst at Robert W. Baird.

Benedict said retail stocks have generally struggled to outperform the market during inflationary periods. While higher prices can help support comps, cost pressures can weigh on margins, and an overall uptick in prices effectively serves as a "tax" on consumers' ability to spend.

As the last two core inflation cycles demonstrate, rising inflation doesn't preclude retail stocks from going up -- it just tends to work against outperformance.

With retail having outperformed the S&P 500 since the March 2009 market bottom and the latest Philadelphia Fed Survey forecast pointing to an uptick in inflation during 2011, prospects for continued sector outperformance appear somewhat limited.

Benedict said inflation does not impact all retailers equally. As a result, Benedict recommends investors keep retail exposure to those companies best positioned to successfully pass through these higher input costs and thus show a benefit to comps without materially damaging profit margins.

"Among the companies best equipped to deal with this inflation dynamic, in our view, are the clubs Costco Wholesale Corp. (COST): about 56 percent of sales food/sundries, higher income customer profile; BJ's Wholesale Club Inc. (BJ): about 65 percent of sales food," said Benedict.

Benedict said Wal-Mart Stores Inc. (WMT), with 51 percent grocery, is also well positioned, though their relatively high exposure to lower income consumers may make full pass-through tougher to achieve.

Finally, inflation in pet/animal feed would likely prove incremental to comps at PetSmart, Inc. (PETM) and Tractor Supply Co. (TSCO) as well.

Which Retailers Can Accelerate Comps in 2011?

Benedict said the recent rebound in consumer spending has brought a number of retailers back close to (or even above) prior peak sales productivity levels.

While inflation will likely prove additive to comps for some retailers in the coming year, increasingly difficult comparisons suggest many companies will be hard-pressed to show an acceleration in comp momentum in 2011.

While comp momentum alone is not necessarily a reason to own or not own a retail stock, Benedict believes the table below provides a useful snapshot for investors looking to assess relative top-line/comp momentum opportunities across the sector.

Benedict sees the best opportunities for improved comp momentum at companies leveraged to food inflation (Wal-Mart, Costco, BJ's Wholesale) and those with identifiable comp driving initiatives in place -- Target Corp. (TGT).

While comps may not accelerate much at The Home Depot, Inc. (HD) and Lowe's Companies Inc. (LOW), Benedict views those two as being in the early stage of a multi-year cycle of recovering comps, and one which he believes investors should have exposure to.

Which Retailers Can Drive Margins Meaningfully Higher in 2011?

Along with the recovery in sales productivity, retail margin profiles have snapped back as companies took steps to right-size their cost structures. As a result, some of the 'low hanging fruit' in terms of recoverable margin potential has been exploited at a number of retailers, Robert W. Baird said in a note to clients.

Of course, just because a company is operating below / at historical peak levels that doesn’t alone make it an attractive / unattractive investment idea. In addition, Benedict believes all of his covered companies are poised to expand margins in 2011.

However, Benedict believes the charts below help frame the discussion around which retailers still have significant runway ahead on the margin front, and which ones are expected to drive the most material improvement.

Among Benedict's covered companies, names like Costco, Williams-Sonoma Inc. (WSM), Dick's Sporting Goods Inc. (DKS), and Vitamin Shoppe, Inc. (VSI) appear particularly well positioned to expand operating margins during 2011, while Home Depot and Lowe's remain in the early stages of what he believes will be an attractive multi-year cycle of margin improvement for those companies.
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