By Phil Izzo
The November Fed statement was very similar to September, with a few new phrases that outline a potential path to rate increases and signal more confidence in an emerging recovery. (Read the full November statement.)
November meeting:
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
September meeting:
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
The Fed clarifies three important issues it is watching (low rates of resource utilization, subdued inflation trends, and stable inflation expectations). Any shift in these trends would let markets know the central bank may be moving closer to raising rates.
November meeting:
To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt.
September meeting:
To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt.
The size of the agency debt purchases were trimmed, as the availability of debt from Fannie Mae and Freddie Mac has slowed and it wasn’t clear how much the program was helping consumers.
November meeting:
Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.
September meeting:
Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.
The outlook on spending is upgraded to expanding from stabilizing.
November meeting:
With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.
September meeting:
Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.
The inflation paragraph was exactly the same as last month.
Wednesday, November 4, 2009
CMBS Savior? Developers Diversified Deal Is Nearer
Fed Worry Is Easing, Clearing Path for Test of TALF; 'We Need a Transaction Approved to Reconnect the Market'
By LINGLING WEI
A closely watched deal that may help uncork the commercial-property debt market is picking up steam after being threatened by some queasiness by the Federal Reserve, according to people familiar with the matter.
The Fed is sending signals that its concerns over the deal are easing, paving the way for the first sale of commercial-mortgage-backed securities, or CMBS, through a major rescue program called the Term Asset-Backed Securities Loan Facility, or TALF. The credit-starved real-estate industry has been hoping that the debt sale by shopping-center giant Developers Diversified Realty Corp. would lead to other CMBS sales.
Developers Diversified announced in early October that it had obtained from Goldman Sachs Group Inc. a $400 million loan, which Developers Diversified and Goldman intended to be converted into a CMBS offering through the TALF program. But the Fed, mindful of protecting taxpayers' interest, had shown reservations about financing the deal because it involves just one borrower, according to the people with knowledge of the issue.
Single-borrower CMBS offerings are considered riskier than multiple-borrower deals, with the risks spread over many different borrowers as well as different kinds of commercial buildings and geographic locations.
"The Fed is being very conservative, very diligent in reviewing collateral and very risk-averse," said Frank Innaurato, managing director at Realpoint LLC, a credit-ratings firm.
The Fed is still reviewing the deal and may still decide it is too risky. But in recent days, the Fed has indicated progress with reviewing the 28 shopping centers owned by Developers Diversified and underlying the $400 million loan, and the deal likely will be closed in the coming weeks, the people said.
If the Fed opted against the deal, Goldman likely would try to sell the $400 million loan outside of the TALF program. Representatives at the Fed, Developers Diversified and Goldman declined to comment.
Mounting Worry
Regulators are getting increasingly worried about the commercial real-estate market as rents and occupancies fall and defaults mount. The growing pressure bad loans are putting on the nation's financial institutions are jeopardizing the economy's recovery.
Part of the problem has been the evaporation of the CMBS market, which had been one of the top sources of real-estate finance. TALF is designed to revive the CMBS market as well as markets for other securitized debt by offering low-cost financing from the Fed for investors buying these securities. Investors can borrow as much as 95% of the bonds' value by pledging the securities as collateral. That means that if there is a default, taxpayers take most of the risk.
Developers Diversified Realty Corp.
Developers Diversified, owner of shopping malls like the Village at Stone Oak in San Antonio, could be key in restarting the CMBS market.
CMBS offerings are considered one of the key tests for the TALF program, introduced by the Fed in March. Since then, TALF has been viewed as a moderate success, helping borrowers from auto companies and credit-card issuers raise capital. The Fed has so far made about $40 billion in TALF loans to investors buying these securities, which has sparked a market rally and reduced the cost of borrowing.
The Fed extended TALF to include newly issued CMBS in June. But there have been no deals so far, even though a dozen or so new CMBS deals are hoping to take advantage of the program.
Like the Developers Diversified deal, these potential deals also are collateralized by multiple properties owned by one owner. While the Fed has indicated concerns over such deals, banks remain reluctant to take on "warehouse" risks associated with having to pool together loans from many borrowers. Other CMBS deals in the pipeline include those by Inland Western Retail Real Estate Trust Inc. and Vornado Realty Trust. J.P. Morgan Chase & Co. is working on both deals.
"We need a transaction approved to reconnect the market," said Jeffrey DeBoer, chief executive of the Real Estate Roundtable, a lobbying body for property owners and investors.
High TALF Bars
The deal Developers Diversified has in the works reflects the high bars the Fed sets for the type of loan it will accept as eligible for TALF financing. The $400 million loan it got from Goldman is secured by shopping centers with stable cash flow because they are occupied by discount retailers that tend to attract business even in a recession. The $400 million loan represents about half of the value of the underlying properties. By comparison, during the years before the recession, banks were willing to lend as much as 70% of a property's value because the debt could be easily sold as CMBS.
But not everyone is going to benefit from the TALF program. Tight restrictions will bar thousands of small developers and commercial-property owners with heavy debt loads from participating. Among loans that won't qualify: floating-rate mortgages, construction loans or loans secured by properties that are being "repositioned" and don't have a stabilized cash flow.
Write to Lingling Wei at lingling.wei@dowjones.com
By LINGLING WEI
A closely watched deal that may help uncork the commercial-property debt market is picking up steam after being threatened by some queasiness by the Federal Reserve, according to people familiar with the matter.
The Fed is sending signals that its concerns over the deal are easing, paving the way for the first sale of commercial-mortgage-backed securities, or CMBS, through a major rescue program called the Term Asset-Backed Securities Loan Facility, or TALF. The credit-starved real-estate industry has been hoping that the debt sale by shopping-center giant Developers Diversified Realty Corp. would lead to other CMBS sales.
Developers Diversified announced in early October that it had obtained from Goldman Sachs Group Inc. a $400 million loan, which Developers Diversified and Goldman intended to be converted into a CMBS offering through the TALF program. But the Fed, mindful of protecting taxpayers' interest, had shown reservations about financing the deal because it involves just one borrower, according to the people with knowledge of the issue.
Single-borrower CMBS offerings are considered riskier than multiple-borrower deals, with the risks spread over many different borrowers as well as different kinds of commercial buildings and geographic locations.
"The Fed is being very conservative, very diligent in reviewing collateral and very risk-averse," said Frank Innaurato, managing director at Realpoint LLC, a credit-ratings firm.
The Fed is still reviewing the deal and may still decide it is too risky. But in recent days, the Fed has indicated progress with reviewing the 28 shopping centers owned by Developers Diversified and underlying the $400 million loan, and the deal likely will be closed in the coming weeks, the people said.
If the Fed opted against the deal, Goldman likely would try to sell the $400 million loan outside of the TALF program. Representatives at the Fed, Developers Diversified and Goldman declined to comment.
Mounting Worry
Regulators are getting increasingly worried about the commercial real-estate market as rents and occupancies fall and defaults mount. The growing pressure bad loans are putting on the nation's financial institutions are jeopardizing the economy's recovery.
Part of the problem has been the evaporation of the CMBS market, which had been one of the top sources of real-estate finance. TALF is designed to revive the CMBS market as well as markets for other securitized debt by offering low-cost financing from the Fed for investors buying these securities. Investors can borrow as much as 95% of the bonds' value by pledging the securities as collateral. That means that if there is a default, taxpayers take most of the risk.
Developers Diversified Realty Corp.
Developers Diversified, owner of shopping malls like the Village at Stone Oak in San Antonio, could be key in restarting the CMBS market.
CMBS offerings are considered one of the key tests for the TALF program, introduced by the Fed in March. Since then, TALF has been viewed as a moderate success, helping borrowers from auto companies and credit-card issuers raise capital. The Fed has so far made about $40 billion in TALF loans to investors buying these securities, which has sparked a market rally and reduced the cost of borrowing.
The Fed extended TALF to include newly issued CMBS in June. But there have been no deals so far, even though a dozen or so new CMBS deals are hoping to take advantage of the program.
Like the Developers Diversified deal, these potential deals also are collateralized by multiple properties owned by one owner. While the Fed has indicated concerns over such deals, banks remain reluctant to take on "warehouse" risks associated with having to pool together loans from many borrowers. Other CMBS deals in the pipeline include those by Inland Western Retail Real Estate Trust Inc. and Vornado Realty Trust. J.P. Morgan Chase & Co. is working on both deals.
"We need a transaction approved to reconnect the market," said Jeffrey DeBoer, chief executive of the Real Estate Roundtable, a lobbying body for property owners and investors.
High TALF Bars
The deal Developers Diversified has in the works reflects the high bars the Fed sets for the type of loan it will accept as eligible for TALF financing. The $400 million loan it got from Goldman is secured by shopping centers with stable cash flow because they are occupied by discount retailers that tend to attract business even in a recession. The $400 million loan represents about half of the value of the underlying properties. By comparison, during the years before the recession, banks were willing to lend as much as 70% of a property's value because the debt could be easily sold as CMBS.
But not everyone is going to benefit from the TALF program. Tight restrictions will bar thousands of small developers and commercial-property owners with heavy debt loads from participating. Among loans that won't qualify: floating-rate mortgages, construction loans or loans secured by properties that are being "repositioned" and don't have a stabilized cash flow.
Write to Lingling Wei at lingling.wei@dowjones.com
Tuesday, November 3, 2009
Buffett Bets Big on Railroad
Berkshire to Buy Burlington Northern for $26.3 Billion, in Long-Term Bullish Signal
By SCOTT PATTERSON AND DOUGLAS A. BLACKMON
Warren Buffett made the biggest bet of his career, agreeing to buy Burlington Northern Santa Fe Corp. in a $26.3 billion deal that reflects his long-term optimism about the U.S. economy.
The deal for the nation's largest railroad operator by revenue will speed the transition of Mr. Buffett's Berkshire Hathaway Corp. into a megaoperator of industrial firms, moving the Omaha, Neb., conglomerate further from its roots as a nimble investment outfit.
Mr. Buffett is betting that in an era of high fuel costs, railroads will perform better than the trucking industry. More broadly, the investment is a wager on the long-term strength of the U.S. economy as it emerges from a prolonged recession. As U.S. commerce recovers, so too will demand to move goods around the country.
Mr. Buffett has been a pessimist on the economy over the near-term. He said on Tuesday that the deal is "not a bet on next month or next year. We're going to own it forever."
In addition, Mr. Buffett noted, he likes U.S. railroads because their businesses are relatively immune to competitive pressures from low-wage overseas economies, which in recent years have battered U.S. auto makers and other industries.
While large, heavily regulated railroad operators provide little in the way of risk, they don't generally offer the double-digit returns Mr. Buffett has scored through his long career.
Given the large premium Mr. Buffett is paying, some analysts contend it could take years for the investment to pay off for Berkshire. If the economic recovery is gradual, it could be a long time before Burlington Northern hits profit levels that justify Mr. Buffett's acquisition price, they say.
Berkshire Hathaway agrees to buy the portion of Burlington Northern railroad it doesn't already own for $26 billion in cash and stock. The News Hub asks whether the deal makes sense. Plus, turnout is key to today's off-year elections and gold hits another high.
'Slow Crawl'
"We're going to have a slow crawl in terms of recovery," says Citigroup Inc. analyst Matthew Troy. "But the reason Warren Buffett is buying BNSF is a 10- to 20-year trend. For us near-term investors, it may seem curious. For him, the trajectory of the recovery over the next one or two years is irrelevant."
Morningstar Inc., the Chicago research firm, says it valued Burlington shares at $90, below the deal's price of $100. If Mr. Buffett offered the same 31% premium when Burlington's stock was at its low in March, he would have paid roughly $67 a share, although Berkshire's stock has also risen from its lows.
Mr. Buffett said $100 was his first and best offer. "You do what you can when you can," he said.
The deal, under which Berkshire will assume $10 billion of debt, values all of Burlington Northern at $34 billion. Burlington Northern executives say the deal's valuation will be justified even if it takes years to fully recover from the recession.
"We don't have to be back to the golden era next year," said Matthew Rose, Burlington Northern's chairman and chief executive, in an interview. "We just need to see continual recovery in terms of more units coming back to the railroad. Our model will work quite nicely."
Journal Community“Look for all rail shares to start to rise and other buyouts in the future. There is an entire school of investors that do what Warren does.”
—Daniel Westerbeck Stock Split
Berkshire will pay about 60% cash and 40% stock for the railroad. Burlington Northern shareholders will have the option to receive either cash or Berkshire shares. To enable small Burlington Northern shareholders to participate in the share swap, Mr. Buffett agreed to a 50-to-1 split of Berkshire's high-priced Class B shares. The company's Class B shares closed Tuesday at $3,325.35. Berkshire's Class A shares, which closed Tuesday at $100,450, up 1.7%, won't be affected. The deal marks the first time Berkshire has split its famously pricey stock.
On the New York Stock Exchange, shares of Burlington rose 28% to $97.
Analysts who follow Berkshire say buying a highly regulated, relatively predictable business could help smooth the transition for a successor to Mr. Buffett, who is 79 years old. "He's trying to acquire these companies that can just chug along with or without him," says Paul Howard, an analyst at Janney Montgomery Scott.
The deal suggests how challenging it has become for Berkshire to find deals big enough to be meaningful, given its size. "We do need to deploy cash, but we can't put many billions to work every year in spectacular businesses," Mr. Buffett said. "To move the needle at Berkshire, they have to be big transactions."
Mr. Buffett said he proposed the deal to Mr. Rose on Oct. 22, when Mr. Buffett was in Fort Worth for a Berkshire board meeting. A day later, the two companies started to hammer out terms.
The investment is in many ways a classic move by Mr. Buffett, who prefers companies with a strong competitive edge over rivals. It would be almost impossible for a new competitor to emerge in the railroad industry, which has consolidated over the years into four major carriers.
Burlington is considered one of the best-managed U.S. railroads, but last month it cut its fourth-quarter forecast. The company's $18.02 billion in revenue last year made it the No. 1 rail company in the U.S., slightly ahead of Union Pacific Corp.
Railroads have enjoyed a resurgence over the past several years, following decades of decline due to the boom in trucking that followed the expansion of the interstate highway system.
During the past decade, as rising fuel prices, congestion on the roadways and price wars staggered trucking, railroads re-emerged as a fuel- and cost-efficient means of moving goods -- especially commodities such as coal, wheat and lumber, and imported finished goods arriving at major ports.
The advantages have given railroads the ability to maintain solid pricing power through the recession.
Mr. Buffett said he expects Berkshire to have about $20 billion in cash left in its coffers when the deal is completed. The deal is expected to close early next year and is subject to Burlington Northern shareholder approval.
The deal is the fourth-largest announced this year in the U.S., and comes amid a moribund period for mergers and acquisitions. Global deal making so far this year is down about 34% from 2008, and more than 54% from 2007.
The deal highlights Mr. Buffett's growing interest in companies that stand to benefit as energy becomes more costly.
Berkshire began accumulating stock in Burlington in 2006 as energy prices surged. Another big Berkshire holding, MidAmerican Energy Holdings Co., an Iowa utility operator, has been making a big push into wind power.
For much of his career, Mr. Buffett avoided capital-intensive industries such as railroads and utilities, focusing instead on businesses like retailing and insurance. Berkshire's second biggest deal ever, completed in December 1998, was the $22 billion buyout of General Re, the reinsurance giant.
But Mr. Buffett has been wading recently into more industrialized sectors. In December 2007, he agreed to pay $4.5 billion for the majority of Marmon Holdings Inc., which makes industrial products, from Chicago's Pritzker family. At the time, it was Berkshire's largest deal outside of insurance.
Berkshire posted its worst year ever in 2008 when it lost 9.6% in book value per share, a common metric Mr. Buffett uses to track performance. While the company's fortunes have rebounded this year, along with the rest of the market, its shares remain more than 20% below where they stood in mid-2008.
—-Jeffrey McCracken contributed to this article.
By SCOTT PATTERSON AND DOUGLAS A. BLACKMON
Warren Buffett made the biggest bet of his career, agreeing to buy Burlington Northern Santa Fe Corp. in a $26.3 billion deal that reflects his long-term optimism about the U.S. economy.
The deal for the nation's largest railroad operator by revenue will speed the transition of Mr. Buffett's Berkshire Hathaway Corp. into a megaoperator of industrial firms, moving the Omaha, Neb., conglomerate further from its roots as a nimble investment outfit.
Mr. Buffett is betting that in an era of high fuel costs, railroads will perform better than the trucking industry. More broadly, the investment is a wager on the long-term strength of the U.S. economy as it emerges from a prolonged recession. As U.S. commerce recovers, so too will demand to move goods around the country.
Mr. Buffett has been a pessimist on the economy over the near-term. He said on Tuesday that the deal is "not a bet on next month or next year. We're going to own it forever."
In addition, Mr. Buffett noted, he likes U.S. railroads because their businesses are relatively immune to competitive pressures from low-wage overseas economies, which in recent years have battered U.S. auto makers and other industries.
While large, heavily regulated railroad operators provide little in the way of risk, they don't generally offer the double-digit returns Mr. Buffett has scored through his long career.
Given the large premium Mr. Buffett is paying, some analysts contend it could take years for the investment to pay off for Berkshire. If the economic recovery is gradual, it could be a long time before Burlington Northern hits profit levels that justify Mr. Buffett's acquisition price, they say.
Berkshire Hathaway agrees to buy the portion of Burlington Northern railroad it doesn't already own for $26 billion in cash and stock. The News Hub asks whether the deal makes sense. Plus, turnout is key to today's off-year elections and gold hits another high.
'Slow Crawl'
"We're going to have a slow crawl in terms of recovery," says Citigroup Inc. analyst Matthew Troy. "But the reason Warren Buffett is buying BNSF is a 10- to 20-year trend. For us near-term investors, it may seem curious. For him, the trajectory of the recovery over the next one or two years is irrelevant."
Morningstar Inc., the Chicago research firm, says it valued Burlington shares at $90, below the deal's price of $100. If Mr. Buffett offered the same 31% premium when Burlington's stock was at its low in March, he would have paid roughly $67 a share, although Berkshire's stock has also risen from its lows.
Mr. Buffett said $100 was his first and best offer. "You do what you can when you can," he said.
The deal, under which Berkshire will assume $10 billion of debt, values all of Burlington Northern at $34 billion. Burlington Northern executives say the deal's valuation will be justified even if it takes years to fully recover from the recession.
"We don't have to be back to the golden era next year," said Matthew Rose, Burlington Northern's chairman and chief executive, in an interview. "We just need to see continual recovery in terms of more units coming back to the railroad. Our model will work quite nicely."
Journal Community“Look for all rail shares to start to rise and other buyouts in the future. There is an entire school of investors that do what Warren does.”
—Daniel Westerbeck Stock Split
Berkshire will pay about 60% cash and 40% stock for the railroad. Burlington Northern shareholders will have the option to receive either cash or Berkshire shares. To enable small Burlington Northern shareholders to participate in the share swap, Mr. Buffett agreed to a 50-to-1 split of Berkshire's high-priced Class B shares. The company's Class B shares closed Tuesday at $3,325.35. Berkshire's Class A shares, which closed Tuesday at $100,450, up 1.7%, won't be affected. The deal marks the first time Berkshire has split its famously pricey stock.
On the New York Stock Exchange, shares of Burlington rose 28% to $97.
Analysts who follow Berkshire say buying a highly regulated, relatively predictable business could help smooth the transition for a successor to Mr. Buffett, who is 79 years old. "He's trying to acquire these companies that can just chug along with or without him," says Paul Howard, an analyst at Janney Montgomery Scott.
The deal suggests how challenging it has become for Berkshire to find deals big enough to be meaningful, given its size. "We do need to deploy cash, but we can't put many billions to work every year in spectacular businesses," Mr. Buffett said. "To move the needle at Berkshire, they have to be big transactions."
Mr. Buffett said he proposed the deal to Mr. Rose on Oct. 22, when Mr. Buffett was in Fort Worth for a Berkshire board meeting. A day later, the two companies started to hammer out terms.
The investment is in many ways a classic move by Mr. Buffett, who prefers companies with a strong competitive edge over rivals. It would be almost impossible for a new competitor to emerge in the railroad industry, which has consolidated over the years into four major carriers.
Burlington is considered one of the best-managed U.S. railroads, but last month it cut its fourth-quarter forecast. The company's $18.02 billion in revenue last year made it the No. 1 rail company in the U.S., slightly ahead of Union Pacific Corp.
Railroads have enjoyed a resurgence over the past several years, following decades of decline due to the boom in trucking that followed the expansion of the interstate highway system.
During the past decade, as rising fuel prices, congestion on the roadways and price wars staggered trucking, railroads re-emerged as a fuel- and cost-efficient means of moving goods -- especially commodities such as coal, wheat and lumber, and imported finished goods arriving at major ports.
The advantages have given railroads the ability to maintain solid pricing power through the recession.
Mr. Buffett said he expects Berkshire to have about $20 billion in cash left in its coffers when the deal is completed. The deal is expected to close early next year and is subject to Burlington Northern shareholder approval.
The deal is the fourth-largest announced this year in the U.S., and comes amid a moribund period for mergers and acquisitions. Global deal making so far this year is down about 34% from 2008, and more than 54% from 2007.
The deal highlights Mr. Buffett's growing interest in companies that stand to benefit as energy becomes more costly.
Berkshire began accumulating stock in Burlington in 2006 as energy prices surged. Another big Berkshire holding, MidAmerican Energy Holdings Co., an Iowa utility operator, has been making a big push into wind power.
For much of his career, Mr. Buffett avoided capital-intensive industries such as railroads and utilities, focusing instead on businesses like retailing and insurance. Berkshire's second biggest deal ever, completed in December 1998, was the $22 billion buyout of General Re, the reinsurance giant.
But Mr. Buffett has been wading recently into more industrialized sectors. In December 2007, he agreed to pay $4.5 billion for the majority of Marmon Holdings Inc., which makes industrial products, from Chicago's Pritzker family. At the time, it was Berkshire's largest deal outside of insurance.
Berkshire posted its worst year ever in 2008 when it lost 9.6% in book value per share, a common metric Mr. Buffett uses to track performance. While the company's fortunes have rebounded this year, along with the rest of the market, its shares remain more than 20% below where they stood in mid-2008.
—-Jeffrey McCracken contributed to this article.
Worried About Inflation? Get Money Right First
October 21, 2009
By Qing Wang Hong Kong & Steven Zhang Shanghai
Fear of Inflation
As economic recovery is underway, there appears to have been increasing concerns among some market participants about potentially high inflation in China in 2010, especially in view of the rapid monetary expansion. The growth rate of broad money, M2, reached 29% in September, the fastest pace since 1997. Some market commentators predict that such an extraordinarily rapid monetary expansion is bound to result in high inflation sooner or later as, they argue, inflation is after all a monetary phenomenon. Out of this concern about serious inflation down the road, these market commentators are calling for early and aggressive policy tightening by the authorities. This fear of inflation appears to have weighed on market sentiment of late.
A Bit of Theory
The ‘quantify theory of money' is the theoretical foundation for gauging the inflation outlook by examining the expansion of money. The macroeconomic relationship between money, economic activity and prices is usually expressed in its most basic form by the well-known equation of exchange: MV = PY, where P is the price level of goods and services, Y represents national output or income, M is the supply of money, and V the velocity of money. With a stable velocity, a stable relationship between nominal national income (PY) and M exists.
The ‘quantity theory of money' argues that money is directly related to nominal income or output, and hence prices (i.e., inflation). It should, however, be pointed out that only purchasing power that is actually used for transactions can influence nominal income. Therefore, a quantity relationship between prices or GDP and money should more precisely refer to that part of the money supply that becomes effective purchasing power.
Get the Measurement of Money Right in China
There are two popular indicators of money supply in China: M1 and M2. However, neither provides a precise measurement of the money as defined by the ‘quantity theory of money', in our view. Compared to many other countries, the definition of M1 in China is too narrow and rather unique, in that it only includes cash and demand deposits by enterprise and does not include demand deposits by households. While the definition of M2 in China is de jure broadly in line with the international standards, it is de facto too broad to be considered as representing ‘purchasing power used for transactions'. Here is why:
Reflecting the underdevelopment of capital markets as a result of ‘financial repression' for decades, a large part of households' deposits at banks - that comprise the M2 - are actually long-term savings (or a form of financial investment) instead of for transaction purposes, and therefore do not represent actual and perhaps even potential purchasing power. This is the key reason why China's M2-GDP ratio is 193%, one of the highest in the world. And Chinese households' deposits account for about 85% of GDP, while their financial exposure to the stock market only accounts for about 25% of GDP.
When the long-term saving component of M2 is stable, the change in M2 primarily reflects the change in money supply/demand for transaction purposes. However, when the long-term saving component becomes unstable, the change in M2 will not necessarily reflect the change in money supply for transaction purposes, and drawing implications of the change in the headline M2 growth to the inflation outlook could become rather tricky and even misleading, in our view.
This has certainly been the case in China in the last 4-5 years. The Chinese stock market has undergone a rapid and profound development in recent years and become a meaningful asset class into which Chinese households are actively seeking to diversify their financial portfolio that has long been dominated by bank deposits. This has led to an unstable relationship between the money supply and CPI inflation in recent years, as the change in the headline M2 growth is influenced by the vagaries of households' bank deposits as a result of a massive rebalancing of households' financial portfolio between cash and stocks. Specifically, when the stock market rises, households' deposits (and thus M2) tend to decline and vice versa.
To get the measurement of money right in China for gauging the inflation outlook entails estimating the underlying household deposits that are free from the influence of the stock market and for transaction purposes only. To this end, we run a regression with households' deposits as dependent variables and nominal GDP as an independent variable and use the fitted value from the regression equation - which can explain about 97% of the variation of the actual household deposits - as a proxy for the household deposits that are used for transaction purposes. The difference between the headline households' deposits and the fitted value can therefore be viewed as a proxy of households' deposits for investment purposes. (In this context, strictly speaking, the households' bank deposits for investment purposes should be interpreted as a deviation from the historical average amount of households' bank deposits for investment purposes.)
The portion of households' bank deposits for investment purposes is heavily influenced by the stock market performance: when the stock market rises, households' bank deposits tend to decline and vice versa.
After pinning down the portion of household bank deposits for investment purposes, we adjust the headline M2 to estimate the ‘true M2' that reflects transaction purposes only. And it is the change in this part of M2 that should have direct implications on inflation. Indeed, the true M2 growth demonstrated a much closer correlation with CPI inflation than the headline.
Of particular note, despite the record-high headline M2 growth of about 29%Y in 3Q09, we estimate that the true M2 growth was only about 20%Y, which is substantially below the recent peak of 26%Y reached in 3Q07. Note that, back in 3Q07, the headline M2 growth was only 18%Y.
What explains these large discrepancies between the headline M2 and the true M2 growth rates? First, despite the seemingly well-behaved headline M2 growth in 3Q07, the overall demand for money has actually declined sharply, because households chose to buy shares over holding cash in the form of bank deposits. As such, the underlying money supply significantly outpaced money demand, as is reflected in the rapid increase of the underlying true M2 growth, generating strong inflationary pressures (we first discussed this topic in China Economics: Tighter Policy on Structural Shift in Money Demand, July 3, 2007).
The situation so far this year is just the opposite: despite the rather strong headline M2 growth since 4Q08, the underlying overall demand for money has actually increased sharply, because extreme caution and risk-aversion amid ‘the most severe financial turmoil since the Great Depression' has caused households to hold cash over buying risk assets. As such, the underlying money demand may have outpaced the supply of money, as is reflected in the not-so-rapid increase of the true M2 growth in 3Q09. In conclusion, the strong headline M2 growth overstates the true underlying monetary expansion, as it fails to account for the change in M2 caused by the shift in asset allocation by households between cash and stocks.
The true M2 growth is estimated to be about 20% in 3Q09. While this is much lower than the headline M2 growth and thus less alarming, it still looks quite high judging by the historical trends of the true M2. Looking at the relationship between true M2 and CPI would make one wonder whether a repeat of the episodes of high inflation during 2003-04 and 2007-08 cannot be avoided. Alternatively, could we expect a repeat of the situation in 2000-01 where inflationary pressures were quite moderate despite relatively high true M2 growth? To this discussion, we turn next.
Friedman versus Keynes
Followers of Milton Friedman's monetarist school believe that inflation is a monetary phenomenon, and rapid monetary expansion will sooner or later result in high inflation. However, the students of the Keynesian school would argue that when aggregate demand is weak, the output gap large and unemployment high, strong inflationary pressures are unlikely to emerge even if there were to be strong money supply growth. This is because the supply of money may be stuck in a ‘liquidity trap' without being able to effectively stimulate aggregate demand.
It is difficult to estimate the output gap for such a rapidly growing economy like China, where structural changes are constant. However, the change in exports can be treated as a proxy for the output gap in China, in our view. Much weaker exports represent a powerful negative demand shock that is deflationary. In particular, China's past experiences suggest that a significant decline in export growth should have a meaningful disinflationary/deflationary impact on the economy. China has suffered three episodes of deflation in the last decade or so: one during the Asian Financial Crisis, the other in the aftermath of the NASDAQ stock bubble burst, and the current one. The deflation either coincided with or occurred in the immediate aftermath of a collapse in export growth.
While the latest data suggest that the sharp decline in exports has stabilized and the negative growth rate has started to narrow, it still makes the decline in exports the largest in China's history. Looking forward, we expect China's export growth to turn positive towards year-end; however, the recovery in 2010 is unlikely to be very robust, as Morgan Stanley's global economics team envisages a tepid recovery in the G3 economies in 2010 (see Global Forecast Snapshots, September 10, 2009). We forecast China's exports to expand by 10% in 2010, which is much lower than the pre-crisis average of 23%. The lackluster export growth will continue to constitute a strong headwind containing inflation pressures in 2010, as was the case in 2009, in our view. In other words, the backdrop for external demand suggests a repeat of the 2000-01 situation in 2010, where inflationary pressures were rather muted despite relatively high M2 growth.
In summary, as a monetarist, one should be worried about potentially high inflation, albeit less so than warranted by the surge in headline M2 growth. However, as a Keynesian, one also has strong reasons not to be concerned about inflation, given the persistence of weak external demand and attendant excess production capacity that limits firms' pricing power. Between the two offsetting forces, which plays a dominant role and what's the net impact on inflation? We turn next to econometric modeling, with a view to quantifying the impact.
The Model: A Hybrid of Two Schools
We construct an ordinary least square (OLS) regression equation with CPI inflation as the dependent variable and the true M2 growth (with a two-quarter lag) and export growth (with a one-quarter lag) as the independent variables. By specifying such an equation, we hope to capture both the inflationary effect of monetary expansion and the disinflationary effect of weak exports. A ‘good' model should ideally have the following three features: the model can explain the bulk of the variation in CPI inflation (i.e., a high R-squared); a positive and statistically significant coefficient for true M2 growth; and a positive and statistically significant coefficient for export growth.
The regression results turn out to be quite good, especially in view of the rather simple structure of the equation. Both the estimated coefficients have the right positive signs with about 99% significance level, and the R-squared is 0.82.
The Inflation Forecasts
To make a forecast based on the inflation model, we plug into the equation our forecasts of M2 and export growth forecasts for 2010. We forecast the true M2 and export growth in 2010 to be 18% and 10%, respectively, which are in line with our forecasts of real GDP growth of about 10%. The model generates a path of CPI inflation forecasts through end-2010.
The model-based CPI inflation forecasts suggest that fear of serious inflation in 2010 is unwarranted. Specifically, the average CPI inflation in 2010 will be about 2.5%. The inflation rate will turn positive in 4Q09 and starts to rise rapidly to 2.4%Y in 1Q10 and 2.6%Y in 2Q10, as the lag effects of strong true M2 growth in 3Q09 and 4Q09 are only partly offset by continued weak exports. CPI inflation will likely peak in 3Q10, at about 2.8%Y, as the pick-up in export growth since 2Q10 will add to inflationary pressures despite some moderation in M2 growth.
Policy Calls
Our policy calls hinge on our outlook for inflation in 2010. Specifically, we expect that the current policy stance should remain broadly unchanged toward year-end and turn neutral at the start of 2010, as the pace of new bank lending creation normalizes from about Rmb10 trillion in 2009 to Rmb7-8 trillion in 2010. Policy tightening in the form of a RRR hike, base interest rate hike, or renminbi appreciation is unlikely until after mid-2010, in our view. We cannot rule out the possibility of 1-2 base interest rate hikes accompanied by RRR hikes in 2H10, as CPI inflation reaches 3%Y and the export growth recovery proves to be more durable, likely by early 3Q10.
Given the de facto USD peg new renminbi regime that has been in place for over a year now, the exact timing of China's rate hike would also be influenced by the timing of the US Fed's first rate hike, in our view (see China Economics: An Exit Strategy for the Renminbi? June 9, 2009). In general, we do not expect China to hike rates before the US Fed does. Morgan Stanley's US economics team expects the US Fed to stay on hold until mid-2010 (see US Economic and Interest Rate Forecast: Recovery Arrives - but Not a ‘V', Richard Berner and David Greenlaw, September 8, 2009).
Where We Can Be Wrong
If the global economic recovery in 2010 were to be much stronger than expected, both China's export growth and global commodity prices could surprise to the upside, likely resulting in stronger inflationary pressures and earlier policy tightening. If, however, we turn out to be wrong, it would suggest that both global and Chinese economies would be in a much better shape than is currently envisaged under our baseline scenario.
We will devote a separate follow-up note focusing on the implications to inflation stemming from potential supply shocks (e.g., high international commodity and domestic food prices). Stay tuned.
By Qing Wang Hong Kong & Steven Zhang Shanghai
Fear of Inflation
As economic recovery is underway, there appears to have been increasing concerns among some market participants about potentially high inflation in China in 2010, especially in view of the rapid monetary expansion. The growth rate of broad money, M2, reached 29% in September, the fastest pace since 1997. Some market commentators predict that such an extraordinarily rapid monetary expansion is bound to result in high inflation sooner or later as, they argue, inflation is after all a monetary phenomenon. Out of this concern about serious inflation down the road, these market commentators are calling for early and aggressive policy tightening by the authorities. This fear of inflation appears to have weighed on market sentiment of late.
A Bit of Theory
The ‘quantify theory of money' is the theoretical foundation for gauging the inflation outlook by examining the expansion of money. The macroeconomic relationship between money, economic activity and prices is usually expressed in its most basic form by the well-known equation of exchange: MV = PY, where P is the price level of goods and services, Y represents national output or income, M is the supply of money, and V the velocity of money. With a stable velocity, a stable relationship between nominal national income (PY) and M exists.
The ‘quantity theory of money' argues that money is directly related to nominal income or output, and hence prices (i.e., inflation). It should, however, be pointed out that only purchasing power that is actually used for transactions can influence nominal income. Therefore, a quantity relationship between prices or GDP and money should more precisely refer to that part of the money supply that becomes effective purchasing power.
Get the Measurement of Money Right in China
There are two popular indicators of money supply in China: M1 and M2. However, neither provides a precise measurement of the money as defined by the ‘quantity theory of money', in our view. Compared to many other countries, the definition of M1 in China is too narrow and rather unique, in that it only includes cash and demand deposits by enterprise and does not include demand deposits by households. While the definition of M2 in China is de jure broadly in line with the international standards, it is de facto too broad to be considered as representing ‘purchasing power used for transactions'. Here is why:
Reflecting the underdevelopment of capital markets as a result of ‘financial repression' for decades, a large part of households' deposits at banks - that comprise the M2 - are actually long-term savings (or a form of financial investment) instead of for transaction purposes, and therefore do not represent actual and perhaps even potential purchasing power. This is the key reason why China's M2-GDP ratio is 193%, one of the highest in the world. And Chinese households' deposits account for about 85% of GDP, while their financial exposure to the stock market only accounts for about 25% of GDP.
When the long-term saving component of M2 is stable, the change in M2 primarily reflects the change in money supply/demand for transaction purposes. However, when the long-term saving component becomes unstable, the change in M2 will not necessarily reflect the change in money supply for transaction purposes, and drawing implications of the change in the headline M2 growth to the inflation outlook could become rather tricky and even misleading, in our view.
This has certainly been the case in China in the last 4-5 years. The Chinese stock market has undergone a rapid and profound development in recent years and become a meaningful asset class into which Chinese households are actively seeking to diversify their financial portfolio that has long been dominated by bank deposits. This has led to an unstable relationship between the money supply and CPI inflation in recent years, as the change in the headline M2 growth is influenced by the vagaries of households' bank deposits as a result of a massive rebalancing of households' financial portfolio between cash and stocks. Specifically, when the stock market rises, households' deposits (and thus M2) tend to decline and vice versa.
To get the measurement of money right in China for gauging the inflation outlook entails estimating the underlying household deposits that are free from the influence of the stock market and for transaction purposes only. To this end, we run a regression with households' deposits as dependent variables and nominal GDP as an independent variable and use the fitted value from the regression equation - which can explain about 97% of the variation of the actual household deposits - as a proxy for the household deposits that are used for transaction purposes. The difference between the headline households' deposits and the fitted value can therefore be viewed as a proxy of households' deposits for investment purposes. (In this context, strictly speaking, the households' bank deposits for investment purposes should be interpreted as a deviation from the historical average amount of households' bank deposits for investment purposes.)
The portion of households' bank deposits for investment purposes is heavily influenced by the stock market performance: when the stock market rises, households' bank deposits tend to decline and vice versa.
After pinning down the portion of household bank deposits for investment purposes, we adjust the headline M2 to estimate the ‘true M2' that reflects transaction purposes only. And it is the change in this part of M2 that should have direct implications on inflation. Indeed, the true M2 growth demonstrated a much closer correlation with CPI inflation than the headline.
Of particular note, despite the record-high headline M2 growth of about 29%Y in 3Q09, we estimate that the true M2 growth was only about 20%Y, which is substantially below the recent peak of 26%Y reached in 3Q07. Note that, back in 3Q07, the headline M2 growth was only 18%Y.
What explains these large discrepancies between the headline M2 and the true M2 growth rates? First, despite the seemingly well-behaved headline M2 growth in 3Q07, the overall demand for money has actually declined sharply, because households chose to buy shares over holding cash in the form of bank deposits. As such, the underlying money supply significantly outpaced money demand, as is reflected in the rapid increase of the underlying true M2 growth, generating strong inflationary pressures (we first discussed this topic in China Economics: Tighter Policy on Structural Shift in Money Demand, July 3, 2007).
The situation so far this year is just the opposite: despite the rather strong headline M2 growth since 4Q08, the underlying overall demand for money has actually increased sharply, because extreme caution and risk-aversion amid ‘the most severe financial turmoil since the Great Depression' has caused households to hold cash over buying risk assets. As such, the underlying money demand may have outpaced the supply of money, as is reflected in the not-so-rapid increase of the true M2 growth in 3Q09. In conclusion, the strong headline M2 growth overstates the true underlying monetary expansion, as it fails to account for the change in M2 caused by the shift in asset allocation by households between cash and stocks.
The true M2 growth is estimated to be about 20% in 3Q09. While this is much lower than the headline M2 growth and thus less alarming, it still looks quite high judging by the historical trends of the true M2. Looking at the relationship between true M2 and CPI would make one wonder whether a repeat of the episodes of high inflation during 2003-04 and 2007-08 cannot be avoided. Alternatively, could we expect a repeat of the situation in 2000-01 where inflationary pressures were quite moderate despite relatively high true M2 growth? To this discussion, we turn next.
Friedman versus Keynes
Followers of Milton Friedman's monetarist school believe that inflation is a monetary phenomenon, and rapid monetary expansion will sooner or later result in high inflation. However, the students of the Keynesian school would argue that when aggregate demand is weak, the output gap large and unemployment high, strong inflationary pressures are unlikely to emerge even if there were to be strong money supply growth. This is because the supply of money may be stuck in a ‘liquidity trap' without being able to effectively stimulate aggregate demand.
It is difficult to estimate the output gap for such a rapidly growing economy like China, where structural changes are constant. However, the change in exports can be treated as a proxy for the output gap in China, in our view. Much weaker exports represent a powerful negative demand shock that is deflationary. In particular, China's past experiences suggest that a significant decline in export growth should have a meaningful disinflationary/deflationary impact on the economy. China has suffered three episodes of deflation in the last decade or so: one during the Asian Financial Crisis, the other in the aftermath of the NASDAQ stock bubble burst, and the current one. The deflation either coincided with or occurred in the immediate aftermath of a collapse in export growth.
While the latest data suggest that the sharp decline in exports has stabilized and the negative growth rate has started to narrow, it still makes the decline in exports the largest in China's history. Looking forward, we expect China's export growth to turn positive towards year-end; however, the recovery in 2010 is unlikely to be very robust, as Morgan Stanley's global economics team envisages a tepid recovery in the G3 economies in 2010 (see Global Forecast Snapshots, September 10, 2009). We forecast China's exports to expand by 10% in 2010, which is much lower than the pre-crisis average of 23%. The lackluster export growth will continue to constitute a strong headwind containing inflation pressures in 2010, as was the case in 2009, in our view. In other words, the backdrop for external demand suggests a repeat of the 2000-01 situation in 2010, where inflationary pressures were rather muted despite relatively high M2 growth.
In summary, as a monetarist, one should be worried about potentially high inflation, albeit less so than warranted by the surge in headline M2 growth. However, as a Keynesian, one also has strong reasons not to be concerned about inflation, given the persistence of weak external demand and attendant excess production capacity that limits firms' pricing power. Between the two offsetting forces, which plays a dominant role and what's the net impact on inflation? We turn next to econometric modeling, with a view to quantifying the impact.
The Model: A Hybrid of Two Schools
We construct an ordinary least square (OLS) regression equation with CPI inflation as the dependent variable and the true M2 growth (with a two-quarter lag) and export growth (with a one-quarter lag) as the independent variables. By specifying such an equation, we hope to capture both the inflationary effect of monetary expansion and the disinflationary effect of weak exports. A ‘good' model should ideally have the following three features: the model can explain the bulk of the variation in CPI inflation (i.e., a high R-squared); a positive and statistically significant coefficient for true M2 growth; and a positive and statistically significant coefficient for export growth.
The regression results turn out to be quite good, especially in view of the rather simple structure of the equation. Both the estimated coefficients have the right positive signs with about 99% significance level, and the R-squared is 0.82.
The Inflation Forecasts
To make a forecast based on the inflation model, we plug into the equation our forecasts of M2 and export growth forecasts for 2010. We forecast the true M2 and export growth in 2010 to be 18% and 10%, respectively, which are in line with our forecasts of real GDP growth of about 10%. The model generates a path of CPI inflation forecasts through end-2010.
The model-based CPI inflation forecasts suggest that fear of serious inflation in 2010 is unwarranted. Specifically, the average CPI inflation in 2010 will be about 2.5%. The inflation rate will turn positive in 4Q09 and starts to rise rapidly to 2.4%Y in 1Q10 and 2.6%Y in 2Q10, as the lag effects of strong true M2 growth in 3Q09 and 4Q09 are only partly offset by continued weak exports. CPI inflation will likely peak in 3Q10, at about 2.8%Y, as the pick-up in export growth since 2Q10 will add to inflationary pressures despite some moderation in M2 growth.
Policy Calls
Our policy calls hinge on our outlook for inflation in 2010. Specifically, we expect that the current policy stance should remain broadly unchanged toward year-end and turn neutral at the start of 2010, as the pace of new bank lending creation normalizes from about Rmb10 trillion in 2009 to Rmb7-8 trillion in 2010. Policy tightening in the form of a RRR hike, base interest rate hike, or renminbi appreciation is unlikely until after mid-2010, in our view. We cannot rule out the possibility of 1-2 base interest rate hikes accompanied by RRR hikes in 2H10, as CPI inflation reaches 3%Y and the export growth recovery proves to be more durable, likely by early 3Q10.
Given the de facto USD peg new renminbi regime that has been in place for over a year now, the exact timing of China's rate hike would also be influenced by the timing of the US Fed's first rate hike, in our view (see China Economics: An Exit Strategy for the Renminbi? June 9, 2009). In general, we do not expect China to hike rates before the US Fed does. Morgan Stanley's US economics team expects the US Fed to stay on hold until mid-2010 (see US Economic and Interest Rate Forecast: Recovery Arrives - but Not a ‘V', Richard Berner and David Greenlaw, September 8, 2009).
Where We Can Be Wrong
If the global economic recovery in 2010 were to be much stronger than expected, both China's export growth and global commodity prices could surprise to the upside, likely resulting in stronger inflationary pressures and earlier policy tightening. If, however, we turn out to be wrong, it would suggest that both global and Chinese economies would be in a much better shape than is currently envisaged under our baseline scenario.
We will devote a separate follow-up note focusing on the implications to inflation stemming from potential supply shocks (e.g., high international commodity and domestic food prices). Stay tuned.
Inflation Outlook in 2010: A Supply-Side Perspective
November 03, 2009
By Qing Wang | Hong Kong & Steven Zhang | Shanghai
Inflation Forecasts: A Demand-Side Perspective
In a recent research note, we discussed the inflation outlook for 2010 from a demand-side perspective (see China Economics: Worried About Inflation? Get Money Right First, October 19, 2009). The conclusion was that "concern about potentially high inflation in China in 2010 is unwarranted. We forecast the average CPI inflation to be about 2.5% in 2010".
In particular, we argued that "predicting high inflation in 2010, based on the strong growth of monetary aggregates so far this year, could err on the side of being too simplistic and mechanical. First, the strong headline M2 growth so far this year substantially overstates the true underlying monetary expansion, as it fails to account for the change in M2 caused by the shift in asset allocation by households between cash and stocks. We estimate that the growth rate of adjusted M2 - that truly reflects the underlying economic transactions - is much lower than suggested by the high growth of headline M2. Second, generally weak export growth, which we think could be used as a proxy for output gap in China, will continue to constitute a strong headwind containing inflation pressures. These two factors combined would suggest that the 2000-01 situation - featuring relatively high money growth but relatively low inflation - would likely be repeated in 2010".
Besides factors related to aggregate demand, inflation could also be caused by supply shocks. In this note, we address to what extent the CPI inflation level and profile shaped by potential supply shocks is consistent with our model-based CPI inflation forecasts from a demand-side perspective.
Tracing the Impact of Supply Shocks
There are typically two types of supply shocks facing the Chinese economy: one from international commodity prices and the other from domestic food prices.
As a major net importer of commodities in the global economy, the rapid increase of international commodity prices tends to cause ‘imported inflation pressure': the cost pressure stemming from high international commodities prices passes through to higher prices of downstream consumer goods. In practice, the work of this transmission mechanism is reflected in the significant correlation observed between the commodity price index, PPI inflation and non-food CPI inflation. Specifically, the global R/J CRB index tends to lead domestic PPI inflation by about three months, while PPI inflation is synchronous with non-food CPI inflation.
There is, however, no such close correlation between international and domestic grain prices. This reflects China's strategic policy objective of achieving grain self-sufficiency. International trade in grains - except soybean - in China is tightly controlled by the state and subject to quantity restrictions, which effectively severs the link between domestic and international prices.
In fact, international grain is among a handful of merchandise items that are still subject to pervasive trade restrictions by many countries in the world. Both trade restrictions and the disconnect between domestic and international grains are the norm instead of exception in today's world. In fact, it is because of the wide difference in agricultural trade policy among member WTO countries that the Doha round multilateral trade liberalization negotiation is still in a deadlock almost seven years after its launch in 2001.
The recent episode of high food price-driven CPI inflation in 2006-08 was primarily due to a sharp increase in pork prices while domestic grain prices were remarkably stable. The surge was, in turn, largely a result of an idiosyncratic domestic supply shock, namely the blue-ear disease that took place in 2006-07 and decimated the hog population.
Inflation Forecasts: A Supply-Side Perspective
Given the transmission mechanism from international commodity prices to domestic inflation, we can map a trajectory of future domestic CPI inflation, if forecasts of international commodity prices are available. Note that the change in crude oil prices demonstrates a close correlation with the R/J CRB index. Starting with our commodity research team's crude oil price forecast for 2010, the process involves three steps: from crude oil price to CRB index, from CRB index to domestic PPI inflation, and from PPI to non-food CPI. Specifically, we assume that the crude oil price level rises steadily from its current level over the course of 2010, reaching about US$94 per barrel by year-end such that the annual average price would be US$85 per barrel, which is the 2010 target price according to our commodity research team (see Crude Oil: Balances to Tighten Again by 2012, September 13, 2009).
The year-over-year change in crude oil price will rise sharply in 1Q10 and peak at over 70% and start to decline thereafter and stabilize in the range of 20-30% in 2H10. This large swing in price change of crude oil largely reflects the low base effect.
The trajectory of the forecasted change in crude oil prices will translate into the trajectory of CRB index and then to the forecasted PPI and non-food CPI inflation. Both PPI and non-food CPI inflation share a similar trajectory (with a 3-month lag to the international commodity price change): a rather sharp increase in 2Q10, peaks at mid-year, starts to decline in 1H10 and then stabilizes in 4Q10. Specifically, PPI inflation would peak at near 9%Y and average 5.2% for the year; non-food CPI inflation would peak at about 2% and average 1.1% for the year.
With non-food CPI inflation likely subdued, the 2010 inflation outlook will likely again be largely shaped by changes in food prices. Unlike non-food price inflation, food price inflation will be a function of domestic factors, in our view. First, as discussed above, domestic and international markets for grains are two separate ones. Second, an abundant domestic grain supply should ensure that any potentially large volatility stemming from the international grain market would unlikely have much spillover impact on the domestic market. In particular, China expects to have another good harvest in 2009, making it the sixth consecutive year of bumper harvest. Moreover, based on a latest official survey, the inventory-to-consumption ratio stood at about 45% as of end-1Q09, more than double the 17-18% benchmark level for grain supply safety according to the United Nations Food and Agriculture Organization (FAO). Third, the current domestic grain prices are between 33% (for rice) to about 100% (for corn and wheat) higher than international levels. This is because while international grain prices declined sharply during the global economic turmoil, domestic prices were kept stable by the authorities' effort to boost famers' income.
The relevant food price inflationary pressures in 2010 could stem from two specific sources: a) the government's decision to hike the minimum purchase prices of grains, which will bring about grain price increases in 2010; and b) the classical ‘hog cycle' that will likely lead to an increase in pork and other meat prices in 2010. In particular, regarding the latter, pork prices have been sliding sharply from the peak since 1Q08 and have fallen below the break-even level (i.e., 6-to-1 pork-to-grain price ratio) in June. Yet, the pork price has started to bottom out since July due to government intervention through frozen pork reserve program and some increase in production cost. According to our agricultural research team, the destocking of live hogs should extend to 4Q09 to complete the supply adjustment, which could cause substantial pork price increases (e.g., mid-teens) over the course of 2010.
Taking into account these factors, we forecast food price inflation to average 7.0% in 2010, with a potential peak of 10%Y in early 3Q10. Under this forecast, food prices are envisaged to reach their previous peak level by end-1Q10 and continue to rise steadily thereafter.
Combining the forecasts of non-food (two-thirds of the basket) and food (one-third of the basket) CPI inflation, we obtain the forecasts of the overall CPI inflation. Specifically, the average CPI inflation in 2010 will be about 3.0%. The inflation rate will turn positive in 4Q09 and start to rise rapidly to 1.8%Y in 1Q10, reaching 3.6%Y in 2Q10 and 3Q10 before moderating to 3.0%Y in 4Q10. The peak of the CPI inflation will likely be in July 2010, at 4.3%Y.
A Robustness Test
Regular readers of our reports would find that our inflation forecasts based on supply-side analysis in this report are not exactly the same as those from the model-based, demand-side analysis presented in another recent report on this subject (see again China Economics: Worried About Inflation? Get Money Right First). Readers may recall that in the earlier report, we wrote that "the average CPI inflation in 2010 will be about 2.5%. The inflation rate will turn positive in 4Q09 and start to rise rapidly to 2.4%Y in 1Q10 and 2.6%Y in 2Q10, as the lag effects of strong true M2 growth in 3Q09 and 4Q09 are only partly offset by continued weak exports. CPI inflation will likely peak in 3Q10, at about 2.8%Y, as the pick-up in export growth since 2Q10 will add to inflationary pressures despite some moderation in M2 growth."
The difference in CPI forecasts between the two approaches is to be expected. We, in fact, intend to use results from the supply-side analysis to test how robust results from the model-based, demand-side analysis are to potential supply shocks. In particular, we assume that the cost pressures stemming from supply-side shocks will be able to pass through the supply chain to be reflected in the corresponding price increase of downstream products without much constraint from the demand side. To the extent that weak demand constitutes headwinds for price increases or firms choose to absorb the cost pressures through lower margins, the supply-side analysis tends to yield inflation forecasts with an upward bias, in our view.
In view of the similar - albeit not the same - forecasts, we think that our model-based, demand-side analysis has passed the robustness test from the supply-side analysis. This is not entirely coincidental though. International commodity prices are not completely exogenous to China, as strong demand from China has a direct bearing on them.
Policy Implications
In view of this inflation outlook, we expect that the current policy stance should remain broadly unchanged towards year-end and turn neutral at the start of 2010, as the pace of new bank lending creation normalizes from about Rmb10 trillion in 2009 to Rmb7-8 trillion in 2010. Policy tightening in the form of RRR hike or renminbi appreciation is unlikely before mid-2010, in our view. If, however, excess liquidity stemming from large external balance of payment surpluses were to emerge earlier than expected, we would not rule out the possibility of the RRR hike cycle beginning as early as the start of 2Q10. Indeed, with inflation pressures likely muted, the monetary policy priority in 2010 will likely be placed on liquidity management through RRR hikes, in our view.
We expect the PBoC to hike the base interest rate in early 3Q10, when CPI inflation is expected to have exceeded 3.0%Y. However, since the CPI inflation is forecast to moderate in 2H10, we expect no more than two 27bp rate hikes over 2H10, the primary purpose of which is to manage inflation expectations. In view of the current de facto peg of the renminbi against the USD, the timing of China's rate hike will also hinge on that of the US Fed, in our view. In particular, we do not expect the PBoC to hike interest rate before the US Fed. Incidentally, our US economics team expects the Fed to stay on hold until mid-2010 (see Richard Berner and David Greenlaw's US Economic and Interest Rate Forecast: Recovery Arrives - but Not a ‘V', September 8, 2009).
Where We Could Be Wrong
If the global economic recovery in 2010 were to be much stronger than expected, both China's export growth and the global commodity prices could surprise to the upside, likely resulting in stronger inflationary pressures and earlier policy tightening. If, however, we turn out to be wrong, it would suggest that both the global and Chinese economy would be in a much better shape than is currently envisaged under our baseline scenario.
In the event of a sudden jump in international commodities prices due to financial speculation without meaningful improvement in global economic fundamentals, we do not rule out the possibility that the Chinese authorities may again resort to temporary administrative controls over upstream prices to prevent volatile financial shocks from disrupting the real economy, as was the case in 2007-08.
By Qing Wang | Hong Kong & Steven Zhang | Shanghai
Inflation Forecasts: A Demand-Side Perspective
In a recent research note, we discussed the inflation outlook for 2010 from a demand-side perspective (see China Economics: Worried About Inflation? Get Money Right First, October 19, 2009). The conclusion was that "concern about potentially high inflation in China in 2010 is unwarranted. We forecast the average CPI inflation to be about 2.5% in 2010".
In particular, we argued that "predicting high inflation in 2010, based on the strong growth of monetary aggregates so far this year, could err on the side of being too simplistic and mechanical. First, the strong headline M2 growth so far this year substantially overstates the true underlying monetary expansion, as it fails to account for the change in M2 caused by the shift in asset allocation by households between cash and stocks. We estimate that the growth rate of adjusted M2 - that truly reflects the underlying economic transactions - is much lower than suggested by the high growth of headline M2. Second, generally weak export growth, which we think could be used as a proxy for output gap in China, will continue to constitute a strong headwind containing inflation pressures. These two factors combined would suggest that the 2000-01 situation - featuring relatively high money growth but relatively low inflation - would likely be repeated in 2010".
Besides factors related to aggregate demand, inflation could also be caused by supply shocks. In this note, we address to what extent the CPI inflation level and profile shaped by potential supply shocks is consistent with our model-based CPI inflation forecasts from a demand-side perspective.
Tracing the Impact of Supply Shocks
There are typically two types of supply shocks facing the Chinese economy: one from international commodity prices and the other from domestic food prices.
As a major net importer of commodities in the global economy, the rapid increase of international commodity prices tends to cause ‘imported inflation pressure': the cost pressure stemming from high international commodities prices passes through to higher prices of downstream consumer goods. In practice, the work of this transmission mechanism is reflected in the significant correlation observed between the commodity price index, PPI inflation and non-food CPI inflation. Specifically, the global R/J CRB index tends to lead domestic PPI inflation by about three months, while PPI inflation is synchronous with non-food CPI inflation.
There is, however, no such close correlation between international and domestic grain prices. This reflects China's strategic policy objective of achieving grain self-sufficiency. International trade in grains - except soybean - in China is tightly controlled by the state and subject to quantity restrictions, which effectively severs the link between domestic and international prices.
In fact, international grain is among a handful of merchandise items that are still subject to pervasive trade restrictions by many countries in the world. Both trade restrictions and the disconnect between domestic and international grains are the norm instead of exception in today's world. In fact, it is because of the wide difference in agricultural trade policy among member WTO countries that the Doha round multilateral trade liberalization negotiation is still in a deadlock almost seven years after its launch in 2001.
The recent episode of high food price-driven CPI inflation in 2006-08 was primarily due to a sharp increase in pork prices while domestic grain prices were remarkably stable. The surge was, in turn, largely a result of an idiosyncratic domestic supply shock, namely the blue-ear disease that took place in 2006-07 and decimated the hog population.
Inflation Forecasts: A Supply-Side Perspective
Given the transmission mechanism from international commodity prices to domestic inflation, we can map a trajectory of future domestic CPI inflation, if forecasts of international commodity prices are available. Note that the change in crude oil prices demonstrates a close correlation with the R/J CRB index. Starting with our commodity research team's crude oil price forecast for 2010, the process involves three steps: from crude oil price to CRB index, from CRB index to domestic PPI inflation, and from PPI to non-food CPI. Specifically, we assume that the crude oil price level rises steadily from its current level over the course of 2010, reaching about US$94 per barrel by year-end such that the annual average price would be US$85 per barrel, which is the 2010 target price according to our commodity research team (see Crude Oil: Balances to Tighten Again by 2012, September 13, 2009).
The year-over-year change in crude oil price will rise sharply in 1Q10 and peak at over 70% and start to decline thereafter and stabilize in the range of 20-30% in 2H10. This large swing in price change of crude oil largely reflects the low base effect.
The trajectory of the forecasted change in crude oil prices will translate into the trajectory of CRB index and then to the forecasted PPI and non-food CPI inflation. Both PPI and non-food CPI inflation share a similar trajectory (with a 3-month lag to the international commodity price change): a rather sharp increase in 2Q10, peaks at mid-year, starts to decline in 1H10 and then stabilizes in 4Q10. Specifically, PPI inflation would peak at near 9%Y and average 5.2% for the year; non-food CPI inflation would peak at about 2% and average 1.1% for the year.
With non-food CPI inflation likely subdued, the 2010 inflation outlook will likely again be largely shaped by changes in food prices. Unlike non-food price inflation, food price inflation will be a function of domestic factors, in our view. First, as discussed above, domestic and international markets for grains are two separate ones. Second, an abundant domestic grain supply should ensure that any potentially large volatility stemming from the international grain market would unlikely have much spillover impact on the domestic market. In particular, China expects to have another good harvest in 2009, making it the sixth consecutive year of bumper harvest. Moreover, based on a latest official survey, the inventory-to-consumption ratio stood at about 45% as of end-1Q09, more than double the 17-18% benchmark level for grain supply safety according to the United Nations Food and Agriculture Organization (FAO). Third, the current domestic grain prices are between 33% (for rice) to about 100% (for corn and wheat) higher than international levels. This is because while international grain prices declined sharply during the global economic turmoil, domestic prices were kept stable by the authorities' effort to boost famers' income.
The relevant food price inflationary pressures in 2010 could stem from two specific sources: a) the government's decision to hike the minimum purchase prices of grains, which will bring about grain price increases in 2010; and b) the classical ‘hog cycle' that will likely lead to an increase in pork and other meat prices in 2010. In particular, regarding the latter, pork prices have been sliding sharply from the peak since 1Q08 and have fallen below the break-even level (i.e., 6-to-1 pork-to-grain price ratio) in June. Yet, the pork price has started to bottom out since July due to government intervention through frozen pork reserve program and some increase in production cost. According to our agricultural research team, the destocking of live hogs should extend to 4Q09 to complete the supply adjustment, which could cause substantial pork price increases (e.g., mid-teens) over the course of 2010.
Taking into account these factors, we forecast food price inflation to average 7.0% in 2010, with a potential peak of 10%Y in early 3Q10. Under this forecast, food prices are envisaged to reach their previous peak level by end-1Q10 and continue to rise steadily thereafter.
Combining the forecasts of non-food (two-thirds of the basket) and food (one-third of the basket) CPI inflation, we obtain the forecasts of the overall CPI inflation. Specifically, the average CPI inflation in 2010 will be about 3.0%. The inflation rate will turn positive in 4Q09 and start to rise rapidly to 1.8%Y in 1Q10, reaching 3.6%Y in 2Q10 and 3Q10 before moderating to 3.0%Y in 4Q10. The peak of the CPI inflation will likely be in July 2010, at 4.3%Y.
A Robustness Test
Regular readers of our reports would find that our inflation forecasts based on supply-side analysis in this report are not exactly the same as those from the model-based, demand-side analysis presented in another recent report on this subject (see again China Economics: Worried About Inflation? Get Money Right First). Readers may recall that in the earlier report, we wrote that "the average CPI inflation in 2010 will be about 2.5%. The inflation rate will turn positive in 4Q09 and start to rise rapidly to 2.4%Y in 1Q10 and 2.6%Y in 2Q10, as the lag effects of strong true M2 growth in 3Q09 and 4Q09 are only partly offset by continued weak exports. CPI inflation will likely peak in 3Q10, at about 2.8%Y, as the pick-up in export growth since 2Q10 will add to inflationary pressures despite some moderation in M2 growth."
The difference in CPI forecasts between the two approaches is to be expected. We, in fact, intend to use results from the supply-side analysis to test how robust results from the model-based, demand-side analysis are to potential supply shocks. In particular, we assume that the cost pressures stemming from supply-side shocks will be able to pass through the supply chain to be reflected in the corresponding price increase of downstream products without much constraint from the demand side. To the extent that weak demand constitutes headwinds for price increases or firms choose to absorb the cost pressures through lower margins, the supply-side analysis tends to yield inflation forecasts with an upward bias, in our view.
In view of the similar - albeit not the same - forecasts, we think that our model-based, demand-side analysis has passed the robustness test from the supply-side analysis. This is not entirely coincidental though. International commodity prices are not completely exogenous to China, as strong demand from China has a direct bearing on them.
Policy Implications
In view of this inflation outlook, we expect that the current policy stance should remain broadly unchanged towards year-end and turn neutral at the start of 2010, as the pace of new bank lending creation normalizes from about Rmb10 trillion in 2009 to Rmb7-8 trillion in 2010. Policy tightening in the form of RRR hike or renminbi appreciation is unlikely before mid-2010, in our view. If, however, excess liquidity stemming from large external balance of payment surpluses were to emerge earlier than expected, we would not rule out the possibility of the RRR hike cycle beginning as early as the start of 2Q10. Indeed, with inflation pressures likely muted, the monetary policy priority in 2010 will likely be placed on liquidity management through RRR hikes, in our view.
We expect the PBoC to hike the base interest rate in early 3Q10, when CPI inflation is expected to have exceeded 3.0%Y. However, since the CPI inflation is forecast to moderate in 2H10, we expect no more than two 27bp rate hikes over 2H10, the primary purpose of which is to manage inflation expectations. In view of the current de facto peg of the renminbi against the USD, the timing of China's rate hike will also hinge on that of the US Fed, in our view. In particular, we do not expect the PBoC to hike interest rate before the US Fed. Incidentally, our US economics team expects the Fed to stay on hold until mid-2010 (see Richard Berner and David Greenlaw's US Economic and Interest Rate Forecast: Recovery Arrives - but Not a ‘V', September 8, 2009).
Where We Could Be Wrong
If the global economic recovery in 2010 were to be much stronger than expected, both China's export growth and the global commodity prices could surprise to the upside, likely resulting in stronger inflationary pressures and earlier policy tightening. If, however, we turn out to be wrong, it would suggest that both the global and Chinese economy would be in a much better shape than is currently envisaged under our baseline scenario.
In the event of a sudden jump in international commodities prices due to financial speculation without meaningful improvement in global economic fundamentals, we do not rule out the possibility that the Chinese authorities may again resort to temporary administrative controls over upstream prices to prevent volatile financial shocks from disrupting the real economy, as was the case in 2007-08.
Ford Stirs Hope of Car U-Turn
Surprise Profit Is Driven by Finance Unit, Market-Share Grab; Focus Turns to Toyota
By MATTHEW DOLAN And JEFF BENNETT
DETROIT -- Ford Motor Co. reported a third-quarter profit of nearly $1 billion, raising hopes the auto industry is starting to pull out of its deep slump.
Ford's unexpected profit -- the result of renewed strength at its credit arm, vastly improved North American operations and the weakness of its Detroit rivals -- suggests the company's efforts to slash costs and improve its vehicle lineup are beginning to have an impact on the bottom line. Last week, Honda Motor Co. raised its outlook for the current fiscal year, saying its cost-cutting measures are starting to pay off, too. Ford's affiliate, Mazda Motor Corp., boosted its forecast as well.
Bloomberg
A Ford Motor vehicle is parked outside the company's headquarters building in Dearborn, Michigan, U.S.
"We believe that the world is starting to recover. Over time, with the fundamentals getting better, the economy and the automobile industry will recover," Ford Chief Executive Alan Mulally said in an interview.
After its earnings report, Ford said it aims to raise an additional $3 billion in cash and push back the maturity date of its revolving loan. The company plans to use a convertible-debt offering to generate $2 billion and sell off some of its shares to raise an additional $1 billion, the company said in a statement Monday.
Ford is also seeking to delay the maturity of its $10.7 billion revolving credit to 2013 from 2011, the company said in a statement Monday. Ford has already secured lender agreements to delay about $6 billion.
The move comes after Ford failed to win more cost-cutting concessions from the United Auto Workers. Rank-and-file members soundly defeated the concessions over the weekend, in part because of Ford's brightening financial outlook.
Ford stock closed more than 8% higher in regular New York Stock Exchange trading, but dropped 4.5% to $7.24 a share after the market's close because selling stock can be seen as diluting the company's equity.
Ford, the only one of Detroit's Big Three auto makers that didn't require a U.S. government bailout, reported net income of $997 million, or 29 cents a share, compared with a year-earlier loss of $161 million, or seven cents a share. Revenue fell to $30.9 billion from $31.7 billion. Most Wall Street analysts had predicted a loss for the quarter.
The Dearborn, Mich., auto maker also revised its forecast, saying the company would be "solidly profitable" in 2011. It had previously said only that it would break even by 2011.
Further clarification of the industry's state should come next week when Toyota Motor Corp. and Nissan Motor Co. report their earnings.
In North America, a region where many auto makers including Toyota have been posting losses, Ford reported pretax profit of $357 million, not including special items. A year ago, the division had a $2.6 billion loss excluding special items. The North American operation last reported an operating profit more than four years ago.
Ford's success in North America stemmed in part from the troubles of its two Detroit rivals, General Motors Co. and Chrysler Group LLC, which were reorganized in bankruptcy court, as well as the law of supply and demand. Ford's ability to decline government aid boosted its image with many American consumers, and its market share increased in the third quarter.
The company had also kept its production in check so that it could keep prices firm and reduce the need for hefty sales incentives, which pumped up its margins. And it had planned to ramp up production in the early summer, which ensured its dealers had ample inventory when the government's "cash for clunkers" rebates caused a surge in sales. By contrast, GM and Chrysler had tighter inventories and were unable to get as much of a bang out of clunker deals.
In the quarter, Ford's North American revenue rose 21% to $13.7 billion.
"I think it's a clear indication of consumer confidence, not only in the product but in the manufacturer," said Tammy Davish, who owns 26 car dealerships, including Ford franchises, mostly in the Washington area. "I don't think GM and Chrysler fully understand how their troubles are helping Ford."
Ms. Davish said her Ford dealerships -- she owns Chevy and Chrysler outposts as well -- can't get enough of the auto maker's Focus and Fusion sedans.
Ford's lending arm, Ford Motor Credit, benefited from rising prices for used vehicles, reporting net income of $427 million, up from $95 million a year earlier. Auto finance companies such as Ford Motor Credit make bets on used-car and truck prices when they lease vehicles to consumers. After the leases expire, the finance company must take the vehicles back and sell them.
Cost cutting helped, too. Ford exceeded its own goals, eliminating $4.6 billion in costs in the first nine months of the year. The largest chunk came from finding efficiencies in its manufacturing and engineering operations for a savings of $2.4 billion.
"They're not reinventing the wheel for every new program, and that saves money," said Michelle Hill, vice president in the automotive group at the Oliver Wyman management firm. Changes to work rules now let union workers perform multiple tasks, allowing Ford to reduce the number of specialty workers and save time and money on the assembly line, she said.
Analysts cheered Ford's results. Standard & Poor's Equity Research upgraded its opinion on the auto maker to buy from hold, and Moody's Investors Service raised its ratings on Ford and its finance arm one notch.
Ford's debt load remains a concern, however. At the end of the third quarter, Ford had $23.8 billion in gross cash but total debt of $26.9 billion. The debt is expected to increase by $7 billion to $8 billion because of payments the company is scheduled to make to a new fund that covers the cost of retiree health care.
And Ford still faces challenges in two of its biggest markets. Car sales in the U.S. remain sluggish. Auto makers expect to sell about 10.5 million cars and light trucks in the U.S. this year, well below the 16 million or more they were selling earlier in the decade.
By MATTHEW DOLAN And JEFF BENNETT
DETROIT -- Ford Motor Co. reported a third-quarter profit of nearly $1 billion, raising hopes the auto industry is starting to pull out of its deep slump.
Ford's unexpected profit -- the result of renewed strength at its credit arm, vastly improved North American operations and the weakness of its Detroit rivals -- suggests the company's efforts to slash costs and improve its vehicle lineup are beginning to have an impact on the bottom line. Last week, Honda Motor Co. raised its outlook for the current fiscal year, saying its cost-cutting measures are starting to pay off, too. Ford's affiliate, Mazda Motor Corp., boosted its forecast as well.
Bloomberg
A Ford Motor vehicle is parked outside the company's headquarters building in Dearborn, Michigan, U.S.
"We believe that the world is starting to recover. Over time, with the fundamentals getting better, the economy and the automobile industry will recover," Ford Chief Executive Alan Mulally said in an interview.
After its earnings report, Ford said it aims to raise an additional $3 billion in cash and push back the maturity date of its revolving loan. The company plans to use a convertible-debt offering to generate $2 billion and sell off some of its shares to raise an additional $1 billion, the company said in a statement Monday.
Ford is also seeking to delay the maturity of its $10.7 billion revolving credit to 2013 from 2011, the company said in a statement Monday. Ford has already secured lender agreements to delay about $6 billion.
The move comes after Ford failed to win more cost-cutting concessions from the United Auto Workers. Rank-and-file members soundly defeated the concessions over the weekend, in part because of Ford's brightening financial outlook.
Ford stock closed more than 8% higher in regular New York Stock Exchange trading, but dropped 4.5% to $7.24 a share after the market's close because selling stock can be seen as diluting the company's equity.
Ford, the only one of Detroit's Big Three auto makers that didn't require a U.S. government bailout, reported net income of $997 million, or 29 cents a share, compared with a year-earlier loss of $161 million, or seven cents a share. Revenue fell to $30.9 billion from $31.7 billion. Most Wall Street analysts had predicted a loss for the quarter.
The Dearborn, Mich., auto maker also revised its forecast, saying the company would be "solidly profitable" in 2011. It had previously said only that it would break even by 2011.
Further clarification of the industry's state should come next week when Toyota Motor Corp. and Nissan Motor Co. report their earnings.
In North America, a region where many auto makers including Toyota have been posting losses, Ford reported pretax profit of $357 million, not including special items. A year ago, the division had a $2.6 billion loss excluding special items. The North American operation last reported an operating profit more than four years ago.
Ford's success in North America stemmed in part from the troubles of its two Detroit rivals, General Motors Co. and Chrysler Group LLC, which were reorganized in bankruptcy court, as well as the law of supply and demand. Ford's ability to decline government aid boosted its image with many American consumers, and its market share increased in the third quarter.
The company had also kept its production in check so that it could keep prices firm and reduce the need for hefty sales incentives, which pumped up its margins. And it had planned to ramp up production in the early summer, which ensured its dealers had ample inventory when the government's "cash for clunkers" rebates caused a surge in sales. By contrast, GM and Chrysler had tighter inventories and were unable to get as much of a bang out of clunker deals.
In the quarter, Ford's North American revenue rose 21% to $13.7 billion.
"I think it's a clear indication of consumer confidence, not only in the product but in the manufacturer," said Tammy Davish, who owns 26 car dealerships, including Ford franchises, mostly in the Washington area. "I don't think GM and Chrysler fully understand how their troubles are helping Ford."
Ms. Davish said her Ford dealerships -- she owns Chevy and Chrysler outposts as well -- can't get enough of the auto maker's Focus and Fusion sedans.
Ford's lending arm, Ford Motor Credit, benefited from rising prices for used vehicles, reporting net income of $427 million, up from $95 million a year earlier. Auto finance companies such as Ford Motor Credit make bets on used-car and truck prices when they lease vehicles to consumers. After the leases expire, the finance company must take the vehicles back and sell them.
Cost cutting helped, too. Ford exceeded its own goals, eliminating $4.6 billion in costs in the first nine months of the year. The largest chunk came from finding efficiencies in its manufacturing and engineering operations for a savings of $2.4 billion.
"They're not reinventing the wheel for every new program, and that saves money," said Michelle Hill, vice president in the automotive group at the Oliver Wyman management firm. Changes to work rules now let union workers perform multiple tasks, allowing Ford to reduce the number of specialty workers and save time and money on the assembly line, she said.
Analysts cheered Ford's results. Standard & Poor's Equity Research upgraded its opinion on the auto maker to buy from hold, and Moody's Investors Service raised its ratings on Ford and its finance arm one notch.
Ford's debt load remains a concern, however. At the end of the third quarter, Ford had $23.8 billion in gross cash but total debt of $26.9 billion. The debt is expected to increase by $7 billion to $8 billion because of payments the company is scheduled to make to a new fund that covers the cost of retiree health care.
And Ford still faces challenges in two of its biggest markets. Car sales in the U.S. remain sluggish. Auto makers expect to sell about 10.5 million cars and light trucks in the U.S. this year, well below the 16 million or more they were selling earlier in the decade.
Business Bankruptcy Filings Increased 7% in October
By ERIC MORATH
Business bankruptcy filings jumped in October, reversing two consecutive months of declining commercial filings and indicating that bankruptcies could continue to rise as the economy struggles to stabilize.
Last month, 7,771 businesses filed for bankruptcy protection, compared to 7,271 that sought shelter from creditors in September, according to new data from Automated Access to Court Electronic Records, or AACER, a private firm that tracks bankruptcy filings.
After two months of decline, the 7% rise in commercial filings shows that businesses are still struggling to access financing and are facing weak demand for their products.
"The margin for success is so thin that any financial hiccup" could cause a business to file for bankruptcy, said Jack Williams, a bankruptcy professor at the Georgia State University College of Law.
The tight credit markets since 2008 "will only be exacerbated" with small-business lender CIT Group Inc.'s (CIT) Chapter 11 filing Sunday, he said.
The hardest-hit industries continue to be real estate and retail, but weakness in those sectors trickles down to a number of other areas, including home building and manufacturing, Mr. Williams said.
On a year-to-year basis, business bankruptcies shot up 24% in October compared with the same month in 2008. Mr. Williams called that increase "substantial" and said it is a bad omen for the final months of 2009 and the first quarter of 2010.
"Bankruptcy filings are a lagging economic indicator so it's likely that we'll see bankruptcy filings increase for the next several quarters," he said.
The first part of 2010 could bring another rash of retail-related filings as disappointing holiday sales may lead shops to seek protection from creditors, Mr. Williams said.
Through the first 10 months of the year, 74,832 businesses filed for bankruptcy, a 16% increase from the same period last year.
The total number of October bankruptcies, including both personal and commercial filings, increased 20% from the same month last year. The number of filings last month, 130,199, is the most total filings since March, and the second-highest figure recorded since the beginning of 2006.
Business bankruptcy filings jumped in October, reversing two consecutive months of declining commercial filings and indicating that bankruptcies could continue to rise as the economy struggles to stabilize.
Last month, 7,771 businesses filed for bankruptcy protection, compared to 7,271 that sought shelter from creditors in September, according to new data from Automated Access to Court Electronic Records, or AACER, a private firm that tracks bankruptcy filings.
After two months of decline, the 7% rise in commercial filings shows that businesses are still struggling to access financing and are facing weak demand for their products.
"The margin for success is so thin that any financial hiccup" could cause a business to file for bankruptcy, said Jack Williams, a bankruptcy professor at the Georgia State University College of Law.
The tight credit markets since 2008 "will only be exacerbated" with small-business lender CIT Group Inc.'s (CIT) Chapter 11 filing Sunday, he said.
The hardest-hit industries continue to be real estate and retail, but weakness in those sectors trickles down to a number of other areas, including home building and manufacturing, Mr. Williams said.
On a year-to-year basis, business bankruptcies shot up 24% in October compared with the same month in 2008. Mr. Williams called that increase "substantial" and said it is a bad omen for the final months of 2009 and the first quarter of 2010.
"Bankruptcy filings are a lagging economic indicator so it's likely that we'll see bankruptcy filings increase for the next several quarters," he said.
The first part of 2010 could bring another rash of retail-related filings as disappointing holiday sales may lead shops to seek protection from creditors, Mr. Williams said.
Through the first 10 months of the year, 74,832 businesses filed for bankruptcy, a 16% increase from the same period last year.
The total number of October bankruptcies, including both personal and commercial filings, increased 20% from the same month last year. The number of filings last month, 130,199, is the most total filings since March, and the second-highest figure recorded since the beginning of 2006.
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