Rate Hike Odds Plunge - Gold Should Benefit

Bloomberg is reporting BOJ Less Likely to Raise Rates as Stocks, Prices Fall.

The Bank of Japan is less likely to raise interest rates in August after global stocks slumped and the nation's consumer prices fell for a fifth month.

Investors see a 48 percent likelihood of a rate increase next month, down from 66 percent yesterday, according to Credit Suisse Group calculations based on the exchange of interest payments. Consumer prices excluding fresh food fell 0.1 percent in June from a year earlier, the government said in Tokyo today.

Japan's retail sales unexpectedly fell 0.4 percent in June, the Trade Ministry said today, as higher taxes, lower wages and a furor over lost pension records weighed on consumer sentiment.

Weak Data

"Given today's weak CPI and retail data as well as the stock decline in the U.S., there are more factors mounting against an August rate increase," said Hiromichi Shirakawa, chief economist at Credit Suisse Group in Tokyo. Shirakawa, a former central bank official, said he put the chances of an August rate increase at "less than 50 percent."

Consumer prices in Japan have failed to rise this year, after posting gains in eight months of last year. Those increases led to speculation that the economy was emerging from more than seven years of deflation that discouraged investment and consumer spending.

Nationwide core prices may fall as much as 0.2 percent in August and September because crude oil costs were near records in those months in 2006, said Takehiro Sato, chief Japan economist at Morgan Stanley in Tokyo.

Competition among mobile-phone operators is also exerting downward pressure on prices. KDDI Corp., Japan's second-biggest mobile-phone carrier, said last week that it will cut monthly fees by half, matching a move by larger rival NTT DoCoMo Inc.

Insane Worry Over Falling Prices

Japan is still worried about falling prices. Imagine that. The idea of course is absurd. Falling prices are actually the natural state of affairs as productivity is constantly improving due to advancements in technology. This allows more goods to be produced with decreasing effort (a price deflationary effect).

It is absurd to be worried about falling prices. Falling prices should be embraced. But worries over deflation in Japan caused Japan to go from surplus to having a national debt in excess of 150% of GDP (250% by some measures I have seen) as Japan fought deflation. What did Japan get for its deflation fighting policies? The answer is bridges to nowhere and massive amounts of debt.

What did the Fed get from fighting an imaginary deflation threat in 2001? The answer of course is the worlds biggest housing bubble, massive debt, tapped out consumers, and a real deflation threat. Of course deflation is not really a threat per se. Deflation is only perceived as a threat because of the insane bubble blowing policies and the risk of crash because of those policies. Deflation is needed to wipe out the many malinvestments of insane fiscal and monetary policy over the last 20 years.

In Inflation: What the heck is it? there is a quote from Ludwig von Mises who describes the endgame brought on by reckless expansion of credit: "There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved."

Thus the real threat is a policy of theft by inflation that steals from the poor and the middle class. Bernanke of course wants that policy of theft for the benefit of those having first access to money (banks and brokerage houses).

Rate Cut Odds Soar

Nonetheless the odds now favor rate cuts as the WSJ headline Futures Markets Bet Fed Will Cut Rates This Year shows.

Amid stocks battered by credit concerns and disappointing durable-goods and new-home data the futures markets now are betting that the Federal Reserve will cut interest rates this year.

Trading in December fed funds contracts translates into the market giving 100% certainty that the Fed will cut rates to 5% by the Dec. 11 Fed meeting from the current 5.25% rate.

That is up from about a 44% chance at Wednesday�s close. The market is pricing in roughly 50% odds that the FOMC could cut the rate as early as the September or October meetings.

Cleveland Fed Charts

The Fed charts do not go out to December but here is the September chart.



Notice how quickly the odds of FF rate holding at 5.25% have plunged with this market selloff. The odds of a 50 basis point cut have climbed to 20% by September. I doubt that but the odds that the next move is down regardless of what it may or may not do to the dollar are increasingly likely.

There has been a bit of a selloff in gold lately and part of that might be attributed to a yield curve that is inverting once again. Part of it can be contributed to a decrease in liquidity everywhere and raising of cash in conjunction with unwinding of leverage.

But this Fed like all others before it will respond the way they always do: by slashing rates and attempting to blow an even bigger bubble. But this is the end of the line. There is no bigger bubble than housing that will create enough jobs to allow a bigger bubble to be blown. The housing bubble was the "bubble of last resort". It cannot be revived by lowering interest rates.

But the Fed will try. The yield curve will steepen, and gold will take off on its next run higher. In the meantime, volatility in gold associated with the unwinding of leverage and various carry trades can be expected.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/