On August 19, 2009, CNBC reported:
The price of oil could slump toward $20 as the fundamentals supporting it are still extremely weak and its currently only being held up by fear of inflation, Johannes Benigni, managing director at JBC Energy, told CNBC.
"People are scared of inflation, that's why they are buying oil and other commodities…," Benigni said.
Although the price of crude oil may be running above levels implied by fundamentals such as global consumption and global crude oil stocks, and such a situation would be consistent with the tendency for markets to overshoot, survey and swaps data indicate that inflation concerns are not the explanation for current oil prices.
• The median expected increase in prices over the July 2009-July 2010 timeframe in the University of Michigan survey of consumers was 2.9%. That was down from the previous month’s figure of 3.1%.
• U.S. Dollar Inflation Zero Coupon securities also paint a picture of low, tame inflation. The 1-year, 2-year, and 5-year figures on August 19 were 1.23%, 1.10%, and 1.56% respectively. The 10-year figure was 2.44%. That data suggests that investors are expecting inflation to remain contained in the near- and medium-term, and generally near levels compatible with price stability a decade out.
Finally, if one examines recent news stories concerning recent oil market developments, market psychology rooted in expectations for an improving global economic outlook may be an important driver of crude oil prices. Three recent examples from The Wall Street Journal:
July 24, 2009 edition: “Although the economy is still in a slump, investors were galvanized by a third monthly increase in existing-home sales in June…”
July 31, 2009 edition: “Crude-oil futures shot up, reversing sharp losses from the prior session as rising confidence in an economic recovery displaced concerns about weak oil demand.”
August 4, 2009 edition: “Crude-oil prices settled at a six-week high, as the dollar dropped to its lowest level against the euro this year amid optimism about the outlook for the world economy.”
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Showing posts with label expectations. Show all posts
Showing posts with label expectations. Show all posts
Thursday, August 20, 2009
Monday, July 13, 2009
Survey Predicts 3.0% Inflation in Next 12 Months, But Actual Inflation Could Be Less
From May 2008 to May 2009, the consumer price index fell 1.0%. That was the biggest 12-month decline since consumer prices fell by 1.1% in the April 1949-May 1950 timeframe.
However, if the latest consumer expectations for inflation are correct, inflation would revive from its slumber over the next 12 months. The latest Reuters/University of Michigan survey predicted that consumer prices will rise 3.0% over the next year.
This latest prediction offers a good opportunity to take a closer look at inflation predictions. Based on the 12-month inflation predictions made in the University of Michigan survey cited above from May 1978 through May 2008, one finds:
• A median predicted inflation rate was 3.1% vs. the median inflation rate that prevailed of 3.2%
• The predictions were tightly clustered in the 2.5%-4.9% range. Nearly 81% of predictions fell in that range. Inflation during the prediction period fell in that range just under 60% of the time. The predictions typically avoided the long-tails (changes in consumer prices of less than 0% and those of 10% or more). Just 1.4% of predictions fell in that area. Actual inflation outcomes fell in those areas 9.6% of the time.
• There was a mean forecast error of 1.2% with a standard deviation of that error of 1.2%. In other words, the magnitude of the forecast error was quite volatile. The smallest mean forecasting errors occured in the 2.5%-4.9% forecast range. Then, the mean error was 0.9%. That conditon is not too surprising given that inflation fell in that range about 60% of the time, while forecasts called for such inflation around 80% of the time. However, when the inflation approached or reached the tails, the mean forecast error rose. Given the present macroeconomic environment, it should be noted that when consumer prices fell, the mean forecast error was 4.7% and when inflation was in the 0%-2.4% range, the average forecast error was 1.2%. Increased forecasting errors also occured during times of elevated inflation.
• In general, the higher the predicted inflation rate, the greater the error. The exception concerned predictions of 10% or greater inflation. A plausible reason for that outcome is that consumers were very reluctant to forecast 10% or greater inflation until such inflation had become established. Consumers forecast 10% or greater inflation just 1.4% of the time. Consumers were also reluctant to expect a continuation of such inflation. 10% or greater inflation occurred 8.2% of the time. The 12-month inflation rate reached 10% in March 1979. Consumers made their first forecast for the 12-month inflation rate to average 10% or above in November 1979. Their last such forecast was made in April 1980. The last double-digit 12-month inflation figure was recorded 6 months after consumers last expected it.
What All This Means:
Comparisons of 12-month inflation predictions and 12-month inflation outcomes provide some general lessons concerning human forecasting. Those lessons include: (1) Forecasts focus in a tight range, namely ranges that are familiar to those making such predictions. That is why tail risk-type events such as major crises are typically foreseen by only a few; (2) During times abnormally high inflation or abnormally low inflation/deflation, forecasting errors are large; and, (3) People view economic phenomena as more stable than such phenomena actually are.
Those general lessons also have specific ramifications for the 3.0% inflation forecast. Adding the prevailing economic dynamics (household deleveraging, an rise in saving as a share of disposable personal income, a weak economy, tighter credit markets, and the loss of the earlier “wealth effect” from high stock and real estate prices that helped encourage consumption) to the general lessons from the inflation prediction experience, odds favor an inflation rate of less than 3% for the 12-month period ending in July 2010. Given the average error associated with various inflation outcomes, it is probably more likely that inflation will amount to 1%-2% over the next 12 months rather than 3%, barring some significant geopolitical shock that disrupts the energy markets for an extended period of time and/or much more robust economic growth than expected develops.
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However, if the latest consumer expectations for inflation are correct, inflation would revive from its slumber over the next 12 months. The latest Reuters/University of Michigan survey predicted that consumer prices will rise 3.0% over the next year.
This latest prediction offers a good opportunity to take a closer look at inflation predictions. Based on the 12-month inflation predictions made in the University of Michigan survey cited above from May 1978 through May 2008, one finds:
• A median predicted inflation rate was 3.1% vs. the median inflation rate that prevailed of 3.2%
• The predictions were tightly clustered in the 2.5%-4.9% range. Nearly 81% of predictions fell in that range. Inflation during the prediction period fell in that range just under 60% of the time. The predictions typically avoided the long-tails (changes in consumer prices of less than 0% and those of 10% or more). Just 1.4% of predictions fell in that area. Actual inflation outcomes fell in those areas 9.6% of the time.
• There was a mean forecast error of 1.2% with a standard deviation of that error of 1.2%. In other words, the magnitude of the forecast error was quite volatile. The smallest mean forecasting errors occured in the 2.5%-4.9% forecast range. Then, the mean error was 0.9%. That conditon is not too surprising given that inflation fell in that range about 60% of the time, while forecasts called for such inflation around 80% of the time. However, when the inflation approached or reached the tails, the mean forecast error rose. Given the present macroeconomic environment, it should be noted that when consumer prices fell, the mean forecast error was 4.7% and when inflation was in the 0%-2.4% range, the average forecast error was 1.2%. Increased forecasting errors also occured during times of elevated inflation.
• In general, the higher the predicted inflation rate, the greater the error. The exception concerned predictions of 10% or greater inflation. A plausible reason for that outcome is that consumers were very reluctant to forecast 10% or greater inflation until such inflation had become established. Consumers forecast 10% or greater inflation just 1.4% of the time. Consumers were also reluctant to expect a continuation of such inflation. 10% or greater inflation occurred 8.2% of the time. The 12-month inflation rate reached 10% in March 1979. Consumers made their first forecast for the 12-month inflation rate to average 10% or above in November 1979. Their last such forecast was made in April 1980. The last double-digit 12-month inflation figure was recorded 6 months after consumers last expected it.
What All This Means:
Comparisons of 12-month inflation predictions and 12-month inflation outcomes provide some general lessons concerning human forecasting. Those lessons include: (1) Forecasts focus in a tight range, namely ranges that are familiar to those making such predictions. That is why tail risk-type events such as major crises are typically foreseen by only a few; (2) During times abnormally high inflation or abnormally low inflation/deflation, forecasting errors are large; and, (3) People view economic phenomena as more stable than such phenomena actually are.
Those general lessons also have specific ramifications for the 3.0% inflation forecast. Adding the prevailing economic dynamics (household deleveraging, an rise in saving as a share of disposable personal income, a weak economy, tighter credit markets, and the loss of the earlier “wealth effect” from high stock and real estate prices that helped encourage consumption) to the general lessons from the inflation prediction experience, odds favor an inflation rate of less than 3% for the 12-month period ending in July 2010. Given the average error associated with various inflation outcomes, it is probably more likely that inflation will amount to 1%-2% over the next 12 months rather than 3%, barring some significant geopolitical shock that disrupts the energy markets for an extended period of time and/or much more robust economic growth than expected develops.
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