Money world

Like a dripping faucet filling up a sink, yields on U.S. Treasuries have been slowly rising for several months now — raising concerns that inflation may be on the horizon.

Higher Treasury yields are a direct result of the Federal Reserve’s near-0%interest rates and its massive quantitative easing strategy, combined with a slowly improving but sluggish economy.

On many fronts, inflation is already here. Oil prices are up 17% from a year ago, and wheat, cattle and coffee prices have all posted doubled-digit increases, deepening worries about skyrocketing food prices.

As fuel prices and food prices keep rising, no one is using the "s" word yet, but there are some whispers of the dreaded stagflation - a condition of low economic growth in an inflationary environment.

We’re not necessarily bracing for a return to the 1970s era of Jimmy Carter sweaters and long gas lines. But with the an unemployment rate of 9.4% and oil at $87 a barrel - it’s not the prettiest picture. On top of that, the first look at fourth-quarter GDP showed growth but fell short of forecasts.

"Frankly we need a little inflation right now, it would show the economy is expanding," said Josh Feinman, chief global economist with DB Advisors, a division of Deutsche Bank.

Still, fears about inflation and stagflation shouldn’t be overblown. Consumers are starting to spend again. Holiday sales were strong and consumer spending in the fourth quarter expanded at its fastest rate in five years, according to the Commerce Department.

So that brings us back to bond prices.

The U.S. Treasury yield curve — a graph of the interest rates on government bonds with different maturities — has steepened noticeably, which typically signals economic expansion and the possibility of inflation paydayloans.

Just six months ago, the curve was much flatter, with investors still talking about the possibly of deflation or even a double-dip recession. The yield on the benchmark 10-year note is currently hovering around 3.4%, compared with the 2.6% level it was at back in September.

"On balance, the general economic picture has been better and the growth prospects have been getting better," Feinman said. "Bond yields are rising because we are no longer concerned at all about deflation or even a double-dip."

But for bond investors who buy investments to hold for months or even years, it’s not what inflation is now that matters, it’s what it it’s going to be down the road.

"The bond market is pricing things in that may happen six months, 12 months, two years down the road, long before this will happen" said Ken Naehu, portfolio manager with Bel-Air Investment Advisors, who manages about $6 billion in assets for mostly high net-worth clients.

If the recovery gains momentum and the threat of inflation becomes a reality, some experts are concerned the Fed may be caught with its pants down, figuratively speaking.

Most economists expect the central bank will keep a 0% interest rate policy at least until the second half of this year or maybe into 2012 by some estimates.

"The longer they keep rates where they are, the faster they are going to have to raise them," said Adolfo Laurenti, an economist with Mesirow Financial in Chicago. "That makes the market a bit concerned." 

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What began more than three years ago as a routine audit of Laclede Gas Co.’s natural gas purchases has boiled over into a bitter dispute between the state’s largest natural gas utility and consumer advocates.

At the heart of the disagreement: Should the utility’s sister company, Laclede Energy Resources, be forced to turn over boxes of records involving gas purchased from third parties? Ultimately, the records could show whether Laclede Gas Co. overcharged its 630,000 customers for fuel to heat their homes.

The Public Service Commission staff - a group of accountants, engineers, lawyers and economists that reviews Laclede’s gas purchases - says the records it seeks are necessary to make sure transactions between affiliated companies don’t harm consumers. The PSC staff advises regulators but doesn’t have rulemaking authority.

So-called affiliate transactions concern the PSC staff and other consumer advocates because of the potential for nonregulated affiliates to charge utilities inflated prices for fuel, in effect padding corporate profits at the expense of utility customers. In this case, Laclede Gas and Laclede Energy Resources operate independently but under the same corporate parent, Laclede Group Inc.

“We always scrutinize affiliate transactions very closely, because they’re not at arm’s length,” said Kevin Thompson, chief counsel for the PSC staff. “So they’re inherently dangerous to a ratepayer. That does not mean we’ve found any evidence of anything improper. That’s why we’re seeking the documents.”

St. Louis-based Laclede Gas agrees that such transactions deserve extra scrutiny. And the utility says it has gone out of its way to provide thousands of pages of records that prove prices its customers paid for natural gas were fair.

“Laclede Gas has provided a substantial amount of information to demonstrate what the market prices of these transactions were,” utility attorney Michael Pendergast said. “We also cooperated with our affiliate, Laclede Energy Resources, and they have provided information related to these transactions including cost information and other market data.”

Cases involving utility audits are notoriously tedious and complex. But this one is tortuous even by those standards.

The stalemate has dragged on since 2007, involving tens of thousands of pages of testimony and pleadings and countless hours of hearings. The PSC has reversed itself on the matter twice. The dispute has since been to state court and back, and may ultimately be headed there again.

The current dispute originated during its audit of gas purchases made by Laclede from 2005 to 2007. Every November, Laclede estimates the price it will pay for natural gas on the wholesale market over the next year. That is the price paid by consumers. Actual gas purchases are later audited by the PSC staff to determine if they match the utility’s estimated costs. Customers are billed or credited the difference.

The PSC staff has asked regulators to disallow $6 million in costs related to transactions between Laclede Gas and Laclede Energy Resources.

To prove its case, it sought records involving transactions between Laclede Energy Resources and third-party gas suppliers.

Those records will show what Laclede Energy Resources paid for natural gas that was later sold to the utility and, ultimately, customers, Thompson said.

“We want to understand the entire universe of sale and purchase transactions that LER made in order to establish the fair market price,” he said.

Laclede Gas only purchases a small volume of gas from its affiliate, usually less than 5 percent of the volume used by utility customers. And the company has turned over all records involving those sales as well as records showing what the utility paid to other suppliers. That’s enough to demonstrate that prices paid were appropriate, Pendergast said.

The PSC staff has two complaints against Laclede Gas. One accuses Laclede of not following special rules that govern how related companies do business with each other.

The other complaint claims the utility violated terms of an agreement that allowed it to restructure in 2001. The restructuring allowed the company to establish Laclede Energy Resources, a wholesale gas marketer.

Meanwhile, Laclede filed its own complaint against the PSC staff. But that case was dismissed by the commission.

If the PSC upholds the complaints against Laclede, it could sue the utility in circuit court and seek penalties of up to $2,000 per day for each violation.

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The world’s largest bond investor says the fight over raising the country’s borrowing limit threatens to throw the debt market into a tailspin.

“It’s the wrong way to do it,” says Bill Gross, manager of the $241 billion Pimco Total Return Fund, the largest mutual fund. “Obviously, I’m all for a move to a balanced budget over time. But this is like imposing the death penalty for shoplifting.”

In arguments over lifting the federal government’s $14.3 trillion debt limit, both sides have used bond investors as a bogeyman.

Congressional Republicans say bond investors will set off a Greek-style financial crisis in the U.S. if the national debt grows. They’ve promised not to raise the limit without deep spending cuts.

The Obama administration says if Congress refuses to raise the debt ceiling in time bond investors will flee U.S. debt and create a larger meltdown than the last one.

And why do governments care what Gross thinks? Because bond buyers like him are essentially bankers to the world, playing a vital but behind-the-scenes role in the global economy. Any country that spends more than it receives in taxes relies on them to make up the shortfall. Deeply indebted governments can easily fall into a crisis when investors like Pimco turn on them.

Under the current limit, the government can borrow another $234 billion, a ceiling that could be reached as early as March. Lifting the limit is usually a non-event: Congress has raised it 74 times in the past 70 years.

This time, however, the battle could turn fierce. Republicans took control of the House in November on a pledge to cut the national debt, which ballooned because of a decade of budget deficits and the Great Recession. The Congressional Budget Office said Wednesday that this year’s budget deficit will reach a record $1.5 trillion.

In response to President Barack Obama’s State of the Union address Tuesday, Paul Ryan, the new Republican chair of the House Budget Committee warned of “a crushing burden of debt” and drew comparisons to the European financial crisis.

Gross and others say the Republican strategy is reckless. Typically, bond investors are fiscal conservatives who want the U.S. to cut its debt and tighten its budget deficits. They worry that rising interest payments will swallow a larger share of the country’s income and hurt the economy. But bargaining over the debt-limit vote raises the specter of a government default, and few things scare investors more.

“The signal it gives to countries that hold Treasurys is that their assets are hostage to a rogue Congress,” Gross says. “That’s the message it sends. It’s unacceptable.”

The real danger comes if the fight drags on. Pimco and other money managers have been selling Treasurys in recent months. The market took a fall in December after the Obama administration and Republicans reached a deal to extend Bush-era tax cuts along with unemployment benefits. The total package is expected to add $400 billion to the current year’s budget deficit.

At a meeting of Pimco’s investment committee last week, the assembled money managers agreed that the closer the government gets to the ceiling, the greater the risk that nervous investors ditch Treasurys en masse. That would push long-term interest rates higher and risk derailing the economic recovery.

“The Treasury market will sell off as this get more press and with more invective,” Gross says fast cash advance. “Investors like us, we sell now.”

Bond investors are creditors, like banks. When investors buy a Treasury note, they lend the government money in exchange for a promise to return it later with interest. And like other lenders, they take a keen interest in a borrower’s ability to pay them back.

The trouble starts when bond buyers worry that a country could default. That leads them to demand much higher interest rates for borrowing. Last year, cash-strapped Greece was essentially locked out of the bond markets because it couldn’t afford the high rates. Greece avoided a default thanks to a 110 billion euro bailout by the European Union and International Monetary Fund last May. Greece needed bond investors to keep it afloat, but bond investors didn’t need Greece.

In contrast, U.S. government bonds and the dollar underpin the global financial system. The Treasury yield is used as a benchmark for all borrowing, a point of comparison for debt around the world. A default on U.S. government debt would cause unthinkable chaos, says Rich Tang, head of fixed-income, equity and foreign exchange sales at the RBS Securities. The dollar would fall and credit markets would seize up around the world.

That’s the main reason why few believe the U.S. will miss an interest payment. If Congress fails to raise the limit, the Treasury has a number of cash-management tricks that could delay a default for a few months. If that fails, analysts believe the government is more likely to stop making Social Security payments to Americans than miss an interest payment to China.

The Treasury took a pre-emptive step on Wednesday to head off a cash crunch. Starting next week it will gradually decrease the $200 billion the government has borrowed in a special program for the Federal Reserve, lowering that amount to around $5 billion.

Some bond investors support the Republican effort. Congress would be unlikely to tackle the budget deficit any other way, says Eric Stein, portfolio manager at Eaton Vance Management. Eventually, Democrats and Republicans will reach a compromise on spending cuts, he says. The end result: “You actually make fiscal progress.”

Even an extended brawl that drives up Treasury rates could have benefits, Stein says. Higher rates would force Congress into taking budget-cutting seriously, much as higher bond yields in Portugal and Ireland led governments to push through austerity packages. “One reason we’re so complacent in the U.S. is because are yields are so low,” he says.

The closest parallel to the current standoff started in 1995 between President Bill Clinton and Republicans in Congress. The federal government shut down for 26 days over three months because the two sides failed to pass a budget. That caused antsy investors to dump Treasurys, sending the yield on the 10-year Treasury note swinging from 5.52 percent to 6.46 percent.

A public backlash helped Clinton win re-election in 1996. That experience should give Republicans pause, says Joseph Balestrino, fixed income strategist at Federated Investors.

“Republicans are making a stink because they feel like they have public support,” he says. “But you don’t hold this hostage. Nobody wins.”

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Johan Vande Lanotte resigned from his mission to mediate stalled Belgian coalition talks when he met with King Albert II this afternoon, the royal palace said in an e-mailed statement today.

The monarch accepted Vande Lanotte’s resignation and will start consultations tomorrow, according to the statement.

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Spanish Finance Minister Elena Salgado said the amount needed to recapitalize the country’s banking system won’t exceed 20 billion euros ($27 billion) and “all or part” of that sum will come from financial markets.

Spain will also make lenders adopt a core capital ratio of at least 8 percent, Salgado said in a news conference in Madrid today. Lenders will have until the fall to raise enough capital to meet that requirement, and those that can’t do so will be able to tap the state’s bank-rescue fund known as FROB, which will take ordinary shares with voting rights in exchange.

The figure is lower than estimates from analysts including those at Moody’s Investors Service, which said today that lenders may need at least 17 billion euros, rising to 89 billion euros in a stressed case. Savings banks, or cajas, have been locked out of wholesale debt markets amid investor concern about 181 billion euros of what the Bank of Spain terms “potentially troubled exposure” to construction and real estate.

“That doesn’t mean that the FROB has to contribute 20 billion euros,” Salgado said. “Our interest, and the interest of the sector, is that all or part of that can be obtained in the markets.”

The Bank of Spain will decide at the end of September which lenders need capital from the FROB. The public fund will only take shares in banks, meaning that cajas in need of funds will have to become commercial banks, she said.

‘Strong Message’

“It’s definitely a step in the right direction, although it still may not be far enough,” said Ricardo Wehrhahn, a partner at Roland Berger Strategy Consultants in Madrid. “It does send a strong message to the cajas though because it sets them a deadline to raise the capital they need. They’re going to have to present a convincing story to investors now.”

Spain, trying to persuade investors it won’t follow Ireland into a European bailout amid a surge in public and private borrowing costs, wants the savings banks to bolster their capital to improve their access to markets. The Socialist government is fighting to stem the third-largest budget deficit in the euro region and wants to convince investors that shoring up the lenders won’t overburden public finances.

The gap between Spanish and German 10-year borrowing costs rose to 209 basis points today, compared with 203 basis points on Jan. 21 and an average of 15 basis points in the first decade of monetary union.

Budget Deficit

Salgado said the program wouldn’t affect the government’s budget deficit, which will fall to 6 percent of gross domestic product this year from 9.3 percent last year. In the “worst case scenario” where the FROB would have to inject 20 billion euros, that would add 2 percentage points to the nation’s debt burden, she said. Spain’s debt amounted to 64 percent of GDP last year. Spain is financing itself in markets “without problems,” and the FROB would be able to do the same, she said.

Savings banks will be able to use existing methods set out in the savings-bank law to raise capital, Salgado said.

Some entities will have to have a core capital ratio of more than 8 percent Salgado said. Those that need more would be those that aren’t traded or don’t have a significant portion of private capital and whose dependency on wholesale markets is greater than 20 percent of assets, she said.

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The filmmaker behind “Up in the Air” had planned to begin shooting his next movie in St. Louis this spring, but now it’s unclear if the project will stay in Missouri after receiving approval for just $1 million out of the requested $4.5 million in state film tax credits.

Michael Beugg, an executive producer and a St. Louis native, is working on a Halloween-themed comedy called “Fun Size,” set to be filmed in St. Louis. Josh Schwartz, the executive producer of Gossip Girl, has been tapped to be the film’s director.

But Kim Tucci, chairman of Cinema St. Louis (which runs the St. Louis International Film Festival), said Beugg might take the film to another state such as Louisiana, which offers more generous tax credits, if Paramount Pictures is not happy with the level of tax credits Missouri is offering.

“They have other choices,” said Tucci, who’s been in frequent contact with Beugg about the film.

“This is a joke not to do it. This is not one of those frivolous things. This is not an earmark. It is not an historic tax credit. … These are concrete dollars we’re talking about coming into the state of Missouri.”

John Fougere, a spokesman for the state Department of Economic Development, which administers the tax credits, provided a copy of the letter sent to Paramount Pictures about the approval for $1 million in film tax credits but did not respond to a follow-up question about why the full request was not granted.

The film project appears to have been caught up in the debate over whether Missouri should continue its $4.5 million film tax credit program. Such tax credits have become a popular tool by many states to lure film crews away from New York City and Los Angeles. But critics say that states often lose money on these programs, and that the positive economic impact of the films dry up once the local shoot ends.

In November, a committee charged by Gov. Jay Nixon to review the state’s 61 tax credit programs recommended that the film tax credit be eliminated along with up to $200 million in other state incentives.

In place of the film tax credit, the commission recommended giving tax credits to angel investors who contribute a certain amount to high-tech startup companies in rural or distressed communities.

Nixon’s budget proposal for the next fiscal year does not include funding for the film tax credit, his spokesman confirmed in an e-mail.

Missouri’s film tax credit program, which is modest compared to other states, pays back 35 percent of what a film spends in the state up to an annual cap of $4.5 million. The most noteworthy film it has supported was the Oscar-nominated “Up in the Air,” which received about $4.1 million in tax credits and pumped nearly $12 million into the local economy, according to a report by the economic development department. But some local boosters, including Tucci, assert that the impact was much larger.

Beugg told the Post-Dispatch in November that it wouldn’t have made sense to shoot parts of “Up in the Air” in Missouri without the tax credits.

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Canada risks losing the scientists and engineers needed to sustain its nuclear industry if the fate of Atomic Energy of Canada Ltd. remains uncertain, says the chief executive of Bruce Power.

Duncan Hawthorne told the Empire Club Thursday that the federal and Ontario governments should make it clear they

Spanish Prime Minister Jose Luis Rodriguez Zapatero wants to lure private investors to the country’s savings banks to share the burden of shoring up their capital. It won’t be easy, analysts and investors said.

“Mr. Zapatero can do lots of things like raise VAT or cut social benefits, but something he can’t do is force a private investor to put his money in a caja if he doesn’t want to,” said Pablo Garcia, head of equities at Oddo Sociedad de Valores in Madrid. “I’m afraid it’s just impossible for now.”

Momentum may be building for the state to provide more capital to the savings banks to restore confidence in an industry and economy stricken by lending to property developers, said Inigo Lecubarri, who helps manage about $200 million at Abaco Financials Fund in London. The savings banks, or cajas, are regional institutions run as foundations that helped fund the property boom and account for about half of Spain’s loans.

Zapatero’s challenge is to fix the savings banks without derailing plans to cut the euro region’s third-largest budget deficit, just two months after losses at Ireland’s banks forced the country to seek an 85 billion-euro ($114 billion) rescue from the European Union and International Monetary Fund. The government would prefer private investors to fill the cajas’ capital hole, Deputy Finance Minister Jose Manuel Campa said this month.

Spain has already lent the cajas about 11 billion euros, equivalent to 1 percent of gross domestic product, and they may need as much as 50 billion euros in additional capital as bad loans pile up, analysts at Evolution Securities estimated in a Jan. 20 report.

‘Praiseworthy’

Officials have played down such estimates. Finance Minister Elena Salgado told reporters in Brussels this week the capital needs “would be very far” from the 30 billion euros to 80 billion euros reported in El Confidencial, an online publication.

Spain’s efforts to reorganize the savings banks so far have been “praiseworthy,” up to a point, Garcia said. The number of cajas declined to 17 groups from 45 after the Bank of Spain pushed them into mergers to cut costs and underpin the weakest lenders. The government also changed the law to make it easier for cajas to raise capital from private investors and become commercial banks.

A group led by Caja de Ahorros del Mediterraneo and Cajastur is among cajas pooling their banking operations and selecting more experienced managers to distance themselves from a model of regional banking that was susceptible to political influence.

The “underlying message” from the central bank is that it wants to see the cajas start to show they can raise private capital, Arturo de Frias, head of banking research at Evolution, said by phone payday loan lenders. Barcelona-based La Caixa, which already has an investment holding company, might be the first to try, he said.

“There is a roadmap in which the cajas go through certain steps and then there’s a further step, which is raising private capital,” said de Frias.

‘Root-and-Branch’

Some investors say the roadmap doesn’t go far enough to make the struggling institutions attractive as a potential investment, especially when weighed against profitable competitors such as Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA, the nation’s largest lenders.

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China should urgently seek guidance on whether its holdings of “euro periphery debt” will be affected by any restructuring, said Yu Yongding, a former adviser to the Chinese central bank.

“Until such clarification is provided, or the eurozone comes up with a permanent resolution mechanism, China should give no commitment to support the eurozone through direct government bond purchases — this simply risks throwing good money after bad,” Yu wrote in the Financial Times today.

Yu’s comments contrast with Chinese government officials’ statements of support for the region and nations including Spain. Euro-area finance ministers pledged yesterday to strengthen the region’s safety net for debt-strapped countries, while indicating they don’t see the need to do more immediately.

The euro has dropped 0.5 percent over the past month in a measure of the currencies of 10 developed nations, according to Bloomberg Correlation-Weighted Currency Indexes.

In other comments, Yu said China may see “significantly lower” growth as the economy shifts away from dependence on exports and investment over the next four years.

The nation’s expansion may become more balanced and stable, he said, adding that the government needs to cool the economy, while avoiding a “hard landing.”

China will on Jan. 20 report a 10.2 percent economic expansion for last year, according to the median estimate in a Bloomberg News survey of 15 economists. Officials have sought to limit inflation risks by raising benchmark interest rates and banks’ reserve requirements. The government also aims to increase the role of domestic consumption in driving growth.

Yu said a stronger Chinese currency would help the U.S. and also aid China’s efforts to adjust its economy and contain inflation.

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Ernst & Young LLP’s Item Club said the Bank of England must “hold its nerve” and not raise its key interest rate until the recovery shows signs of overcoming the impact of the government’s budget squeeze.

“With inflation likely to reach 4 percent this spring, the Monetary Policy Committee will come under intense pressure,” the research group said in a report in London today. It should “keep base rates where they are until it is clear that the economy is taking the fiscal adjustment in its stride.”

The bank maintained emergency stimulus last week as it weighed the threats of spending cuts against the risk that higher oil prices and sales tax rate will keep inflation above the government’s 3 percent limit. A senior lawmaker from the ruling Conservative Party called yesterday for increases now, and economists at banks including Citigroup Inc. said they may come faster than previously anticipated.

Inflation may have accelerated to 3.4 percent in December from 3.3 percent in November, according to the median forecast of 31 economists in a Bloomberg News survey. That would be the highest in seven months. The Office for National Statistics will publish the data at 9:30 a.m. in London tomorrow.

In a sign of mounting price pressures, input-price inflation accelerated to 12.5 percent in December from 9.2 percent, data last week showed.

Growth Forecasts

The Item Club, which uses the same forecasting model as the U.K. Treasury, revised its prediction for economic growth this year to 2.3 percent from 2.2 percent. It cut its 2012 projection to 2.8 percent from 2.9 percent.

“The fiscal retrenchment will keep gross domestic product subdued,” while inflation will “leave the MPC agonizing” over the interest rate, Item Club chief economic adviser Peter Spencer said. “However, it’s vital that the MPC stands firm.”

The group also said that exports and investment will be “sufficiently strong” for the recovery to continue and that inflation will slow.

Societe Generale SA, BNP Paribas SA and Citigroup this month changed their forecasts for rate increases from a record low of 0.5 percent. Citigroup says it sees two quarter-point rate increases in 2011 instead of one, and the other banks say the first move will come this year, not in 2012.

Michael Fallon, a Conservative member of the lawmaker panel that scrutinizes the central bank and the Treasury, told BBC Radio 5 yesterday that the policy makers should start a series of “gradual” rate increases now to avoid sharper rises later.

“I tend to be a ‘now man’ because we’ve had constant reassurances that inflation will fall and it hasn’t fallen,” he said. “Given that rates are artificially low, they’re going to have to go up anyway eventually, I’d rather see them start moving up gradually than go up in a huge jump, perhaps in the autumn.”

In a separate report today, Deloitte & Touche LLP chief economic adviser Roger Bootle predicted U.K. GDP growth of 1.5 percent this year and next and said he sees no change in the central bank rate until at least 2013.

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