Endogenous Analysis

Interest rate (lagging indicator) is used as a reactionary tool by the central bank (Federal Reserve
Bank) in respond to the leading drivers.

Fed funds rate is interest rate at which depository institutions trade with each other.
Federal Reserve sells government bond to reduce money in the economy.

The federal open market committee meet 8 times per year.

Interest rate is used by the Federal Reserve to control the supply of money.

Low interest rate cause money to lose value because the supply of money will increase
Based on historical date there is correlation between the magnitude (percentage change) at
which the Federal Reserve reduce interest rate and reduction of the annualize GDP growth
rate.

Summary
Interest rate takes slower time to impact the economy.
Interest rate is not a statistical distribution like m2.
Percentage change verses the level real GDP.
It’s the percentage change that affect the GDP rather the actual rate.
Percentage change in the interest rate is reactionary to some anomaly
Long currency bias for small percentage decrease in interest rate
Big decreases in the percentage change we take a Short currency (low level of GDP) predicting
inflation hence reduction in the value of the currency
Inflation coincidence indicator
Consumer price index inclusive of food and energy(CPI)

Low and stable rate is very important for capitalism.

CPI (consumer price index) and PPI (producer price index)

Standard deviation
80% of the time price move, the change will be within the bounds of 0.35% of the mean
Have short currency bias when there is extreme cases of deflationary period because the fed will
react the deflationary condition.
To build the score cards use the best fit line find the average CPI relative to GDP

When deflation occur the value of the money increases then we take a long currency bias
When inflation occur the value of the money decreases then we take a short currency bias
CPI Ex Coincident indicator
CPI excluding food and energy
It is not as useful as the CPI inclusive of food and energy. The federal reserve usually react to the
numbers of this index.
Distribution of return is the framework for decision making relative to the CPI ex associated
with real GDP growth.

Analysis of the CPI ex

Ascertain normality
PPI including food and energy producer price index (coincident indicator)
Real goods sold to consumers
This require a long data set. This will give more accurate result
This date was continued in 2009.
PPI finish goods.
When the economy is contracting the fed will intervene and to stop the deflationary situation
(long bias). From this, as traders we most anticipate the oppose and predict inflation which we
must have a short bias. In extreme inflationary period we have a short bias, however when
inflation reach extreme we must anticipate the move from the fed to counter the situation.

PPI excluding food and energy producer price index (Coincident indicator)
Core PPI does not have exposure to exogenous market place.
Gaging reaction to business inflation and deflation.
Compare percentage changes PPI and GDP.
The sliding scale determine abnormality.
Is the percentage change within normal historical range, is it below or above average
Be cognizant of oil prices there is a correlation with PPI including food and energy.
EMPLOYMENY (coincident indicator)
When us to gage inflationary period

NONFORM PAY ROLE

This help us decided whether the predictions of the leading indicators were accurate
Don’t use coincident indicator to initial position or any one indicator to decide on current or
future prospects.

NFP numbers is lagging or backward looking which telling what has already occurred.
In professional circle the NFP is fully expected, means months before this NFP would have been
predicted.
It is useful to give us the gage on current deflationary or inflationary situation.
base matrix is obtain by calculating percentage.
Abnormality lies outside one standard deviation
Claims data lead NFP data it is provided weekly.
NFP is not a panacea to tell you everything.
Observe One standard deviation of the sample and compare it to the change in real GDP and
assign a score base on how far away the change in real GDP is from one standard deviation.
Action of central authority
Federal Reserve and government
Injection/withdrawal

Government
Balance Sheets and sovereign liquidity
Debt to GDP ratio analysis
If a government is spending more than it earns will result in injections of money in the economy
and this will lead inflation

Withdrawal is deflationary
Debt to GDP ratio USA 102% as of 2015
Surplus or deficit
The United States is currently running a deficit of -2.17% as a percentage of GDP (as 2015)

As debt to GDP increases in an economy real GDP is dependent on spending of the government
to maintain a stable level of inflation.

The debt to GDP ratio increases if real GDP growth is higher than debt to GDP rate.
Trouble zone of Debt to GDP is 80% historically
Default on debt occur at 100% historically.

Interest bill (cost of debt)

The interest of percentage is deflationary because it is adding to the withdrawal of money from
the economy. INTEREST CANNOT BE NEGATIVE
Liquidity cover
Ability to pay interest bill
How many times tax revenue cover interest bill

Bench mark and sovereign rates

Low rates means low risk and confident in the government to pay debt
Demand and supply affects the rate at which the private sector lend money to the government

If the 10 year benchmark rate on Treasury bill increase it is deflationary because less room for
spending
If the 10 year benchmark rate on Treasury bill decrease it inflationary because more money to
spend in system.
Large government debt to GDP requires low interest rate so that the government can run a
deficit.
The central bank’s balance sheets
Federal Reserve
The Federal Reserve has been purchasing bonds since 2010 to create low interest rate.
Quantitative easing

The central bank by purchasing bonds (treasury bills) is lending money to the government
Scores
Growing and above +5 to +8 Short Bias
Above and slowing 0 to +5 Short bias
Below and slowing -5 to -8 Long bias
below and growing O to -5 Long bias
Above and slowing for the first time -8 to -10 Long bias predict deflation
Below and growing for the first time +8 to +10 Short bias predict inflation