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Reports of the Death of Inflation Have Been Greatly Exaggerated

With the FOMC meeting tomorrow, equity traders are hoping for a half point rate cut.

According to Barron's Econoday, the Fed Fund Futures are pricing in a "42% probability for a 25 basis point cut versus 58% for a 50 basis point cut from the current target of 5-1/4 percent, based on fed funds futures close on September 14."

A key element of the Punch Bowl Caucus -- those millionaire billionaire fund managers begging for a cut -- is that inflation, if not already tame, will become so as the economy cools. The obvious criticism is that these are the same folks who have been telling us for many months that the economy is just fine (therefore you should buy U.S. equities).

Now, as their prior arguments have proven to be hollow falsehoods, they have traded them in for this year's model (Hurry in for great deals on 2007 models!). In place of the former rhetorical argument, their new position crossover argument is that the economy is slowing, the Fed must cut rates (therefore you should buy U.S. equities).

My preference is for objective analysis, and I take the shill-driven spin as what it is: Biased, self-promotional spin by (mostly long only) shills for their firm's asset gathering business.

My own agenda is similar: we run a fee-based asset management business, but prefer to find an "objective Truth" about the economy. Maybe we are too small to be corrupted by the system. Perhaps we simply find it easier to approach it this way. Regardless,  what we continue to find is that inflation remains "sticky" -- even as the economy cools.

Why do we say that?

-Oil is near all time (nominal) highs of $80 (Crude Closes at New Record High)

-Gold Advances to Near 16-Month High (Gold is well over $700)

-Health-Care Inflation continues to gain at double digit levels

-Corn hit over $4.50 last week February

-Wheat is near $9/bushel

-Soybeans Rise to 3-Year High   

Natural Gas, Orange Juice Soar

Dairy prices have almost doubled from 2 years ago

There are lots of other examples, but these are the most recent ones that come to mind. And, the Fed is well aware of these issues.

That's why a 50 bps cut would surprise me.

Goldman Sachs Agricultural Index

Monday, September 17, 2007 | 08:35 AM | Permalink | Comments (54) | TrackBack (1)
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Comments

I think David Malpass (who has flip flopped from calling for hikes to expecting a cut) noted that government inflation statistics are set to POP higher in September on a year over year basis, due to what happened in 2006. Will the Fed cut 50 bps only to have CPI reported at 4 or 4.5% a week or two later? Doubtful.
Inflation is real as BR notes, and rising in my opinion. However, raising and lowering the FFR target to control inflation is perverse and ineffective. They should cut rates based on the outlook for growth. If rate cuts can spur some growth, it will more than soak up the excess liquidity that is driving gold, oil, agriculturals higher.

Posted by: REW | Sep 17, 2007 8:56:16 AM

Keep your eyes on Europe in weeks ahead, it may be from there we find a triggering event such as bank failures that sweep aside petty Fed decisions on a quarter or half point of interest. Forgotten in the mad rush to parse the US economy is the following: there is a worldwide housing bubble, and it's more exaggerated in several countries like the UK and Spain and India and China than it is here.

Likewise, businessmen in those economies are looking at the causes of the US meltdown and finding either pockets of the same causes, or widespread practices that resemble US lending practices. I hope nobody thought greed was dead in the rest of the world. Better not ignore it either.

Posted by: OldVet | Sep 17, 2007 8:58:27 AM

All this economy needs is a little surge (don't worry if you've been a "get gov't off my back" type, what you would rather have: billions and the hypocrite label? or not?)

I'm talking top marginal tax cuts. They worked so well last time until they stopped working, right?

Posted by: VennData | Sep 17, 2007 9:13:44 AM

"...I'm talking top marginal tax cuts. They worked so well last time until they stopped working, right..?"

Posted by: VennData | Sep 17, 2007 9:13:44 AM

_________________________________________

I agree - but only for those who make over $250K/yr. Maybe we should also default on our national debt and move all US government offices to Dubai.

Wanna' buy a nice house?

Posted by: Marcus Aurelius | Sep 17, 2007 9:43:17 AM

There's little the Fed can do to affect agricultural prices. More people eating better = supply and demand pressures. Inflation is a monetary phenomena. Too much money. Rising prices is NOT inflation. It is only A symptom of inflation as prices can rise for many reasons. Just like oil. Am a believer in peak oil so again, there is very little the Fed can do there as well.

Posted by: Stuart | Sep 17, 2007 9:48:08 AM

Another thing to add to the stew of relatively s.t. inflation indicators. Since Volcker with Reagan's political support broke the back of inflation the early 80s, at the traditional pound of flesh price recession-wise, we've enjoyed a secular decline in interest rates and inflation/expectations. From here there's no where to go but up and managing things to avoid re-starting a secular uptrend will be hard, painful and expensive. The implications are going to ripple thru investment, the business cycle and the l.t. behavior of the economy. Ouch.

Posted by: dblwyo | Sep 17, 2007 9:58:59 AM

OldVet.... housing inflation was very high in india in 04/05/06 and Reserve bank of india raised the interest rates to 10%...housing loans are 12%....but house prices are yet to go south (after appreciating 2to 6 times in three years).

i am not sure that we can have a housing bubble in india with 12% interest rates.

even if there is a bust....it will be a big loss for the home builders and flippers who are still building million units/year...

Posted by: techy2468 | Sep 17, 2007 10:08:00 AM

"...in the short term, a Fed cut could give the dollar a boost..."

-- Dan Molinski, "Dollar Could Get Lift if Fed Trims Target' from 'Rupert Murdock's Wall Street Journal' pp C7, September 17, 2007.

The Wall Streeters are pulling out all the stops on this one. If a 'Main Streeter' said this, he'd be ridiculed... if any Democrats said this... they'd be accused of being 'naive' 'ignorant of economics' etc. But when the Wall Streeters and the "Save Bush's tax-cut-based economy' crowd say it, it's OK.

The Bush crew are Keynesians in drag at the Debt & Deficit Cabaret.

(oh yeah... the deficit's going down! er... a.. well... if you don't include Katrina, Afganistan, Iraq, and sundry other off budget items.)

Posted by: VennData | Sep 17, 2007 10:37:52 AM

Stuart,

The fed CAN affect the price of food.

If they cut rates, the USD will be cheaper than it otherwise would be, at least with respect to floating XR's (eg. CAD). That means that either US prices rise to the XR adjusted CAD level, or the CAD prices drop to XR adjusted USD level. Since supplies are tight and demand (especially in Asia) is growing, odds are that the US price rises.

Posted by: Estragon | Sep 17, 2007 10:55:10 AM

Estragon, agreed. I was referencing more the broader macro effects brought on by supply and demand pressures for consumables as ultimately the primary driver, but you make a good point.

Posted by: Stuart | Sep 17, 2007 10:58:43 AM

What source did you use for the corn price? Near month corn futures (Dec 07) are $3.50 and going into 09 you can get up to a little over $4.00. Dec 07 contracts peaked out at 4.30 in mid June but Corn has been down to tame since then.

The other commodity inflation figures are real and even at $3.50 corn is considerably higher than it was a year ago. But the $4.50 number does not appear to be accurate.

~~~

BR: Oops! My bad -- that was February, not September. I'll fix it up top

Posted by: Red Ocean | Sep 17, 2007 11:03:48 AM

Barry,

As a first timer to Vegas, really hoping that you do a post that fleshs out your experience. I'm sure your firm has looked at g*mbling stocks as a sector play, so also curious about any impressions there too.

Thanks!

Linda P.

Posted by: Linda P. | Sep 17, 2007 11:07:40 AM

why mainstream economists have stood by and failed to point out the inflationary impact of 1) massive deficit spending, and worse according to Samuelson MILITARY spending, 2) the collapsing US $, is beyond me. i guess the mainstream has shifted so far Right that any criticism is verboten

Posted by: scorpio | Sep 17, 2007 11:22:13 AM

And right on cue (the day before the fed decision) and ML has to announce job layoffs at it's mortgage biz.....like that is ANY surprise to anyone.....the timing is just too suspect.

Trying a bit too hard to game this decision as it was all contained up to this point and now it suddenly is not when the brokerages stand to benefit the most?

Expect a few more announcements of layoffs today and into 2pm tomorrow.

Add in the games being played with the oil patch and it all adds up to the brokers "demonstrating" that a rate cut is necessary to "save jobs". When the entire float of a stock turns over in a day the SEC launch an investigation however in the oil pit it's described as "active trading". That's exactly what has happened with oil futures last week.....all the trading and most of the contracts that trade will be canceled way before any of that oil is "delivered"....Like we have anyplace to store 290 million barrels of oil in a given month. But our market allows these to be traded and then canceled (when the contract is about to be up ) and then reported as a shortage in the inventory...

Nice trick they are allowed to play...

Ciao
MS

Posted by: michael schumacher | Sep 17, 2007 11:24:45 AM

I completely agree. A 50 basis point would be rather surprising from a Fed that has pointed out how large the inflation risks are. More likely is a 25 basis point cut that speaks of the possibility for more.

Posted by: Aaron | Sep 17, 2007 11:50:05 AM

Hilarious. Did you even bother to read any of the articles you linked to in your "objective" analysis of price levels?

My favorite is the WSJ article you linked to:

The title of the article is:
Natural Gas, Orange Juice Soar on Threat of Storms

You shorten it to:
Natural Gas, Orange Juice Soar

Classic.

More: Tropical-storm jitters sent natural-gas and orange-juice futures on a tear in New York.

Oh, but there's more! The soybean article is titled:
Soybeans Rise to 3-Year High as U.S. Crop Faces Frost Damage

Whew! That long title is too hard to read. Thank god you shortened it to "Soybeans Rise to 3-Year High."

Where would we be without your objectivity? [BR: Who ever said I was objective?"]

And of course, the wheat. You say "Wheat is near $9/bushel." The article title says, "Wheat Price Rises to Record $9 a Bushel on Global Crop Concerns"

The actual article says: Wheat surpassed $9 a bushel for the first time as a drought in Australia and Canada cut production, pushing global stockpiles toward a 26-year low.

Keep fighting the man, you truth-teller, you!

~~~

BR: I am writing about the prices -- not the rationale that the headline writer chose.

They are as significant to me as the line "Stocks fell today on profit taking."

What do you have to say about the prices of Oil? Dairy? Health Care? Beef? Education? Gold? Housing? Natural Gas? Timber?

Is it your position there is little or no inflation, only storms, droughts, and floods?

Lastly, and this is painfully obvious, if I were "hiding" anything, explain why would I put a link to the full article?

Maybe its too subtle of a point, but the gravaman of our discussion is rising prices -- not some half-assed explanation as to WHY these prices are rising.

Posted by: Steve | Sep 17, 2007 12:45:44 PM

Eclectic reminded us in a previous post to state our predictions ahead of Mr. B showing his hand tomorrow. Ok then..."my" "prediction" is: no cut but a change in bias.

Posted by: wunsacon | Sep 17, 2007 1:02:04 PM

Steve,

It is true the titles were shortened. But his point is about higher prices and inflation. If higher prices are caused by weather related issues does that make them less inflationary? It could make the inflationary pressures less persistent if it can be corrected next year, but its still inflationary now isn't it?

Posted by: Red Ocean | Sep 17, 2007 1:06:17 PM

Correction - health care premiums are rising at double the rate of inflation (about 6%), not at double digits. - for what it is worth.

Posted by: bsneath | Sep 17, 2007 1:06:18 PM

Barry is required reading by Nouriel Roubini this semester.

http://pages.stern.nyu.edu/%7Enroubini/Readingl3.html

Posted by: Jack Stevison | Sep 17, 2007 1:16:23 PM

It is true the titles were shortened. But his point is about higher prices and inflation.

Red Ocean,

It's inflation in the most broadest sense of the term. However, in the context of monetary policy and the Fed, it's not inflation. What the Fed does on Tuesday isn't going to impact the weather in Australia.

Posted by: Steve | Sep 17, 2007 1:19:00 PM

Ah, but what weather in Australia does on Tuesday may end up impacting what the Fed does.

Isn't that the real point? That Big Ben and the gang can't lower too much in the face of the economic context, whatever is causing that context?

Just saying.

Posted by: dark1p | Sep 17, 2007 1:31:11 PM

Hey Steve,

Wow....Soybeans is up over 3 bucks over the last year and its all because of frost damage over the weekend. Wow...the market truly is an amazingly omniscient discounting engine! You talk about Barry not being objective!

Soybeans are up due to energy inflation hitting corn and thus beans. Attributing the move to 3 year highs to crop damage in the last three days...well...that aint very objective.

Posted by: pkts | Sep 17, 2007 1:37:03 PM

"What the Fed does on Tuesday isn't going to impact the weather in Australia."

True, however the fed actions have never been targeted at supply. The actions of the fed impact demand which then impacts prices. In the context of tight supply demand cannot be allowed to run unchecked or it will increase inflationary pressures. Thats why the supply picture is important irrespective of the causation behind the supply situation. In the near term the reason that supply is tight doesn't matter when it comes to prices.

Posted by: RedOcean | Sep 17, 2007 1:41:44 PM

pkts,

An objective person looks at overall price levels and doesn't selectively choose the assets that are increasing in order to argue their point.

Posted by: Steve | Sep 17, 2007 1:44:23 PM