Investment News: Money Morning » Inflation

What to do When the Federal Reserve Finally Gets Serious about Inflation

Martin Hutchinson — Tue, 05 Aug 2008 01:16:52 +0000

By Martin Hutchinson
Contributing Editor

The U.S. Personal Consumption Expenditures deflator, believed to be the primary gauge of inflation for U.S. Federal Reserve Chairman Ben S. Bernanke, rose 0.8% in June. That wiped out the gains from the June infusion of tax rebates and turned the key Personal Consumption Expenditure – which had risen a solid 0.6% in cash terms – into a feeble 0.2% drop in real terms.

It’s obvious that inflation is continuing its inexorable increase. It’s also obvious that the world’s monetary authorities – including the Federal Reserve – are going to have to get serious about this potentially ruinous trend.

For long-term investors, all of this leads to a single conclusion: It’s time to get prepared.

The policymaking Federal Open Market Committee meets today (Tuesday), and is expected to keep the Federal Funds target rate at its current level of 2.0%. Even if the FOMC surprises the market and raises the target to 2.25%, that would still leave short- term interest rates about 3% below the current (actual) level of inflation.

In short, this wasn’t a serious attempt to slay the inflationary dragon.

A real such attempt might, however, have a useful effect on global commodity prices. When you look at a graph of commodity prices over the past year, it becomes very clear that their vertical ascent was ignited at just about the time that Bernanke began cutting interest rates last September.

As the Federal Funds rate was cut from 5.25% to 2%, oil almost doubled in price and overall commodities prices shot up by about 40%. Since interest rates stopped dropping at the end of April, commodities prices have stabilized and indeed oil prices have backtracked from their record high of about $145 per barrel to about $120 per barrel.

Even the start of a monetary-tightening cycle would very likely cause a reversal in commodities markets, with speculators closing off their positions and prices dropping back toward their long-term-trend levels – even if the continued demand growth emanating from the emerging markets prevents them from dropping back all the way.

That, in turn, would be immensely helpful to the global economy; after all, even oil at a $100 a barrel – a level first reached in January, just months ago – still seems like a faint-and-withering dream.

High Inflation and Loose Monetary Policy

Of course, inflationary pressures and a need for tighter money are not exclusive to the United States. Even in Japan, which for a decade has worried about falling – not rising –prices, inflation has reached 2%. That’s above the 1.53% yield on Japan’s long-term government bonds, and is well above the Bank of Japan’s policy rate, which has been stuck at 0.5% for the last 18 months.

China and India both appear to have double-digit inflation – as well as interest rates well below the inflationary level.

China is not yet admitting its true level of inflation, since it wants to present a rosy picture for the Olympics, but the first statistics released after the Olympics conclude may be grim.

As for India, it is fighting inflation not by monetary means (The Reserve Bank’s interest rate is still only 8%, compared to inflation’s 12%), but by subsidizing the price of oil, food, and other basic goods. And those subsidies are causing the country’s budget deficit to spiral out of control – it almost equals 10% of India’s GDP.

In Europe, the European Central Bank (ECB) has made fighting inflation its top priority. At 4.1% in July, compared to the ECB’s policy interest rate of 4.25%, inflation is far above the ECB’s target of 2%. In Britain, the Retail Price Index (the one the government hasn’t fiddled with) is currently up 4.6% over the past year, although the Bank of England has managed to keep interest rates positive in real terms at 5%.

A few countries are fighting inflation vigorously. In Brazil, where retail price inflation is around 6%, the central bank interest rate is 13% – producing mouth-wateringly tight money that will allow the domestic economy to grow even after the commodities boom (from which Brazil generally benefits) has turned down.

However, countries with positive real interest rates, which allow them to fight inflation, are few and far between. At the other extreme, you have monetary basket cases like Dubai, where inflation is 22%, but you can get a home or a commercial real estate mortgage at a fixed rate of 7%. This has naturally led to a gigantic construction boom that could end cataclysmically.

Nevertheless, the global picture is clear. In the United States and worldwide, inflation is reaching levels at which policymakers are forced to pay attention. Their first steps will doubtless be inadequate, since rate-setters remain concerned about recessionary risks, and global interest rates will mostly remain negative in real terms. At some point, however, the gradual tightening of monetary policy will bring an end to the commodity price bubble.

Where to Be When the Fed Gets Serious

When policymakers finally start raising interest rates and the commodity cycle turns downward, stock markets will initially be adversely affected. The shares of oil companies and commodity producers will drop, and other shares will remain affected by the likelihood that higher interest rates will translate into lower profits. But there are two clear investment groups that are poised to benefit:

First, to profit from rises in dollar interest rates, you might consider the Rydex Juno Fund (RYJCX), the price of which is inversely linked to T-bond prices (the fund shorts Treasury bond futures).

Second, you should consider investing in countries that have few domestic energy and commodity resources, and that have been particularly hard hit by the price spikes as a result. Those would include Japan and Korea, both highly productive economies that are forced to rely on imports for most of their raw materials. In Japan, the iShares MSCI Japan Index ETF (EWJ) is currently trading at 16 times earnings, and features a yield of 1.6%, giving it a good market spread. In Korea, the iShares MSCI South Korea Index Fund ETF (EWY) trades at a lower Price/Earnings ratio of 12, though with a beefier yield of 1.9%

News and Related Story Links:

Commerce Department:
Price Indexes for Personal Consumption Expenditures by Major Type of Product, Monthly

Money Morning:
Although Federal Reserve Policymakers Are Set to Meet, They Have Little Room to Maneuver

Money Morning

Department of Labor reported yesterday (Wednesday). That brings the inflation rate for the past 12 months to 5%, well above the U.S. Federal Reserve’s preferred target of 2.0%.

The increase was higher than expected as a 6.6% jump in energy costs and a 0.8% rise in food prices helped to boost CPI up past the expected rate of 0.8%. So-called core CPI, which excludes highly volatile food and energy costs, was 0.3% — higher than its expected rate of 0.2%.

"The core increase is not likely to be repeated. But we have to get used to the idea of 5% headline inflation," Alan Ruskin, chief International strategist at RBS Greenwich, told Reuters.

Also, yesterday, Eurostat, the EU statistics office, confirmed inflation in the 15-nation Eurozone clocked in at 4% in June, an increase from the 3.7% rate in May, in large part due to a 53% increase in heating oil costs.

Both reports indicate that inflation is ramping up, despite economic downturns in both the United States and European Union. The worsening inflation situation puts the two central banks – the U.S. Federal Reserve and European Central Bank – in a tight spot as interest rate hikes to curb inflation will further hinder economic growth. Conversely, any attempt to boost gross domestic product with an interest rate cut will add fuel to the inflation fire.

"We have a stagnating economy with rising inflation," Joel Naroff, president and chief economist of Naroff Economic Advisors said in a note to clients after the CPI report was released. "Clearly, the rate of inflation and the slowdown in economic growth is nothing near what we saw in the 1970s, but the combination of the two is creating real problems for the Federal Reserve."

The ECB raised its key interest rate to 4.25% at its July meeting, however, a softening Eurozone economy could prohibit additional rate hikes over the next several months.

"This all has to do with this oil-price surge and for central bankers, it’s a most frustrating source of inflation because it’s out of their reach," Janwillem Acket, group chief economist at Julius Baer Holding AG in Zurich, said in a Bloomberg Television interview. "We will probably see in the months ahead growth momentum going lower and then allowing the ECB, probably early next year, to cut rates."

News and Related Story Links:

Bloomberg News:
U.S. Consumer Prices Climb by the Most Since 2005

Bloomberg News:
Europe Inflation Accelerates to 4% as Oil Prices Soar

Reuters:
Zimbabwe inflation hits 2.2 million percent

Reuters:
INSTANT VIEW: CPI up 5.0 pct in year

MarketWatch:
Consumer prices jump 1.1% in June

Money Morning:
Eurozone Growth Revised Down as Inflationary Pressures Trump Economic Growth

Eurozone Growth Revised Down as Inflationary Pressures Trump Economic Growth

Jason Simpkins — Wed, 09 Jul 2008 19:57:13 +0000

By Jason Simpkins
Associate Editor

First-quarter growth in the 15-nation Eurozone was weaker than first reported, yet another worrying development for a region already struggling with soaring inflation.

The combined Eurozone economy grew by 0.7% in the first quarter compared to the three months prior, revised down from a previous forecast of 0.8%, Eurostat reported. While the figure is still relatively strong, a U.S. slowdown, rampant inflation, and low consumer demand could drag the economy down even further in the second half of the year.

The European Commission’s gauge of consumer confidence declined to a level of -17 in June from -15 in May. Economic sentiment declined to 94.9 from 97.6 in May. Much of the decline was attributed to a steep rise in Eurozone inflation, which hit a 16-year high of 4% in June.

“The surge in food and energy prices is clearly squeezing the life out of the consumer side of the economy,” said Ken Wattret of BNP Paribas SA (OTC ADR: BNPQY) told Thomson Financial.

The European Central Bank (ECB) voted to raise its main interest rate last week to 4.25% in an attempt to subdue inflationary pressures, but ECB President Jean-Claude Trichet isn’t convinced the quarter-point hike will be enough.

“Risks to price stability over the medium term remain clearly on the upside… and have intensified in recent months,” he told legislators in Strasbourg, France.

“The Governing Council is strongly concerned that price and wage-setting behaviour could add to inflationary pressures through broadly-based second-round effects. First signs are already emerging in some regions of the euro area,” he said.

However, any further action could severely jeopardize an economy that is clearly starting to limp, particularly as the U.S. rate remains as low as 2%. The euro’s continued strengthening against the dollar has adversely affected European exports and could further endanger the Eurozone’s two biggest economies, France and Germany, which each suffered in May with exports plummeting 1.7% and 3.2% respectively.

“I have the right as president of the French republic to wonder if it is reasonable to raise the European rates to 4.25 percent while the Americans have rates of 2.0 percent,” French President Nicolas Sarkozy said in Paris on Saturday.

Meanwhile, Spain is on the brink of a possible recession, as a housing slump similar to that being experienced in the United States and Britain has racked the country. Spain’s gross domestic product (GDP) has grown at an average annual rate of 3.75% for the last decade but the collapse of a housing bubble has left the economy in disarray.

In 2006, more than 700,000 houses were built in Spain,
The Wall Street Journal reported, more than France, Germany, and the United Kingdom combined. And investment in housing accounted for 10% of the country’s GDP, more than twice the Eurozone average.

However, a large accumulation of debt and tighter credit conditions caused the housing boom to grind to a halt. Now, analysts anticipate fewer than 300,000 homes will be built in Spain this year.

Spanish retail sales fell 5.3% in May, The Journal reported, and unemployment shot up to 9.9%. GDP growth in the country slumped to 0.3% in the first quarter, down from 0.8%.

“There’s a high likelihood the [Spanish] economy could be in recession at the end of the year,” Fernando Eguidazu, vice chairman of the Circulo de Empresarios business association told journalists Monday.

Stagnation or contraction in the Spanish economy could shave as much as 0.1% off the region’s quarterly growth rate, according to Holger Schmieding, Bank of America Corp.’s (BAC) chief European economist. Schmieding expects Eurozone growth will drop to 0.2% in the third and fourth quarter.

News and Related Story Links:

Reuters:
Euro zone Q1 GDP growth revised down to 0.7 pct

Thomson Financial:
DATAWATCH Euro zone consumer confidence fading, French spending rise just a blip

Reuters:
ECB still worried by inflation despite rate rise

Wall Street Journal:
Spain Faces Recession, Threatening Euro Zone

Money Morning:
E.U. Stocks Slide as ECB Gears Up to Fight Inflation with Higher Rates

Mexico Joins the Global Battle Against Inflation with Surprise Rate Cut

Jason Simpkins — Fri, 20 Jun 2008 19:52:46 +0000

By Jason Simpkins
Associate Editor

Mexico’s central bank unexpectedly raised its benchmark interest rate by a quarter percentage point to 7.75% Friday, warning that the rate of inflation may exceed its previous forecast.

“The recent inflation dynamic is worrying,” Banco de Mexico’s five-member board said in a statement. “The balance of risks for inflation has worsened.”

Consumer prices in Mexico jumped nearly 5% in May from a year earlier, the biggest jump since 2004, according to Bloomberg News. The government has issued a price freeze on tortillas, cooking oils, beans and roughly 150 other items this year to ensure its population is adequately fed.

The decision surprised many analysts as it flouted the country’s president, Felipe Calderon, who has hinted that borrowing costs are already too high. Still, inflation demanded Mexico’s attention as soaring food and energy costs have resulted in what has fast become a worldwide inflation epidemic.

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Soaring fuel prices pushed India’s inflation rate to a 13-year high in early June, adding to speculation the central bank may accelerate its own monetary tightenting initiative, Financial Times reported. Inflation reached 11.05% in the 12 months ended June 7, up from 8.75% the previous week, and well above the 9.82% median forecast in a Reuters poll of analysts, the paper reported on its Web site.

Earlier this month, the Reserve Bank of India announced a surprise rate increase of its own, pushing its key lending rate up 25 basis points to a full 8%. The bank also raised its cash reserve ratio – the amount of cash banks must keep on hand – by 25 basis points to 8.25% as recently as April 29.

In China, consumer prices rose 7.7% in May after inflation reached a 12-year high of 8.7% in February. China’s producer price index rose 8.2% in May, the highest in more than three years.

The problem isn’t any better in mature markets either. Eurozone inflation hit a 16-year high in May, as costs pushed inflation up 0.6% to an annualized rate of 3.7%. High commodity costs fueled the increase, as food costs jumped 6.4% in May up from 6% in April. Energy prices soared 13.7% year-over-year on the back of record high oil, up from a 10.8% increase the month prior.

In the United States, the producer price index (PPI) jumped 1.4% in May, the largest increase since November. Over the last 12 months, producer prices have increased 7.2% compared to the 6.5% increase in April.

“Just about everywhere prices are rising and they are doing so at a strong pace,” said Joel Naroff, president and chief economist at Naroff Economic Advisors. “While the pathway from intermediate and crude goods price increases to consumer prices is quite unclear, it is never good news to see the extensive nature of price increases that were contained in this report.”

After nine months of cutting interest rates and lending freely to financial firms hoping to ease the credit crunch pain, U.S. Federal Reserve Chairman Ben S. Bernanke is signaling a new willingness to reverse course and battle inflation.

“The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so,” Bernanke said earlier this week. “The Federal Open Market Committee (FOMC) will strongly resist an erosion of longer-term inflation expectations.”

The FOMC is scheduled to meet June 24 and 25. It is widely expected that it will vote to hold rates steady.

News and Related Story Notes:

Bloomberg:
Mexico Central Bank Unexpectedly Raises Lending Rate

Financial Times:
Fuel prices push Indian inflation past 11%

Money Morning:
ECB Stands Firm Against Inflation

Money Morning:
India Fuels Inflation by Bailing Out Refineries

Money Morning:
ECB Rate Hike More Likely After European Inflation Hits New High

Can Inflation Save Canada From Recession?

Mike Caggeso — Fri, 20 Jun 2008 06:04:51 +0000

By Mike Caggeso
Associate Editor

Canada’s consumer price inflation rose 2.2% year-over-year in May, edging ahead as the Bank of Canada signaled it would last week. The spike suggests Canada’s economy of is also sputtering alongside that of the United States, but soaring commodities costs just may help our northern neighbor skirt recession.

Inflation is up significantly from the 1.7% increase reported in April, Statistics Canada reported yesterday (Thursday). And high gas prices are to blame as fuel costs rose 15.0% in May compared with the same month last year – that’s considerably faster than the 12-month change of 11.6% posted in April.

Excluding gasoline prices, 12-month inflation grew 1.6% in May.

Last week, the central bank voted to keep its overnight interest rate at 3%, warning that inflation risks have “shifted slightly to the upside.” But the bank quickly followed that up by saying global demand for Canadian goods and services remains strong despite a U.S. slowdown.

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“This report will not push the bank to raise rates in 2008, but we do see 100 basis points of hikes coming in 2009 as Canada’s inflation problem heats up,” Meny Grauman, an economist with CIBC World Markets Inc. in Toronto, said in a note to clients, Bloomberg News reported.

With an end to the rate cuts, the Canadian dollar is on the rise. The loonie has gained 1% since the June 10 decision to hold rates steady, Bloomberg reported.

Recession Protection?

Earlier this month, Canada announced its gross domestic product (GDP) shrank 0.1% in the first quarter, marking the country’s first decline since the second quarter of 2003.

But this is where inflation could actually be a friend.

In today’s world, where interest rates are low and commodity prices are high, Canada’s in a very strong position for two reasons:

It has oil reserves – somewhat larger than the Middle East – in the form of the Athabasca oil sands.

And it’s the world’s largest producer of uranium, with 25% of the world market. (Australia is a close second, with about 23%.)

Since Canada is a chief oil exporter, its oil companies are on the receiving end of soaring prices. And in turn, that helps pad the economy’s pocket, becoming an unlikely protective barrier to another quarter of negative GDP growth.

Also working in the economy’s favor, month-to-month wholesale sales jumped 1.4% in April, more than doubling forecasts of 0.6%, Reuters reported. This suggests that domestic demand is able to wade through inflationary waters and lends credence to justifying a future interest rate hike.

The Bank of Canada’s next scheduled date for announcing the overnight rate target is July 15.

News and Related Story Links:

Statistics Canada:
Consumer Price Index

Bloomberg:
Canada Inflation Rate Rises More Than Forecast on Gas

Bloomberg:
Canada’s Dollar Gains for a Fourth Day as Inflation Accelerates

Money Morning:
Canada’s Negative GDP in the 1Q Doesn’t Spell Disaster

Reuters:
Canada May wholesale trade up by 1.4 percent

Investors Will Watch as Inflation Dominates the Spotlight This Week

William Patalon III — Sun, 15 Jun 2008 23:50:37 +0000

By William Patalon III
Executive Editor
Money Morning/The Money Map Report

Investors better keep an eye on bonds this week.

While the stock market may be more fun to follow, fixed income is often a stronger gauge of investor expectations of the economy, future U.S. Federal Reserve policy, and inflation.

With the consumer price index (CPI) safely in the books for another month, economists can now turn their focus to wholesale inflation with the release of the May producer price index (PPI). Economists, mistakenly, often disregard the energy component of this data each month and focus mainly on the so-called “core” releases – which excludes “volatile food and energy prices.”

While food and energy prices often suffer from month-to-month volatility based on seasonal factors, they cannot be overlooked these days as they continue to have significant impact on the global economy.

Also, Lehman Brothers Holdings Inc. (LEH) can’t seem to avoid the limelight, as the eyes and ears of the investment community will be sharply focused on its earnings announcement today (Monday), which also is expected to detail plans for its much needed capital infusion.

U.S. Treasury Secretary Henry Paulson welcomes his friends from China for Strategic Economic Dialogue IV, as both countries are sure to bicker over unfair trade practices, protectionism, and currency valuations. (And, “bickering” has become a very popular sport in Washington as of late… too late for the Beijing Olympics?).

Market Matters

So let the partisan bickering and political pandering begin. With the executive branch up for grabs in November, the Democratic-led U.S. Congress introduced legislation that has virtually no chance of passing, merely to be used as ammunition as the campaign season heats up. So-called “Big Oil” became the latest villain with politicos proposing windfall profit taxes on record company earnings. Our friends within the Organization of the Petroleum Exporting Countries (OPEC) did not escape the wrath of the Dems, who want to file suits over perceived price-fixing.

In typical partisan fashion, Republican Presidential candidate John McCain has touted his opponent, U.S. Sen. Barack Obama, as a traditional “tax-and-spend” liberal, the wrong choice during this period of economic challenges. Sen. Obama pegged his opponent as a continuation of the previous eight years of failed policies that have led the country into recession/inflation/deflation.

Lehman Brothers has remained front and center in the “who will be the next Bear Stearns Cos. (BSC) watch“ as the financial giant attempted to raise $6 billion in new capital to compensate for its disastrous second quarter. The company also bid a (not-so) fond farewell to two high-ranking executives as it goes to great measures to regain some lost public trust. Over a four-day time frame, its stock gave up more than $4 billion in shareholder value.

Always a day late, Moody’s Investors Service jumped in to protect investors by downgrading the firm from “Stable” to “Negative.” In other business news, transactions headlined the week as Staples Inc. (SPLS) will be acquiring the Dutch office supply company, Corporate Express NV (ADR: CXP), for $2.7 billion. Anheuser-Busch Cos. Inc. (BUD) turned to Mexican brewer Grupo Modelo SA de CV (OTC: GPMCF) to help fend off an unsolicited offer by rival InBevNV.

Meanwhile, Yahoo Inc. (YHOO) finally said good riddance (presumably, for the last time) to Microsoft Corp. (MSFT) in any merger, partnership, or other relationship (and jumped into bed with Google Inc. (GOOG) with a search ad agreement). Apparently, McDonald’s Corp. (MCD) remains recession/inflation proof as the fast food chain reported strong domestic and global sales in May.

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Crude traded within a $10 range throughout the week to settle around the $135-a-barrel level as traders over-analyzed news of declining demand, OPEC made comments about “unjustifiable rise on oil prices,” and polls blaming industry insiders for “unethical behavior.” In the “misery-loves-company” category, the United States is not the only nation to struggle with energy-related inflation.

China’s Shanghai Composite Index fell to its lowest level of the year as the country attempted to fight off related price pressures. Likewise, India reported that its inflation rate climbed above 8% in May, while Vietnam devalued its currency because of soaring prices. Closer to home, Broadway ticket sales are down more than 10% from last year’s levels – meaning that even the “rich-and-famous” group of consumers are suffering the ill-effect of soaring oil and gas prices.

After an extraordinary day in the markets that saw the Dow plunge close to 400 points and oil surge to almost $140 per barrel on June 6, any recent volatility seemed tame by comparison. While investors searched for bargains in equities, the fixed-income markets struggled mightily last week as prospects for future Fed rate hikes grew more likely. The yield on the benchmark 10-year Treasury surged past 4% (and beyond), reaching its highest level of the year. Anyone inside the Beltway you’d care to blame, senators McCain and Obama?

Market/Index	Year Close (2007)	Qtr Close (03/31/07)	Previous Week (06/06/08)	Current Week (06/13/08)	YTD Change
Dow Jones Industrial	13,264.82	12,262.89	12,209.81	12,307.35	-7.22%
NASDAQ	2,652.28	2,279.10	2,474.56	2,454.50	-7.46%
S&P 500	1,468.36	1,322.70	1.360.68	1,360.03	-7.38%
Russell 2000	766.03	687.97	740.37	733.61	-4.23%
Fed Funds	4.25%	2.25%	2.00%	2.00%	-225 bps
10 yr Treasury (Yield)	4.04%	3.43%	3.91%	4.26%	22 bps

Economically Speaking

Undoubtedly, a universal theme is emerging at the Fed and other world central banks: Inflation, Inflation, Inflation.

And, on that note, most Fed-watchers believe that the next move in rates will be higher. Last week, Fed Chairman Ben S. Bernanke reiterated his concerns about price pressures and many of his partners in crime followed in step by towing the company line. Dallas Fed President Richard Fisher and his counterpart in New York, Tim Geithner, promoted the prospects (rather realities) of rising energy costs and the declining dollar as major concerns. Boston Fed President Eric Rosengren echoed the sentiment by stating that higher energy prices were “trickling through the economy.”

Philly Bank President Charles Plosser went so far as to predict that the Fed would have no choice but to raise rates to combat inflation. Even the Fed’s Beige Book reported that the domestic economy remained sluggish through May, and has been “pinched by rising food and energy prices.” On the global front, European Central Bank President Jean-Claude Trichet targeted July as a date the ECB would look to hike rates should inflationary pressures continue.

Meanwhile, the Bank of Canada held off on a much anticipated rate cut because of – what else – higher energy costs.

For now, however, the recent data showed that inflation (outside of food and energy) remained well-contained as the core CPI climbed by a modest 0.2% in May. (WE have warned you about looking only at the “non-core” figures).

By the way, the CPI, as a whole (including food and energy), experienced its largest one-month-rise in six months. Consumer activity offered perhaps the most promising news of the week as May retail sales surged by 1% as many Americans took those government rebate checks from the stimulus package directly to the malls. Even after removing gasoline sales from the equation, the retail data still experienced its best showing in a year.

Weekly Economic Calendar

Date	Release	Comments
June 10	Trade Balance (04/08)	Surprising jump on higher oil prices
June 11	Fed Beige Book	Fed must balance inflation with sluggish economy
	Budget Statement (05/08)	Huge seasonal fluctuations follow April’s tax inflows
June 12	Initial Jobless Claims (06/07/08)	Surprisingly large increase in benefits claims
	Retail Sales (05/08)	Stronger than expected results aided by rebate checks
June 13	CPI (05/08)	Sharpest increase since November 2007
The Week Ahead
June 17	Housing Starts (05/08)
	PPI (05/08)
	Industrial Production (05/08)
June 19	Initial Jobless Claims (06/14/08)
	Leading Indicators (05/08)

News and Related Story Links:

The Associated Press:
Wall Street ends turbulent week with sharp gains.

Bank of Japan Plays Down Inflation Concerns

admin — Fri, 13 Jun 2008 12:50:05 +0000

By Jennifer Yousfi
Managing Editor

Despite having the lowest overnight rate of the Group of Seven nations, Japan’s central bank unanimously voted today (Friday) to keep its key interest rate steady at 0.5%.

“Our judgment is that our current stance on monetary policy, under current conditions, is the best,” Bank of Japan (BOJ) Governor Masaaki Shirakawa told reporters at a press conference in Tokyo.

While President Jean-Claude Trichet of the European Central Bank (ECB) and U.S. Federal Reserve Chairman Ben S. Bernanke have taken a hawkish stance on inflation in recent days, Shirakawa felt it was not yet time for the BOJ to tighten its monetary policy. Trichet has even suggested the ECB could raise rates as early as July.

“People took it that he wasn’t joining on the hawkish axis that we’ve been hearing from the two other G3 central banks,” David Cohen, director of Asian economic forecasting at Action Economics in Singapore, told MarketWatch, referring to the recent anti-inflation rhetoric from central bank governors in the U.S. and Europe. “He didn’t appear to be shifting to a tightening bias just yet, still being focused on the weakening in the economy as their immediate concern.”

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Shirakawa noted the effect high oil and commodity prices are having on the economy and said that Japan’s current expansion could be over as company earnings suffer under the current global economic environment.

“We must watch the downside risk that deteriorating terms of trade will erode incomes and hurt domestic demand,” Shirakawa said after today’s policy decision. “We need to monitor upside risks for prices relating to consumers’ inflationary expectations and companies’ price-setting actions.”

Derivatives are pricing in about a 95% chance of a Japanese rate hike by the end of this year, according to Reuters data, as the country is faced with the terrible prospect of stagflation caused by rampant inflation coupled with poor economic growth.

“The Bank of Japan has no choice but to take a wait-and-see stance,” Yasunari Ueno, chief market economist at Mizuho Securities Co. in Tokyo, told Bloomberg News. Economic conditions “rule out the possibility of raising rates, while a rate cut is difficult because the governor has repeatedly said monetary conditions are accommodative.”

News and Related Story Links:

MarketWatch:
Bank of Japan governor plays down oil threat

Bloomberg News:
Bank of Japan Keeps Rate at 0.5% as It Examines Growth Risks

Reuters:
BOJ keeps rates steady; focus on inflation

As Gas Prices Escalate, Worries About a Recession Turn Into Fears of Inflation

William Patalon III — Mon, 02 Jun 2008 11:40:25 +0000

By William Patalon III
Executive Editor
Money Morning/The Money Map Report

As the post-Memorial Day hangover lingers, and $4 per gallon gasoline becomes a national reality, expect more and more daily energy prognostications.

Goldman Sachs Group Inc. (GS) already is on record for $200-a-barrel oil. As you all know, our own Keith Fitz-Gerald – Money Morning’s investment director – has projected a crude-oil price of $225 a barrel. Do I hear $250? What about $5 a gallon gasoline by July 4th?

Sometimes, these daily price gyrations take on lives of their own, but at the end of the day, the basic laws of supply and demand always work themselves out.

The upcoming week’s hectic economic calendar could go a long way to clarifying the "Are we in a recession, yet?" discussion. Crucial news from manufacturing and labor highlight the week and any renewed strength in these sectors could put an end to the "R" talk for the time being (or until next week). In fact, the National Association of Business Economic forecast 0.4% economic growth for the 2nd quarter and a much stronger 2.2% gross domestic product (GDP) pickup in the 3rd quarter as the U.S. Federal Reserve and those tax rebates begin to work their ways through the system. Suddenly, economists are projecting a rebound and cries of recession have become somewhat muted (and replaced by cries of inflation).

Market Matters

Market/Index	Year Close (2007)	Qtr Close (03/31/07)	Previous Week (05/23/08)	Current Week (05/30/08)	YTD Change
Dow Jones Industrial	13,264.82	12,262.89	12,479.63	12,638.32	-4.72%
NASDAQ	2,652.28	2,279.10	2,444.67	2,522.66	-4.89%
S&P 500	1,468.36	1,322.70	1,375.93	1,400.38	-4.63%
Russell 2000	766.03	687.97	724.10	748.28	-2.32%
Fed Funds	4.25%	2.25%	2.00%	2.00%	-225 bps
10 yr Treasury (Yield)	4.04%	3.43%	3.83%	4.05%	+ 1 bps

Now that Memorial day has come and gone, investors seem to be monitoring the daily energy trades even more closely than usual (if that is possible) for signs that prices have peaked and Americans will be able to afford summer travel again. Well, in the aftermath of the holiday, gas prices actually continued their trek toward that dreaded $4/gallon level and hit a new national average of $3.96 late in the week. In fact, 11 states and the District of Columbia already are reporting average prices at the pump in excess of that psychological barrier.

While crude prices fell from last week’s record highs of $135/barrel, the ongoing "supply/demand vs. speculation" debate rages on. In one corner…The Department of Energy said that exports from the top oil producers dropped by 2.5% in 2007 and are on pace for a similar showing this year. While much of the increased demand focus has been on China, oil consumption throughout the Middle East (and Saudi Arabia, in particular) has skyrocketed in recent years, thus, leaving less to export and meet the growing demand abroad. On the flipside, conspiracy theorists cry wolf that prices have been running without any regard to true supply/demand issues. They point to escalating trades in commodity (petro) futures indexes and make Internet bubble comparisons (remember those fun days?) as explanations for the wild price swings. This week, the regulators got involved (typically a day late and a dollar short) as the Commodity Futures Trading Commission initiated a probe into potential market manipulations by energy insiders.

And suddenly those increased water cooler discussions about the dreaded "I" word are starting to move from speculation to reality. Dow Chemical announced a 20% across the board price increase to "mitigate the effects of raw material costs." German-based DHL soon will be "outsourcing" its North American delivery biz to competitor UPS as its seeks to reduce costs. Discounter airline JetBlue will not be adding to its fleet as expected because it too suffered the ill-effects of rising fuel prices that have prompted major changes throughout its industry (can you say consolidation?). Likewise, automakers continued to struggle from consumer activity (rather inactivity) as both Ford Motor Co. (F) and General Motors announced major reductions to their respective workforces. Apparently, the "rich and famous" have been impacted far less than others as Polo Ralph Lauren and Tiffany both reported better than expected quarterly earnings. Even Dell Inc. (DELL) surprised many analysts with a solid quarter on strong sales in Asia. Turning to financials, shareholders finally approved the JP Morgan Chase & Co. (JPM) acquisition of The Bear Stearns Cos. (BSC) (like they had much of a choice), though $10 a share is a far cry from the $170 the stock traded at in early 2007.

Investors took their clues from declining crude prices this week and again looked for value in the equity markets. The major indexes traded higher (often at the expense of fixed income). In fact, the yield of the benchmark 10-year drifted back above 4.0% for the first time in about five months as talks of inflation seemed to overshadow prior recessionary fears (see below). Still investor sentiment can change on a dime these days and next week brings significant economic releases that are sure to be over-analyzed. Until then, happy motoring (at $4/gallon).

Economically Speaking

If the consumer truly accounts for 2/3 of the growth of the economy, the latest confidence readings cannot be good news. The Conference Board reported that its confidence index fell for the 5th consecutive month to its lowest level in almost 16 years. Meanwhile, the competing U. of Michigan sentiment survey plummeted to a 28-year low. (So, whatever your index of choice…the consumer appears to be in hibernation.) Then again, what consumers SAY and what consumers DO are often two very different things. Of note, orders for durable goods dropped by 0.5% in April; HOWEVER, once aircrafts and autos were factored out of the equation, sales of these high ticket items actually rose by 2.5% last month. In fact, orders for appliances and electrical equipment surged by over 25%, the best reading ever reported. Overall consumer spending also increased in April, though the naysayers quickly point out that much of the gains were reflective of higher prices as opposed to increased sales. (Bear in mind, any over-analysis of the data can lead to a variety of diverse and confusing conclusions about consumer activity…so pick your poison, but don’t read too much into any one number).

This past week also found the revision of the 1st quarter GDP which had initially been reported as growth of 0.6% during the January through March months. Again, the pessimists in the bunch claimed that recession already was in our midst, and (by true definition) two consecutive quarters of negative activity were closing in. Instead, the revised GDP reflected a 0.9% gain in the 1st quarter, a weak showing by any measure, but still positive and far from recessionary.

Date	Release	Comments
May 26	Memorial Day	Can any afford to travel?
May 27	Consumer Confidence (05/08)	5th straight decline and worst reading since Oct. 1992
	New Home Sales (04/08)	Increase still left sales at lowest level in 17 years
May 28	Durable Goods Orders (04/08)	Excluding transportation, best showing in 9 months
May 29	GDP (1st Qtr)	Revision shows slightly stronger quarterly growth
	Initial Jobless Claims (05/24/08)	More claims reveals softening labor market
May 30	Personal Income/Spending (04/08)	Increase in spending offset by rise in prices
The Week Ahead
June 2	Construction Spending (04/08)
	ISM – Manu (05/08)
June 3	Factory Orders (04/08)
June 4	ISM – Services (05/08)
June 5	Initial Jobless Claims (05/31/08)
June 6	Unemployment Rate (05/08)
	Nonfarm Payroll Additions (05/08)
	Consumer Credit (04/08)

News and Related Story Links:

Money Morning Special Investment Research Report:
Money Morning Boosts Oil Target Price to $225 a Barrel, Thanks to Continued Scarcity, Burgeoning Demand in China.

Inflation Threatens Eastern Europe, But Region Still Expected to Grow

admin — Mon, 19 May 2008 19:54:37 +0000

By Jennifer Yousfi
Managing Editor

The European Bank for Reconstruction and Development (EBRD) kicked off its annual meeting in Kiev with an inflation warning for Eastern Europe.

"Inflation, now in double digits in many countries, is the region’s most pressing current problem," the EBRD said in its economic outlook report, Reuters reported. "If left unaddressed, inflation could risk price-wage spirals, exchange rate re-alignments, or could force a belated and sharp response by monetary policy."

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The EBRD, which was formed in 1991 to aid former Soviet states, announced that economic growth in Eastern Europe would slow to 6% in 2008, down from 7.3% in 2007. However, despite the slow down from the prior year, the 6% estimate represents an upgrade from the bank’s January assessment of the region’s growth.

Shortly after the New Year, the EBRD predicted a 5.0% to 5.5% growth rate for Eastern Europe. But the commodity-rich nations have proven more resilient to the slowing economies of the United States and European Union, which prompted the revision.

But rampant inflation, which last month reached 17.5% in Latvia, 11.4% in Estonia and a staggering 30.2% in Ukraine, according to Bloomberg data, has crippled consumer spending and harmed retail sales.

"The current rate of inflation is unsustainable" in Ukraine, the EBRD’s chief economist Erik Berglof told reporters in Kiev on the first day of the annual meeting, Bloomberg reported. "There’s a possibility of a hard landing" unless the government and the central bank respond with a more flexible currency policy, he said.

However, Berglof also noted the effect of the global credit crunch on the region has been "limited" so far with the noted exception of Kazakhstan, where it had "a real effect on growth," Berglof said. The oil-rich Central Asian country’s economic growth will likely slow to 5.1% this year, according to the EBRD.

"Kazakhstan has been hit by the crisis because it’s been very dependent on foreign lending," Berglof said.

To date, despite the soaring consumer prices, cheap labor relative to Western Europe combined with the region’s rich natural commodity resources have helped Eastern European countries to fare better than some of their Western neighbors during the international credit crisis.

While Eastern Europe isn’t expected to grow as fast as China or India, a 6% gross domestic product (GDP) growth rate is still quite respectable. Especially when you consider the United States will be lucky to eke out even 1% annual GDP growth in 2008.

There aren’t many options for American investors looking to play the region, says Money Morning Contributing Editor Martin Hutchinson. One option is an exchange-traded fund that tracks the region. While the SPDR S&P Emerging Europe ETF (GUR) is on the small side for an ETF with a capitalization of only $85 million, it is also one of the only ways to tap into Eastern Europe’s expected growth.

News and Related Story Links:

Reuters:
EBRD raises E.Europe growth call, warns on inflation

Bloomberg News:
East European Growth to Slow on Inflation, EBRD Says

Money Morning:
European Growth Strong in the First Quarter, but Will it Last?

Intimidated by Inflation, Gulf States Consider Cutting Ties with Dollar

Jason Simpkins — Thu, 01 May 2008 20:56:11 +0000

By Jason Simpkins
Associate Editor

Even with a bit of a rebound, of late, the dollar is down more than 7% against the euro in the past six months, 12% in the past 12 months and nearly 28% in the last 54 months.

The decline has been so drastic countries that have pegged their currencies to the beleaguered greenback are beginning to consider alternatives.

But Gulf States, particularly, have been torched by the dollar’s decline. About 18% of inflation in the United Arab Emirates is caused by the Gulf state’s currency peg to the dollar, Emirates Business 24/7 reported, citing the Dubai Chamber of Commerce & Industry’s senior economist. The U.A.E.’s inflation rate is about 12%, the report said.

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Inflation has risen to 10% in Saudi Arabia and Qatar’s consumer prices rose 14% in the fourth-quarter, Bloomberg News reported.

In an interview with Bloomberg, Kuwaiti Finance Minister Mustafa al-Shimali acknowledged that several Gulf States are considering abandoning the peg even though the United Arab Emirates and Qatar have ruled out such action.

"Yes, there are some" Gulf Cooperation Council states considering dropping their pegs to the dollar, al-Shimali said. "Some countries will do what we are doing."

Kuwait dropped its peg to the dollar a year ago. Since then, the Kuwaiti dinar has appreciated nearly 8% against the dollar.

Last month, a panel of experts was convened in the U.A.E. to assess the nation’s peg to the tumbling dollar. Ultimately, the panel recommended keeping the fixed exchange rate, but a committee was established to further probe the possibility of a currency revaluation.

In spite of soaring inflation, several Gulf States were forced to cut interest rates to keep in line with the U.S. Federal Reserve, which slashed the federal funds rate to 2.0% yesterday (Thursday). Dollar pegs in the region compel these states to track the Fed and maintain the relative value of their currencies.

Yesterday, Qatar and Bahrain cut their deposit facility and one-week deposit rates to 2% respectively. The U.A.E. central bank reduced its overnight repurchase rate, the rate at which the central bank lends to other banks, to 2% from 2.5%.

"Gulf states are taking the steps they can to dampen the impact of the inappropriate monetary stance that the dollar peg is forcing them into," Simon Williams, regional economist at HSBC Holdings PLC (HBC), told Reuters. "The goal is to moderate liquidity growth without triggering flows onto the currency."

Last month, speculation that the Gulf States would begin distancing themselves from the dollar provoked a rush of investment into their respective currencies. They would like to avoid that kind of speculative distortion in their exchange rates moving forward.

News and Related Story Links:

Bloomberg:
Gulf States May End Dollar Pegs, Kuwait Minister Says

Gulf Daily News:
DINAR-dollar peg ‘will help Bahrain’

Reuters:
Gulf cuts some key rates as Qatar signals tightening

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