Monday, September 24, 2007

Inflation Fears

Post-rate cut, the Wall Street Journal says the bond market's got 'em, although not so much the stock market. The Dow is just 180 points off its all time high. Even so, the Journal says some money managers believe the Fed will have to raise rates in the spring to offset the inflation they stoked with last week's mostly unexpected 50 bps rate cut:

Until the credit crisis struck, the Fed had signaled no intention of cutting rates so soon. Lower rates typically stimulate the economy by making it easier for companies, consumers and investors to borrow. If the Fed continues cutting rates before inflationary pressures have been stifled, it risks pushing inflation higher.

The Fed has acknowledged the concern, noting in the statement announcing last week's rate cut that "some inflation risks remain." Inflation could come from the still-booming global economy and from the lower rates themselves, which push more money into the economy, making it easier to raise prices.

Some money managers already are warning that inflation may force the Fed to raise rates early next year, taking back last week's gift. Higher rates would hurt stocks because they stifle the economy and make it harder for investors to borrow.

Something similar happened in 1999, when the Fed had to raise rates after cutting them during the 1998 financial crisis. The economy ended up in recession in 2001.

Stocks soared in the 1998-1999 period. The S&P increased by 39% during that time.

As of today, investors don't seem too worried about inflation. Marketwatch says Wall Street is set to extend its post-rate cut rally today and the Dow will probably will reach an all-time high sometime this week.

And yet, given the plummeting dollar (a euro is now worth $1.41 and the Canadian dollar achieved parity to the U.S. dollar), all these stock gains may not really mean what the bulls think they mean. Barry at The Big Picture quotes Jack Ablin:

"Growth in the S&P 500, up almost 8% in dollars year-to-date, dwindles to 1% when denominated in euros. If the dollar falls further, U.S. markets become much less compelling for overseas investors."

Huh - you mean some of the stock market gains are illusory increases from inflation?

Who knew?

Still, the market will reach all-time highs again and we will hear from the Larry Kudlows who will tell us that all is well with the bestest economy ever ( The Bush Economy!!!) and that all we need to make the economy even better is more tax cuts and more rate cuts. Don't worry, they will say, inflation is not a problem!!!!

Meanwhile, I went to the grocery this week and discovered bread was up 20 cents, tofu up 20 cents, soy-based foods up 30 cents, corn up 20 cents... is $739 a ounce, oil is $82 a barrel, gas prices are set to spike as a result of rising oil prices...

...Con Edison wants a 20% rate hike for energy, the MTA wants a 20% rate hike for a subway ride...

...yada, yada, yada...

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