Wednesday, July 16, 2008

Surprise, Surprise, Things are Getting More Expensive

Today's CPI report showed inflation jumped 5% from 2007 which is the biggest jump since 1991. The core rate of inflation jumped 2.4% (ex-food and energy) also ahead of expectations. Frankly, even these numbers feel low to anyone that has had the joy of shopping for consumer staples lately.

Perhaps more troubling is that average hourly earnings slipped in June by 0.9%.

So while the cost of everything is rising, the average household income is slipping. This is particularly difficult situation to address for policymakers. If prices AND wages rise, the recipe is simple - raise interest rates. If prices and wages are falling, cut rates. Unfortunately, the Federal Reserve has lost sight of these guiding principals and instead focuses on the daily swings in the stock market.

An important note was raised by UBS (the large Swiss Banking firm):

"Whilst Bernanke took centre stage, macro data showed the increasing problems we face. Producer prices rose by 9.2% y/y, the highest by quite a margin since July 1981 when U.S. interest rates were still at 15.5%. " Note that - The last time producer prices rose this fast (ie, we had high inflation), interest rates were 15.5%!!! Today rates stand at 2%. Clearly the lack of wage pressure is the key difference, but if the Fed is wrong we are in for a world of hurt.

However, there is one factor that could change everything. Oil. It's down about $10 in recent days as a result of concerns about slowing global growth, but I also suspect that some big traders have started to unwind the oil trade over fears that the Gov't is going to increase regulation to limit trading in oil futures. That's just my guess, though.

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