Wait...So Your Saying Rate Cuts Fuel Inflation?

Posted by urbandigs

Tue Apr 15th, 2008 09:23 AM

A: As Bernanke & Company did what they had to do to save wall street and 'forestall future adverse effects to the economy', you are seeing the side-effects of this type of policy. Our fed has clearly moved from a dual mandate of price stability (inflation) & economic growth, to one solely of economic growth! Now, I'm reading headlines like 'Food Shortage Rises With Prices' and 'Food Prices Rising Fastest in 17 Years'. Now that the fed used up much of its arsenal, I'm wondering when the time will come that they will have to combat inflation by hiking rates; and whether we will be out of this housing/credit mess by that time?

Can you imagine rates rising when housing is still pressured and loans are still hard to secure? There is no such thing as a free lunch and right now, the fed has poured a rainstorm of stimulus onto wall street in the hopes of easing the credit crisis (seizing up of credit markets resulting in the inability to offload assets on the secondary mortgage markets) that resulted from natural market forces related to the housing/debt correction. We are no longer a society that allows a market to go down, for fear of the consequences. Instead of taking our medicine now, we have to deal with the side effect of commodity inflation as housing continues to deflate. Will we need to take the medicine later anyway? The fed's actions, while understandable given the depth of the problems we face, may still not be enough and I am concerned that inflation will runaway from us; what am I saying, it already has!

According to Bloomberg:

Treasuries fell as a government report showed wholesale prices rose at almost double the pace forecast, while New York manufacturing unexpectedly grew, fanning concern that inflation will accelerate.

The producer price report is "a wake-up call that's there is still inflation pressure," said T.J. Marta, a fixed-income strategist in New York at RBC Capital Markets. "It's definitely bearish for bonds." Prices paid to U.S. producers increased 1.1 percent in March from 0.3 percent the previous month, the government said. The median forecast in a Bloomberg survey was for an increase of 0.6 percent.
Every time the fed cuts rates to cure one ailment, they make another scratch somewhere else. With each cut, the US dollar gets weaker and commodities priced in dollars rise. The speculative trade riding the currency wave isn't helping much either; leaving the fed hoping that a slowdown will be the driving force to bring down commodity prices. I've said this so many damn times on this site: commodity inflation + housing deflation is NOT A GOOD MIX! Pipeline inflation is bubbling and we can expect future inflation data to be very troubling indeed.

The fix? Here's a thought: ANYTHING THAT WILL SUPPORT THE US DOLLAR! We MUST remove the speculative currency trade that has driven commodity prices higher; arguably there could be $30/barrel in speculative trade in oil as an example. Even if this means the fed changes verbiage to put their bias into the fight against inflation, then so be it! That would be interpreted by traders that future rate cuts are in serious doubt, the US dollar will be supported, and it would remove a good portion of the speculative trade in most commodities. It doesn't fix the supply problem that has resulted from fast growing economies like China & India, but it will help by removing the bets made simply on the premise of a weakening US dollar.

Barry Ritholtz, the ever present force arguing against the use of CORE datasets (for the simple reason that food & energy price rises have NOT been self defeating and have NOT been temporary in the past 4 years), provides this chart of March PPI; with the red dotted line showing the fed's target level:


If we let inflation runaway much further, because of the continued bias on growth and the current crisis, we will enter a period of rate hikes in the medium term future to combat the side effects that resulted from the management of this crisis. Think about how that will impact consumer debt payments, the bond market and lending rates and how healthy the credit markets may or may not be at that time! Inflation is a silent killer and as the saying says, 'is the cruelest tax of them all'!