FYI | Sep 13 2007
By Greg Peel
Inflation. Remember that? Wall Street has been so fixated on the R-word in the past month that that it seemed pointless to talk about the I-word. A slowing economy does not tend to be inflationary, and the primary focus of the Fed should be to solve the potential recession problem first before worrying about inflation.
And when one talks about core inflation – the favoured measure of central bankers – it is undeniable that (a) core inflation in the US is currently running at a comfortable 2% and (b) a consumer slowdown is more likely to affect an easing in prices at the outset. However, many a commentator has noted (including FNArena) these past months that removing food and energy prices from inflation measures due to their month-on-month volatility may have merit, but to ignore these prices is dangerous when it is clear that the only way is up.
The Fed was still in inflation mode on August 7 when it left the target rate unchanged – a move that in hindsight has all the hallmarks of a wood duck* reaction. A month later we’re looking at a possible 50bps cut. When the oil price fell back through US$70/bbl on fears of the US slowdown it appeared that headline inflation was no longer an issue. But the correction didn’t last long.
Oil for October delivery passed the US$80/bbl mark for the first time in history last night. It settled back to close at US$79.91/bbl – up US$1.68 in the session.
Oil has been trading recently on the basis of tight supply challenged by unrelenting demand. On Tuesday OPEC’s production quota increase was dismissed for the fantasy that it is. Concern lay with last night’s US inventory figures, which were expected to show a decline of 500,000bbl. The number came in at a 700,000bbl decline.
Adding to the equation were news from the weather bureau that the tropical depression in the Atlantic may yet turn into a Gulf-threatening hurricane, and that the US government has drawn up contingency plans to either bomb Iran or block its oil exports or both (which isn’t really new news, just an unfortunate reminder).
This is a record for oil in nominal terms. In real terms, oil traded at around the US$90-100/bbl mark back in the seventies depending on which inflation measure one discounts by. But a simultaneous record was also set in wheat last light, which hit US$9/bushel before settling back to US$8.60/bushel.
Wheat has been rising rather relentlessly this past year, driven by drought in Australia and other parts of the globe, rising food demand from emerging economies, and the ill-conceived explosion in ethanol production. The reduction in land given over to the production of wheat for food has forced flow on price hikes in other grains, soybeans (farmers are now growing corn for ethanol instead) and meat and dairy products (livestock eat grains).
Around the globe – Australia included – shoppers have all but fainted at the sight of price tags for everyday staples. In Italy, where the price of pasta has risen 27% these past months, frustrated consumer groups have called for a one-day “pasta strike” as a protest against rising prices.
The price of gasoline in the US stands at around US$2.81/gal at present – off from the May record high of US$3.23/gal. But there is a lag of months between movements in the crude price and movements in the price at the pump. Gasoline prices will only rise steadily from here, and this will come at a time when US consumers are already looking to tighten their belts.
US Treasury Secretary Henry Paulson, who has to date attempted to pour cold water on the subprime inferno in the best political fashion, admitted last night that the mortgage crisis will take a lot longer to be resolved than initially thought.
Meanwhile on equity markets, it was a case of range trading as the push and pull of the oil price effect and other news provided no obvious direction. The Dow closed down 14 points on light NYSE volume. Unless anything particularly untoward happens between now and next Tuesday, stocks should be on hold before the world learns of the Fed’s decision. Can it provide the cut the market wants in a headline inflationary environment? Should it provide what the market wants? A cut of only 25bps will not be well received.
But the US dollar is already priming itself for further weakness. Last night it hit a record low against the euro at US$1.3904. It also fell back again against the yen. But the Aussie continues to exert its economic fundamentals (don’t mention the carry trade) in trading to US$84.17. Can the Fed justify a rate cut which will only pressure the greenback further? And when the US dollar falls, the price of imported oil only rises.
Having had a solid run through the US$700/oz mark, gold remained relatively steady at US$711.60/oz last night. Movements in base metals were also minimal.
The SPI Overnight rose 18 points.
* A wood duck is someone who fails to absorb new information when everyone around has. Duck hunters float a wooden replica duck onto a pond to fool real ducks into thinking the pond is safe. When the real ducks take to the air when the shooting starts, the wood duck just sits there going: what?
