All Signs Point to an Economy Headed in the Wrong Direction

by: Enzio von Pfeil

Do you buy or sell the market in light of cooling house prices?

Readers know that we have held the "Fed Funds will reach 6% in 2006" view since June 2004, when the last tightening cycle began.

Those hoping that Fed Funds will stop rising are now pointing to higher bond yields; after all, they are driving down home prices. Indeed, the home-builders are feeling increasingly pessimistic about their residential property. The market feels that lower housing prices will depress consumption, so down goes inflation, dragging Fed Funds with it.

Not so fast! Last Thursday, wages growth for the first quarter was released, at an annual rate of 5.8%. That is over 3x as fast as the previous quarter! Next to rising wages, another inflation booster will be rising unit labour costs: in our Economic Time report on America, we alluded to slower productivity growth.

Rising unit labour costs are inflationary in that they will be passed on to the consumer: companies have to protect their profits, so with turnover waning, they have to protect their margins - by passing higher costs onto consumers.

We reckon that this cost-push inflation is going to propel Fed Funds ever higher, possibly leading to a mild form of stagflation in America.

Money-saving implication: Avoid the US market as America's Economic Time is worsening.