Offshore Troubles, Domestic Fears

 |  Includes: DIA, QQQ, SPY
by: James Picerno

Another monthly report on import prices, and another monthly record high. If that sounds familiar, you're right. In fact, we can almost set our watch by the reliability of the trend these days.

No wonder, then, that we've become a broken record on the subject. Our only defense is that our recurring message is a reflection of the consistent rise in import prices, which we've written about regularly in the recent past, including here and here and here.

As we've discussed over the years, there are many hazards of letting prices rise with nary a monetary peep. The hazards continue to increase now that import prices are advancing at more than 20% a year, as of last month. As far as we can tell, that's the fastest pace on record, based on the data available on the Bureau of Labor Statistics' website, as the BLS chart below shows.

12-month rolling change in U.S. import prices:

Source: Bureau of Labor Statistics


The rationale for doing nothing is that a recession/deflation risk coexists with the inflation danger, as the Bank for International Settlements noted in its recently published annual report:

 This combination of rising inflation pressures and financial disturbances slowing demand growth is open to a spectrum of interpretations. On the one hand, if slower growth were thought just sufficient to hold global inflation in check, albeit with a lag, this could be viewed positively. On the other hand, the eventual global slowdown could prove to be much greater and longer-lasting than would be required to keep inflation under control. Over time, this could potentially even lead to deflation, which would evidently be less welcome. Unfortunately, when one considers the possible interactions between a weakening real economy, high household debt levels and a severely stressed financial system, such an outcome, even if unlikely, cannot be ruled out entirely.

With conflicting signals swirling about, these are not easy times for central banks. Dealing with one or the other is within policy powers of the Fed (assuming the discipline to carry out the relevant monetary prescription). Tackling both simultaneously, however, is more of gray area, with limited precedent of success for encouraging optimism with the current battle.

That leaves us to question whether it's time to hedge one's bets a bit by at least tightening slightly. For the moment, the Fed is having none of that and instead seems intent on betting exclusively on the recession/deflation risk, in effect hoping that the inflation hazard will fade away in due course.

It's a nice theory, and it may ultimately prove accurate. But heaven help the man in the street if the Fed's wrong. So far, one can argue that the bet has been a net loser for Joe Sixpack, courtesy of the bull market in oil. Crude is priced in dollars, and to the extent that dollar-based inflation is a problem, oil prices will rise in sympathy. True, supply/demand factors are also pushing up oil prices, but a portion of that rise is surely linked to the weak dollar. And with the Fed's current monetary stance, combined with Europe's monetary tightening, the dollar may weaken further.

It's anyone's guess if Bernanke & Co. will win this game of chicken. So far, there's not yet much sign of success in the numbers, least of all in import prices. Even if you take out petroleum, which is the primary source of the imported inflation, import prices are still climbing by more than 7% a year. That's better than 20%, but it's still not encouraging, all the more so when you consider that higher oil imports are this country's destiny for some time to come.

By comparison, the 10-year Treasury yield is a mere 3.81%, as of last night's close, and Fed funds remain at 2%.

For the moment, we're left to wonder (and hope) that next week's update on consumer prices will bring better news on the inflation front. Meantime, it promises to be a long weekend.