Reports of the Death of Inflation Have Been Greatly Exaggerated

by: Barry Ritholtz

With the FOMC meeting Tuesday, equity traders are hoping for a half point rate cut. According to Barron's Econoday, the Fed Fund Futures are pricing in a "42% probability for a 25 basis point cut versus 58% for a 50 basis point cut from the current target of 5-1/4 percent, based on fed funds futures close on September 14."

A key element of the Punch Bowl Caucus -- those millionaire billionaire fund managers begging for a cut -- is that inflation, if not already tame, will become so as the economy cools. The obvious criticism is that these are the same folks who have been telling us for many months that the economy is just fine (therefore you should buy U.S. equities).

Now, as their prior arguments have proven to be hollow falsehoods, they have traded them in for this year's model (Hurry in for great deals on 2007 models!). In place of the former rhetorical argument, their new position crossover argument is that as the economy is slowing, the Fed must cut rates (therefore you should buy U.S. equities).

My preference is for objective analysis, and I take the shill-driven spin for what it is: Biased, self-promotional spin by (mostly long only) shills for their firm's asset gathering business.

My own agenda is similar: we run a fee-based asset management business, but prefer to find an "objective Truth" about the economy. Maybe we are too small to be corrupted by the system. Perhaps we simply find it easier to approach it this way. Regardless, what we continue to find is that inflation remains "sticky" -- even as the economy cools.

Why do we say that?

-Oil is near all time (nominal) highs of $80 (Crude Closes at New Record High)

-Gold Advances to Near 16-Month High (Gold is well over $700)

-Health-Care Inflation continues to gain at double digit levels

-Corn hit over $4.50 last February

-Wheat is near $9/bushel

-Soybeans Rise to 3-Year High

-Natural Gas, Orange Juice Soar

-Dairy prices have almost doubled from 2 years ago

There are lots of other examples, but these are the most recent ones that come to mind. And, the Fed is well aware of these issues.

That's why a 50 bps cut would surprise me.

Goldman Sachs Agricultural Index ()



Sources:
Higher Prices. It’s What’s For Dinner.
David Gaffen
Marketbeat, September 5, 2007, 10:57 am
http://blogs.wsj.com/marketbeat/2007/09/05/higher-prices-its-whats-for-dinner/

Health-Care Premiums Climbing Faster Than Inflation, Studies Say
VANESSA FUHRMANS
WSJ, September 12, 2007; Page D9
http://online.wsj.com/article/SB118951621359523764.html

Tyson's Grain Costs Trickle Down
Forecast Is Lowered; Restructuring Plan Will Reduce Ranks
LAUREN ETTER
WSJ, September 6, 2007; Page A4
http://online.wsj.com/article/SB118899464156417984.html