The Big Problem

You mean that inflation is not under control?

I found it laughable last month when April's inflation numbers came in "lower than expectations" and all the talk of the bottom being behind us was abound. It was laughable because in May we had seen energy prices sky rocket to all time highs on a daily basis.

How could so many people not see it? They were looking back at a report when the current picture was dramatically different. It is the problem with all reports, as I have said before, are backwards looking. It is like driving a car when all you can see is only where you have been and not what lies in front of you.

I have a hint for you. June's inflation number will be fairly muted and either hit or be below the consenus estimate. The only reason it won't is that food prices will continue to rise in the next couple of weeks in response to the flooding in Iowa and Indiana.

The whole, "Oil will hit $150 by July 4th," has some way to run. I don't know. I don't follow it that closely, but it sure doesn't seem like oil has the gusto at this moment to hit $150 in the next couple of weeks, but it still may hit it sometime this year.

As for my friend, the Fed. Well, frankly, you're screwed. You have no plays. You can't lower the rates anymore because the dollar will continue to fall and inflation will continue to rise. That's no good and they have FINALLY admitted as much. You can't raise the rates right now because of the housing slump and banks still really need the liquidity to stay afloat and that little thing called the Presidential Election.

So, the answer is that the best plan of action is no action at all and bluff and blow hard that you are going to raise the rates aggressively as needed. Which you will have to do to curb inflation. Look even the low-ball government estimate is putting inflation at just a touch over 4%. The current Fed rate stands at 2%. The rates will have to be HIGHER than inflation to curb stem it's tide.. Little .25% increases will not cut it.

Another Reason Inflation Won't Moderate

With President Chavez doing some saber rattling yesterday we say the price of oil surge and the price at the pump took a nice jump today right along with it.

Also there is news that OPEC will help control supply to help keep the cost of a barrel of oil around $90.

So much for inflation moderation.

We also see commodities, anything from gold to Minnesota wheat having a giant bull market.

The ECB has still been making it's stand firm that it will continue to fight inflation.

And this bit brought a smile to my face and my thoughts to hypocrisy.

The White House warn about legislation regarding mortgage reform.

This statement caught my eyes:

"Markets naturally self correct, rewarding good strategies and punishing bad ones. Government actions may be less effective at differentiating between the two and may prevent markets from creating products that benefit consumers," the report concluded.

No kidding? Then why oh why are is the Federal Reserve tampering with the markets every step of the way with their rate cuts. The cut before the market opened after President's Day was made to try to prop up the stock market. That was it. The full effects of the cut will not be felt for months. But the White House and Congress fully supports the actions of the Fed.

Now, I am not a financial historian, but it seems to me that Mr. Ron Paul may be right that the Federal Reserve needs to be disbanded. Open manipulating of the markets cannot be a good thing and the price to pay later on will be severe.

Market Falls Based on Inflation News

Ok, so there was a lot of news that pushed the market lower today, when it should have rebounded to some extent from the knee-jerk reaction to the ISM report yesterday.

Those included:

Merrill Lynch possible downgrade by Standard & Poor's because of their involvement in the sub-prime mess. To me, this is overdone also. Merrill has already written off billions of dollars and have changed their CEO. That new CEO (John Thain) will write down even more in billions trying to clean out the old guard.

Goldman Sachs downgraded GM & Ford, citing consumer spending slowdown. Like that is a surprise. Car sales have lagged for the last few years based on the change of consumer wants (no SUV and more high MPG cars) and a move by the companies away from high incentitives.

But to me, the big one was Mr. Plosser's speech on the economy. He mentions his concerns that inflation is not going to moderate even in the face of a slowing economy.

This is big. The market took this that the Fed won't be cutting rates until at least March. Boy, it breaks my heart to disappoint the market like that. 1.25% in two week wasn't good enough. Bill Gross from Pimco stated that his expectation for the Fed rate to hit 2.5% from it's current 3%. I still believe that it will not go below 2%.

Inflation is here to stay. This will keep the Fed bankers on their toes, even more than a slowing economy. Slowdowns are natural and a necessary part of every open economy and it is about time that the Fed and the rest of our government take a honest look and realize that all growth all the time is not necessarily the best for the future. There is always a price to pay when the Fed starts dropping rates and it is always inflation.

The Rally Ends & Inflation Begins

Told you that FedEx would play a roll in the rally. Today the company announced better than expected earnings but lowered their forecast based on the rising cost of energy. Probably wise on their part, with oil hitting $83.90 as an intraday high. Oil won't get better near term with producers in the Gulf still being jitterish about hurricane season. Also the low dollar doesn't help either.

Two more things about the dollar. First, the Canadian dollar hit parity with the US dollar. Uh, what? My Canadian nickel is actually worth 5 cents? Get out! And second, the Saudi's did not cut their rate in step with the US for the first time. Does this signal the end of their pegging their currency with the US dollar? If so, that is bad news for the dollar and the economy. If the Saudi's end the peg, so will other countries. This will trigger a mass pull out of the dollar, which will make our currency fall further. People, a rate cut cannot help this sort of issue. It would only enhance the issue.

Long term bonds continue to sell off, pointing to inflation. Oil hitting record highs, points to inflation. The lower dollar, points to inflation. Higher gold, points to inflation. You can't cut rates anymore in the face of inflation.

Want to guess what stock was my best performer on the day? Barrick Gold (ABX) was up 5.68% today. The stock is up over 30% on the month.

And just one more issue from my little meeting today. The genius who kept proclaiming the profitability of FHA loans, said that he fully expects mortgage interest rates to come down and we will see a refinance boom (though small) next year. Hey genius! If long term bonds keep selling off (which they will unless the dollar rebounds and oil comes down) the yield will increase pushing mortgage rates higher. Obviously I don't share his view. The mortgage arena is going to stay ugly next year. Rates, at best, will remain at current levels or move slightly higher. Rates aren't bad now.

If you are facing an ARM reset set and do not have a pre-payment penalty, do yourself a favor, get out of the loan sooner than later.

Samuri Ben

Ok, I gave 10 reasons not to cut this weekend and did Ben & Co. listen? Nope. They didn't listen to a darn thing that I wrote. I was encouraged that they did still mention that inflation was still a concern. If I say it once, I will say it a hundred times...inflation should forever and always be the Fed's main concern. Look at what treasuries did today.

Short term bonds are already starting to price in another cut. I think that may be misplaced. By cutting the rate .50 basis points here, the Fed can sit back and watch how things unfold over the next couple of months (as long as things don't get worse) and see what happens. If they had cut by only .25 basis points, that would have signaled a rate cutting campaign.

But notice that longer term treasuries sold off? Long term bonds determine long term interest rates, i.e. mortgages. It also is a clear signal that inflation is going to raise. Not a good thing.

Ultimately, I'm a little disappointed that the Fed did not make a stand here. By cutting the rate, it sets up the future to be more grim. Throwing easy money at an issue created by easy money doesn't make sense and someday in the future, maybe not this year or next, or even the year after that but someday we will all have to pay for the excesses we have seen over the last few years.

So we had a good rally today because of the Fed. Lehman Brothers posted a better than expected earnings report. Does this make everything gung-ho going forward? Not so fast my friend. Too many issues still remain and will remain no matter what the Fed does. It makes the holiday season a little brighter as credit card rates will decline. It will make businesses reinvest and start spending money again but these are short term fixes to a long term problem.