Tuesday, December 19, 2006

Not Good News

The Producer Price Index which measures core inflation pressure took it's biggest jump in decades last month. This is not good news for the economy.

Economists had been expecting a rebound in wholesale prices following two months of big declines. However, the 2 percent jump was four times bigger than the 0.5 percent increase they had forecast. Even excluding volatile energy and food prices, core inflation posted a 1.3 percent advance, the biggest jump in 26 years.

This jump is a big change from the consumer price index which was flat in November. This has actually been declining for the recent few months. Most of this disparity is because of energy costs, which went down in the consumer number but were up 6.1 percent in the November survey of wholesale prices.

Combine these numbers with what we are seeing in the housing industry coupled with the inverted yield curve in the bond market and you are looking at all the warning signs of recession. I wouldn't be surprised if the Fed cranks up interest rates after the first of the year and that might just push us over the edge into a full blown recession. Gird thy loins folks it may be a rough ride.

1 comment:

Eric Bergen said...

In 1996, authors Estrella and Mishkin released a famous Fed study that developed a probability table about how likely a recession would be 4 quarters later, given a particular level of the yield curve spread. Their study accurately predicted the stock market crash in 2001 when the yield curve was inverted one year earlier.

The last few months, the spread between the 3-month & 10-year bonds has been -0.40% indicating a ~40% chance of a recession.

Every time a bearish set of economic data was released in late 2006, the stock market shrugged it off since it heightened expectations of a Fed rate cut in 2007 (which stimulates growth). On the other hand, when positive data was released, the market still rallied. Thus, the stock market was going to rally no matter what the news!!!

This year should be different due to (a dirty word for investors) STAGFLATION. Yesterday’s Fed minutes indicated the presence of this double whammy: slowing growth AND rising inflation. These 2 phenomena rarely work in opposition. What this means is that the economy is slowing, but the Fed is unlikely to cut rates as long as inflation is an issue. This is very bad for the stock market and, to a lesser extent, the bond market.