Inflation Watch: 'They Are Capitulating...'

By: John Rubino | Fri, Apr 22, 2011
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Lately just about the only things not soaring in price are US houses and electronics beginning with "i". Raw materials, for instance, have had a good week based on the price action of this commodities ETF:

PowerShares DB Commodity Index

Those higher raw material costs seem to be finally working their way through to restaurant results:

Inflation on McDonald's Radar

With inflation on everyone's radar, it comes as no surprise that McDonald's will feel the pinch. Operating margin fell to 17.7% at the Golden Arches, as input costs began to put serious pressure on profits. While McDonald's doesn't give an official inflation outlook, its SEC filing reveals that "With about 75% of McDonald's grocery bill comprised of 10 different commodities, a basket of goods approach is the most comprehensive way to look at the Company's commodity costs. For the full year 2011, the total basket of goods cost is expected to increase 4-4.5% in the U.S. and Europe." (Read Why World Food Prices Will Keep Climbing).

Oil and gasoline are inching up:

Crude futures break through $112 a barrel

SAN FRANCISCO (MarketWatch) -- Crude-oil futures regained some footing Thursday, inching higher on a weaker dollar and resuming their upward trajectory after recent sharp gains.

Crude for June delivery CLM11 +0.15% added 5 cents to $111.50 a barrel on the New York Mercantile Exchange.

Gasoline Extends Gains After Report Shows Decline in Inventories

April 20 (Bloomberg) -- Gasoline futures extended their gains after the U.S. Energy Department reported a decline in inventories and an unexpected drop in crude oil inventories.

Stockpiles of gasoline dropped 1.58 million barrels to 208.1 million, the report showed. The median forecast of 14 analysts surveyed by Bloomberg News was for a decline of 1.75 million barrels.

Crude oil stockpiles fell 2.32 million barrels to 357 million. Analysts had expected a gain of 1.3 million barrels.

Gasoline for May delivery rose 1.94 cents, or 0.6 percent, to $3.2525 a gallon at 10:33 a.m. on the New York Mercantile Exchange.

Precious metals and the US dollar continue to move in opposite directions:

Precious Metals and US Dollar Charts

And home prices are soaring in countries to which the US is exporting its inflation:

Housing Bubbles Percolate Far From Crises Elsewhere

Housing prices are rising rapidly in Australia, Canada, China, Hong Kong, Israel, Singapore, South Africa and Sweden. Housing prices are flat--or falling--in Britain, France, Germany, Ireland, Italy and the U.S.

Welcome to the two-speed global economy.

When most observers talk about a "two-speed economy," they are contrasting slow-growing mature or advanced economies (the U.S., Europe, Japan, etc.) with fast-growing developing or emerging-market economies (China, India, Brazil, etc.). Philip Suttle of the Institute of International Finance, a bankers' association, calls it "a two-and-six world." In mature economies, growth and inflation are at around 2%; in emerging markets both are around 6%. Whenever anything nudges them off that course, he says, something else nudges them back.

But there's another way to divide the world: Some economies had a big banking crisis. Some didn't. And the ones that didn't are the ones where housing prices are shooting up. Slow growth in mature economies is leading them to keep interest rates low and credit conditions easy. Because they (so far) dominate world financial markets, that means global credit is easy, too easy for emerging markets where inflation--in wages, prices and asset prices--is the worry.

In Canada, for instance, commercial banks were hardly shaken by the crisis but the Bank of Canada has been holding its key rate at just 1% to foster economic growth. The consequence: Housing prices in February were up nearly 9% from year-earlier levels, the Canadian Real Estate Association says. The worry in Canada and elsewhere is that what goes up might come down, and history amply illustrates the economic harm done when housing prices plunge.

In Israel, banks were spared the worst of the crisis; they hadn't invested much in U.S. subprime mortgages. But Israel wasn't immune from shock waves from abroad so its central bank cut rates all the way to 0.5% in 2009. That made mortgages cheap. Over the past year, the house prices are up 16.3%.

In this (and perhaps only in this) respect, Israel isn't unusual. The average house price in Hong Kong rose more than 20% in 2010 following a 30% increase the year before. In the first two months of this year, prices rose another 7%.

Then there's this from Brazil, with one very interesting passage (bold added below):

Brazil Raises Key Interest Rate; Move is Smaller

SAO PAULO -- Brazil's central bank raised its benchmark interest rates by less than what many economists say is needed to keep inflation in check, in a gamble that soaring global food prices helping drive inflation higher will eventually ease off by themselves.

Brazil's central bank raised its benchmark interest rate a quarter of a percentage point to 12%. That was a smaller raise than two previous hikes of half a percentage point earlier this year.

"They are capitulating in terms of their inflation target for this year and are going to let inflation run through system," says Alberto Ramos, an Latin America economist with Goldman Sachs, who called for a hike twice or three times as big. "The risk is that inflation becomes entrenched."

Fast rising inflation, pushed in part by soaring global food and fuel prices, has put Brazil's new central bank President Alexandre Tombini in the difficult predicament of seeking to balance the country's need to fight price rises with a desire to avoid hampering Brazil's extraordinary growth story by pushing rates even higher. The dilemma is set against real questions about how effective local interest rates are in fighting inflation caused by global trends like soaring food and fuel prices.

Mr. Tombini is not alone. Last week's jump in inflation and rate hike in China coupled with rising inflation in India, illustrate how quickening inflation has suddenly emerged as a potential speed bump-and key test for policy makers-across the fast-growing emerging markets.

The stakes couldn't be higher for Mr. Tombini. For starters, Brazil already has the highest interest rates of any major economy, and its leaders are wary about pushing them higher.

At the same time, inflation is the historical bete noir of the Brazilian economy. The South American giant battled four-digit inflation as recently as the early 1990s, and its success in bringing it down to the single digits in recent years is seen as central to its economic success of recent years.

What's driving concern is that an already tricky inflation scenario worsened in recent days. Brazil said Wednesday that its benchmark inflation rate, which is broadly similar to the U.S. consumer price index, quickened to 6.44%-its fastest rate in more than two years. Meantime, central bank surveys say that inflation expectations are Brazilians are deteriorating.

And Brazil's decision on how much to raise rates is complicated by its other big macro economic headache: An overvalued currency.

Like some other emerging market countries, Brazil is letting its currency appreciate in order to stem inflation. But the Brazilian real has already soared around 40% since early 2009 as global investors pour money into the financial system to profit-at least in part-from Brazil's high interest rates. Brazilian businesses are grumbling that the strong currency is making them vulnerable to competition from countries with weaker currencies.

A bigger rate hike could exacerbate that trend by pulling more foreign capital into Brazil.

Some thoughts:



John Rubino

Author: John Rubino

John Rubino

John Rubino

John Rubino edits and has authored or co-authored five books, including The Money Bubble: What To Do Before It Pops, Clean Money: Picking Winners in the Green Tech Boom, The Collapse of the Dollar and How to Profit From It, and How to Profit from the Coming Real Estate Bust. After earning a Finance MBA from New York University, he spent the 1980s on Wall Street, as a currency trader, equity analyst and junk bond analyst. During the 1990s he was a featured columnist with and a frequent contributor to Individual Investor, Online Investor, and Consumers Digest, among many other publications. He now writes for CFA Magazine.

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