The Fed on Commodity Inflation: What, Me Worry?

Is it inflation or speculation? The Fed Chairman spoke very plainly today, but what he left out is important. Coincidently, he spoke right after the ISM Report on expectations. Good news: manufacturing expectations are booming. Bad news: inflationary expectations are also booming.

These CPI expectations (the blue line) do not predict inflation, but a lot of folk are worried. Not Ben. He said commodities price increases are NOT a concern. 

His comments have been picked up by the punditsphere, and you can get a quick read from Barry Ritzholz thinks ("I disagree") and Cullen Roche at PragCap ("totally oblivious"). Here is Ben's view of surging commodities:

[T]he increases in commodity prices in recent months have largely reflected rising global demand for raw materials, particularly in some fast-growing emerging market economies, coupled with constraints on global supply in some cases.

Commodity prices have risen significantly in terms of all major currencies, suggesting that changes in the foreign exchange value of the dollar are unlikely to have been an important driver of the increases seen in recent months. 

The rate of pass-through from commodity price increases to broad indexes of U.S. consumer prices has been quite low in recent decades, partly reflecting the relatively small weight of materials inputs in total production costs as well as the stability of longer-term inflation expectations.

I think all three assertions are true, but hide the truth: his QE2 policies have driven up speculation, and that has driven up commodities across the board. Let's look at his assertions:

• demand and shortages have driven up prices - ok, but why would all commodities be going up in lockstep due to weather here or there, or other local causes of shortages? And why up so much when the great demand generator, China, is slowing down? As Cullen Roche opines: "There is nothing normal about cotton prices rising 200% in six months."
• prices have risen across all currencies - ok, inflation is the result of weaker currencies, and normally the whole world does not weaken at the same time in much the same pace. Also, QE2 does not 'print money' in the way people casually toss out. Still, his core assertion is too loose: prices have gone up faster in Dollar terms than Euro or Yen, bespoking Dollar relative weakness since QE2. Still, the inflation argument would have more weight if the Dollar were falling faster than it is, given how much commodities have risen. 
• commodity price rises are not being passed through - ok, so far anyway. I see blogosphere comments about official stats hiding the real inflation going on, but it is pretty clear that other than food and energy, where costs have an easier time being passed through, most industries are having a terrible time passing on the rise of input costs. This is why corporate earnings are about to run into a margin squeeze. 

Under the New Austrian School of Economics, interest rates are mechanisms to adjust business investment behavior. Normally low rates speak to longer investment horizons, but in the deflationary depressive aftermath of a credit bubble, keeping rates artificially low as the Fed is doing has the opposite effect: it spurs short-term, speculative investments over the long term. You could think of low rates as destroying the returns on sunk capital, leading to low replacement of existing plant - pretty much what has been going on during the Great Recession. 

BTW Bernanke let out his own estimates of how much he has lowered longer term rates - 75 bp. ZeroHedge extrapolated his formula across all his various QE measures:

The sum of QE 1, QE lite (the top off of QE1) and QE2 is $2.35 trillion. Using Bernanke’s formula you get a range of 4% to 5% as the approximate interest rate consequence of QE. 

That is an extraordinary number. The Fed’ ZIRP policy set interest rates at zero. QE has brought that to -4.5% (average) based on Ben’s numbers.

I don’t think that this has ever happened before in the USA. The examples I can think of in history outside of the US all ended badly. Ben has set monetary policy so that interest rates are 5-6 % below inflation. There can be only one possible result. Inflation of everything we use is going to explode. 

Maybe. The ISM reports are clear in seeing price increases on inputs across the board, and maybe American industry will not accept the margin squeeze and will try to pass it on. If so, prices should begun to push up in the next six months, and while this might make GDP tick up (see chart), it could just as well depress consumer spending:

The other explanation than coming inflation is that the speculative fervor is about to cool. We will likely see this first with oil and the Dollar. A strong Dollar reversal will unwind the speculative positions (priced in Dollars), and a break in oil will remove the biggest driver of cost-push seen by the ISM managers. 

Comments

[Wave Rust]

dont fade the fade of the fed on flation.

i prefer the in type versus the de type.

i dont want to play the de game ,,,, very nasty.

if the in game comes, so be it.

wave rust

btw, yel,,,, great title! :)

[emma]

I subscribe to the guy from australia http://www.forecastfortomorrow.com
that guy has called many big events before they have happend,
i.e. market crash, Economic collapse etc.

They have been accurate on alot of the world events
latetly, and i follow them closely.

They have a big launch for an ebook they are releasing
next week called "THE U.S. SECRET HIDDEN TREASURE MAP!"

Looks VERY intresting. Their prelaunch page is over at :-

http://www.forecastfortomorrow.com/news/products

[Mamma Boom Boom]

-------QE INFINITY------

http://www.screencast.com/users/MammaB/folders/Default/media/6945c1e3-b459-4e9c-bfca-06d18c3c0771

[da bear]

Is QE INFINITY already priced into the markets?
What about DEFAULT CITY?
FED GOV just wants to be the last one to default. That's what QE 4 EVER means.

da bear

[da bear]

The blogger at Subprime JD is calling for $100 silver.

link: http://subprimejd.blogspot.com/2011/03/silver-will-hit-100-per-ounce.html

That can't be a good omen for silver bugs...

da bear

[Mamma Boom Boom]

>That can't be a good omen for silver bugs...<

It's hard to find a bear in the metals.

[Hank Wernicki]

http://www.elliottfractals.com/

10 points today without TA

cheers

Hank

[da bear]

Mamma,

silver is up 4 times off the late 2008 low.
It's up 8 times or something like that in 10 years.
So, it can pull back.

I like EWI's view that silver is in a 'B' wave off the January 1980 high. If so, then silver will bottom when stocks and other assets will. That makes more sense.

I also think that gold is in a 'B' wave. Actually, an a-b-c upward correction. The rise from late 2008 in gold and silver is wave c. Depends on the scale, but five waves in on silver or close to it. Gold could go either way...

da bear

[Mamma Boom Boom]

da bear .... I think, eventually, both go much higher. But shorter term, it seems to me that strong forces are building to drive both down, and the dollar up.

[da bear]

MBB,

state governors are about to go all "Chainsaw Al" on redundant employees and wasteful spending. This is deflationary.

da bear

[Fredo]

Emma

in the interest of a balanced discussion, i'd like to alert everyone else here to what sort of newsletter Forecast for Tomorrow really is.

Firstly, the title is a misnomer, as there is no actual forecasting in it (or none that I could see anyway). It's just commentary and discussion on current events - I believe i've seen that sort of prose before - it's called a newspaper or the internet. The newsletter content is about as forward looking as last weeks news.

There's more than the occasional spelling error. You may want to proof read it before it goes out. I assume it's being written on a computer. I hear that they now come with a spell check function; you may want to take advantage of such an awesome feature. Also, try and use less colloquial language. We're not having an informal discussion amongst friends, so more formal language will make the newsletter seem more professional. And don't forget that spell check.

Subject headings within the newsletter say one thing but the ensuing commentary tends to drift off after that. A nice way of saying that it's superfluous language. Try cutting out a few paragraphs and it'll make the narrative a bit tighter, keeping the reader on track and stopping them from shoving a pencil up their nose for entertainment. Again, get someone to proof read the document.

On more than one occasion, the newlsetter has "promoted" the Law of Attraction.
Remember a few paragraphs ago I said there wasn't much "forecasting" being discussed, yeh, that's at least one of things I was alluding to. So we can all just "grow rich by thinking about it". So that's why I don't have 8 houses, 9 cars and a private jet - I just wasn't "wishing" for it hard enough. My mistake, i'll wish harder next time I walk past the exotic car dealership.
Don't get me wrong, I'm as happy go lucky as the next Charlie Sheen, but I think the newsletter misses the point of "forecasting" if it's taling about this, even if it is a side topic.

By now, you can kind of see that the newletter didn't thrill me. So I asked for my money back, a guarantee it offers if you're not satisified. Well that was 2 months ago and I still haven't heard back. I don't want to use the word liar but oops, the keyboard has already spelled it out for me.

Emma, I come to this blog because of the intelligent contributions from Yelnick and others. I've learned a lot by doing so, so don't come here and pimp the newsletter unless you're sure it can at least match that level of intelligence. If this is my experience, then you may find others also think the same. Just saying.

So there you have it, feel free to make up your own minds on the newlsetter, i've just shared my experience.

Good trading to all.

Fredo

[joe]

They seem to be good at selling themselves though, Fredo. SO many attempts to discount their stuff on so many redirects ....

I wanted to add - what a well written, articulate post you made.

Joe

[Mamma Boom Boom]

>MBB,
state governors are about to go all "Chainsaw Al" on redundant employees and wasteful spending. This is deflationary.
da bear<

That is exactly right. And it still won't be enough. Some will be looking for the bankruptcy version, when it becomes law.

Neo-Mamma

[AngencegefJub]

sokat tanultam

[Intrinsic]

dont fight the fed. untill you realise they can make mistakes as well.