Oxstones Investment Club™by Randall W. Forsyth, Barron’s,
Commodity prices could squeeze economy, just as in 2008.
China’s central bank raised interest rates for the third time in four months, and undoubtedly not the last time, to counter the growing inflation that is besetting fast-growing emerging economies.
That inflation so far is visible mainly in the price of commodities (presuming rising asset prices are not counted in the calculation.) And based on the Continuous Commodity Index, an equal-weighted gauge of prices, commodities have exceeded their old highs set in 2008 and have set a new record, according to Bank of America Merrill Lynch’s technical analysis team led by Mary Ann Bartels.
Energy, grains and metals all have participated in the advance to new highs without the headline-grabbing price of crude oil topping $100 a barrel and retail U.S. gasoline prices hitting $4 a gallon, as they did in 2008.
Even so, the run-up in commodity prices could threaten the global recovery, just as they did in the summer of 2008, writes Melissa Kidd of Lombard Street Research in London. That’s especially so if central banks in other emerging economies join the People’s Bank of China, the Reserve Bank of India, the Bank of Thailand as well as those in industrialized economies such as the Reserve Bank of Australia in raising their policy interest rates.
World trade has fully recovered from the collapse that began in 2008 well before the global financial near-meltdown that fall. It should be recalled that economies in the U.S. and abroad already were sliding that summer as crude soared to its record past $140 a barrel.
The Federal Reserve then already was easing its policy aggressively in reaction to the financial fissures opening up, including the collapse of Bear Stearns in March. That helped to send the dollar sliding, which was exacerbated by other central banks led by the European Central Bank continuing to tighten to counter the price pressures generated by rising commodities.
The ensuing squeeze on American consumers’ disposable income from soaring prices at the pump in the summer of 2008 sent their confidence tumbling and forced them to cut back on other spending.
There are hints of déjà vu in the latest ABC consumer comfort index, which showed a sharp drop to its lowest level since November. “It’s likely no coincidence that the change in sentiment follows the federal government’s report yesterday that gas has jumped to an average $3.13 a gallon, up steadily from $2.74 six months ago, $2.65 a year ago and $1.89 two years ago this month,” said ABC, given consumers’ psyches and gas prices are “correlated significantly.”
As commodity prices feed into “headline” inflation — which takes in the higher food and energy prices that “core” inflation measures omit — pressure will rise for central banks in developing and developed markets to raise interest rates, LSR’s Kidd says. “These factors are a threat to global activity, dampening the medium-term growth outlook. However, it would take further sharp leg up in commodity prices to turn these concerns into a reality in the near-term,” she concludes.
But commodity inflation could threat asset deflation, Stephanie Pomboy, the ever-provocative proprietress of MacroMavens, contends. Commodities and financial assets compete for liquidity at the margin. So, rising prices of stuff siphon away buying power for stocks and bonds. Conversely, disinflation has been bullish for financial assets.
So far, the Fed’s binge buying of Treasuries has provided plenty of liquidity to lift both the commodity and financial asset boats. But Fed officials have expressed doubts about the central bank’s program to purchase $600 billion of securities by mid-year.
Richmond Fed President Jeffrey Lacker said Tuesday said the central bank needs to take “quite seriously” a reevaluation of QE2, as the purchase scheme is popularly known, “because inflation is capable of accelerating, even if the level of economic activity has not yet returned to pre-recession trend.”
That follows Dallas Fed President Richard Fisher saying he would be “wary” of an expansion of QE2 past the $600 billion currently planned. Fisher, a member of the policy-setting Open Market Committee, added that he expects to be “at the forefront of the effort to trim back our Treasury holdings and tighten policy at the earliest sign that inflationary pressures are moving beyond the commodity markets and into the general price stream.”
Fed Chairman Ben Bernanke, by contrast, has been the driver behind the central bank’s expansive policy and its intent to maintain extraordinarily low rates for its federal-funds target for “an extended period,” which he’s implied will last as long as unemployment remains elevated.
But even with the Fed remaining accommodative, rising commodity prices could squeeze consumers’ wallets and companies’ profit margins, resulting in setbacks for the economy and the stock market alike. The experience of 2008 provides a script for such a scenario.
Tags: 2008 redux, central banks, commodities, consumer spending, economy, energy, gasoline, inflation, interest rates, oil, profit margins, Quant Easing, trends