Monday, November 20, 2006

Goldilocks Napping

Core inflation is spreading slower than we expected (core CPI up 0.1% in October), while the correction in housing and autos came more abruptly (Q3 GDP increased 1.6%). The result may be a smoother path for the overall economy. Growth in the second half of 2006 may be 2.3% or less, leaving room for a reacceleration in 2007. the [sic] risk of the Fed having to overshoot to regain confidence has declined markedly.

So reads the summary of one Wall Street economist’s early morning comments today, summarizing the “Goldilocks” economic scenario prevailing on Wall Street these days—at least, if stock and bond prices are any indication.

This is all quite a turnaround from just three months ago, when markets were depressed by fears the Fed had tarried too long in switching from deflation-fighting mode to inflation-fighting mode. Back then, both stocks and bonds feared the resurgent “core” CPI would not be tamed until several more Fed rate hikes had done their worst on the U.S. Housing Bubble, not to mention the U.S. Consumer.

But gasoline prices began dropping a week or two before Labor Day, and two things happened in response: the U.S. Consumer began to spend like drunken sailors, boosting third quarter earnings reports and helping the stock market recover; while whatever inflation measure economists chose to follow began decelerating, lifting bonds.

Lost in the current Goldilocks euphoria—as strong today as was the bearish gloom of late summer—is what companies are seeing coming down the pike in the way of costs.

And what they are seeing is, generally speaking, cost increases. Significant ones.

From a big ore mining supplier expecting steel price increases for next year no matter what the current spot price says, to a well-known branded apparel makers whose Asian suppliers have jacked up the landed cost of next fall’s product line by 5%—the first general all-purpose increase this company has seen out of its formerly deflation-inducing Asian supply base, ever—I am hearing a consistent message: the cost of doing business around the world has stopped going down.

It is, rather, going higher, not matter how many houses remain unsold in Stuart, Florida or Sacramento, California or Reno, Nevada.

Now, along these lines, it is no new news to anybody that UPS last week announced a 4.9% rate hike for its all-important services in 2007.

But what the bond market may not have noticed—so eager is it to see Goldilocks out frolicking in the woods as opposed to something that might interrupt the current picnic—was that 4.9% represents the net rate increase, after a 2% decline in the fuel surcharge to match the recent drop in oil prices.

Which means that the UPS “core” rate increase (have we not been trained by the Fed to look at the “core” rate?) is actually 6.9%.

So not only is the cost of stuff coming out of Asia going to rise in 2007, but the cost of getting it from the docks in Long Beach and Charleston to your house in Menlo Park or Newton Massachusetts will rise as well.

The bond market, as I understand it, suspects that we are on the verge of a significant cooling down of inflationary pressures.

But unless China and the rest of the world is about to hit the wall like a Sacramento tract house, I don't see that what the Fed does or does not do next month or next year will be relevant.

It's not "the economy, stupid." It's the "world-wide economy, stupid."

And that ain't slowing down.

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.


MyDailySlice said...

Whaddaya know, foreign countries like the Western-way! Maybe the powers-that-be need to change the term "inflation core rate" to "quality-of-life core rate".

SiamTwin said...

that's "Newton" MA, not "Newtown", though it was probably that originally. sorry to be a pedant.

Lee_D said...

I really don't have anything monumental to contribute here, but a dear friend and former colleague left a comment on my blog post covering Mr Matthews post that was quite droll.

the good reverend has obviously had too much coffee this morning, but it made me grin.

Laurent GUERBY said...

If you're interested, a small story about inflation measurement.

Sam E. Antar said...


The issue here like the Goldilocks scenario you have described in your commentary is the spin people use to describe facts and events.

I finally learned many years ago during my Crazy Eddie days from investor “road shows” that accounting (financial information) is more art than science (no, I did not learn that in college).

There is a saying we all heard before “accentuate the positive” since most of the consumers of information look at it with “rose colored glasses" anyway, so why not help them along.

To be an effective “spinner” you first make your time limited. Then you give only the positive spin (accentuate the positive) in your talking points during the limited access you provide the public.

Maybe later, the few (far too few) "smart guys" will sort out the facts and raise questions. The “smart guys” who try to sort out the real facts are then labeled as having an “agenda."

The "spinners" and the “rose colored glasses” glass crowd will not attack the substance of “smart guys” analysis but instead resort to attacking their so called “conspiratorial intentions” or "agenda.”

Jeff, keep asking the good questions.

However, in the end as I learned after a Barron’s article forewarned investors about our spin previous to going public (the rest is now history), most people will see information through their the prism of their own expectations.

My cousin Eddie once told me that “people live on hope” therefore their hope must be fed through our spin and lies. I guess after almost twenty years of leaving behind a criminal life and watching events from the side lines I can see that nothing has changed. Most people never learn.


Sam E. Antar (former Crazy Eddie CFO & ex-felon)

PS: Like you I am not making this up but I used to be part of the crowd that wrote fairy tales.

Fiske.Silk said...


It seems to me that what you have described really is the Goldilocks scenario. The admittedly debatable rationale for having a core and overall inflation rate is to separate the internal vs external causes of inflation. The internal causes are the ones the Fed ostensibly needs to fight. The external causes are actually a drag on the economy, functioning very much like a tax -- oil and all the money that we send to OPEC being the prime example. To the extent that global prices are rising because China is growing I feel the Fed is right to take no action.

That's not to say I'm not worried. I think if the American consumer's spending dries up, we'll be looking at trouble. I'm having a hard time sorting out just how much of U.S. spending is driven by home-dreived credit fueled spending -- but my sense is a lot (not to mention the huge part of the economy that was formerly building houses, but will soon be looking for work). Raising rates, then, in the face of falling home prices and external price pressures, only seems to worsen the fall, not soften the landing. We're too late for that now... we can make it worse by raising rates, but cannot make it better.