Thursday, October 25, 2007

OPEC to Fed: “Go Ahead, Make My Day”



The Fed should cut rates half a point next week.

At least, that’s what some big money manager is saying, according to my Bloomberg:

In order to reduce uncertainty, the Fed has to get ahead of market expectations and should cut by 50 basis points. Failure to do so will damage market sentiment and force even deeper cuts in December.

Now, I just so happened to be reading those words while listening to the Rohm & Hass earnings call.

Rohm & Haas, in case you never heard of it, is as plain-vanilla a company as they come. By “plain vanilla,” I don’t mean “low-tech” or “mediocre.” It’s just a low-profile specialty chemicals company that makes stuff you use every day—the computer you’re using to read this, for example, is using semiconductors packaged in Rohm & Haas materials—yet never think about.

Furthermore, the company's chemicals are at the heart of not only the U.S. manufacturing economy, but the world's economy as well, with half its business coming from overseas.

And what Rohm & Haas was saying while the aforesaid Bloomberg article scrolled across my machine, was this:

Now, as we speak, we are seeing dramatic increases with no seasonal easing in key raw materials… We now expect to see an increase in the total raw material cost for Q4 on the order of $50 million…. This is a development of the last two or three weeks.

In other words, since the surprise Fed rate cut in late September, prices of the company's key raw material have spiked.

How is Rohm & Haas planning to deal with this?

Well, don't tell the Fed, but Rohm & Haas is already raising prices. That's right:

As you know, we announced yesterday our intention to increase pricing in the 5% to 15% range effective November 1 of this year.

Now, the spike in raw materials prices at Rohm & Haas wasn't a big surprise to listeners on the Whirlpool earnings call earlier in the morning.

After all, Whirlpool’s management complained not only about the downside of having Sears as a large customer, but also the upside to their cost structure from the half-billion dollars of extra raw materials prices the appliance maker has had to absorb this year:

This is the first year ever where we have seen a significant decline in demand in the U.S. and significant raw material inflation. In essence, we have had both a demand decline and a cost spike at the same time.

Nor were the Rohm & Haas comments a surprise to listeners of the Schlumberger earnings call the day before, when the subject of tight labor markets and rising costs was most emphatically on the minds of one of the world's all-time great straight-shooting management teams, as was another, equally troubling issue that makes me think the folks at OPEC would love nothing more than another larger-than-expected Fed rate cut next week.

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Here's what Schlumberger said:

Global demand for oil remains strong, while non-OPEC production continues to disappoint. Production decline rates in mature area and continuing project delays will inhibit non-OPEC supply increases, while personnel and equipment shortages will restrict the industry's ability to respond.

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There you have it: on top of “cost spikes,” “personnel and equipment shortages” and “dramatic” raw material cost increases, add the declining non-OPEC oil supply to the list of problems next week's Fed rate will exacerbate, as Bernanke continues his apparently ceaseless efforts to rescue Wall Street's banking goliaths from their self-created CDO tar pits.


"Go ahead Ben," the folks in Riyadh, who've been watching the Saudi Light crude chart spike to new highs, must be saying to themselves, “make my day.”



Jeff Matthews
I Am Not Making This Up


© 2007 NotMakingThisUp, LLC

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.

7 comments:

mfsveteran said...

oil at $90 for too long = a recession in 2008. Why are stocks holding in?

Gordon said...

A long post detailing a lot of inflationary pressures, and you think the Fed's going to CUT rates by a half point? No way.

Look at what happened after the last rate cut--the dollar declined pretty sharply. If the Fed cut rates a half point from here, they'd be risking a lot harsher reaction from the currency markets this time around. There are too many inflationary pressures around to risk a half point rate cut. That would make things worse, not better.

dblwyo said...

Thanks - appreciate the conference call recaps and the reporting/de-coding and analysis thereof. Very revealing.
While inflation is rearing it's ugly head it's also benign at the CPI level. What's more worrisome is that the old "transitory and noisy" argument for CPI ex-food & energy appears to be break down due to the structural changes in the energy markets.
That's not the real problem though - if you look at cumulative changes CPI has risen significantly above CPIx but PPI is far above both. In other words suppliers and manufacturers are experiencing growing inflationary pressures, which is part of your point. But they haven't been passing them on so far, which you also point to.
But if they do then...whoops; in the meantime pressure on profits has got to be growing as well.

Just-in-case and FWIW the charts are posted here rather than take my word for it. Or you can replicate the work via the STL Fed data tables.
Inflation analysis: http://tinyurl.com/327bdt
Inflation Re-visited: http://tinyurl.com/2anlj6

whydibuy said...

.....and long treasuries continue to soar with yields plummeting down towards a flat 4%. They've been flying since the 3 day bear market right after the first rate cut. So why not cut again. The feds have the green light from the capital markets. 4% treasuries and 14% inflation. Yeah, that makes sense. I'm sure all those books on finance Buffett advocates reading will confirm this economic relationship.

Alexander said...

I would agree with Gordon
See what most of you are missing is that the price of Oil, golc, copper and so on isnt really going up, or at least not that fast. if you do't believe look at a chart of oil expressed in EUR, Loonies, AUD etc. US$ is going down, not less nothing more than that. At current pace, America's period in history when it was saved by the fact that everything is priced in USD is over.

What is surprising is how many of you still think a fed interest cut will solve anything. all it will do is to escalate te fal of the dollar and imported inflation.

Aaron said...

Jeff: Only one thought comes to mind after reading your post: Where's Paul Volcker when you need him? Hello, stagflation, goodbye corporate profits (and I could be wrong....)

Briangobosox said...

Alexander,

What your post really point out is that in a "real sense" Oil, gold, copper at al are not rising that much. What is really happening is not so much that commodities are rising in value from the chimerical "Chinese demand," but that the Dollar is simply declining in value, ie being debased. That is the definition of inflation.

As is always the case, those commodities traded in real-time, liquid markets reflect the decline in the value of the unit of account most quickly. The inflation only show up in the CPI statistics with a long and variable lag, as contracts (for employment, purchasing, leases etc) are unwound and rewritten to reflect the new, higher price levels being reflected in commodities and other inputs.

Yet because the long and variable lag seems a bit longer and more variable this cycle, the cognoscenti has determined that "the decline in the Dollar doesn't matter." This is a classic inflationary error, and will end in the same way that every significant currency debasement therought economic history has ultiamtely ended - with higher prices.