Iteresting article on inflation worries.
Friday May 14, 3:10 pm Eastern Time
It's always something: Now, interest-rate jitters
By Pierre Belec
NEW YORK (Reuters) - It's always something. First Wall Street worried about the global economy, then it was corporate earnings and high stock prices. Now, the nail-biting is over interest rates. The experts say: ''Don't worry.''
Stock investors played their latest hunch about the direction of interest rates this week and they concluded that inflation may force up the cost of borrowing for everything from houses to cars.
A rise in interest rates would not be a crowd pleaser.
Wall Street has learned that Great Bull Markets just don't fade way. They are slaughtered by rising interest rates, which can have a strangling effect on the economy's growth and on corporate profits.
Federal Reserve Alan Greenspan again had a hand in stoking the latest inflation fears.
The Fed chief, who has had problems explaining why the economy has grown strongly for nine years without a hint of inflation, warned recently that the low jobless rate would fuel inflationary pressures.
Many investors took this to mean that the next move in U.S. interest rates would be up. For that reason, all eyes will be on next Tuesday's meeting of the central bank's policy-setting Federal Open Market Committee, which will look at the interest-rate story.
Greenspan's warning had its usual impact on the inflation-sensitive bond market with the yield surging to the highest level in more than a year. The key 30-year Treasury bond's yield climbed to 5.90 percent, flirting with the dangerously high 6.00 percent level. Less than two weeks ago, it was only 5.66 percent.
But the experts are scratching their heads, wondering where is the inflation?
''Fed chief Alan Greenspan repeated his favorite warning about 'tight labor' markets causing inflation,'' said Richard Salsman, senior economist for the Boston-based consulting firm H.C. Wainwright & Co. ''That tale, devoid of the expected ending, has been told for many years now, but it's a tall tale, at odds with facts.''
Inflation typically creeps into the economy when too much money chases too few goods. But the economy is still growing and there is still plenty of capacity to avoid shortages of goods that chase up prices.
Salsman said Wall Street has the wrong perception that fundamentals are changing.
''What we are seeing is the end of the deflation period and this does not signal the return of inflation,'' he said. ''Commodity prices have just simply stopped falling.''
The slide in commodity prices is leveling off because of a rebound in recession-hit economies of Asia and Latin America.
Meanwhile, the evidence mounts that inflation is not making a major comeback.
The experts said there may be increases in inflation in the coming months as the leap in crude oil prices, or special cases, filter through the economy.
But the increases will be just blips. Overall, there will be no scary deterioration in the big picture, they said.
The U.S. economy created more jobs and workers' wages increased at the slowest pace on record in the first three months of this year.
The Producer Price Index for April was flat, while the Consumer Price Index posted a rise of 0.7 percent last month after a 0.2 percent gain in March, with oil prices contributing to the jump.
Salsman noted that gold -- the best inflation indicator -- is not flashing any warnings.
''The highest correlation of inflation has shown up in gold, with a lead time of nine to 12 months,'' he said. ''With gold selling at a 20-year low of less than $280 an ounce, it shows there's no inflation threat.''
Historically, investors have bought gold as an inflation hedge. For the last couple of years, however, the metal has been in the dog house because inflation has been non-threatening and interest rates have fallen.
The last time bond interest rates soared was in 1994, when the yield on the 30-year Treasury jumped from 5 to almost 8 percent and the Fed unexpectedly boosted interest rates for the first time in five years, preempting a build-up of inflation as the economy grew.
''The leadup to the rise in interest rates was gold, which started moving from $320 in the spring of '94 to $420 in the summer,'' Salsman said.
Gold was also a precursor of falling interest rates when it plummeted 30 percent between 1997 and 1998 to today's depressed level as the rate of price increases was the slowest in decades.
Salsman said the problem is that the Federal Reserve has been handcuffed to the old mindset -- which no longer applies in this modern economy -- that inflation is caused by constant growth and a low unemployment rate.
Greenspan has rattled Wall Street over several years with warnings that trouble may be bubbling in the economy and financial markets.
The most famous was in December 1996, when he triggered a global market sell-off after saying that stocks were being driven higher by ''irrational exuberance,'' and the United States risked a Japanese-style crash.
The Fed chief made the comment when the Dow Jones industrial average was at 6,400 points. The world's most closely-watched stock index has since zoomed to 11,000.
But Greenspan has succeeded in scaring the Nervous Nellies because Wall Street believes that if Greenspan spends 5 minutes talking about inflation, then it must be on his mind.
The experts said Greenspan is just trying to open investors' eyes to the downside risk of the super-charged economy and stock market.
The Fed fears that a market collapse would stun the economy and shake consumer confidence, which has been a key driver of the past nine years of growth.
Greg Smith, chief investment strategist for Prudential Securities, said the continued small increases in U.S. wages confirm that global competition is still at work, and it's keeping companies on their competitive toes.
''The 1990s taught us a lesson about cost pressure, whether it results from tight labor markets or tight supplies of almost anything,'' he said.
''It's virtually impossible in the global economy of the 1990s to pass on cost increases through to the end consumer, unless costs increase for the entire world business community,'' Smith said.
The companies would have to bite the bullet, which would slam their earnings, but the impact will not be on inflation.
The bottom line is that the no-pricing-power scenario means no inflation.
''Very few companies have any pricing power,'' he said. ''Probably no industries can raise prices, and in many cases the business environment requires some drop in prices.''
The non-pricing story could continue for years in this New World economy.
''As the world economy starts to show some signs of life, gradually and grudgingly through 1999 and with more clarity and strength in 2000, it seems to me that the same pricing restraints will be in place,'' Smith aid.
''There will still be virtually nonexistent pricing power and only the most efficient and most capable companies on a worldwide basis will be able to compete successfully,'' the Prudential strategist said.
(Questions or comments can be addressed to Pierre.Belec(at)Reuters.Com)
--------------------------------------------------------------------------------
Related News Categories: banking, US Market News
--------------------------------------------------------------------------------
Help
--------------------------------------------------------------------------------
Copyright © 1999 Reuters Limited. All rights reserved. Republication or redistribution of Reuters content is expressly prohibited without the prior written consent of Reuters. Reuters shall not be liable for any errors or delays in the content, or for any actions taken in reliance thereon.
See our Important Disclaimers and Legal Information.
Questions or Comments? |
