Inflation Scare - Overdone?

Sat. June 14, 2008; Posted: 08:07 AM

(RTTNews) - The markets were awash with speculation over the inflation ogre waking up from its slumber after remaining under wraps for a while. Fed speakers added fuel to the fire by reinforcing their tough stance in their crusade against inflation. An extended period of sub-trend growth that followed the onset of the subprime mortgage market and credit crises had transitorily wiped away fears over inflation, which has shown signs of a pick up of late. Lehman Brothers is of the view that import price inflation along with a rise in commodity prices is offsetting the disinflationary effects of sluggish growth, thereby keeping inflation uncomfortably high.

The Fed is not the only central bank that is burning midnight oil over the issue of inflation. Across the Atlantic, the European Central Bank President Jean Claude Trichet sent a strong message that the bank may be preparing to announce an interest rate hike as early as the next month.

In a two-day meeting of the Finance Ministers of the G-8 countries that concluded on Saturday in Osaka, Japan, there were calls for increasing oil production so that crude prices, presently hovering around over $130 a barrel, are stabilized, and that there would no inflationary pressures on world economy.

Are the fears unfounded? The consumer price inflation report for May released on Friday went on to emphasize views that the fears may be overdone. The headline consumer price index rose 0.6%, with the increase reflecting higher gasoline prices. Prices of most other commodities showed only modest increases. The core consumer price index was up merely 0.2% compared to the previous month, while it rose 2.3% from the year-ago period.

The other reports released during the week relayed mixed messages. Jobless claims rebounded sharply, portending more bleakness in the employment market. Meanwhile, the Labor Department's import and export prices report showed that import prices rose at a 2.3% monthly pace, suggesting the prevalence of import price inflation.

Retail sales were up 1% in May, reflecting the effect of the tax rebates. On a positive note, the previous two months' sales were revised higher. The core retail sales, excluding gasoline, building material and autos, increased a solid 0.8%, which signals strong growth in the second quarter. Economists expect the rebates to boost spending over the next few months. However, the effect is likely to be transitory and therefore has the potential to push the economy into an era of negative growth in the fourth quarter.

Going by the retail sales data, Wachovia Securities predicts that GDP will rise at an annual rate of 1% in the second quarter and a 1.9% annual rate in the third quarter. The firm expects a 0.4% decline in fourth quarter growth, with the decline blamed on a decline in consumer spending following summer's tax rebate fueled gains.

The National Association of Realtors' pending home sales report for April showed that the pending home sales index rose 6.3% to 88.2 compared to expectations for a 1% decline. The reading, though representing the highest level since October 2007, represents a 13.1% year-over-year decline. The pending home sales index rose in all the regions, with the exception of the Northeast, where it declined 1.9%.

As the economy grapples with a stagflation-like condition, market participants are likely to sift through each piece of economic evidence coming their way to gauge the economy's resilience. In the upcoming week, the market focus is likely to be on a few key reports like the Commerce Department's housing starts report, the results of the June manufacturing surveys of the New York Federal Reserve and the Philadelphia Federal Reserve and the Fed's industrial production report for May.

The produce price inflation report of the Labor Department, due to be released in the week, does not carry much significance, given the fact that it is released after the consumer price inflation report. Additionally, the markets may pay attention to the Conference Board's leading index for May, the National Association of Home Builders' housing market index for June and the regularly scheduled weekly jobless claims and crude oil inventory reports.

Housing starts, though not on the recovery path yet, is inching closer to a bottom. Wachovia predicts another 5%-10% decline from current levels before the housing market takes a turn for the better. Starts are likely to witness their thirteenth straight month of declines in May.

Meanwhile, industrial production may stay just flat due to the positive performance of utility output, which benefited from cooler-than-normal weather during the month. That said, weak auto production is likely to push manufacturing output lower.

The producer price inflation report for May is expected to show a sharp increase, given the solid growth in wholesale energy prices. Food prices are also expected to have increased in May, especially those of dairy and meat products. Higher inflation expectations are being translated into higher prices for businesses and consumers, thereby worsening the inflationary environment.

Monday

The results of the New York Federal Reserve's empire state manufacturing survey, which elicits response from 200 manufacturing executives in New York state, is slated to be released at 8:30 AM ET on Monday. The headline general business conditions index for June is expected to improve to -2.4.

The results of the May survey showed that the headline general business conditions index May dipped to -3.2 in May from 0.6 in the previous month. Economists expected the index to show a reading of 0 for the month.

The new orders index remained close to zero, while, the shipments index declined sharply, but held above 0. The employment indexes hovered near zero. On a more negative note, the future indexes were down from the month-ago levels.

The Treasury Department is due to release a report on the flows of financial instruments into and out of the U.S. for April at 9 AM ET on Monday.

The National Association of Homebuilders' is scheduled to release the results of their survey on homebuilders' confidence on Monday.

The housing market index for May fell 1 point to 19. The present sales index also fell 1 point to an all time low of 17, while the future sales index declined 3 points to 27. The index of buyer traffic also slipped, dropping 2 points to 17.

Federal Reserve Chairman Ben Bernanke is due to speak at a Senate Finance Committee Health Summit at 10 PM ET. On the same day, Richmond Federal Reserve President Jeffrey Lacker is slated to speak about the U.S. economic outlook at 1 PM ET.

Tuesday

The Commerce Department is scheduled to release its report on current account balance, which measures the nation's international trade balance in goods, services and unilateral transfers on a quarterly basis at 8:30 AM ET on Tuesday.

A report on housing starts, which refer to the number of privately-owned new homes on which construction has been started over some period, and building permits, which is the number of permits issued for new housing units each month, is slated to be released at 8:30 AM ET on Tuesday. Economists estimate housing starts for April of 980,000 units and building permits of 950,000.

Housing starts rose 8.2% in April to a seasonally adjusted annual rate of 1.032 million units from a revised rate of 954,000. Economists had estimated housing starts to come in at an annual rate of 940,000 units.

On a year-over-year basis, housing starts declined 30.6%. Building permits, a leading indicator to housing starts, rose at a monthly rate of 4.9%, but they are down at a year-over-year rate of 34.3% to 978,000.

The U.S. Labor Department is scheduled to release a report on the producer price index for May at 8:30 AM ET on Tuesday. The index measures the average change over time in the prices received by domestic producers of goods and services. Economists expect the headline index for May show 1% growth and the core reading to show 0.2% growth. Producer prices for April showed a 0.2% increase, while the core producer price index increased 0.4%. Economists had expected the headline index to show 0.4% growth and the core reading to show 02% growth.

Food prices ended unchanged, while energy prices eased 0.2%. On a year-over-year basis, the producer price index rose an unadjusted 6.5%.

The industrial production report of the Federal Reserve is due out at 9:15 AM ET on the same day. Economists estimate the industrial production for May to show 0.1% growth, while capacity utilization is expected to come in at 79.7%.

In April, industrial production showed a sharper-than-expected 0.7% drop, with auto production serving as a drag on the headline index. Capacity utilization dropped below 80 to 79.7, marking its lowest level since September 2005. The decline in capacity utilization reflects the availability of a significant amount of slack in the economy.

Wednesday

The Energy Information Administration is scheduled to release its weekly petroleum inventory report at 10:30 AM ET on Wednesday.

The inventory report for the week ended June 6th showed that crude oil stockpiles declined for the fourth straight week, dropping by 4.6 million barrels in the recent week to 302.2 million barrels. However, gasoline and distillate inventories increased by 1 million barrels and 2.3 million barrels, respectively. Refinery capacity utilization averaged 88.5% over the four weeks ended June 6th compared to 88% in the previous week.

Thursday

The Labor Department is due to release its customary weekly jobless claims report for the week ended June 14th at 8:30 AM ET on Thursday.

The number of individuals claiming for unemployment benefits rose 25,000 in the week ended June 7th to 384,000 from the previous week's revised figure of 359,000. Economists had expected jobless claims to rise to 370,000 from the 357,000 originally reported for the previous week.

Meanwhile, the less volatile four-week moving average increased 2,500 to 371,500 from the previous week's revised average of 369,00. Continuing claims in the week ended May 31st came in at 3.139 million from the preceding week's revised level of 3.081 million.

The Conference Board is scheduled to release a report on the U.S. leading index for May at 10 AM ET on Monday. The consensus estimate calls for a flat reading for the month.

The leading indicators index for April showed a 0.1% increase, marking its second consecutive month of growth. The coincident index remained flat, while the lagging index rose 0.1% in the month. Stock prices, interest rate spread, building permits, inverted weekly initial claims for unemployment insurance, the index of supplier deliveries and manufacturer's new orders for consumer goods and materials were positive contributors to the leading index.

The results of the Philadelphia Federal Reserve's manufacturing survey are due out at 10 AM ET on Thursday. Economists expect the diffusion index of current activity to show a reading of -12 for June, an improvement over the previous month's -15.6.

The Philadelphia Fed's May survey showed an improvement to -15.6 in May compared to -24.9 in April. While it still represented a contraction in the manufacturing sector, it was not as bad as the reading of -20 expected by economists.

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