MolloMarketReport

Inflation in the Economy, Deflation for Oil

            The inflation chickens are coming home to roost.  Although it seems that the big story of the day as far as the media was concerned was the sudden drop in the price of oil, what I think is most important to highlight today is the rise in inflation.  The Labor Department’s wholesale inflation report told us that over the last year inflation has risen 9.2% and 1.8% over the last month.  If that monthly figure was annualized we are looking at a figure of 21.6%!  Month over month figures can bounce around quite a bit so don’t take that last number too seriously, but do keep in mind that this is the fast rate inflation has grown in over 27 years, and it looks as though double digit inflation may become a reality for the near future.  Even the fools who focus on the core rate can’t be very happy as that was showing an increase of 3.1% year over year.  This high rate of inflation is a direct result of the Fed’s loose monetary policy of lowering rates and furiously lending money to every in need financial institution in the country (OK, not everyone – Just ask Indymac).  The Fed’s supposition is that the slowing economy will eventually lower inflation as there is less demand for goods.  So far we are not seeing it.  It has also been my supposition that the lowering of rates is actually harming the financial system more than it is healing it.  First of all consumers who have to make the choice between a rising mortgage cost and rising food and gas costs are going to be less likely to pay that mortgage.  Furthermore, even if all the payments were being made on time that mortgage would be worth less (or is it worthless?).  Buyers of fixed income securities (such as mortgage bonds) are less interested in a 6.5% yield when inflation is 9% than when it is 3% as that yield under the inflation scenario is actually negative.  Furthermore those mortgage bonds are dollar denominated with a falling dollar in part caused by . . . loose Fed policy.  I’ll say it once and I’ll say it again; things will not improve until the Fed begins to raise interest rates.  Either that or the US government makes massive spending cuts which is unlikely to happen until we have a new president and even then the chances are slim.

Now then, let’s discuss oil.  A lot of ink was spilt on the fact that oil made its largest one day drop since the Gulf War and was down over $10 at one point.  This is good news, but not as great as you would believe.  As I pointed out last week oil will need to close below $130 a barrel before it breaks the uptrend it has been in since February.  And even that would still be contained within the broader uptrend that has been ongoing in the last few years.  And most important, oil is up 30%+ in the last year.  Today’s drop of $6.44 is fairly small in the grand scheme of things.  It’s been up a lot lately, so the pull backs will also seem more dramatic.  Headlines have also said that there was no specific reason for the drop. The dollar made a new low against the euro, and there is an oil worker strike in Brazil, so oil should be up based on that news, and it was for the first part of the day.  I’m guessing the fall came because it has been awhile since anyone said anything scary in the Middle East.  If the rhetoric heats up, we will probably see some more rises.

The SEC has bowed to the pressure of populism by creating an emergency rule that disallows “naked” short selling of any big financial names such as Fannie, Freddie, and Lehman Brothers.  Although it is still available, this means that short selling is now more difficult.  Most likely this will remove short selling from the repertoire of the amateur day trader, but still leave it in the hands of the more sophisticated professional hedge fund type trader.  I’m not sure how that is supposed to help things, but short selling has become a “villainous” activity of late that is blamed for falling stock prices.  My recommendation to the SEC is that if they need someone to blame for the falling stock prices of financial firms, they should look at the financial firms and the executives that run them.  The fact that the SEC is trotting out the evil short seller idea makes me think there might be a lot more desperation in the Treasury Department then they are admitting to in public, because they are willing to try any hare-brained scheme.  It kinda makes me want to short some financial firms.

Speaking of financial firms Merrill Lynch said today that it believes the US could face a financial crisis due to the Freddie and Fannie debacle.  I would tend to agree, especially as our response has been driving up inflation and driving down the dollar.

And lastly here is an interesting tidbit I found today on the web.  Although it often stated that Fannie and Freddie own or guarantee about half of the mortgages in the United States ($5.3T out of $12T), they are currently originating 80% of the new mortgages today.  Essentially they are holding up the mortgage market with a few hangers on picking up some odds and ends.  If these giants fall, expect there to be almost no mortgage loans outside of private lenders for a few months if not longer.

Today the indices had a bumpy ride.  The market made a 2% drop, before rallying to a .5% gain and then falling again to a drop of over 1%.  The Dow Jones Industrial Average also lost the fight for 11,000 and closed below that benchmark for the first time since the summer of 2006. For the day the Standard and Poor’s was down 13.39 or 1.09% to 1,214.91, the Dow dropped 92.65 or .84% to close at 10,962.54.  However, the Nasdaq managed a gain of 2.84 or .13% to 2,215.71.  Intel announced better than expected earnings after the close and it was up over 1% in after hours trading.

David Mollo

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