The Fed is already intimating to traders, investors, and bankers to get ready for interest rate hikes in 2009 if slowing economic growth doesn't stem inflation.
And rightfully so. Inflation at the consumer level has increased at the fastest pace in 17 years. Even inflation at the producer level was double economists' expectations, rising nearly 10 percent from a year ago. That's the biggest increase since 1981.
So inflation is very much alive and well, and it's not stopping just because we've had a near term pull back in oil. Oil is not the only inflationary component out there, although it is one of those with the greatest impact.
Don't think we get off the hook because oil pulls back from $145 to $120 or $110 a barrel. So what! Overall inflation will still be high if it drops below $80 a barrel.
So while it will be nice if oil drops, it won't solve the whole inflation dilemma. Many Fed officials are finally starting to realize it.
Formerly, it was only Dallas Federal Reserve Bank President Richard Fisher who was singing the rate-hike tune when others were hollering for rates to be held steady. No one seemed to pay attention to Fisher's comments because he has been the lone dissenter at the last five Fed meetings.
Well, now Fisher has more Fed officials starting to join his band.
Just this past week Richmond Federal Reserve Bank President Jeffrey Lacker stated that "higher interest rates may be needed to bring down inflation even before growth and financial markets return to normal."
Lacker went on to say, "It is important to withdraw this monetary policy stimulus in a timely way."
Even Federal Reserve Bank of Atlanta President Dennis Lockhart is starting to open up to the possibility that rates will have to be hiked, and stated that, "the reasonable policy debate will be around holding versus raising rates"
Charles Plosser, president, Federal Reserve Bank of Philadelphia also said that, "Policy makers should act before inflation expectations become unhinged."
Then we come to Federal Reserve Chairman Ben Bernanke himself, who stated in a recent speech that "policy makers will act if price increases don't slow over the medium term."
In my opinion, this means if inflation doesn't start diving by the time of the November election, then you could see rate hikes possibly at the December Fed meeting. More than likely you'll see rate hikes in the first quarter of 2009.
Even Bernanke admitted that "the benchmark interest rate is relatively low given an increase in price pressures." Translation: For those of you who were holding out for more rate cuts, that just crushed those thoughts.
I'm a fan of former Fed chairman Paul Volcker, who did the unpopular thing of taking the bull by the horns and crushed inflation in the near-term, for the longer term good of the economy.
These days we don't seem to run monetary policy quite the same way.
It seems the focus these days is always on the near-term benefit and on bowing down to Wall Street to keep them all happy and never let any one of them fail.
The Fed can't be the savior to everyone. They have to allow businesses to fail, even if they are Wall Street businesses. They can't come in all the time and save everyone. It will only encourage too much risk-taking and more bubbles in the future.
Let me ask you something. If your dad came in and bailed you out every time you overspent, would it encourage you to shape up? Of course not.
Well, the Fed is acting like the U.S. economy's dad, and bails out any Wall Streeter, it seems these days.
I'm not saying they shouldn't offer any assistance under any circumstance. But my gosh, pretty soon the Fed will carry your home and car loans at their "window" if this doesn't stop.
I must say that I tend to agree with Lacker (who will be a voting Federal Open Market Committee member in 2009) that even if energy prices moderate, there's still an overall pattern of rising prices that needs to be dealt with.
How do you deal with that? Raise interest rates and crush it, even if it doesn't feel good in the near term.
Right now, it's about time to do some much needed surgery on the U.S. economy by cutting the cancer of inflation out of the U.S. economy by using the surgical tool of interest rate increases.
So now that more members of the Fed are staring to talk rate hikes, the "big money" currency traders are starting to reposition themselves.
Many who were formerly of the opinion of a cut or a hold and traded in that direction, which was to short dollars, are now repositioning themselves for rate hikes at some point ahead, which is to buy dollars in anticipation of rate hikes to come.
As you've seen this massive changing in the smart money, you've seen the dollar turn around and get a much needed bump up over the past week or two as investors have started to prepare for what lies ahead.
The average Joe in the currency markets doesn't pay nearly enough attention to these Fed officials and what they say in their speeches. But if you listen closely, and the smart money does, then you will see what they are planning well ahead of time.
This doesn't mean the dollar won't have some corrections here and there. Just on the EUR/USD pair alone, the buck took the euro behind the wood shed this past week or two.
So do expect dollar pullbacks here and there along the way. But also expect the dollar to be much more resilient than its been in several years.
And, as the euro zone and U.K. economies continue to crumble, money will run to the buck. As gold and oil pull back, money will run to the greenback as well.
Remember that the U.S. economy doesn't have to be fully recovered or even out of tough times before the dollar can do up. No, currency investors start investing in it ahead of time while it's still beaten down and there's a lot of value to be had.
If they just started investing when it became obvious that we were out of the woods, then a lot of the value would already be realized. And that's not what they get paid for. They get paid to notice and prepare for changes long before the average Joe sees them. That's what makes them worth their salt and worth that insane pay they get.
So be open to change. Because it's coming, and sooner than many will realize.
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