Tags: Inflationary | Expectations | Rise

Inflationary Expectations Rise

Friday, 16 September 2005 12:00 AM

Dear MoneyNews Reader,

A busy week for the markets was punctuated by a reversal in President Bush's take on who was responsible for the slow and chaotic response to Hurricane Katrina. That resulted in the resignation of FEMA Director Michael Brown. Markets also digested some key information on inflation and retail spending for August - prior to the hurricane.

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Still, I'm not putting the blinders on here.

A separate survey from Merrill Lynch did stir up the view that the hurricane and high oil prices were set to weigh on stocks in the months ahead.

Investors also expect annual corporate earnings per share to grow at the lowest level in four years.

While investors also expect the Fed to keep raising rates to at least 4% -- which they see as a "neutral" level - marginally fewer respondents see rates being higher than they will be in a year's time.

So where's the money flow?

The Merrill Lynch survey, admittedly taken ahead of last week's Japanese election, indicated that fund managers were most bullish on Tokyo stocks and the yen, as well as German stocks.

Well, we have had a good bull run on equities of late and so a mid-week decline was probably to be expected.

What's weighing in the background at the moment is the price of oil and fears over whether sticker shock at the pump will be enough to create a consumer decline.

The retail sales data that emerged on Wednesday did show a sharp decline - but only because of a pullback in spending on autos. Otherwise the report was pretty healthy. The August report - again showing the state of consumption ahead of the hurricane - illustrated that sales were strong "virtually across the board," according to Barclays Capital in New York.

Deutsche Bank Securities in New York says "this tells us that job and income prospects are better than what is commonly understood."

While things were probably better than first anticipated, we are now facing a prolonged plateau in oil prices. What the consumer used to have at their discretion is now possibly going toward increased energy consumption costs.

In addition, Bond yields stayed in a tight range during the week, with the yield on the ten-year treasury note at 4.13%. Eurodollar futures expiring in December indicate that the Fed will have moved to at least 4% by year's end.

Stocks had a mixed week. Technology outperformed as the broad market felt the strain. But let's not confuse things by crafting a scary story to fit the picture.

As I noted above, equities have had a good, strong run. So as we approach important highs, it's only likely that prices will pull away as active profit-taking gets in the way.

Take a look at the chart.

Hurricane Katrina quickly inspired drivers in surrounding states to fill the tank, sending gas prices to record levels above $3 per gallon.

But the ramifications are being felt not just locally or nationally - but internationally as well.

In parts of Britain, protesters called for a midweek day of disruption to blockade refineries. They are irate at the failure of the British government to soften the rising price of gasoline by cutting fuel tax.

But protesters only shot themselves in the foot by causing a nationwide run on the pumps amid rumors that stations were running dry. Once underway, at many stations lines of up to one hour developed in what has been described as panic buying.

In one case a computer failure caused the temporary closure of a station, leading to a run on other local stations, where consumers began to get irate with workers.

In France, 18-wheeler trucks, with their long history of successfully bringing major arteries to a standstill, lifted their blockades of wholesale gas depots only after the French prime minister agreed to announce measures likely to help French commuters deal with high fuel prices.

But is the problem as bad as it seems?

Clearly, the problems above were man-made. But what about the trends in output? Do they support the tight supply story?

According to the Financial Times, the world's biggest oil producers are already investing more in finding oil today than they have been in the last two decades.

Add to that the fact that OPEC, which controls 75% of the global pool of oil, has drilled 7.5% more than it did in 2003 and you'll see a trend of increasing supply, at least on the surface.

According to Baker Hughes, a company that has monitored the operations of global oil rigs for decades, OPEC's 11 members have 18.8% more rigs in operation in the Middle East than in 2003. The 248 active rigs in August compares to 100 rigs in operation on average throughout the 1990s.

The big issue seems to be a refinery crisis.

These plants can take several years to build and have proven to be a scarce investment step - at least here in the United States in the last 30 years, where the last was completed in 1976.

As Europe's finance ministers meet in Manchester, England, to call upon OPEC to boost output, cartel members simply shrug and retort that there is plenty of oil to go around; the problem lies with refinery capacity.

We are watching commodity prices drop, with some blame falling on the fundamental situation and some being laid at the door of a rising dollar. However, take a look at this week's final chart, which shows the raging price of gold this week to the highest since December, when the dollar was on its knees. Perhaps we will see wheat roar ahead in coming months.


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Dear MoneyNews Reader, A busy week for the markets was punctuated by a reversal in President Bush's take on who was responsible for the slow and chaotic response to Hurricane Katrina. That resulted in the resignation of FEMA Director Michael Brown. Markets also digested...
Friday, 16 September 2005 12:00 AM
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