There was some heat being generated on Larry Kudlow's show last night as all of us, Kudlow, Farrell, Michael Pento, and Jack Gage of Forbes all read the markets horrendous action the same way. The downturn was a complete in your face repudiation of the Fed's decision to not raise rates. Gold soared, oil went up over $5 and the stock market plunged as a refusal to defend the dollar fueled fears that inflation will rise.
Inflation is the cruelest form of taxation. It eats away at buying power and once uncorked, it's very hard to contain. I know the concept of "core" inflation drives everyone crazy. A measure that excludes food and energy seems useless. But it is an important gauge to measure if the "headline" number is percolating down and becoming imbedded in the general price level. So far it has not. The core rates of inflation are moderate, but I fear they won't stay that way unless we raise rates, strengthen the dollar and bring the price of oil down.
One of the reasons the core rate of inflation has been well behaved is that wage rates and wage demands have been modest. But the WSJ reports the Conference Board's June survey of consumer sentiment showed Americans believe inflation over the next 12 months will be 7.7%. That's up from 6.8% in April, 5.4% in February, 5% last September, and the highest in 20 years. Those expectations are being fueled every time you pull into a gas station. They will soon enough begin to show up in wage demands and price increases throughout the economy.As these inflation expectations become more firmly rooted, the harder they will be to change.
The Fed, in its recent statement, implied that it believes the economy's weakness is temporary and they said "overall economic activity continues to expand." Recent reports bear that view out. Dennis Kneale, ever the clear voice, mentioned on the show that existing home sales rose 2% in May. I would guess that was due to prices getting low enough to attract buyers despite mortgage rates having moved up a bit. First quarter GDP was revised up a tad to 1%, and Q2 GDP looks like it's tracking toward the same number due in part to the tax rebates.
Unemployment claims, one of my most closely watched numbers, were 384,000 and the four week moving average was a moderate 378,250. Below 400,000 indicates the economy is still expanding. Incidentally, Morgan Stanley noted in a recent blurb the recessionary average for claims is 470,000.
As Dennis pointed out, not all the news is bad. Even a couple of the stocks that got pummeled yesterday, Research in Motion and Oracle, had very good reports, but when negative sentiment prevails, nothing is good enough.
The time for Fed action is now. As the election gets closer, the political weighs ever more heavily. There is good news but it will be overturned by an ever weakening dollar and an escalating oil price. Ben, take note of what the market is saying and raise rates.