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All those on Wall Street hoping for a US interest rate cut were dealt another blow yesterday, as Federal Reserve chairman Ben Bernanke pointed out that inflation remained ‘uncomfortably high’. He remains sure that the sub-prime troubles in the housing market will not spill over, and is unconvinced by his predecessor Alan Greenspan’s forecasts of recession.
The Dow Jones closed down nearly 100 points, at 12,300, as traders digested his remarks.
Meanwhile, as Bernanke was talking down concerns about the economy, durable goods orders rose a disappointing 2.5% in February – disappointing because excluding aircraft orders, they actually fell by 0.1%.
But even though we don’t buy the idea that the sub-prime debacle will be contained – falling house prices hurt everyone, not just those who are bad credit risks – we don’t think Bernanke will be able to cut rates either. Inflation will continue to be a problem – and here’s why…
The rising oil price was one of the major factors driving official inflation figures higher across the globe in the past few years. It’s also served as a convenient excuse for politicians to point to – ‘rising inflation isn’t our fault, we can’t do anything about the oil price’ – as Tony Blair effectively said last year.
However, while oil prices are still high, and have consistently trounced the inflation optimists who have been insisting that we’re only a few months away from $40 a barrel for a few years now, they are no longer the biggest threat.
One problem – which the Bank of England has already said it is worried about – is that companies seem more and more able and willing to push higher prices onto consumers. A recent CBI survey showed that manufacturers are more optimistic about hiking prices than at any time since 1995, while the British Retail Consortium’s price index has risen on an annual basis in each of the past eight months.
But the other problem comes from a set of raw materials even more vital than oil – foodstuffs.
We were reading an interesting report yesterday from Donald Coxe, of BMO Financial Group. While he is more sanguine than ourselves about the woes of the US housing market, he’s also not expecting the Fed to cut interest rates. And the reason is that the world is very short on food, at a time when demand has never been stronger.
This means that US consumers are about to find that their burgers, their buns, their daily pint of milk, and everything else they eat are going to tick up in price over the coming year. As Coxe says: ‘For most of the past quarter century, food prices have been benign. Most importantly, they have not contributed to inflationary pressures since oil took off from $21 a barrel. That has already begun to change.’
The latest US producer price index data from February showed that food prices rose 6,8% on the previous year. It’s little wonder – data from the US Department of Agriculture suggests that the amount of coarse grains left over this year to carry over to the next ‘could be the lowest – in relation to consumption – in decades.’ And this is at a time when there have been ’16 straight years of favourable growing conditions in the Midwest – the world’s leading producing region. This is an historic winning streak.’
So what’s happening? Well, for a start, as we’ve mentioned many times before in MoneyWeek, all those emerging middle-class Asians have emerging middle-class appetites too – they want to eat more meat. The most protein-efficient of these happens to be poultry – according to Coxe, ‘a bushel of corn produces 19.6 pounds of retail chicken, but just 13 pounds of pork, and a mere 5.6 pounds of beef.’
The trouble is, Asians have been put off chicken and the like by avian flu – understandably, as Asia’s where of the human casualties of the virus have appeared so far, ‘which has doubtless accelerated the move into the red meats.’
But that’s not all there is to it. There’s the demand for ethanol and biofuels, which are putting further pressure on corn and soya bean crops. Subscribers can read more about this in a recent cover story by MoneyWeek’s Jody Clarke: How to profit from America’s ethanol rush.
In short – food is getting more expensive – and consumers are likely to start realising that this year. As Coxe says – “if Smithfield…Wal-Mart and McDonald’s raise their meat prices month-after-month, and the big dairy operations [as well] … then consumers will be getting sticker shock weekly at the checkout counters. They will not be willing to accept Fed statements that inflation remains within acceptable ranges.”
And as we already know, when people start thinking inflation is rising, that’s when they look for pay rises, and that’s when the real danger begins. That’s not a situation the Fed wants to find itself in – which is why US interest rates are unlikely to fall any time soon.
As for what this means for investors – well, with rising demand, and vulnerable supply, it looks like the only way is up for soft commodities. You can get exposure to soft commodities directly (see Jody’s cover story for more details) or by buying into relevant stocks – Mark McLornan of Agro-Terra also told MoneyWeek about his top three stocks to play the soft commodities boom in a recent issue. Subscribers can read the piece here: Why the world needs grain.
And if you’re not already a subscriber, you can get access to all the content on the MoneyWeek website and sign up for a three-week free trial of the magazine, just by clicking here: Sign up for a three-week free trial of MoneyWeek.
Turning to the stock markets…
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London stocks ended yesterday in the red as triple digit losses on Wall Street weighed on investor sentiment. The blue-chip FTSE 100 closed 25 points lower, at 6,267, and the broader indices also lower. Asset manager Amvescap fell over 5% along with fellow financials including Legal & General and Old Mutual. For a full market report, see: London market close
Elsewhere in Europe, the Paris CAC-40 ended the day 34 points lower, at 5,552, and the Frankfurt DAX-30 was 41 points lower, at 6,816.
Across the Atlantic, the Dow Jones ended the day 96 points lower, at 12,300, having fallen 140 points earlier in the day, following Bernanke’s speech. The Nasdaq closed 20 points lower, at 2,417. And the S&P 500 dropped 11 points to end the day at 12,300.
After Wall Street weakness prompted a sell-off early in the session, the Nikkei recovered to end the session 9 points higher, at 17,263, today.
Crude oil was trading at $63.73 this morning, whilst Brent spot was at $65.35.
Spot gold was at $665.30 today, off yesterday’s high of $669.50. Silver, meanwhile, had fallen to $13.31.
And in London this morning, the Bank of England announced that approvals on loans for home purchases had not fallen in February as expected, suggesting that higher interest rates were failing to dampen the residential property market. Banks granted 119,000 home loans last month, the same as January.
And our two recommended articles for today…
Our top six forecasters’ investment predictions
– At the end of last year, six MoneyWeek experts gave their predictions for 2007, including the stocks and sectors set to perform best over the next 12 months. Their predictions are now also available to non-subscribers, so click here to see how well their recommendations are performing – and what’s still to come: Our top six forecasters’ investment predictions
More trouble looms for US real estate
– Having ploughed through the relevant data and charts, D.R. Barton has come to the conclusion that the US real estate market is a ‘house of cards’ set to get much worse before it gets much better. To find out how investors should deal with further weakness, read: More trouble looms for US real estate