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Please Wake Up and Smell the Roses - Inflation, Interest Rates, and Deficits
Pepper Pike, OH
Saturday, October 15, 2005
Volume III – Number 2 October, 2005
PLEASE WAKE UP AND SMELL THE ROSES-
INFLATION, INTEREST RATES AND DEFICITS
To me, there was no surprise when the September U.S. consumer price figures were released which showed an increase of 1.2%. This was the largest in 25 years. There was no surprise when September energy prices increased 12%. And still there was no surprise when the September core inflation grew only 0.1%. Quoting from the Wall Street Journal Online – "CPI is Great…if Oil Doesn't count –U.S, consumer prices rose at the fast pace in 25 years, and that is somehow a positive for the economy and the markets? Puhleeze" Mr. Labor Department, please wake up and smell the roses. My August newsletter was headlined – "Is Core Inflation Tainted?". I asked - "Why exclude these dramatic increases in energy, if consumers are forced to reduce their spending…?". Why is this being observed now when this was so evident several months ago? Granted, core inflation (excluding food and energy) will eventually increase, caused by the effects of the increases in energy, as these costs filter down to the multitude of products using petroleum derivatives. Why not face the facts now? Consumer inflation has now gone up 4.7% in the past 12 months. This is the highest since 1991. However, core inflation has only increased 2% for the same period. On the positive side, there will be some relief from the recent extremely high gas prices. The Fed will address these facts at their next meetings in November and December. Mark Zendi, chief economist with Economy.com, says that while core rate of inflation remains reasonably tame, the Fed "has to be forward looking. More companies will try to pass their energy and material costs along" Due to the massive surge in energy prices, I expect that the inflation rate for 2005 will now be at about 4%. In 2006, we should expect to see only moderate growth in energy prices and a general slow-down in the economy. This should result in an inflation figure of about 3%, an increase from earlier predictions.
There had been much speculation that the Fed would increase the Federal Fund Rate (The rate that banks use to lend to each other) at its November meeting but skip any potential December rate hike. They would want to see the affects on the economy of Hurricane Katrina. However, as I expected, the Fed will increase rates ¼% in both November and December. The Federal Funds rate will be 4 ¼% at year-end 2005. The Fed will continue this rate hike into January, 2006 where another ¼% increase would be likely. I expect that the Fed Fund rate should be at/or slightly below 5% at year-end 2006. Ironically, the economic growth, although still rising, albeit slowly, might not warrant further interest rate increases, which could eventually cause an economic turn-down in 2006. At this point, however, I believe the Fed will choose to err on the side of continued moderate economic growth with continued rate increases. It is also interesting to point out that the present Federal Funds rate is about 1.5% on an inflation-adjusted basis or real rate. From comments by Fed officials that real rate should be 1% higher to be in a so called neutral level for the economy. (1.5% + approximately 2% current = 3.5%) (1.5% + 3.5% expected = 5% year-end 2006).
The growth of the national economy (Gross Domestic Product or GDP), as I had indicated, will continue to be moderate showing 3 3/8% to 3.5% for 2005. It is expected that the effect of Hurricane Katrina on the national economy will be less than anticipated. There will be much counter balancing or off-setting effects from this tragedy. There have been, and will continue to be, supply disorganization, combined with the high energy costs that will cause large economic problems. However, offsetting this will be the many billions of dollars spent reconstructing the destroyed areas. The actual federal costs of reconstruction, which President Bush had mentioned to be $200 billion, are expected to be well under that figure.
With consumers showing a lack of confidence (Consumer Confidence statistics) in the economy and their personal spending, plus a great concern about the high cost of gasoline, the outlook for the upcoming holiday retail sales is not very promising. If lucky, many retailers might see increases of 2% to 3% from 2004. Many retailers may see actual declines, year over year, for the first time in 20 years. Quoting Leon Nicholas, (KiplingerForecasts.com), "a consumer markets analyst with Global Insight, a business consulting firm, warns that most consumers will be hit with a double whammy at the height of the holiday spending. Not only will there be high gasoline prices, but the first big heating bills of the cold weather season will come in November….even larger ones in December" So let the sales begin. Expect to see extremely deep discounts on merchandise shortly after Halloween. As a result, the expected 5% increase in 2005, might be in the 3% to 4% area, a major disappointment. 2006 shouldn't fair much better with retail sales increases in the area of 4%. High end goods should continue to sell well, but not like previous years.
As expected the housing markets have begun to cool down. It is now a buyers market as inventories of unsold existing homes is now at a high level. It has not become a problem yet, but if the economy should slow you will begin to see a glut on the market. It appears that the higher priced homes, presently, are the most difficult to move. Mortgage rates continue to rise to 6 month highs. The 30year fixed mortgage is now just shy of 6%. With rates expected to further rise, expect increases in sales and prices to slow. Most of the home slow-down is in the areas where there was rapid price appreciation, as much as 25% during the past year. These areas would include Southern Florida, Southern California, Las Vegas and parts of New York City, Boston, Chicago and some area around Washington, D.C. In those areas prices should stabilize but not decline.
Other areas of the economy, such as the job market, continue to be fairly firm with unemployment still low. The drop of 35,000 jobs in September due to hurricane Katrina had little effect on the job market. Employment growth for the year continues to be expected at a large 2.1 million jobs in 2005.
The stock markets continue to trade in a narrow range. These markets should, by all rights, be good due to current and expected company profits. However, the stock markets continue to be effected by hurricanes and other outside influences which we have no control over. It is still possible to have a strong stock market rally during the last few months of the year, if we have no further disturbances.
I sound like a broken record, but the fixed-income markets will continue to be effected by future increases in interest rates. Wise investors should continue to ladder their portfolios in the 1 to 7 years maturities to protect themselves against these increases.
PLEASE WAKE UP AND SMELL THE ROSES-
INFLATION, INTEREST RATES AND DEFICITS
To me, there was no surprise when the September U.S. consumer price figures were released which showed an increase of 1.2%. This was the largest in 25 years. There was no surprise when September energy prices increased 12%. And still there was no surprise when the September core inflation grew only 0.1%. Quoting from the Wall Street Journal Online – "CPI is Great…if Oil Doesn't count –U.S, consumer prices rose at the fast pace in 25 years, and that is somehow a positive for the economy and the markets? Puhleeze" Mr. Labor Department, please wake up and smell the roses. My August newsletter was headlined – "Is Core Inflation Tainted?". I asked - "Why exclude these dramatic increases in energy, if consumers are forced to reduce their spending…?". Why is this being observed now when this was so evident several months ago? Granted, core inflation (excluding food and energy) will eventually increase, caused by the effects of the increases in energy, as these costs filter down to the multitude of products using petroleum derivatives. Why not face the facts now? Consumer inflation has now gone up 4.7% in the past 12 months. This is the highest since 1991. However, core inflation has only increased 2% for the same period. On the positive side, there will be some relief from the recent extremely high gas prices. The Fed will address these facts at their next meetings in November and December. Mark Zendi, chief economist with Economy.com, says that while core rate of inflation remains reasonably tame, the Fed "has to be forward looking. More companies will try to pass their energy and material costs along" Due to the massive surge in energy prices, I expect that the inflation rate for 2005 will now be at about 4%. In 2006, we should expect to see only moderate growth in energy prices and a general slow-down in the economy. This should result in an inflation figure of about 3%, an increase from earlier predictions.
There had been much speculation that the Fed would increase the Federal Fund Rate (The rate that banks use to lend to each other) at its November meeting but skip any potential December rate hike. They would want to see the affects on the economy of Hurricane Katrina. However, as I expected, the Fed will increase rates ¼% in both November and December. The Federal Funds rate will be 4 ¼% at year-end 2005. The Fed will continue this rate hike into January, 2006 where another ¼% increase would be likely. I expect that the Fed Fund rate should be at/or slightly below 5% at year-end 2006. Ironically, the economic growth, although still rising, albeit slowly, might not warrant further interest rate increases, which could eventually cause an economic turn-down in 2006. At this point, however, I believe the Fed will choose to err on the side of continued moderate economic growth with continued rate increases. It is also interesting to point out that the present Federal Funds rate is about 1.5% on an inflation-adjusted basis or real rate. From comments by Fed officials that real rate should be 1% higher to be in a so called neutral level for the economy. (1.5% + approximately 2% current = 3.5%) (1.5% + 3.5% expected = 5% year-end 2006).
The growth of the national economy (Gross Domestic Product or GDP), as I had indicated, will continue to be moderate showing 3 3/8% to 3.5% for 2005. It is expected that the effect of Hurricane Katrina on the national economy will be less than anticipated. There will be much counter balancing or off-setting effects from this tragedy. There have been, and will continue to be, supply disorganization, combined with the high energy costs that will cause large economic problems. However, offsetting this will be the many billions of dollars spent reconstructing the destroyed areas. The actual federal costs of reconstruction, which President Bush had mentioned to be $200 billion, are expected to be well under that figure.
With consumers showing a lack of confidence (Consumer Confidence statistics) in the economy and their personal spending, plus a great concern about the high cost of gasoline, the outlook for the upcoming holiday retail sales is not very promising. If lucky, many retailers might see increases of 2% to 3% from 2004. Many retailers may see actual declines, year over year, for the first time in 20 years. Quoting Leon Nicholas, (KiplingerForecasts.com), "a consumer markets analyst with Global Insight, a business consulting firm, warns that most consumers will be hit with a double whammy at the height of the holiday spending. Not only will there be high gasoline prices, but the first big heating bills of the cold weather season will come in November….even larger ones in December" So let the sales begin. Expect to see extremely deep discounts on merchandise shortly after Halloween. As a result, the expected 5% increase in 2005, might be in the 3% to 4% area, a major disappointment. 2006 shouldn't fair much better with retail sales increases in the area of 4%. High end goods should continue to sell well, but not like previous years.
As expected the housing markets have begun to cool down. It is now a buyers market as inventories of unsold existing homes is now at a high level. It has not become a problem yet, but if the economy should slow you will begin to see a glut on the market. It appears that the higher priced homes, presently, are the most difficult to move. Mortgage rates continue to rise to 6 month highs. The 30year fixed mortgage is now just shy of 6%. With rates expected to further rise, expect increases in sales and prices to slow. Most of the home slow-down is in the areas where there was rapid price appreciation, as much as 25% during the past year. These areas would include Southern Florida, Southern California, Las Vegas and parts of New York City, Boston, Chicago and some area around Washington, D.C. In those areas prices should stabilize but not decline.
Other areas of the economy, such as the job market, continue to be fairly firm with unemployment still low. The drop of 35,000 jobs in September due to hurricane Katrina had little effect on the job market. Employment growth for the year continues to be expected at a large 2.1 million jobs in 2005.
The stock markets continue to trade in a narrow range. These markets should, by all rights, be good due to current and expected company profits. However, the stock markets continue to be effected by hurricanes and other outside influences which we have no control over. It is still possible to have a strong stock market rally during the last few months of the year, if we have no further disturbances.
I sound like a broken record, but the fixed-income markets will continue to be effected by future increases in interest rates. Wise investors should continue to ladder their portfolios in the 1 to 7 years maturities to protect themselves against these increases.
Ivan Gelfand
America's Money Man
Ivan Gelfand
Pepper Pike, OH
888-886-1960
216-831-8375
First Url: Ivan Gelfand, Inc.
