Recession Watch: Oil, Inflation, the Fed

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A Rate Cut Not Expected This Cycle

From John Ryding, chief U.S. economist, Bear Stearns (BSC): The last Fed rate cut was a "close call" and the Fed appears to be increasingly concerned about the inflation outlook. Since the last meeting, core PPI and import price inflation rates have hit new highs, and the University of Michigan's five-year inflation expectations index has risen to a 12-year high of 3.3%. In addition, oil prices are over $132 per barrel ($20 per barrel higher than they were at the time of this FOMC meeting). It seems unlikely to us that the funds rate will be cut again in this rates cycle.

Oil Prices and Tax Rebates

From Tony Crescenzi, chief bond market strategist, Miller Tabak: At 11 a.m., Bloomberg posted a headline noting the price of a barrel of crude oil had leaped above $131 a barrel. Three minutes later there was another alert when oil crossed $132. The rapid increases are numbing, and they are eating increasingly into the $130 billion tax rebates being sent to consumers. An additional $30 billion or so of stimulus is expected to be reaped by businesses in the form of accelerated depreciation and bonuses for the purchase of new equipment.

Unfortunately, this sizable stimulus is in peril of being completely engulfed by the recent rise in energy costs. When the Stimulus Act was signed on Feb. 13, crude oil closed at $93.29 a barrel. It has since climbed by $40. Given that the U.S. consumes roughly 20.5 million barrels per day, this means that if recent price increases are sustained, the cost of energy to U.S. consumers will increase by about $300 billion over the next 12 months. The actual toll will be smaller than that, given that some of the extra oil expenditure will be recorded as revenue by U.S. entities and because shareholders in U.S. energy companies are reaping benefits, but the fact remains that the tax-rebate checks won't go as far as they would have.

Oil: Too Far Too Fast?

From Action Economics: A reasonable case can be made arguing that the market has become frothy and the doubling in prices in little over a year will inevitably erode demand. Also, the recent market frenzy, a good proportion of which has been driven by speculative accounts, seemingly belies supply developments: Saudi Arabia has been pumping an extra 300,000 barrels per day (bpd) since May 10 and is planning to maintain production levels through the next month; Iraqi oil production is set to rise by at least 125,000 bpd in June; the U.S. government last week approved legislation to stop refilling the U.S. emergency stockpile until crude prices fall below $75 a barrel, a measure that will add around 75,000 bpd (according to Reuters). Recent bullish forecasts may have stolen the limelight, but that would be typical in any market that has been experiencing a strong bull trend and, despite the secular growth in demand [from emerging economies], it doesn't seem too outlandish to suggest that the market may be getting ahead of itself.

Stagflation Has Become a Reality

From Joachim Fels, chief global fixed income economist, Morgan Stanley (MS): What was still a threat six months ago has become reality in the U.S. and is likely to arrive in Europe soon: stagflation, defined as a period of weak or no growth and unusually high inflation. The underlying reason for persistent inflation pressures is a very lax global monetary policy stance. Central banks around the world are fueling and accommodating the surge in food and energy prices. Spillover into other prices will follow. We find many important parallels between the stagflationary 1970s and today. History won't repeat itself, but it rhymes.