Money and Metals

This editorial suggests the Fed is in a trap. "The Fed has a major problem on its hands. In order to prevent soaring energy prices from creeping into the general economy it must continue to raise the fed funds rate until it hurts. A number of corporations have already begun tacking surcharges onto their prices in the hope that consumers will perceive them as temporary, while others are attempting to hike prices directly."

"In the meantime, Wall Street is assuming that core prices will remain under control and that the Fed is near the end of its tightening cycle, seemingly without realizing that these potential outcomes are contradictory."

"As long as the rate hikes have no effect and consumers continue spending, the Fed cannot stop tightening. They realize that if they stop tightening too soon, and inflation takes off, it will eventually be that much harder to bring it back down. The only way to stop higher prices from spreading to core prices is to keep raising the funds rate until consumer demand softens to the point where business finds that they can no longer pass along the increased cost of energy."

"The problem is that the Fed will only know that their policy has worked when it sees the actual signs of the slowdown, and by that time they will have instituted two or three more rate hikes than they needed. The result, as usual, is likely to be a recession."

"With household debt at record highs; consumer savings at record lows; housing prices at the top of a bubble; the trade imbalance at record levels; and the federal budget already in serious deficit, a recession could easily feed on itself and become a damaging deflationary downturn at a time when the market is highly overvalued."

"The Fed is therefore facing the difficult problem of both a near-term inflationary threat and an eventual undesirable deflationary outcome at the same time that it is undergoing a change in leadership. We believe the current complacency and downright optimism in the stock market will prove to be yet another example of the majority being wrong at the turning point."