Goldilocks Napping

Core inflation is spreading slower than we expected (core CPI up 0.1% in October), while the correction in housing and autos came more abruptly (Q3 GDP increased 1.6%). The result may be a smoother path for the overall economy. Growth in the second half of 2006 may be 2.3% or less, leaving room for a reacceleration in 2007. the [sic] risk of the Fed having to overshoot to regain confidence has declined markedly. So reads the summary of one Wall Street economist’s early morning comments today, summarizing the “Goldilocks” economic scenario prevailing on Wall Street these days—at least, if stock and bond prices are any indication.

This is all quite a turnaround from just three months ago, when markets were depressed by fears the Fed had tarried too long in switching from deflation-fighting mode to inflation-fighting mode. Back then, both stocks and bonds feared the resurgent “core” CPI would not be tamed until several more Fed rate hikes had done their worst on the U.S. Housing Bubble, not to mention the U.S. Consumer.

But gasoline prices began dropping a week or two before Labor Day, and two things happened in response: the U.S. Consumer began to spend like drunken sailors, boosting third quarter earnings reports and helping the stock market recover; while whatever inflation measure economists chose to follow began decelerating, lifting bonds.

Lost in the current Goldilocks euphoria—as strong today as was the bearish gloom of late summer—is what companies are seeing coming down the pike in the way of costs.

And what they are seeing is, generally speaking, cost increases. Significant ones.

From a big ore mining supplier expecting steel price increases for next year no matter what the current spot price says, to a well-known branded apparel makers whose Asian suppliers have jacked up the landed cost of next fall’s product line by 5%—the first general all-purpose increase this company has seen out of its formerly deflation-inducing Asian supply base, ever—I am hearing a consistent message: the cost of doing business around the world has stopped going down.

It is, rather, going higher, not matter how many houses remain unsold in Stuart, Florida or Sacramento, California or Reno, Nevada.

Now, along these lines, it is no new news to anybody that UPS last week announced a 4.9% rate hike for its all-important services in 2007.

But what the bond market may not have noticed—so eager is it to see Goldilocks out frolicking in the woods as opposed to something that might interrupt the current picnic—was that 4.9% represents the net rate increase, after a 2% decline in the fuel surcharge to match the recent drop in oil prices.

Which means that the UPS “core” rate increase (have we not been trained by the Fed to look at the “core” rate?) is actually 6.9%.

So not only is the cost of stuff coming out of Asia going to rise in 2007, but the cost of getting it from the docks in Long Beach and Charleston to your house in Menlo Park or Newton Massachusetts will rise as well.

The bond market, as I understand it, suspects that we are on the verge of a significant cooling down of inflationary pressures.

But unless China and the rest of the world is about to hit the wall like a Sacramento tract house, I don’t see that what the Fed does or does not do next month or next year will be relevant. It’s not “the economy, stupid.” It’s the “world-wide economy, stupid.” And that ain’t slowing down.

Jeff Matthews I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.