As noted in the Investor’s Soapbox submitted by Lehman Brothers yesterday [Barron’s Online], inflation fears may be overblown:
Even though oil prices are still very high, the mere fact that prices have become less volatile and, by extension, less surprising, is contributing to the recent simultaneous increase in oil and S&P 500 prices. There are three other contributing factors are also at work.
First, the current combination of oil prices, monetary policy, and fiscal policy is collectively not tight enough to cause a recession.
Second, in the face of rising energy costs, corporate profitability has been more resilient than initially expected.
Third, despite high energy prices and some pass-through, broad-based measures of core inflation are not apt to accelerate to dangerous levels.
Indeed, the leading indicators of inflation point to low but positive levels of core inflation in the months ahead, just as they did a couple of years ago when many investors were worried about deflation.
One of the pass-throughs besides oil prices include building materials. Builders may get squeezed because they expect to have a limited ability to pass through higher costs to the consumer who they feel are nearing peak levels of affordability [REJ].
Despite the recent actions by the Fed, the bond market rose yesterday [WSJ], concerned that we are headed for an economic slowdown, influenced by Katrina and further damage by Rita. Rising bond prices would hold down long-term (including mortgage) rates.
In other words, the weakened economy does not allow producers to pass through all their increased costs to the consumer. The bond market views the price volatility of fuel and building materials as a drag on the economy, which could dampen the inflation-risk. However, the Fed does not agree.