The Ultimate Price of Inflation

Rob Parenteau, editor of The Richebächer Letter, sees inflation rearing its head in 2010. Yes, Rob still sees a host of numbers that indicate weak economic growth. Nevertheless, he observes that “nonfood materials prices, excluding energy, are up over 20% from a year ago.”

In theory, producers should have to eat rising wholesale prices when the economy is sluggish. In theory, producers can’t pass on those rising prices to consumers who are still losing jobs and servicing high debts. “But that is not what we are observing at the moment,” says Rob. “Pass-through of those price increases to wholesale finished goods prices is no less than it was just two years ago when the unemployment rate was half of the current rate and capacity utilization was closer to 80%… Inflation took only a brief vacation.

Inflationary Rebound

“The Fed can pretend that inflation poses no problem whatsoever. But if GDP in the fourth quarter of 2009 comes in around 4% or higher, as now appears highly likely, interest rates could start climbing rapidly. My concern is that Q1 2010 could see a backup in Treasury bond yields, with the 10-year breaching 4%… If the new housing market is barely stable now, imagine what higher mortgage rates might add to the picture.”

Higher mortgage rates sure won’t do much for the high end of the residential real estate market. Homeowners with mortgages of $1 million or more are now defaulting at nearly double the national average.

90 Day Mortgag Delinquencies

That 12% figure compares with less than 5% a year ago. Ouch.

In large part, that’s a function of the fact that Fannie Mae and Freddie Mac can’t buy “jumbo” loans of more than $729,750. In other words, once you reach the high six figures, you don’t have Fannie and Freddie propping up the market with artificially low interest rates. So prices can fall more quickly to a more natural level…and high-end homeowners can find themselves way underwater.