The Unraveling
Surveying the headlines this morning, the thought crosses my mind: All the paper clips and rubber bands that the Fed and Treasury have used to keep the U.S. economy together are starting to give way. This could be the start of The Unraveling.
Two key things strike me:
1. The world has examined Hank Paulson's plan to keep Fannie and Freddie afloat, and found it wanting. Leave aside the sliding stock indexes. The sliding dollar is the real tell here. If the plan were to work as intended, a short-term dollar bounce should have been one of the results. "Confidence" would be "restored," however fleetingly. But it's not happening. Traders know Paulson is saving Fannie and Freddie by assuring the creation of more money and credit, which won't be enough, and so it will require the creation of further money and credit, and so on, and so on…
2. Wholesale inflation has reached a level unseen since the early days of the Reagan administration — 9.2% over the last year. And while I don't know whether PPI has been subjected to the same degree of statistical sleight-of-hand as CPI, it's a safe bet the real number is higher. Of course, pollyannas will point out core PPI last month was just 0.2%, and that was below analysts' forecasts. It's the core number the Fed likes to look at when it gauges "inflation expectations."
But we may be rapidly approaching a point where this fuzzy metric of sentiment is starting to come unglued from core inflation rates. For businesses and consumers alike, high energy prices are forcing too much rethinking of cash flow and monthly budgets for "inflation expectations" to stay low from here on.
Watch what Bernanke says about inflation expectations to Congress today. And Paulson's testimony should provide hints about the dollar, although that will require more reading between the lines. Can they keep the shell game going for a while longer? We shall see.
Update: Good lord. From the Wall Street Journal: "Mr. Bernanke also dwelled on an 'unusually uncertain' inflation outlook, and cautioned that the Fed is watching for any sign that higher energy and commodity prices are becoming embedded in wages and expectations."
If there's anything traders like even less than a Fed that makes a wrong call, it's a Fed that hesitates to make any call at all. As I write, the Dow is within about 150 points of 10,750 — a critical level many Dow Theorists are watching…
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