Double Squeeze: Between a Rock and a Hard Place

The Fed meets today to discuss their inflation expectations (see nearby chart), and the gradual end of their policy of accommodation. Since what they will do is essentially a fait accompli, we are left waiting to read the tea leaves of what they will say. It is likely that they will emphasize the gradual removal of their accommodative monetary stance, and that the recent “soft patch” is showing signs of abating.

That stuff is now boilerplate. Most concerning is what the Federal Reserve will say about growth and inflation. They are likely to assert inflation is benign, and for it stay that way, they will be moving towards a neutral policy.

We fear that in each of these instances, the Fed will get it wrong. Inflation is not at all benign. That point was made clear by household names in the consumer non-durable sector: Coca Cola, Colgate Palmolive, Unilever, each pre-announced disappointing earnings. The reason for their weakness were two-fold: 1st, the prices of their raw materials have risen significantly. Yet these firms find themselves unable to pass along these increases to their customers, hence, a margin squeeze. 2nd, their consumers are facing Oil in the mid-40s, hence, a sales reduction. It’s a commodity based “double-squeeze,” as costs go higher, while their client’s have less cash.

At the same time, we continue to see evidence that the U.S. soft patch is anything but. GDP is likely to muddle along at the ~3% level, until hiring and corporate CapEx picks up. Unless and until that happens, growth is going to be anemic. To paraphrase one of our favorite commentators, “for the first time in 3 years, there are no government tax cuts, no rebate checks, no other one-off items to spur the economy forward. The refinance afterburner has flamed out, and the Fed is raising rates.” The pig is through the python.

That is the quandary the Fed finds itself in: They find themselves trapped between inflationary pressures, and feeble growth – a rock and a hard place – with most of 2003’s stimulus far behind us.

We mentioned last week the sledding would be getting more difficult from this point forward. The SPX and Dow are still working off their overbought conditions, retreating in the face of overhead resistance, while looking for the next positive catalyst. The Nasdaq, while not yet at major resistance, is groping for both direction and leadership. We are not quite yet at a point of denouement. Thus, we continue to advise caution here, waiting for better entry points – long or short.

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