Inflation and Interest Rates at Forefront of this Weeks Economic Data

By: William_Patalon_III

You can bet there will be a lot of discussion about interest rates this week, thanks to the release of the producer price index (PPI) report tomorrow (Tuesday) and the U.S. Federal Reserve meeting minutes on Wednesday.

The PPI report will undoubtedly rekindle the inflation-versus-recession debate (with more than a few comments about stagflation thrown in for good measure).

While the wholesale inflation gauge (PPI) provides another look into how escalating food and energy prices are impacting the economy, the most recent moves in oil and gas may not be factored in for another month or two.

On an optimistic note, gasoline prices historically peak around Memorial Day and then fall throughout the remainder of the summer. As we've said here a number of times before, don't expect that pattern to repeat itself this year [Indeed, please click here to check out a related story in this issue of Money Morning that details our expectation that oil-and-gasoline prices are headed even higher].

In this column four weeks ago, we told you to ignore a U.S. Energy Department forecast that gasoline prices at the pump would reach $3.73 a gallon before falling. In fact, I said flat out that the Energy Department was wrong . And Money Morning Investment Director Keith Fitz-Gerald shortly thereafter reiterated that belief that the Energy Department's prediction was way off the beam . And how right we were - that price already has been surpassed and consumers in some parts of California and Hawaii are paying in excess of $4.00 a gallon.

Less than two weeks ago we actually boosted our target price for oil to $225 a barrel (remember that Keith Fitz-Gerald, now Money Morning 's investment director, was probably the first investment guru to predict triple-digit oil prices).

As noted, however, much of this won't be reflected for a couple of weeks.

Wednesday's release of the minutes from the last Fed meeting should provide investors with a bit more insight into the mindsets of central bank policymakers and just how likely they will be to stand pat on interest rates: In one of the most aggressive rate-cutting campaigns in the central bank's history, policymakers have pared the benchmark Federal Funds rate seven times since mid-September. Investors expect the Fed to sit tight (and hold off on further rate activity) at least through the summer months.

More retailers will report this week [ Target Corp. ( TGT ) , The Home Depot Inc. ( HD ) but few surprise are expected at this point in an earnings cycle that - except for the discounters - has been full of disappointing retail-sales reports .

The Money Morning Story SNAFU

When they received their daily e-letter last Monday, sharp-eyed Money Morning readers noticed something peculiar about this column.

It seemed familiar.

There's a very good reason they felt that way. They were right.

Due to a technical problem, and some human error, the column we'd put together for Monday's newsletter was inadvertently replaced by the afore-mentioned April 14 story in which we'd told you that the Energy Department's optimism about summer gasoline prices was wrong.

We replaced that story on the Web site with the correct piece - a warning about the week's upcoming retail-sales reports, but we heard about the mistake. As we deserved to.

As bad as we felt about the mistake, we still found several positives. First and foremost, we were reminded yet again that we have a loyal following that reads our work closely and carefully - and for the most part enjoys and benefits from what we do.

And if you all had to read one of our "old" stories a second time, I'm happy to say that it was a strongly worded prediction piece that proved us correct.

Market Matters

Over that past year-plus, the subprime debacle and related credit crisis have prompted discussions about "disaster," "devastation," "tragedy," and "catastrophe."  Homeowners were unable to afford their houses, institutions faced significant asset write-downs, hard-working folks lost jobs, and investors watched portfolio values decline.  While these financial consequences undoubtedly have been traumatic for many, the events of the past two weeks can serve to lend some perspective.  The death toll in Myanmar has reached about 80,000 with another 50,000 people still missing.  Likewise, in China, where the earthquake eventually may take over 50,000 lives as well.  Somehow, missing quarterly earnings by a few cents simply does not seem quite as significant. 

Speaking of…earnings season plugged along and the results to date have given some analysts (the slightest) reason for optimism.  As the week began, about 90% of Standard & Poor's 500 Index companies had reported and 62% actually beat expectations.  While average quarterly earnings have plummeted by over 17% on a consolidated basis, the results looked far stronger once the financial firms were removed from the equation.

Without that struggling sector, first-quarter profits actually increased by more than 7%.  Retailers took center stage this week as Wal-Mart Stores Inc. ( WMT ) proved again that discounters are benefiting from the current consumer nervousness.  However, while Macy's Inc. ( M ) and JC Penney Co. Inc. ( JCP ) suffered from weak sales, their results (and guidance) bested Street projections.  Sony Corp. (ADR: SNE ) rebounded as TVs and cameras moved back onto consumer shopping lists.  Bond insurers MBIA Inc. ( MBI ) and Freddie Mac ( FRE ) reported wider losses, while UK-based HBSC Holdings PLC (ADR: HBC ) realized higher profits.   

Board directors and corporate execs again played "Let's Make a Deal" as CBS Corp. ( CBS ) announced its intent to buy CNET Networks Inc. ( CNET ) ; Hewlett-Packard Co. ( HPQ ) made overtures toward Electronic Data Systems Corp. ( EDS ) ; General Electric Co. ( GE ) is reportedly putting its long-time appliance biz up for auction ; and billionaire stakeholder Carl Icahn pushed for Yahoo! Inc. ( YHOO ) management to reopen talks with Microsoft Corp. ( MSFT ) .  Analysts often welcome merger news and consider it a positive sign of a rebounding business climate.  Research in Motion Ltd. ( RIMM ) shares soared this week on news that its newest Blackberry creation will soon hit the market; and Merck & Co. Inc. ( MRK ) received a major victory when a Texas appeals court overturned a Vioxx verdict that, initially, awarded $32 million in damages. 

Goldman Sachs Group Inc. ( GS ) apparently enjoyed the limelight (and the stir its analysts caused) two weeks ago. Last week, the investment bank was at it again, forecasting that crude prices will rise to $141 a barrel during the second half of 2008.  Oil surged to about $128 a barrel late last week as gasoline prices soared to over $3.75 a gallon - just a week before the widely-traveled Memorial Day weekend.

The S&P 500 Index and the Nasdaq Composite Index each hit five-month highs, although some profit-taking set in as the week came to a close.  Hopefully, the weekend will bring some positive developments in Myanmar and China (or, at least, a beginning to the end of the devastation).           

Economically Speaking

As regular Money Morning readers know all too well, we are big believers that Wall Street analysts are a fickle bunch.  Just a few weeks ago, virtually everyone and their mothers believed that a recession was fait accompli (my mother was a holdout).  In a recent Merrill Lynch & Co. Inc. ( MER ) survey, only 29% of global fund managers expect the whispered-about "R" word to become a reality and many now feel that inflation is a greater domestic concern.  Some economists are crediting the work of the Fed for improving the credit markets, though Federal Reserve Chairman Ben S. Bernanke himself claimed that the situation remained "far from normal."  Bernanke, however, did praise financial institutions by noting that he is "encouraged by the recent ability of banks to raise capital from diverse sources."  Meanwhile, the bankers themselves continued to offer less-than-favorable assessments.

JPMorgan Chase & Co. ( JPM ) Chief Executive Officer James "Jamie" Dimon believes that the credit crisis is nearing an end, but " the recession is just beginning ."  Likewise, Bank of America Corp. 's ( BAC ) Global Consumer Banking president, Liam E. McGee , finds that consumers still feel " significant economic pressure ." 

Turning to the numbers, retail sales dropped by 0.2% in April, as auto sales suffered its worst showing in 10 months.  Once autos were factored out of the data (some economists always look for that silver lining), retail sales actually surged by 0.5%, a much better result than many analysts had expected.

Likewise, the news from the inflation front was not half-bad either.  The consumer price index (CPI) climbed by only 0.2%, despite the significant rise in food costs.  Still, many economists point out that oil and gas prices are setting new records daily (thanks Goldman), and the overall inflation picture may get worse before it gets better.  Though housing starts skyrocketed in April - recording their largest gain in over two years - the naysayers remain pessimistic on the sector, contending that the increase was the result of apartment construction and noting that single-family home starts continue to struggle.  Despite some positive economic readings, a consumer confidence poll revealed that recent sentiment fell to its lowest level in 28 years. 

Weekly Economic Calendar

News and Related Story Links:

• Money Morning Economic Analysis: Better Than Expected Economic Reports Signal the Economy Could Be Ready for a Fed on Pause .
• Money Morning Economic Analysis : With Seven Rate Cuts Since Fall, Could the Fed Be Exporting Stagflation to Europe?
• Money Morning Special Investment  Research Report : Money Morning Boosts Oil Target Price to $225 a Barrel, Thanks to Continued Scarcity, Burgeoning Demand in China
• Money Morning Weekly Forecast Column : With the Energy Department's Prediction for Gasoline Prices, the ‘Experts' Get it Wrong Yet Again .
• Money Morning Financial Commentary : One Sure-Fire Sign That Gas Prices are Heading Higher .
• Money Morning Weekly Forecast Column : Will This Week's Retail Reports Help Investors Decode the Mystery of the U.S. Economy?
• Money Morning News : With its Profits Lagging, GE May Have a Deal in the Oven, Analysts Say . 

By William Patalon III
Executive Editor

Money Morning/The Money Map Report

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