Economist Diane Swonk sees continued inability to pass along price increases to consumers

CNBC’s Lori Ann LaRocco interviewed Diane Swonk, Chief Economist at Mesirow Financial, about the status of the economy.

Swonk noted that most of her clients are worried about inflation. However, she sees inflation as a two-sided coin. On one side, inflation is squeezing producers, but companies that deal with consumers cannot pass on price increases:

“I remind [my clients] of how little pass through inflation that we have experienced in the last decade.

When I ask them how much they have passed along to consumers and you see a fairly substantial break. There are those who can pass along some of the increase in costs if their clients are other businesses. Those who deal with consumers can’t pass along the increases as easily or are paying the price in volume if they do.”

Swonk also notes that rising oil prices will be destructive for all economies. In particular, higher oil prices will further increase food prices and magnify the suffering of poorer nations, leading to yet more social unrest.

7.5B pounds of investment targeting UK residential development

The Financial Times is reporting that investment interest is pouring into residential real estate in the United Kingdom and putting upward pressure on prices. The push is particularly strong in London which is attracting 71% of the 7.5B pounds targeting residential real estate. This adds up to pre-recession levels of investment activity in the London market. For more, see “Interest soaring in London land.”

Fidelity notes stocks are benefiting from an inflationary boom

Great piece from Fidelity considering the implications of the inflationary boom that seems to be driving stocks skyward (“Is this bull unstoppable? The key is how—and when—the Fed exits its historic stimulus program.”)

I highly recommend reading the article as it contains excellent charts showing the relationships amongst monetary policy, earnings, stock prices, and commodity prices.

Here are some key quotes:

“I believe it is becoming increasingly clear that stocks are following the playbook of an inflationary boom. The Institute for Supply Management’s (ISM) January 2011 manufacturing survey is the highest in years, earnings are strong, and now money supply growth is picking up steam. Ultimately, I fear this inflationary boom scenario may be followed by an inflationary bust (or stagflation), but perhaps that day is farther away than I have been anticipating.”

“Food and energy prices have moved sharply higher in recent months and appear to be trending higher rather than mean-reverting. If this remains the case, I believe the Fed could misstep by focusing on core inflation rather than the perhaps more relevant headline inflation. After all, for most of the world, food and energy inflation are critical matters.”

“How long can this go on before the “rubber band snaps,” either by commodities plunging in a deflationary crash (like in 2008) or the Fed being forced (by the bond market) to tighten and thereby undermine the recovery? Or what if the Fed does nothing and the dollar falls further and sends inflationary expectations skyward?”

High cotton prices drive up linen and towel costs

In “As Cotton Prices Rise, So May the Cost of Hotel Rooms“, CNBC cites the soaring costs of linens and towels as a potential contributor to higher hotel prices. I was most fascinated with the incredible price hikes since last summer.

Prices are from 2010 to 2011 as paid by hotels.

  • Queen-sized sheets: $72/dozen to $116/dozen (+61%)
  • Pillows: $8.80 to $9.56 (+9%)
  • Bath towels: $41/dozen to $64/dozen (+56%)

Cotton prices have been the main driver for skyrocketing costs.

Using BAL as an example, cotton has risen at least 162% since the end of 2010.

Using BAL as an example, cotton has risen at least 162% since the end of 2010.

Inflationary concerns rising amongst ECB members

In “Mersch Says ECB May Warn of Upside Inflation Risks Next Week”, Bloomberg reports that European Central Bank (ECB) council member Yves Mersch has added his concerns over inflation to a growing list of worried voices:

“Mersch is the fourth policy maker this week to signal increased unease about inflation. Executive Board member Juergen Stark said last night that the ECB is “prepared to act decisively and immediately if needed” to maintain price stability. Fellow board member Lorenzo Bini Smaghi said the bank may need to reassess its policy stance.”

Most importantly, Mersch indicated:

“I would not be surprised at most colleagues concluding that we have upside risks to price stability”

The biggest concern seems to be that increased food and energy prices will motivate labor unions to press for wage increases, thus stoking general inflationary pressures. Strong economic growth in Germany is also increasing the need for higher rates but lingering issues with sovereign debt in the periphery countries may yet prevent rate hikes.

Will corporate margins be the next victims of inflationary pressures?

Corporate profit margins have hit record levels, but it seems inflationary pressures are waiting in the wings to send those margins back toward the mean. Zero Hedge summarizes the latest Philly Fed report, pointing out that prices paid less prices received has not been higher since 1979.

Doug Kass presents two possible outcomes from these pressures:

  1. businesses try to increase prices, can’t, and see their margins cut;
  2. or

  3. businesses do raise prices, people buy less, and revenue gets hit.

The stubbornly high unemployment rate has convinced many that resistance to price increases is a foregone conclusion. However, I would like to layer on a more nuanced scenario here. Given that increasing employment is the Federal Reserve’s stated goal of its latest quantitative easing program, we should assume that the Fed’s response to either of the above scenarios will be more quantitative easing. If profits or revenues fall, companies will not hire more workers in response. If anything, companies will fire more workers. In other words, even with inflationary pressures building in the economy, especially in scenario #2, the Federal Reserve could actually find more reason to continue adding to those pressures. We may not get a self-reinforcing negative feedback loop, but it will feel close!

The Bank of England already faces this conundrum of accomodative monetary policies even in the face of stubbornly high inflation – but governor Mervyn King has found a lot of comfort in the United Kingdom’s current output gap and a conveniently tame outlook for inflation.

So, what if quantitative easing actually works and increases employment? Well, there should be a lot of increased prices waiting to eat into those newly minted paychecks.

It seems everywhere we look, inflationary pressures are inescapable. Corporate margins may be the last canary in the coal mine…

AK Steel wastes no time increasing prices again

When AK Steel (AKS) reported earnings for the latest quarter, the company made it clear that it would drive for more pricing power with its customers. True to form, AKS has already announced three separate price hikes in the past in less than three weeks:

February 1
AK Steel Announces March 2011 Surcharges For Electrical And Stainless Steels
AKS announces “…a $430 per ton surcharge will be added to invoices for electrical steel products shipped in March 2011.”

February 10
AK Steel Announces Price Increase For Carbon Steel Products
AKS announces it “…will increase current spot market base prices for all carbon flat-rolled steel products, effective immediately with new orders. Base prices for carbon flat-rolled products will increase by $50 per ton.”

February 18
AK Steel Announces Stainless Steel Price Increase
AKS announces “…it will increase base prices for all 200, 300 and 400 series flat rolled stainless steel products, effective with shipments on February 27, 2011….Base prices of automotive exhaust grades will increase by $.04 per pound. In addition to the base price increases, AK Steel will increase the price for its bright anneal finish extra by $.05 per pound.”

Disclosure: author is long AKS stock

France joins a growing group of nations concerned about inflation

In “G-20 Stung by Faster Inflation as Imbalance Dispute Rages“, Bloomberg reports that French Finance Minister Christine Lagarde has added her voice to the growing group of nations concerned about inflation:

“We clearly need to keep inflation at bay…Too much inflation is not going to be conducive to growth.”

While these conclusions are obvious, the remarkable quality of these comments is that they come at a time when inflation remains a concern amongst developing and emerging economies and not the (relatively) stagnating ones of Europe and the United States.

Only time will tell whether comments like these will translate into any changes in monetary policy anytime soon. For example, Governor Mervyn King made it quite clear this week in his discussion of the Bank of England’s Inflation Report, that he has no intention of changing monetary policy anytime soon even with inflation continuing to print well above the Bank’s mandated target of 2%.

Inflation expectations increase in Singapore

Looks like Singapore is now feeling some inflation pressure. The small island nation raised its inflation forecast for 2011 and may be forced to raise interest rates.

Bloomberg reports in “Singapore Raises 2011 Inflation Forecast to 3%-4% After Record Expansion“:

“Consumer prices may climb as much as 4 percent this year while exports may rise 10 percent, the trade ministry said today. The economy expanded a revised 14.5 percent in 2010, with gross domestic product growing an annualized 3.9 percent in the three months to Dec. 31 from the previous quarter, it said.”

Bloomberg also quotes Ravi Menon, the permanent secretary at the trade ministry:

“The key macroeconomic challenge this year will not be growth but dealing with emerging cost pressures…At this juncture, we expect these pressures to be relatively contained although there may be some pockets of tightness that we should continue to be watchful for.”

Inflation scheduling an autumn arrival in the U.S.?

Inflation may be scheduling an autumn arrival in the U.S. The New York Times reports in “Companies Raise Prices as Commodity Costs Jump” that businesses across the economy are chomping at the bit to raise prices soon:

“A package of Oscar Mayer cold cuts. A pair of Nine West boots. A Whirlpool washing machine.

By the fall, people will most likely be paying more for each of them, as rising prices hit most consumer goods, say retailers, food companies and manufacturers of consumer products…

…Many big companies, including Kraft, Polo Ralph Lauren and Hanes, say they cannot hold off any longer and must raise prices to protect some profits.”

While such talk has come later in the economic cycle than we expected, its arrival should be taken seriously. The NYT article quotes analysts who take the other side of the story, for example claiming that consumers will not pay the higher prices. However, with corporate profits at historic levels despite extremely high unemployment, we should not underestimate the inflationary pressures that could stick once companies feel compelled to finally pass on their higher costs to consumers.

WSJ provides advice on getting ahead of inflation

In “How to Profit From Inflation: The Scourge of Rising Prices Hasn’t Hit Home Yet, but the Underlying Signs Point to Trouble Ahead. Here’s What You Should Do Now” the WSJ provides some advice on getting ahead of inflation. It makes a lot of sense to buy inflation protection when it is “cheap.” In other words, you should worry about inflation when no one else is worrying instead of when the protection is expensive and inflation is on everyone’s mind. We are currently at a kind of middle ground where inflationary pressures are rising almost everywhere EXCEPT the United States, but I believe the U.S. is just the last bastion of deflationary expectations…

Some key quotes from the article:

“…it is a much different situation overseas, particularly in the developing world. In South Korea, the CPI rose at a 4.1% clip in January from a year earlier, higher than the 3.8% estimate. In Brazil, analysts expect prices to rise 5.6% this year, exceeding the central-bank target of 4.5%. China, meanwhile, has been boosting interest rates and raising bank capital requirements to keep inflation, which rose to 4.6% in December, in check….

…Even some developed economies are seeing rising prices. Inflation in the U.K. surged to 3.7% in December, while the euro zone’s rate climbed to 2.4% in January, the fastest rise since 2008.”

“…Of course, the main inflation driver is usually wages—and that isn’t a factor in the U.S., where high unemployment has kept a lid on pay for three years.”

The WSJ advices selling bonds, especially long-dated Treasurys. Sell some TIPS, Treasury inflation-protected securities, because the trade is over-crowded. The WSJ is also lukewarm to negative on real estate, gold, and stocks. On the other hand, WSJ recommends buying money-market mutual funds that are only invested in short-term bonds, inflation-linked savings and bonds products, floating-rate funds, and some commodities through ETFs.

Clearly, since inflation is already raging globally in energy, materials, and agriculture, it is a little late to give more straightforward advice than the eclectic mix presented above. The best time to get ahead of inflation was when deflationary fears gripped the entire globe. Inflation Watch has attempted to be one of the few reminders that deflation will not be a permanent condition in the global, or even U.S., economy.

As always, the best strategy for you will depend upon your own risk tolerance and inflation expectations and your financial goals.

Disclosure: author is long GG and TIP.

China tightening cycle hits its third rate hike

China raised interest rates for the third time in four months as the scramble against inflation continues. For a good accounting of the move and its implications see “China raises rates to battle stubbornly high inflation.”

Steel prices pushing through the economy

Talk to any steel company, and you will quickly discover the impact of commodity inflation. Steel companies in general have struggled to keep up with the soaring prices of coking coal and iron ore. It seems it is only a matter of time before these price pressures begin to push their way into the rest of the economy.

For example, in its latest earnings report, AK Steel (AKS) announced its plans for achieving greater pricing power by passing on input prices more quickly to its customers. We have also chronicled many of AK Steel’s price increases over the past year.

In “Steel-Price Increases Creep Into Supply Chain“, The Wall Street Journal demonstrates how steel companies are responding to higher input costs by passing along these costs to their customers:

“Steelmakers have increased prices six times, for a total increase of 20% to 30%, since November on basic flat-rolled steel, used in everything from cars to toasters, to offset higher input costs of raw materials, such as iron ore and coal. Higher costs for steel, which are expected to continue well into this year, are hitting bottom lines of companies and prompting additional price increases.”

The general expectation seems to insist that these pricing pressures will not percolate into final end consumer prices. However, I believe this thinking is just the lingering aura of the deflationary mindset of the last recession, and it will fade as surely as commodity prices have soared.

Disclosure: Author owns shares in AK Steel

Whirlpool will respond to inflationary pressures with its own price increases

It is almost commonplace now for companies to address inflationary issues in their earnings reports. With its products made of steel, Whirlpool (WHR) is certainly no exception.

In its earnings report this morning, Whirlpool had the following to say about its outlook for inflation, and its impact on the company:

“In 2011, we expect to expand our operating margins despite significant global inflation and generate good levels of free cash flow and further strengthen our financial position…

…Raw material inflation is driving costs higher and we expect to mitigate these costs with improvements in cost productivity, innovation and recently announced price increases.”

Expect to pay more for that kitchen upgrade in the near future…

(Author owns WHR)