A growing case for tightening

The proponents of a Fed rate cut point at the ongoing housing debacle, rising interest rates and commodity prices which they are argue are threatening to stifle consumer and business spending. On the other hand buoyant corporate profits, rising energy and food prices and strong global growth threatens to spillover in the form of higher inflation, warranting an eventual tightening of rates. Until recently, the bears had the upper hand, forecasting a fed rate cut before the end of the year but things have changed recently with the concerted global central bank effort to hike rates, indicating growing fears on inflation. Energy prices have been on an uptrend, coming within close range of last year’s records as a result of a combination of ever so stronger demand and tighter supplies. A catastrophic hurricane season over the summer is all it may take to push prices above last years record. Food prices have also been on an uptrend mainly as a result of growing demand for bio fuels. With U.S. legislation moving towards tighter environmental standards as a result of a combination of greater awareness of the issues at stake and the upcoming presidential elections, the move to alternative sources of energy will only exacerbate the short term pressure on food prices. As the correlation between headline and core inflation measures are relatively high (roughly 0.75 going back to the early 90’s) and as there tends to be a 6 month lag on average between the two measures, it is only a question of time before the jump in food and energy prices impact the core figures. As a result of this, the market is predicting a possible tightening by the fed no later than the first quarter of 2008.