Higher Rates?

Central bankers may have to swallow a cup full of bile.

At this point, salvation for the market bulls must take place in the form of a meltdown in commodity prices, particularly oil. Corporate earnings are getting slashed. Financials are in the piranha tank. Ben and crew cannot lower interest rates anymore and risk further erosion in the dollar and egregious commodity price advances. Period.

With commodity price inflation, interest rates need to go higher so people can buy $2 gas again for their SUVs.

People, look at what is going on in the emerging countries. They are experiencing massive inflation. China’s inflation rate stayed near a 12-year high of 8.7 percent in May; prices in Vietnam jumped 27 percent in June and Indian wholesale prices increased 11.6 percent last month, the fastest in 13 years. Inflation is higher than lending rates in China, Russia, India and at least a dozen other emerging countries.

Central Bankers are going to have to fight inflation by raising interest rates. Unfortunately, since these countries have pegged their currencies to the $USD, they have had to keep monetary policy somewhat linked to Fed policy. Fools. 

They might be faced with pulling a “Volker”, aggressively raising interest rates.  Pushing borrowing costs above the level of inflation will help to cool things down, but at a time when economic growth is already weak. Prediction: Pain.

However, what we saw in the early 1980’s, when Fed chair Paul Volker raised rates to 20%,  was oil prices drop in a big way. Perhaps the Fed overshot, but it also ushered in the longest bull market in history from 1982 – 2000.

Were all this to happen, we could see a spiral down in commodity prices, thus cutting the nuts off the bears. This would help the cause for Bernanke and Company, as well as the ECB. They are afraid of $200 – $250 oil, and bears with big balls. This will be a major topic for discussion at the G-8 meeting (except for the part about the big bear balls).