Inflation On the Brain

There is a ton of news today about inflation. Consider the following:

From the WSJ:

Inflation worries are heating up around the world and jolting financial markets in the process.

On Tuesday, China's stock market was the latest to feel the blow, with the benchmark Shanghai Composite Index tumbling by 7.7%, to its lowest close this year. The drop came after the government announced steps to remove cash from the financial system in an attempt to tamp down inflation.

.....Also Tuesday, officials in Vietnam effectively devalued their currency in a step aimed at easing market pressures related to soaring inflation rates. (See related article.)

And in the U.S., investors sold off U.S. Treasury securities, one day after Federal Reserve Chairman Ben Bernanke warned that the run-up in oil prices is adding to upside risks for inflation. The price of the two year Treasury note, most sensitive to the Fed's moves, has fallen sharply (and its yield has risen) as investors grow convinced that the central bank may have to raise rates this autumn to contain inflation. On Tuesday, the two-year note's yield was 2.9%, up from 2.4% on Friday, marking a major jump in that rate.

Meanwhile, the Bank of Canada surprised markets Tuesday by holding off on an expected interest-rate cut; the central bank said the risk of inflation, driven by high energy prices, had grown too great to allow for further rate cuts. The European Central Bank is also considering interest rate increases to fend off inflation.

From Bloomberg:

European Central Bank board member Juergen Stark damped speculation of a series of interest-rate increases, saying policy makers have signaled only that they may raise borrowing costs in July.

``The markets have understood the Governing Council's signal,'' Stark, 60, said in an interview in Chatham, Massachusetts, late yesterday. ``However, we are not talking about a series of rate increases.''

ECB President Jean-Claude Trichet said last week the bank may raise its benchmark rate by a quarter-point to 4.25 percent in July to curb inflation, which is running at the fastest pace in 16 years. Investors responded by increasing bets on higher borrowing costs. They expect the ECB to lift the key rate twice this year, taking it to 4.5 percent, according to Eonia forward contracts.

.....

Oil prices above $130 a barrel and rising food prices pushed inflation in the 15-nation euro region to 3.6 percent in May, well above the ECB's 2 percent limit. Central banks around the world are changing rate policy in response to surging inflation.

Global Policy Shift

Vietnam, Brazil, Chile, the Philippines and Indonesia all lifted borrowing costs this month. The Bank of Canada yesterday unexpectedly kept its benchmark rate unchanged after four straight reductions. U.S. Federal Reserve Chairman Ben S. Bernanke has also signaled the Fed is done cutting rates, saying this week he'll ``strongly resist'' any surge in inflation expectations.

Tie this information to the CRB chart below, especially the following points.

1.) The weekly chart is still in a major rally.

2.) The daily chart is still bullishly aligned

3.) The P&F chart shows a series of multiple new highs.

These developments explain the following statement from Bernanke's most recent speech:

Inflation has remained high, largely reflecting sharp increases in the prices of globally traded commodities. Thus far, the pass-through of high raw materials costs to the prices of most other products and to domestic labor costs has been limited, in part because of softening domestic demand. However, the continuation of this pattern is not guaranteed and future developments in this regard will bear close attention. Moreover, the latest round of increases in energy prices has added to the upside risks to inflation and inflation expectations. The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as for inflation.

NY Fed President Geithner echoed Bernanke's sentiment:

Geithner also said containing global inflation risks will probably require tighter monetary policy. The Fed has cut U.S. interest rates sharply to 2 percent since September, though markets expect it to raise them later this year.

And Treasury Secretary Paulson has supposed dollar intervention which is a de facto way to cure inflation caused by the dropping dollar:

U.S. Treasury Secretary Henry Paulson on Tuesday said he stood by comments made a day earlier in which he said he would never rule out currency intervention as a potential policy tool.

"I'll let my comments stand," Paulson said in an interview with Bloomberg Television. "I never like to say never, but my focus is on long-term fundamentals."

Now -- US officials have talked a good game for awhile, but haven't done anything. Let's see if they are will to act.