How Dangerous Is Current Inflation?

The broad markets turned cautious on Monday as the USD basically stood in place against the EUR and GBP with limited range movement. The JPY continued to languish near the weaker parts of its value and the AUD gave back a sliver of ground. It appears that Central Banks are casting a heavy shadow on the markets taking into consideration that the ECB and BoE will both hold important monetary policy meetings this Thursday. Yesterday Ben Bernanke, the Federal Reserve Chairman, in a speech said that he believes inflation will actually decrease by the end of this year and said that pricing pressure is transitory. This viewpoint flies in the face of the ECB outlook and President Trichet interestingly enough, and the fact that the European Central Bank is expected to raise their key rate on Thursday makes for comparisons. Yes, the Federal Reserve’s mandate is linked to employment, while the ECB’s mandate is linked to inflation, but the different interpretations regarding the ‘dangers’ of rising prices from energy and food costs is worth noting.

The USD has found itself trending lower for a few months against the EUR and GBP and plenty of this is because the ECB has been holding out the promise of an interest rate hike. The question now will focus on how much of the ‘promised’ interest rate has already been factored into the FX markets. The dominant factor may reside in the press conference that President Trichet holds after the monetary policy statement. If Trichet continues to say that the ECB may in fact consider further rate increases it could cause the EUR to move stronger. However, the argument many analysts and economists have been pointing out is that a hawkish policy by the ECB will likely hurt E.U. nations which are still clearly within recessionary cycles. What will become of Portugal, Spain, Greece, Ireland, and even Italy with an interest rate hike? This question has led many to believe that any interest rate hike now means that the ECB will not increase rates again during the year.

The price of Crude Oil is being watched by traders not only because it is interesting by itself, but because of its impact on international economies. Oil is well entrenched above 100.00 USD a barrel which serves as a warning flag. The fear is that Crude Oil will continue to climb and what would happen if this scenario plays out. The broad markets have been trading on nervous sentiment for a couple of months as the situation in North Africa and the Middle East continues to develop. The crisis in Japan has also thrown nuclear energy concerns into the mix because of the possibility that populations will demand that their countries shy away from nuclear technology and use other means to produce energy, which would mean more Crude Oil and Coal consumption. Thus the multi-billion dollar question for the world’s economies is what would happen if Crude Oil were to go above 120.00 USD per barrel. If this were to happen it would certainly have an effect on the global economy. Gold as of this writing is above 1438.00 USD an ounce and is touching its record territory.

The ECB decision will not come until Thursday but investors are taking positions based on this. Wall Street turned in a mixed day of results on Monday. Economic data will be rather light today internationally. Europe will release Retail Sales figures and the U.K. will publish Services PMI. The U.S. will present their ISM Non Manufacturing PMI results.

Traders must continue to monitor news coming from Europe regarding Sovereign Debt which is not going away. Portugal is lurching towards a bailout even though they deny it, and Moody’s rating services has downgraded Portugal as of this morning. While Europe seemingly moves towards an interest rate hike, it is also nearing another encounter with its financial problems that plague some of its nations. The EUR has a complex mix of issues surrounding it. The Single Currency has been strong for months, but the question many investors are asking is if its value can be sustained?

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