Inflation and Rates

Good morning, producer prices increased in March but not as much as expected. Surprisingly, food prices actually went down bringing the overall index to only 0.70% higher for March (1.00% expected).

On that note, the Fed Beige Book was released yesterday afternoon shedding light on the state of the economic conditions in the 12 Federal Reserve districts. The report mentioned that most of the districts reported an improving economic landscape, especially in the manufacturing sector. However, the survey also stated that these improvements were “moderate” and that uncertainties remain high as a result of the recent disaster in Japan. The report also mentioned concerns on inflation stating that an increase in commodity costs was putting inflationary pressure on prices. As the economic recovery continues, it is evident that inflation is becoming the key topic in market participants’ minds.

“Higher commodity costs were widely reported to be putting increasing pressures on prices. Energy prices were cited most often, but raw materials in general were an increasing concern of businesses. The ability to pass through cost increases varied across Districts, with manufacturers generally finding less resistance to price increases than either retail or construction (where weak demand was a limiting factor)”Fed Beige Book, April 13^th 2011

Nevertheless, inflation is increasingly becoming prevalent in investors’ minds as they become more and more focus on this for a couple of reasons:

A) High oil prices could push inflation much higher than desired, making a real dent on future growth (GDP).

B) Higher inflation expectation means the Fed could raise rates sooner rather than later (everything from Home Mortgages to student loans would be affected).