Wednesday, June 11, 2008

Inflation Worries Spook Wall St/Interest Rates Rise

We are off to a rough start this morning with the DOW down 100 points. As i briefly discussed yesterday, bond yields are beginning to rise as Wall St. begins to really worry about interest rates. The drop in AAA CDO's is weighing on the banks today as well as the threat of these higher rates.

The 10 year is up to 4.14%. India raised interest rates for the first time in 15 moths which added to the inflation anxiety this morning. As I have explained before, rising interest rates will start raising mortgage rates which will add to the carnage in housing as they become even less affordable.

Here is the news from Bloomberg:

June 11 (Bloomberg) -- Government bonds will fall in the Americas, Asia and Europe over the next six months as global inflation accelerates, a survey of Bloomberg users showed.

The results show investors are more concerned about inflation than mounting losses related to subprime mortgages, which sparked demand for the safety of government securities earlier this year. The average yield on global sovereign debt climbed to 3.67 percent from 2.77 percent in March, according to indexes compiled by Merrill Lynch & Co.

``The market is shifting from a flight-to-quality mindset to one of looking at inflation and real rates,'' said Andrew Harding, who helps manage $18 billion as chief investment officer for fixed income at Allegiant Asset Management in Cleveland and a survey participant.

Investors became more bearish as central banks signaled they may raise interest rates to curb inflation. Treasury 10- year yields reached 4.14 percent on May 29, the highest since Dec. 28 and up from this year's low of 3.28 percent on March 17.

Federal Reserve Chairman Ben S. Bernanke said this week that policy makers will ``strongly resist'' any surge in inflation expectations. European Central Bank President Jean- Claude Trichet said on June 5 that policy makers may raise borrowing costs in July to contain inflation

``There's a global recognition now that the inflation genie is out of the bottle and it must be capped,'' Tony Crescenzi, a Treasury market strategist at Miller Tabak & Co., said. ``There's a sense the central banks have become very serious about fighting inflation. The galvanizing factor is oil and its abrupt move up. The credit market improvements have given Bernanke leeway.''

For developing nations, ``the inflationary risk and impact of high food and oil prices pose an even more serious challenge than the effects of the U.S. slowdown and financial turmoil,'' Hans Timmer, an economist at the World Bank, said in a report yesterday. Some of them are already ``feeling the heat of the international environment,'' he said. "

My Take:

Whats now happening is inflation is becoming a bigger threat to the economy than interest rates. The last quote above explains it perfectly. The Fed is now going to be forced to raise rates. The 10 year rates in the bond market are then forced to rise out of inflation fears in order to remain attractive as an investment.

As a result, bank stocks are free falling because higher rates kill profits and hurts housing. Higher ratesalso lessens the chance that the their CDO crap sandwiches will ever come back in value. Like that wasn't going to happen anyway!

Consider this a triple whammy for the banks. Washington Mutual looks like its on its last leg. All of the investment banks are down today as well.

Its pretty obvious that inflation is getting out of control. Steel has tripled in the last 6 months, and we already know the oil story. The language out of the Fed is warning you right now: They will let an explosion go off in our financial system before they let inflation destroy the economy.

You need to take this warning seriously. This isn't rhetoric. As I have said before, hyperinflation destroys everything and the government will shrink the money supply and take liquidity out of the system to save us from hyperinflation. The Fed will take the financials and the stock market out to the woodshed for a beating before they let this happen.

This will be painful but its the right thing to do.

I don't think anyone here has any desire to pay $1000 for a loaf of bread. This the devastating effect of hyperinflation and we cannot let it happen.

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