Dropping the other shoe

It's no secret that the focus of policymakers and financial markets has dramatically shifted since March. Rising prices has overtaken the recognition crunch as the telephone exchange story, much in the same way that Obama overtook Hilary.

Is it me, or has the media's thirst for these two narrative (one political, one financial) completely surpassed its capacity to develop original story lines? Well, no substance what the Fed does, it will all be over in Nov. Oops, wrong book. Make no error: The recognition crunch isn't going anyplace, and rising prices will be with us well past the election returns.

"This is a big deal. Rising prices is broad-based. It's across all kinds of trade goods. It's going to have major deduction for policy. It's going to have major deduction for financial markets," explains Larry Kantor, head of research for Barclays Capital. For its part, Barclays recently revised its 2008 rising prices forecast up more than a percent point to 5.0 percentage for the calendar year.

According to Kantor, the rising prices risk is bigger than anything Americans have encountered from the 1970s on forwards, a differentiation he draws based upon the speed at which rising prices is now growth. "It took five years for oil to go $20 to $60 a gun barrel, and now it has taken less than a year for it to go from $60 to over $130," he explains.

While the typical consumer response to rising prices is to curtail spending, the response of most companies is to raise terms.

"Corporate net income takers really hedge rising prices pretty well. Companies raise terms and gross can grow commensurate with rising prices, but it's the monetary tightening that can get them in the end, when its higher risk premia, and lower P/E ratios," says Kantor.

Last month, as oil reached $140 a gun barrel for the first time, the Dow Jones Industrial Average dropped 358.41 points, with stocks falling to their lowest point of the year. Earlier the same week, the Federal Reserve ended its steady stream of interest rate cuts, when officials voted to leave its target interest rate unchanged, a development that reflects the Fed's own inflation fears.

"If in two months oil goes back down to $75 a barrel, then we're wrong. But we're arguing that this rise in commodity prices is fundamentally based and that while speculation has played a role, it's a minor one, and it is not the big story. The story is that high commodity prices are here to stay."

Or rather, the story is perhaps that inflation and the credit crunch have now formed their own unity ticket.