This is a compilation of posts I have made on my blog

Here is the news release from the BLS:

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.9 percent in March, before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. The March level of 205.352 (1982-84=100) was 2.8 percent higher than in March 2006.

.....

For the first three months of 2007, consumer prices increased at a seasonally adjusted annual rate (SAAR) of 4.7 percent. This compares with an increase of 2.5 percent for all of 2006.

Let's cut through all of this static.

1.) Everybody talks about the core rate, but almost no one explains why the Federal Reserve looks at the core rate. The Fed looks at the core rate to see if the more volatile price components of CPI (food and energy prices) are bleeding through to other areas prices. If core CPI is tame, it usually means the more volatile prices are not impacting other prices. This is what has given the Federal reserve the confidence to continually state price pressures should subside over time.

2.) All that being said, outside of this policy perspective, the core rate is practically useless. Everybody consumes gas and food so the overall rate is what is important from an individual's perspective. And this number is not good. It indicates prices are increasing at an uncomfortable rate.

3.) Notice the year-over-year number increased 2.8%. That is .8% above the Fed's preferred level of 1%-2%. Translation: the Fed isn't lowering rates anytime soon (barring clear signs the economy is tanking hard).

4.) There are some very scary 3-month compound growth rate numbers in this report. Food: +7.4%, Transportation, +8.3%, Energy +22.9%, Medical Care +5.6%.

So --- why is this happening?

From the most recent FOMC statement:

Members agreed the statement also should indicate that inflation pressures seemed likely to moderate over time, but that recent readings on core inflation had been somewhat elevated and the high level of resource utilization had the potential to sustain inflation pressures. A persistence of inflation at recent rates could eventually have adverse consequences for economic performance. All members agreed the statement should indicate that the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected. The Committee agreed that further policy firming might prove necessary to foster lower inflation, but in light of the increased uncertainty about the outlook for both growth and inflation, the Committee also agreed that the statement should no longer cite only the possibility of further firming.

Yeah, I know -- this is very much a, "we want our cake and eat it too" kind of statement. However, once you get beyond the Fed double-speak, it's actually pretty obvious what they're saying:

The Committee agreed that further policy firming might prove necessary to foster lower inflation, but in light of the increased uncertainty about the outlook for both growth and inflation, the Committee also agreed that the statement should no longer cite only the possibility of further firming.

Let me explain why. Right now there are two really strong upward trends on prices that aren't going away anytime soon.

Gas Prices

According to the Department of Energy:

Gasoline prices saw another significant increase for the week of April 2, 2007, jumping 9.7 cents to 270.7 cents per gallon. This is the ninth consecutive week of increases; prices are now 11.9 cents per gallon higher than at this time last year. All regions reported higher prices. East Coast prices were up 9.6 cents to 267.1 cents per gallon, while Midwest prices rose 9.6 cents to 261.4 cents per gallon. The Gulf Coast saw the largest regional increase, with prices up 12.3 cents to 256.5 cents per gallon. In the Rocky Mountains, prices increased 8.1 cents to 261.9 cents per gallon. West Coast prices were up 8.0 cents to 309.6 cents per gallon, with the average price for regular grade in California up 7.6 cents to 322.8 cents per gallon, 48.5 cents per gallon above last year's price.

Here's a chart from the same report. The red line -- which is higher -- represents this years prices.

One of the primary reasons for the decease is a declining inventory of gasoline. Here is a chart of gasoline stockpiles represented by the orange line.

Aside from dwindling gas stockpiles, oil supplies are also dropping:

The International Energy Agency warned Thursday that output by the Organization of Petroleum Exporting Countries had hit its lowest level in over two years on production outages and self-imposed cuts, a factor likely to drain global oil stocks in the coming months.

In its monthly oil market report, the agency, the energy security watchdog for the Organization for Economic Cooperation and Development, highlighted unexpected product-led reductions in world oil stocks and what it described as "astonishing" demand growth in China, where it was forced to revise up its growth expectations for this year.

Unexpected production outages in Nigeria and maintenance in Saudi Arabia contributed to OPEC's daily output in March falling to a little over 30 million barrels, the lowest since January, 2005.

Let's look at the price of oil. First, here's the daily chart. We had a nice dip when the Britain/Iran situation calmed down, but prices spiked back up to the $64 area the next day. In addition, we have two upward slanting trend lines to deal with. Finally, oil prices are using the 20 and 50 day SMAs for technical support.

On the weekly chart, we appear to have a head and shoulders formation with prices now moving above the neck line.

So, what does all this mean?

We're probably going to have higher gas prices as the summer progresses. And the higher those prices go, the less likely the Fed will cut interest rates. Remember the Fed has been hoping the economy would do the Fed's job of lowering inflation. But, that's not happening right now.

In part one, I showed how oil and gas prices are increasing, which in turn will keep the Fed on the sidelines. Below, I will discuss agricultural prices which are also increasing:

From the blog, Financial Sense

Thanks to Federal mandates and subsidies, corn used for the production of corn ethanol is expected to increase from ~ 700 M Bushels in 2000/2001, to 3.2 B bushels in 2007/2008 – an increase of 357 percent. On December 11, 2006, the USDA estimated 2006-2007 U.S. ending stocks would be 935 million bushels, down from 1.97 billion bushels in 2005-2006. That decreases the ending stocks by more than 50 percent and puts the ending stocks to use ratio at 8%, - the lowest in 11 years. It should be obvious to all, we are going to need a lot more acreage and big yield improvements if corn production is going to keep up to demand. Prices could exceed $4.50 per Bu by the end of 2008. That’s a price increase of 125% over 2005/2006 season prices.

Let's take this one point at a time.

...corn used for the production of corn ethanol is expected to increase from ~ 700 M Bushels in 2000/2001, to 3.2 B bushels in 2007/2008 – an increase of 357 percent.

In other words, demand hasn't just increased; it has spiked off the map. Econ 101: increased demand equals increased price.

On December 11, 2006, the USDA estimated 2006-2007 U.S. ending stocks would be 935 million bushels, down from 1.97 billion bushels in 2005-2006. That decreases the ending stocks by more than 50 percent

Supply is contracting as well, and not by a little. By a lot. Econ 101: decreased supply = increased price.

It should be obvious to all, we are going to need a lot more acreage and big yield improvements if corn production is going to keep up to demand. Prices could exceed $4.50 per Bu by the end of 2008. That’s a price increase of 125% over 2005/2006 season prices.

To respond to the increased demand farmers planted more corn this year. This is why the daily agricultural prices dropped a few weeks ago. But notice prices are right back up to to where they were a few weeks ago.

This situation in the corn market is impacting all other agricultural products as well -- everything is going up in price. Here's the daily chart.

Also notice that on the long-term chart we have a two year bull market. It's hard to stop a trend like this, especially with the above mentioned supply/demand situation. Also note the price rebound from the news of increased corn plantings is apparent on this weeklychart -- that's how strong the rebound was.

And it's not just corn that's increasing in price. Remember corn is a basic ingredient in a ton of food.

If corn prices increase by ~ 55 percent, year over year, then will the corn used for hog, cattle, chicken, turkey and fish feed go up 55 %? Doesn’t that increase the price of meat, poultry, fish, milk and eggs? If corn is used in corn meal, corn flakes, corn oil, and hundreds of other food items goes up 55%, doesn’t that increase the price of all these foods? Maybe. Since 2000, the price of beef is up 31%, eggs up 50%, corn sweeteners up 33%, wet corn milling up 39%, and corn flakes are up 10%. Chicken prices haven’t changed very much. Yet. Food producers are predicting higher prices.

So, here's the summation. Food prices are going up. The ethanol mandates are increasing demand. Although farmers planted more corn this year, supplies are still dwindling. Econ 101: increased demand plus decreased supply = increasing prices.

And here's the grand summation:

Prices are heading higher. Oil producers have cut supply at a time when demand is increasing. Farm prices are going up because of population increases and the ethanol market.

This places the Federal Reserve is a really difficult position. They can either:

1.) Raise rates to stop inflation and in the process probably send the economy into a recession, or

2.) Let inflation run its course and possible get out of control, and perhaps lead to a mild or major dose of stagflation.

Either way, they are in a really terrible policy spot