Inflation is the talking point this week, and that theme will play again in Wednesday's stock market when Fed Vice Chairman Donald Kohn weighs in on the topic. The Fed also releases its beige book on the economy at 2 p.m.
Kohn participates in an 11:30 a.m. panel on "Lessons for Central Bankers" at the Boston Fed's conference on inflation. Fed Chairman Ben Bernanke's spoke at the same conference Monday night and warned that the Fed is on heightened alert against inflation.
That reinforced the market's view that that the Fed is setting up to reverse course and start raising rates, a positive for the dollar. It's also a double edged worry for some in the stock market, who would like to see the dollar strengthen and topple commodity prices but also fear higher interest rates could reduce liquidity.
Bernanke and other Fed officials have been peppering their remarks with heightened concern about inflation since Bernanke's June 3 speech to the International Monetary Conference. Despite competing comments about inflation fighting from the European Central Bank, the dollar is finding a firmer footing. On Tuesday, that dollar move contributed to oil's slide. The dollar rose 1.1 percent against the euro and 1 percent against the yen Tuesday.
Oil finished at $131.31, off $3.04 per barrel. It also moved in part on a report from CNBC anchor Melissa Francis, who said Saudi oil sources told her they were increasing production by 500,000 barrels. They also called the price of oil "unacceptable."
The Saudis have called for a global meeting of oil producers and consumers for June 22 in Jeddah to discuss oil prices.
Michael Darda, chief economist for MKM Partners, said he thinks the Fed's beige book will reflect the Fed's view that the economy is basically under control. "I think by and large the market is now sniffing out a recovery and pricing in a series of interest rate increases, and the Fed is fanning those expectations," said Darda. He said data has been better than expected with the exception of the scary 5.5 percent unemployment rate reported Friday.
"I think they're (the Fed) realizing the bulk of Wall Street was in this fantasy land that the Fed could ease and that inflation was going to fall because the economy was weak ... The most widely anticipated recession in the history of man looks elusive," said Darda.
On Wednesday, Fed Governor Randall Kroszner also speaks on consumer credit markets in Cleveland at 12:15 p.m.
The Dow finished up 9 and the S&P was down 3 after stocks tracked moves in the oil market much of the day. The Nasdaq lost 10.
Stocks in the News
Lehman stock continued to get crushed Tuesday. Lehman on Monday said it lost $2.8 billion in the second quarter and that it was raising $6 billion, a move analysts see as highly dilutive.
Ladenburg Thalmann analyst Richard Bove said he believes that Lehman "simply screwed" up several times recently, and that is not helping it recover confidence. He said they appear to have booked profits on liabilities this past quarter, "which the street really hates." He also said the firm took a hit selling assets after loading $95 billion onto its balance sheet in the first quarter, and it also made a costly mistake hedging in the most recent quarter.
"If things were doing well, they wouldn't feel the need to do things like this.. Last week when they were buying back stock, that's what a junior trader would do to show bravado when everybody knows he's weak," he said.
Bove follows banks as well as brokers. In a discussion about the industry, he said prices have gotten to the level where there could be a new wave of deal making.
One stock he sees as a merger candidate is Washington Mutual , a perennial rumor stock. That stock was up sharply Tuesday after being battered Monday.
"The issue that people are forgetting, and they're forgetting that with all bank stocks at the moment, is that Wamu has $188 billion in deposits. The value of those deposits are roughly $27 billion dollars if you were to sell them in a block in the open market," he said. "... the value of the deposits is three times greater than the value of the company."
Speaking of deals, its worth watching for headlines from the Wall Street Journal Deal and Deal Makers conference Wednesday. BlackRock's Larry Fink and Bank of America CEO Ken Lewis are among the speakers.
Continental Airlines and Caterpillar hold annual meetings Wednesday.
Amber Waves of Inflation
Rising grain prices have been one of the biggest worries when it comes to food inflation, and the move up in corn is being watched closely. Corn futures rose Tuesday to a record $6.732 after the U.S. Department of Agriculture said the 2009 season will result in three percent less corn than previously expected. The yield would be the lowest in 13 years and 10 percent lower than this year.
Dan Yergin, chairman of Cambridge Energy Research Associates, checked in with us yesterday from Moscow, on his way to Astana, the capital of Kazakhstan. Yergin, CNBC global energy analyst, sent the following message:
"Whatever the view at lower levels of prices, there's no question that the world is now in another oil shock and that means we've moved into a break point scenario, where the response to higher prices, in terms of greater efficiency, will become increasingly clear over time. The politics are already there -- and getting stronger. Right now, the market seems to be responding only to things that drive the price up further. The premise seems to be that demand is on the same course that it was a year ago. But that was a very different another price level, and demand is on a different course.
Today one of the main factors in the market was a new report from the International Energy Agency. But the IEA is sometimes misunderstood. A major theme of the IEA is not that the world is physically short of resources, but that investment is not happening at the pace that is necessary to meet demand.
Investment was one of the big themes at the St. Petersburg Economic Forum over the "white nights" weekend, which was the showcase for the new President Dimtri Medvedev, and which was attended by several thousand people -- including quite a number of Western CEOs. Russia is one of the world's two top oil producers, but its production has flattened out because almost all revenues above $25 a barrel go to the government in the form of tax. Meanwhile costs have gone through the roof. That flattening out is alarming the Kremlin, and the government made clear at the forum that there are going to be changes in the tax regime to try to rekindle production growth.
You can see the building response to price in everything from the Saudi message about stepping up production to the comments from the president of the European Central Bank warning about the risks of a new oil shock."
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