Inflation Getting Stronger than a 'Whiff'

There's more than just a whiff of inflation in the air, especially if you're standing outside a Hershey chocolate factory or shopping in a Walmart.

Hershey Wednesday announced a nearly 10 percent price increase across its line of candy products to cover rising raw material costs, fuel and transportation.


Those rising costs are impacting many other manufacturers that rely on everything from diesel fuel to corn to cotton to copper and of course, cocoa.

It will also be true if you are shopping in Walmart, or anywhere else. Wal-Mart Stores CEO Bill Simon told USA Today this week that inflation "is going to be serious" and price rises are already showing up in dairy and cotton products and more are coming in transportation-related products.

Moody's economist Mark Zandi said the idea that inflation is picking up may be actually more of a reality than economists are currently forecasting. He said he attended a meeting with consumer products companies officials this week, and he heard plenty.

"They were all on the verge of jacking up their prices," he said. Price increases are not always seen as bad though. When companies have pricing power, it often means there is some traction in the economy, but it's a fine balance.

The threat of inflation is even more worrisome now that oil has crossed above $105 per barrel and looks set to stay high due to unrest in the Middle East. Some commodities have also seen shortages for other reasons and that has combined to drive prices. For instance, cocoa, trading lower Thursday, has been driven higher by civil war in Ivory Coast.

"You would expect some kind of pass through, with the surge in commodities prices. It's not unusual, at least not yet. The key is if this becomes self-reinforcing and drives inflation expectations and wage demands," Zandi said.

Zandi currently expects overall CPI inflation to accelerate from 1.7 percent in 2010 to 2.4 percent in 2011, and then moderate in 2012 to 2.1 percent as oil and food prices stabilize. He sees core inflation, without food and energy, at 1.4 percent in 2011 and 2.1 percent in 2012, from less than 1 percent in 2010.

The markets have been watching this creeping trend of higher prices, which has been much more dramatic outside the U.S. but is now increasingly showing up inside the U.S. The Fed's easy monetary policy has been blamed in part for the weakening dollar and run-up in commodities prices around the globe, but the Fed does not yet see inflation as a problem and it just recently stopped seeing deflation as problem. Other central bankers do, however, and rates are expected to rise, even in Europe as early as next week.

The topic of Fed policy was top of mind in markets this week, and it was brought there by Fed officials themselves. A troop of Fed presidents, in the past week, have been on the speaking circuit, all weighing in on the merits of continuing with their quantitative easing program (QE). The QE program is scheduled to end in June, and was intended to involve the purchase of $600 billion in Treasury securities by the Fed. Those purchases in theory were expected to reflate assets, pushing investors into riskier assets, while keeping interest rates low.

Minneapolis Fed President Narayana Kocherlakota said Thursday that quantitative easing has boosted inflation expectations more than he had anticipated and that higher short-term rates are possible in late 2011.

Richmond Fed Presdient Jeffrey Lacker Thursday joined St. Louis Fed President James Bullardin suggesting the Fed should be able to back off from some of its bond buying, ahead of the scheduled end of the program.

"I think they were trying to prepare us for moving from stimulus to restraint. There's a fair amount of debate as to the timing and how aggressively they should tighten. I think it's appropriate for them to start this discussion now," said Mark Zandi of Moody's

Kansas City Fed President Thomas Hoenig is one of the Fed presidents who has been outspoken about the Fed's low rate and easy money policies and he was vocal again on Wednesday. Economists do not expect the Fed to adjust its near zero rate policy until sometime next year, and there is a low expectation that the quantitative easing program could be extended.

Fed Chairman Ben Bernanke has said global demand is helping fuel commodities prices, but Hoenig blamed the Fed and other central banks.

"While some of the increase may reflect global supply and demand conditions, at least some of the increase is driven by highly accommodative monetary polices in the United States and other economies," said Hoenig.

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