Pentonomics – ISM Has Some Warts

January 3, 2011 at 10:53 PM

Some seemingly better economic news was released today from the Institute of Supply Management’s Manufacturing report. The ISM index climbed to 57 last month from 56.6 in November. However, the employment index slowed from 57.5 to 55.7, while the inflation index increased yet again. The prices paid component rose to 72.5 from 69.5 and was the 18th month in row of gains.

For me, this will be THE story of 2011. Rising prices and increasing borrowing costs will place a white hot spotlight on Ben Bernanke. It looks like a replay of 2007 is in order. Oil and food costs soar while the Fed claims there is no inflation. Then, perhaps in the 3rd or 4th quarter, Bernanke merely begins to hint about removing some of the liquidity. Maybe, by the start of 2012, he begins to hike rates in ¼ point increments but commodities still move inexorably higher just as they did throughout Ben’s baby steps from 2004 thru 2006.

That’s because bank lending isn’t curtailed very much by a Fed Funds that rises by just a few hundred basis points. What popped the housing bubble wasn’t so much that borrowing costs became too high but rather that home prices became unaffordable at any interest rate and the pool of available buyers finally dried up.

Investors would do well to remember that given the Fed Chairman’s obsession with the Great Depression, he will be anything but aggressive when it comes to removing monetary stimulus.

-Michael Pento