Dow Tumbles On Inflation Fears

Posted on May 17, 2006

The Dow fell 214.28 points, or 1.88 percent for the biggest decline in over three years. The Nasdaq also hit a new low for the year, with the release of the Consumer Price Index.

Behind the market's reversal is a growing concern among investors that inflation may not be as firmly under control as they had hoped. Even as most economic signals continue to point to a growing economy, the prospect that the Federal Reserve might still feel compelled to keep raising interest rates has unnerved many on Wall Street.
"Many investors have taken large positions in stocks and they are getting spooked," said James Glassman, senior United States economist for J. P. Morgan Chase & Company. "These investors are often hedge funds and foreigners, and if the Fed is going to raise rates more than they thought, that makes it less attractive for them to hold onto their big positions." Indeed, the sudden unwinding in the market began on May 11, the day after Fed policy makers raised interest rates another quarter-point, to 5 percent, and left open the prospect that more interest rate increases "might yet be needed to address inflation risks."
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Yesterday's government report was seen as the worst omen yet. The Bureau of Labor Statistics announced a jump of 0.6 percent in the Consumer Price Index for April, mostly because of gasoline prices, but also because, as the government calculates it, the cost of owning a house and renting an apartment was up smartly. The latest increase in consumer prices came on top of a 0.4 percent increase in March.

American consumers have tapped out their homes as a source of equity and we have a negative savings rate. The crash in the housing market will come, the only question is when and how hard will the crash be. If inflation spurs the Fed to raise interest rates faster, well, all I can say is: I hope you enjoyed the Jimmy Carter years, because here they come again.