Smith Faculty Opinion Article	September 18, 2007
By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

Producer Prices Fall 1.4 Percent in August
Federal Reserve Poised to Cut interest Rates, Stocks to Rise

Today, the Labor Department reported the Producer Price Index fell 1.4 percent in August, after rising 0.6percent in July.

Energy prices fell 6.6 percent, after rising 2.5 percent in July. Food prices fell 0.2 percent, after falling 0.1 percent in July.

Core producer pricesproducer prices less food and energyrose 0.2 percent in August, after rising 0.1 percent in July.

Over the last year, producer prices have risen 2.2 percent, and producer prices excluding food and energy have risen only 2.2 percent.

Increases in core wholesale prices indicate bringing core consumer price inflation down below Federal Reserve Chairman Ben Bernankes target of 2 percent a year remains an illusive target.

Outlook for Fed Policies, Bond and Commercial Paper Markets

International oil prices continue to surge, and gasoline and heating oil prices are heading up. Economic growth in China and elsewhere in Asia, and the U.S. ethanol program are driving up prices for corn and substitute grains, like wheat and soy. These will have predictable effects on prices for cooking oils, baked goods, meats, and dairy.

Hence despite a slow economy and contained inflation among core items, the threat of oil and food price inflation remains apparent. The Federal Reserve can do little to affect conditions in international oil and grain markets but it will remain fearful that those conditions could spread to core items and ignite unacceptable levels of inflation.

Closer in the Feds field of focus, chaotic conditions in the short-term credit and corporate bond markets, the poor state of new home sales, and broader weakness in consumer spending and jobs creation make the risk of recession real, indeed compelling.

The Federal Reserve should cut the target for the federal funds rate later today; however, with inflation remaining a risk, it will move cautiously in the months ahead.

Dont look for the Fed to drive down the federal funds rate down to 1 percent as it did in June 2003.

A lower federal funds rate will not do much to buyer confidence in the U.S. bond market. That will require leaders at Standard and Poor and other rating agencies to behave more like adults, quit suspending disbelief in the shortcomings of their business model, and stop their chronic and suspicious denial of systemic problems in the U.S. bond rating architecture.

However, near-term, a lower federal funds rate should help ease the squeeze in the short-term, commercial paper market. Many companies can be directly evaluated by lenders and cheaper primary sources of funds for banks and other entities that function like banks, such as money markets, should help support business spending.

Growth will slow but absent another unforeseeable shock, the economy should avoid a recession.

Outlook for Stock Prices

The stock market came through the subprime crisis reasonably well. Despite wide fluctuations, the Dow Jones average rose 146 points in August after falling 197 points in July. As of September 17, the Dow Jones was up 181 points from July 31, and 2327 points from its August 2006 low.

Global economic uncertainty, created by the meltdown in U.S. subprime mortgage lending and panic sell offs of hedge fund assets, is driving investors around the globe into short-term U.S. Treasury securities and U.S. equities.

Skepticism about the quality of U.S. bond ratings will continue, thanks to the denial at Standard and Poor and other rating agencies, but coupled with lower short-term rates, pessimism about the security of corporate bonds should be good for equities.

With U.S. companies earning large profits from robust growth in Asia and uncertainty in credit markets driving foreign money into U.S. stocks, steady or falling U.S. interest rates create a great incubator for an end of year stock market rally. The bull market will continue, and the Dow should breach 14000 again soon, and pierce 15,000 before the end of 2008.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission. ►More Faculty Opinion Articles