US, Jap CPI Nov10.pngIn one of its first posts, at the time of the ill-fated Access deal for Lyondell in July 2007, the blog highlighted the strange divergence that had developed between the front pages of the newspapers, and their business coverage:

“If you read the financial pages of your newspaper, everything sounds rosy. But if you turn to the news section, its all gloom. Both views can’t continue to exist alongside each other for ever. Whichever scenario comes out on top, will have major implications for the chemical industry. My own view is that this week’s Access deal for Lyondell will be seen, in hindsight, as marking the top. ”

Today, the same disturbing trend has returned.

• The €90bn ($125bn) Irish bailout, for example, is very clearly bad news. As the blog noted back in May, Europe’s banks have lent $495bn to Ireland, more than twice the €182bn at risk in Greece. And, of course, next in line are Spain (€792bn) and Italy (€961bn).
• Equally, the US housing markets remains very difficult. Already the government has committed $188bn to keep the two main lenders (Fannie Mae and Freddie Mac) alive. And there are few signs of any real improvements as we head into the seasonally difficult winter months.
• Plus, most importantly of all for chemical demand, China’s economy is moving into an enforced slowdown, as the government worries about soaring inflation – up from 3.6% to 4.4% in just one month. Price controls are likely on key foodstuffs, whilst interest rates have already begun to rise to cool the real estate bubble.

Yet the financial pages are full of optimism about the economic outlook. Most remarkably, there seems a consensus that interest rates will need to rise dramatically. Almost all commentators warn that inflation is about to soar, due to the strength of the economic recovery now underway.

As in 2007, the blog begs to differ. The chart above, from the New York Times, shows the parallel between Japan’s core inflation rates (green line) after its housing bubble burst in June 1991, and US inflation (blue line) since its housing market peaked in June 2006.

October’s US core inflation was a record low of just 0.6%. The previous low was 0.7% in February 1961. And, as always, the blog believes that the major retailers are a far better indicator of what is happening in the real economy, than financial markets. Thus it believes Wal-Mart’s announcement that it intends to follow a “price-leadership” strategy virtually guarantees US inflation rates have further to fall.

If Wal-Mart are right, then financial markets must be wrong in their assessment of the underlying state of the US economy. And in turn, this has critically important implications for chemical companies. Lower oil prices, and destocking down the value chain, are serious risks if today’s sunny optimism in financial markets starts to be seriously challenged.

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