WASHINGTON - After a couple of months of calm, nervousness returned to financial markets yesterday. Stocks slumped after the government reported that a key indicator of inflation jumped sharply in April and the Federal Reserve's second-in-charge signaled that inflation remains a threat, making further interest rate cuts unlikely.
Adding to the gloom, oil prices closed above $129 a barrel for the first time - ahead of this weekend's start of the summer driving season.
The day's events stood in contrast to the optimistic picture painted by the Bush administration only Monday, when Treasury Secretary Henry M. Paulson Jr. told the president that the worst seemed over for the slumping U.S. economy.
A day later, stocks on the Dow Jones industrial average finished the day down 199.48 points, while the S&P; 500 lost 13.23 points and the Nasdaq 23.83.
Meanwhile, the price of a barrel of oil surged $2.02 to $129.07.
Weak earnings reports by retailers Home Depot and Target helped sour the mood on Wall Street. A research report by Oppenheimer & Co. also spooked the markets. Analyst Meredith Whitney, who last year correctly forecast problems at Citigroup, the nation's largest bank, wrote yesterday that the worst of the crisis in the nation's credit markets is still ahead.
Yesterday's developments were the latest in a spate of bad economic news. Earlier in the day, the Bureau of Labor Statistics reported that the core price of finished goods, excluding food and energy prices, jumped by four-tenths of 1 percent last month. That left prices 3 percent higher in April than they were a year ago, marking the highest rate of core inflation on the producer level in 16 years.
Digging deeper into the numbers shows just how tough things are for American manufacturers. Prices for crude materials such as steel and iron have risen 78.7 percent since the start of the year.
Manufacturers try to transfer these costs up the production and supply chain, but the slumping economy is forcing them to eat losses.
"Wholesalers' profit margins remain under pressure in this inflationary environment," wrote Sam Bullard, an economist with Wachovia, a Charlotte, N.C.-based national bank. "Weak domestic demand is making it difficult to pass along the price increases to retailers."
The rising costs of crude materials reflect the soaring price for base metals and commodities, the latter driving up food prices for American consumers by the highest rate in decades.
In a speech yesterday to pension fund managers, Federal Reserve Vice Chairman Donald Kohn mentioned inflation concerns when signaling that policymakers appear to have reached a point where interest rates are low enough to help economic activity and anything lower could further fuel inflation.
"The rise in commodity prices presents particular challenges ... because such increases both add to near-term inflationary pressures and damp demand," Kohn said, stressing how higher prices quash consumer spending. "A tendency for increases in commodity prices to become a factor in ongoing pricing and wage-setting more generally would be a worrisome development that would over time tend to undermine economic welfare."
But continuing weakness in the U.S. economy should eventually reduce demand and bring commodity prices back down, he suggested, expecting this year's slow economic growth to pick up steam next year.
Not everyone is as optimistic. The chief economist for the Manufacturers Alliance/MAPI, a manufacturing trade group, issued a statement yesterday suggesting that hopes for a rebound in the U.S. economy are likely to be dashed. Daniel Meckstroth expected a mild but prolonged recession this year and revised downward - to just 1.9 percent - growth estimates for next year.
"The outlook is for a prolonged period of subpar growth rather than a concentrated adjustment," he said.
Translation: The economy will plod along sluggishly until 2010.
That view isn't far from a forecast released Monday by the National Association for Business Economics, whose members are economists at U.S. and global corporations.
"While our panel anticipates an improvement in credit markets and a bottoming out in housing this year, the forecasters have marked down their estimates for growth for both 2008 and 2009," said Ellen Hughes-Cromwick, NABE's president and chief economist at Ford Motor Co., in releasing the survey of 52 business economists.
About 56 percent of NABE economists surveyed believe the U.S. economy is now in recession, and they project that unemployment will rise from the current 5 percent to an average of 5.6 percent next year.