Looking For Inflationary Trouble

Are prices hitting the danger zone? The Fed isn't taking any chances

Just a few months ago, Whirlpool Corp. was being squeezed through the wringer of deflation. Despite the strong U.S. economy, fierce global competition had forced U.S. appliance makers to cut prices by 2% last year. But now, says Chief Financial Officer Ralph F. Hake, "we're seeing an abatement of the pricing pressures. This is an upbeat industry."

Whirlpool is a telling micro-indicator of what is happening in the U.S. economy. With signs of a turnaround in the global economy, the pressures that have driven down prices around the world are easing. For two years, economists and investors in the U.S. had scanned the horizon for signs of the inflation they feared must accompany low unemployment and rapid growth. Instead, they found that inflation had shrunk--to 1.6% in 1998--as the global meltdown slashed the cost of Asian imports, oil prices plunged, central bankers pushed down interest rates, and companies squeezed more productivity out of their operations to offset rising wages.

On May 14, however, the inflation watchers found something to worry about. The Bureau of Labor Statistics reported that the consumer price index had spiked 0.7% in April--the largest monthly jump since October, 1990, lifting the CPI to an annualized 3.9% rate over the past three months. "It was a wake-up call," says Cynthia Latta, chief U.S. economist for Standard & Poor's DRI.

The second alarm sounded on May 18, when the Federal Reserve announced that the governors at its open-market committee meeting had adopted a tightening bias--meaning that it is now prepared to hike rates if the "buildup of inflationary imbalances" doesn't subside. It was a clear sign that Fed Chairman Alan Greenspan was once again worried.

To be sure, this year's inflation is a much gentler creature than the monsters that terrorized the economy in the '70s and '80s. And economists, including Patrick C. Jackman of the BLS, are quick to point out that the April number was distorted by "special factors"--including a big jump in tobacco prices--and is unlikely to recur.

Another factor in the CPI jolt, the 50% surge in oil prices, reflects a comeback from last year's steep deflation--to more normal levels. With global demand slack and supplies plentiful, crude had fallen to below $11 a barrel last December. But since OPEC has reasserted some control over output and demand has picked up in Asia, prices have soared--to nearly $19 in early May. Gasoline, which rose a record 15% in April, accounted for more than half of the CPI hike. But, says James A. Osten, a fuel analyst with Standard & Poor's Platt's, "prices are simply getting back to where they were at the end of 1997." Indeed, the price of gas has fallen back a bit, and on May 19, oil had slipped to $16.88 a barrel.

Furthermore, despite the signs of pricing power that Whirlpool sees, most corporations aren't anticipating big price hikes. The latest survey of CFOs in the Financial Executives Institute found they expect to raise their prices a mere 0.8% in 1999. The National Association for Business Economics, meanwhile, now predicts consumer prices will creep up 2.0% this year, and then 2.4% next year.

One sign that the April scare is perhaps just that is the reaction of the Fed. The central bank cited concern over inflationary pressures building in the economy--but chose only to announce a tightening bias rather than a rate hike. Indeed, the Fed didn't have to act: On May 19, the yield on the benchmark 30-year treasury bond was 5.80%, up a full point from the low during last fall's global crisis. That has already slowed mortgage refinancings and may cool the economy enough to ease the inflation threat without a hike.

AGGRESSIVENESS. On the other hand, there are lots of places where inflation seems more than an idle threat. "We are beginning to see pressures in the cost area, particularly fuel," says James E. Goodwin, president of UAL Corp. In response, U.S. airlines have been trying to raise fares, but not always successfully. Similarly, industrial commodities have been struggling for higher prices. Copper has climbed back to 70 cents a pound, from a low of 62 cents, and nickel and aluminum are also rising. We're in "transition from abject bearishness to neutral," says William O'Neill, head of commodities research at Merrill Lynch & Co. "And I see more upside in 2000."

Manufacturers, too, are at least thinking about raising prices. Until recently, U.S. manufacturers, including Detroit's auto makers, felt they had "zero pricing power," says Gordon Richards, chief economist of the National Association of Manufacturers. But at the early May meeting of the Business Council, companies that expected their pricing power to be stronger in six months outnumbered those that expect it to be weaker by a 4-to-1 margin.

The more aggressive approach is already apparent among drugmakers and health-care providers. Prices for existing drugs jumped 4.2% in the first quarter over year-ago levels, according to IMS Health--vs. 3.2% for all of 1998, and 2.5% in 1997. But "that is trivial" compared with the "astronomical" prices of new drugs, complains Dr. Joe Gerstein, medical director for pharmacy programs for Tufts Health Plan. High drug prices are part of what's driving health-care costs to levels "that should be seen as alarming," adds Daniel S. Messina, chief financial officer for Aetna U.S. Healthcare Inc. Aetna increased its HMO pricing by 7% for 1999, and premiums for non-HMO plans by 7% to 10%.

And as buyers in most housing markets can attest, anybody selling a house or condo has palpable pricing power. Nationally, the median price of an existing home jumped 4.6% over year-ago levels, to $131,600 in the first quarter, according to the National Association of Realtors. But in hot markets on both coasts, and some in between, prices are soaring--13.2% in San Francisco, 12.9% in Miami, and 13.6% in Kalamazoo, Mich.

WAGE WARNING. The big question now is whether inflation will remain contained in such pockets as housing and health care or break out into the wider economy. Supermarket prices are "fairly flat," says Blythe J. McGarvie, CFO of Hannaford Brothers Co., a $3.3 billion supermarket chain. Says Wal-Mart Stores Inc. CFO John B. Menzer: "We're not seeing any price inflation." Indeed, Wal-Mart is accelerating its "price rollback" program.

Although Detroit is having another banner year, prices are not. Ford Motor Co. could only inch up the sticker price of its hot-selling pickups, minivans, and sport utilities by $50 to $95 in May. Meanwhile, prices for telecommunications and computer gear--the engines of the New Economy--are still falling.

Now, all eyes are on the next batch of statistics to determine whether the April numbers were just a cruel scare. So far, labor cost increases have remained modest, even as unemployment has sunk to 4.3%. And in recent months, real wage hikes have actually been slowing. But, warned Greenspan on May 6, "at some point, labor market conditions can become so tight that the rise in nominal wages will start outpacing the gains in productivity, and prices will inevitably begin to accelerate." Indeed, cautions Nicholas Perna, chief economist at Fleet Financial Corp., "you can no longer say there are no signs of inflation." Just look.