Interest rates, inflation and oil

In April, stocks went down because of concerns of a soft-patch. Since then, as inflation indicators have come below consensus, market has started thinking that Fed interest rate tightening cycle will end soon, sending stocks higher. There seems to be a growing consensus that the Fed is going to stop raising rates sometime this year, to end the year at 3.5% to 3.75%.

Oil prices continue to rise, today it is above $56. Oil prices have spiked up again recently, which can lead to inflation concerns again being ignited in the second half of the year.. This would imply that Fed continues increasing rates. This would continue to make US treasuries attractive for foreign banks and investors, keeping the 10-yr bond yields at low levels. The result - a flattening yield curve, which has histroically been a harbinger of recession. Maybe, as Greenspan thinks, it is not the case this time. But then, banks get killed in a flattening yield curve environment, as they stop making money in the carry trade business (borrowing on the short end of the curve and lending on the long-end). And so they curtail lending, which impacts the economy as a whole. Lets see if it is different this time.

On a separate note, on the question I raised the other day (Do monsoons really impact Indian auto companies bottomline) Smith Barney wrote a report recently. It suggested that while monsoons have had an actual less impact on performance of the Indian auto companies, they did have an impact on the stock performance. The key drivers seem to be consumer finance and level of competitive intensity.