To end the week, I have a couple of quick takes on some hot topics from the financial news. Let’s start with inflation.

Inflation

Yesterday, the producer prices report showed that inflation continues to creep up at the business level. A drop in energy prices kept the headline index flat on the month and took the annual rate down from 3.4 percent to 3.3 percent. But the core index, which excludes food and energy, rose by 0.3 percent on the month; the annual rate was 2.8 percent, close to a six-year high. There were also signs that tariffs were starting to push up costs even faster, notably in steel. As of now, that is not showing up in the aggregate numbers, but the pressure is building.

This morning, the consumer price report revealed that inflation is also showing up at the consumer level. The headline inflation rate rose from 0.1 percent to 0.2 percent on a monthly basis, and it stayed at 2.9 percent on an annual basis. The core rate, again excluding food and energy, stayed steady at 0.2 percent for the month. It rose from 2.3 percent to 2.4 percent for the year, which is the highest level in 10 years.

While inflation is not exploding upward, the steady increases have taken it to levels we haven’t seen since before the crisis. This rising level should keep upward pressure both on interest rates through the Fed, which is likely to keep raising short-term rates, and potentially on longer-term rates. It is not an immediate problem, but it is one that is likely to get worse through the rest of the year.

Turkey

The other big story today is Turkey, which may be seeing the early stages of an economic collapse. The Turkish lira is down about 30 percent from the start of the year. As such, the country’s external debt of more than $450 billion, denominated in dollars and euros, just got that much more expensive to service. Unsurprisingly, investors are now demanding to be paid much more to compensate for that risk. Turkish interest rates are up sharply, making the problem harder to solve.

Finally, Turkish reserves of foreign currency, while still substantial, are starting to erode at an increasing pace. This scenario is how other emerging market crises have started in the past. The worry is that Turkey will kick off the next one, as contagion effects take Turkey's problems and translate them around the world.

Contagion seems quite possible, as we are already seeing knock-on effects in other emerging markets. Argentina and Brazil have been hit, as has Russia (although Russia has other problems as well). More generally, emerging market currencies are under pressure, and the interest costs on their debt are rising.

One good point here is that this situation, while just hitting the headlines, has been developing for weeks. So, hopefully, the banks have been working on contingency plans. The real damage is done when a crisis seemingly comes out of the blue. We have lived through several of these crises over the past couple of decades, so this time the system will be neither surprised nor at a loss for what to do.

If there is a crisis—one remains unlikely, but the possibility is rising—how would it affect the U.S.? The direct effects could be meaningful, as the U.S. is the largest holder of Turkish financial assets, but that would likely hit only the owners. From a systemic point of view, however, the U.S. financial system is both less exposed and better capitalized than it was in previous crises. While there could certainly be turbulence, a significant crisis seems unlikely at this point. The risk appears to be higher for the European financial system, which did less cleanup after the last financial crisis, and the systemic effects there may well end up being meaningful. Here in the U.S., though, while the potential for damage is real, it should not be either substantial or systemically dangerous.

Keep calm and carry on

That outlook is pretty much what the financial markets are telling us as well. The U.S. stock market is down a bit, but not substantially; it remains within 2 percent of its all-time highs. Per above, markets are expecting turbulence but not the end of the world. Overall, that seems like a pretty good read from a financial perspective as well.

Brad McMillan is the chief investment officer at Commonwealth Financial Network, the nation’s largest privately held independent broker/dealer-RIA. He is the primary spokesperson for Commonwealth’s investment divisions. This post originally appeared on The Independent Market Observer, a daily blog authored by Brad McMillan. Forward-looking statements are based on our reasonable expectations and are not guaranteed. Diversification does not assure a profit or protect against loss in declining markets. There is no guarantee that any objective or goal will be achieved. All indices are unmanaged and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance is not indicative of future results.

© Commonwealth Financial Network

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