The Fed's stagflation fear

The economy grew at weaker pace than expected in the fourth quarter but inflation was higher too. Plus: Why Yahoo is tech sector's Rudy Giuliani.

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By Paul R. La Monica, editor at large

GDP: Slowing pains
A weaker-than-expected economic report sets investors on edge as they await the Fed decision.

Nothing to Yahoo about
A disappointing forecast from Internet company and massive loss from UBS set the stage for rocky road on Wall Street as investors wait for the Fed decision.

NEW YORK ( -- Uh-oh. The Federal Reserve's decision at 2:15 p.m. just got a little tougher.

Fourth-quarter growth in gross domestic product was lower than expected, rising only 0.6%, compared to forecasts of 1.2% growth and way below the 4.9% growth in the third quarter.

That certainly lends credence to the arguments that the economy is nearing - if not already in - a recession and that the Fed should slash interest rates again this afternoon.

Another number in the GDP report should give the central bank pause, however.

The core personal consumption expenditure (PCE) deflator, an admittedly wonky sounding piece of econojargon that is actually a very important indicator of inflation, rose 2.7% on an annualized basis. That's up from 2% in the third quarter and was higher than the 2.5% that economists were expecting.

As I wrote in Monday's Morning Buzz, inflation is still something the Fed has to be concerned with. The latest number proves that. Still, this probably won't be enough to keep the Fed from cutting rates by another half-of-a-percentage point.

But the threat of stagflation, a period of both economic sluggishness and rising price pressures, has to weigh on the Fed when it puts together its carefully constructed statement.

The central bank needs to continue to talk tough on inflation and may need to signal to the market that after today's expected half-point cut - which would leave the federal funds rate at a pretty accommodating 3 percent - that it's time to hold steady for awhile.

As bad as the subprime mortgage mess has been, letting prices for many consumer goods run out of control by further weakening the dollar with aggressive rate cuts could have an even more damaging effect on the economy.

In fact, inflation could be contributing to the current slowdown.

"Domestic demand readings were weaker than we expected, not holding up well in the face of the inflation surge, driven mostly by energy costs," wrote Citigroup analyst Steven Wieting in a report this morning.

And no less an authority than former Federal Reserve chief Alan Greenspan warned about the possibility of stagflation as recently as last month. And with food and energy prices continuing to rise, hopefully current Fed Chairman Ben Bernanke and the rest of the Fed will take Greenspan's words to heart.

Boo-hoo for Yahoo. What do Rudy Giuliani and Yahoo have in common? After their respective performances in Florida and on Wall Street yesterday, even their most fervent supporters would have to admit the jig is up.

Yahoo (YHOO, Fortune 500) disappointed Wall Street yet again Tuesday. Sales guidance for 2008 was much weaker than expected, the company announced it would be laying off 1000 workers and CEO Jerry Yang warned that the company faces "headwinds" this year.

The world's second-largest search engine is now entering year three of what is starting to look like a never-ending turnaround story for the company. Although some of the actors have changed - exit Terry Semel and enter Yang - the results are the same.

With that in mind, just as Giuliani is expected to drop out of the presidential race today and lend his support to John McCain, I think it is time for Yahoo to bow out of the online ad race and align itself with a larger rival who would be better able to manage the company.

The sad thing about Yahoo is that it has a wonderful portfolio of Web sites that should be doing better than they are. In addition to the flagship Yahoo site, the company owns popular photo sharing site Flickr, social search engine Yahoo Answers, bookmark sharing service and career site HotJobs.

But Yahoo has had one excuse after another as to why it continues to lose ground to Google (GOOG, Fortune 500) in search and cannot capitalize on its established lead in display advertising.

Yahoo's stock hit a new 52-week low when it started trading this morning and the stock is now 31% below the price it traded it when Semel was ousted last June.

Microsoft (MSFT, Fortune 500) and eBay (EBAY, Fortune 500) have often been mentioned as possible suitors for Yahoo in a takeover scenario. And now, with the stock as low as it is, the company could even wind up being tempting for an "old" media company like News Corp (NWS, Fortune 500)., Walt Disney (DIS, Fortune 500) or, dare I say it, my parent company Time Warner (TWX, Fortune 500) to take a stab at buying Yahoo and restoring it to its former glory.

In fact, Jefferies analyst Youssef Squali wrote in a research report on Wednesday that the main reason he's keeping a "buy" rating on Yahoo is because "we believe that the downside risk is limited by the likelihood of a sale."

And if Yahoo can't turn things around as the one-year anniversary of Yang taking over rolls around in June, expect that likelihood to become a reality.

Get your daily Buzz via RSS! Thanks again to all the readers who have checked out the first two Morning Buzz columns and have responded to the TalkBacks. Once again, there was a spirited debate about yesterday's piece on the "Wal-Mart Stimulus" Now, you can get Morning Buzz delivered to you by subscribing to an RSS feed. Click here to sign up.

What do you think? Should inflation be a major concern for the Fed?

And how about Yahoo? Do you think the company will be acquired? To top of page

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