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What Inflation?
Dear American Capitalist Reader,
We have written extensively about the implications of a slowing economy in 2007. Indeed, as far back as last spring, it was our contention that the Fed’s long series of mini-hikes would eventually become a drag on the economy, although the data at the time suggested the Fed needed to move more quickly. Throughout the summer, however, the data began to incorporate the higher rates, the housing bubble popped, and by the fall we started seeing good, old-fashioned softness on the part of manufacturers and retailers.
The logical result of this development, we reasoned back in June, was going to be a lessening of inflation pressures. Under a slowing economic backdrop, it is extremely difficult for inflation to maintain any steam on the consumer level (commodity or raw materials pricing pressure is almost always swallowed by producers wary of pushing price increases through to end users). And since the fall, this is what the bond market has been waiting for.
Today we received another confirmation that inflation pressures are in full retreat. Initial readings for the month of November show the Consumer Price Index virtually unchanged from October. This was the third month in a row where pricing pressure was far more subdued than Wall Street had expected.
The implications for the economy and for the stock and bond markets are enormous. First, it means that all the talk being thrown around at the Fed about “risks of inflation” is just that -- talk. There is very little inflation reaching consumers, especially if you take out energy.
With 2006 mostly in the history books, core inflation is going to have run roughly 2.2% or so, a clear improvement over the 3.5% last year that got everyone so worked up. For the Fed, this means there is ample room to cut rates in the first half of 2007 if need be. There doesn’t seem to be much risk of an inflationary spiral in the economy. As usual, the wild card remains oil.
For the markets, we should continue to see the best of both worlds: a rising stock market coupled with falling bond yields. Eventually, one of them will turn, and our bet will be on the bond market first. But for now, the inflation data this morning is another strong indication that the “soft landing” is on track.
Until next time,
Steven Lord, Editor, Editor, Trend Investor
