Politics & Policy

Inflation Remains the Key Variable

The data don't gel with the Fed's (new) dovish tone.

The Federal Reserve hiked its overnight rate on Thursday to 5.25 percent from 5 percent. The accompanying statement said inflation expectations are contained and that any additional firming will depend on inflation and growth. Although equities and bonds rallied on the news, the dollar weakened on the Fed’s dovish tone. Gold hit $600 per ounce, and is now up 38 percent year-over-year. Though I’m not a fan of the TIPS spread (nominal yield minus real yield), I note that it widened after the release of the Fed’s statement. TIPS’ inflation expectations jumped.

 

#ad#I believe that inflation is the key market and economic variable today. While I do expect core inflation measures to rise, should they stay at current levels the economic outcome will be very good. In effect, the Fed will have achieved a soft landing in which the extreme monetary stimulus of 2004 supported the economy and weakened the dollar without causing too much inflation. Equities would be right to celebrate.

 

That said, I was surprised by the Fed’s statement. The Fed worked hard in June to increase the awareness of the inflation risk, causing interest-rate expectations to rise. But the June 29 statement went in the other direction: “Readings on core inflation have been elevated … Economic growth is moderating … the moderation in the growth of aggregate demand should help to limit inflation pressures …”

 

The Fed noted the “quite strong pace (of growth) earlier this year,” which understates the 5.6 percent real GDP growth and 8.9 percent nominal GDP growth of the first quarter. Since the Fed is linking growth to inflation, it’s important to correctly factor in the strong starting point for the moderation.

 

The most recent data on corporate profits (up 28.5 percent year-over-year in the first quarter, the fastest 12-month growth since 1984!) underscores the economy’s strength. Some argue that profitable companies won’t raise prices, but I’m skeptical given the weakness of the dollar (which encourages even profitable companies to raise prices).

 

So my concern is that inflation is likely to rise even higher if the value of the dollar stays at its current (weak) level. We’ve already had substantial inflation in commodities, the producer price index, the consumer price index (4.7 percent year-over-year in September 2005; still 4.1 percent in May 2006), the GDP deflator, and the core GDP deflator. Core CPI in for the March-to-May period rose at a 3.8 percent annual rate.

 

The dollar is weak. Since the end of 2001, euros have gone up 42 percent, yen 14 percent, and gold 119 percent. This puts upward pressure on prices just as the strong dollar of 1999 and 2000 put downward (deflationary) pressure on prices.

 

Wages also add to the inflation story. Average wages rose 3.7 percent year-over-year in May, reaching $16.62. We all like wage gains, but I believe they will add to core inflation.

 

I don’t agree with the Fed’s sense that inflation expectations are contained. The best indicator is gold, which, at $600 per ounce, is 72 percent above its 10-year moving average. The market prefers gold to a 5.25 percent yielding U.S. dollar, a strong vote against the dollar and in favor of inflation.

 

– David Malpass is the chief economist for Bear, Stearns.

Most Popular

Politics & Policy

The Great Misdirection

The House Democrats are frustrated, very frustrated. They’ve gotten themselves entangled in procedural disputes with the Trump administration that no one particularly cares about and that might be litigated for a very long time. A Washington Post report over the weekend spelled out how stymied Democrats ... Read More
World

Australia’s Voters Reject Leftist Ideas

Hell hath no fury greater than left-wingers who lose an election in a surprise upset. Think Brexit in 2016. Think Trump’s victory the same year. Now add Australia. Conservative prime minister Scott Morrison shocked pollsters and pundits alike with his victory on Saturday, and the reaction has been brutal ... Read More
NR Webathon

We’ve Had Bill Barr’s Back

One of the more dismaying features of the national political debate lately is how casually and cynically Attorney General Bill Barr has been smeared. He is routinely compared to Roy Cohn on a cable-TV program that prides itself on assembling the most thoughtful and plugged-in political analysts and ... Read More
Film & TV

Game of Thrones: A Father’s Legacy Endures

Warning! If you don't want to read any spoilers from last night's series finale of Game of Thrones, stop reading. Right now. There is a lot to unpack about the Thrones finale, and I fully understand many of the criticisms I read on Twitter and elsewhere. Yes, the show was compressed. Yes, there were moments ... Read More
Culture

Cold Brew’s Insidious Hegemony

Soon, many parts of the United States will be unbearably hot. Texans and Arizonans will be able to bake cookies on their car dashboards; the garbage on the streets of New York will be especially pungent; Washington will not only figuratively be a swamp. And all across America, coffee consumers will turn their ... Read More
National Security & Defense

The Warmonger Canard

Whatever the opposite of a rush to war is — a crawl to peace, maybe — America is in the middle of one. Since May 5, when John Bolton announced the accelerated deployment of the Abraham Lincoln carrier group to the Persian Gulf in response to intelligence of a possible Iranian attack, the press has been aflame ... Read More