Thursday, May 25, 2006

Inflation: How Bad Is It?

Last week the Bureau of Labor Statistics released data on consumer prices for April. Unfortunately, the numbers were not comforting on the inflation front with year-over-year growth of more than 3 percent in the overall consumer price index (CPI) and more than 2 percent in the core CPI (excluding food and energy). Investors did not take this news well with the stock market moving downward since that release. Of course the reason for this negative outlook for investors was the renewed belief that the Federal Reserve (Fed) will continue to raise interest rates in the months ahead to quell this "excessive" inflation.

The Fed has now raised short-term interest rates by 4 percent in the past 2 years. However, even with the Fed’s foot on the brakes, and rapidly rising energy prices, the U.S. economy continues to expand at a breakneck pace. Not surprisingly, we are recording some pass through of higher energy prices with transportation firms adding surcharges that are showing up in supply prices.

The prices-paid index for April from our survey of purchasing managers in 9 states rose for the second straight month to 79.1 from March’s 78.6 and February’s 74.3.

Last week Fed chief Bernanke issued a more positive short-term interest rate outlook. Given the budding inflation that we are seeing in our survey and in other regional and national data, I expect the Fed to continue to raise rates in the months ahead. I place the likelihood of Fed rate increase at more 70 percent at its June meeting. Higher short and long term interest rates have failed to slow even construction in the region as individuals and businesses undertake projects in anticipation of even higher rates in the months ahead.

The Fed has indicated that future rate changes will be data driven. So what data should investors be watching for early indications of Fed actions. Here are data releases that you should pay special attention to:
1. The employment report released on June 2 (,
2. The CPI released on June 14 ( and
3. The yield on the 10-year U.S. Treasury (
4. On June 1, we will release our regional ISM report ( while the national ISM will release the equivalent national report ( Keep an eye on the prices-paid index for signs of inflation and the overall index for an expanding economy.
5. The next release of retail sales on June 13th ( will be an important gauge of consumer spending.


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