Monday, February 01, 2010

Inflation Outlook: Can We Believe the Fed?

At their January 26-27 meetings, the Federal Reserve interest rate setting committee said that, "With substantial resource slack continuing to restrain cost pressures and with longer-term inflation expectations stable, inflation is likely to be subdued for some time." Surveys of supply managers both ISM's national ( and Creighton's regional ( ) run contrary to this assertion and point to elevated inflationary pressures.

The Fed normally would like to see inflation running at 1.75% to 2.00%. Based on surveys of supply managers, I expect the inflation rate to rise to 3.5 percent by the middle of 2010. This will push long term rates up even as the Fed holds short term interest rates "too low." The Fed needs to be increasing rates now before inflation and inflation expectations get out-of-hand. Meantime the Fed attempts to control expected inflation by issuing the statement listed above. To be fair, they are caught between a "rock and a hard place." A fragile economy that needs low interest rates and monetary growth and an economy that is heating up with rising inflation and inflation expectations. However, they need to err on the side of higher short term interest rates in my judgment. Ernie Goss

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