July 15, 2005
INFLATION BEATS A HASTY RETREAT
Inflation may or may not be dead as a long-term threat, but after digesting this week's serving of price reports for June it's harder to lose any sleep over this erstwhile enemy of central banks everywhere.
The fun started on Wednesday with news that import prices last month rose 1%, the Bureau of Labor Statistics reported. Hardly a reason to celebrate, but after taking out food and energy June's import prices actually fell by 0.4%. Not bad, as far as it goes.
Even more encouraging news came packed in yesterday's consumer price report for June, which revealed no inflation last month, otherwise depicted as 0%, the government explained. Nice data, if you can get it. But was it a fluke? Apparently not, or so this morning's wholesale price report for last month suggested. Producer prices for June were also unchanged, adding confirmation to yesterday's CPI dispatch.
Taking the obvious cue from the week's reports, Ed Yardeni, chief investment strategist at Oak Associates, today writes in an email to clients that the inflation scare is history. "The cyclical rebound in core CPI inflation appears over, with the rate dropping to 2% in June, and core prices little changed over the past three months," he predicts. "Our forecast of 1.5% inflation this year remains on track, no matter which core measure is used."
Reasonable, perhaps. But if the future path of inflation is so clear and it's prospective sting so seemingly mild, why has the bond market become so skittish this week? It's more than a little curious that in a week when the latest measures of inflation suggest pricing pressures are waning the bond market decides to respond with a collective "huh?" Consider that the yield on the benchmark 10-year Treasury Note closed a week ago, July 8, at roughly 4.1%. As of today, the yield's bumping up against 4.2%? What? No big rally? Are the bond boys anxious? Ill? Or simply inclined to buy on the rumor and sell on the news?
The stock market, by contrast, has found reason to buy this week. The S&P 500 on Thursday closed at its highest in four years, putting to rest for the moment any fears that equities this year had lost the upward momentum of 2003 and 2004 and were thus poised to continue moving sideways or worse in 2005.
Perhaps the news that the consumer is still spending, combined with the low inflation reports, convinced equity traders to throw in the towel and resume a bullish posture that makes no apologies. Indeed, the Census Bureau reported yesterday that retail sales for June rose by 1.7%, which ranks among the stronger monthly reports for the series in recent years. Meanwhile, the industrial side of the economy refuses to be left out of the current boomlet: industrial production advanced by 0.9% last month, the highest monthly increase since February 2004.
If the sight of continued strong spending by Joe Sixpack, economic strength in the industrial sector, and the June taming of inflation generally looks a bit incongruous, well, so be it. This isn't your father's economic expansion. That may or may not be helpful, but for the moment it's good enough for the equity market. But that still leaves the question: What does the bond market really think?
Posted by jp at July 15, 2005 5:04 AM
Yields going up despite the low inflationary numbers could have 2 reasons. One being profit taking from the latest drop in yield to the 3.9 level (which is a technical selling point) and two being the increased anticipation of the Remnibi revaluation. Both are not connected to inflation numbers....
Posted by: rupert at July 15, 2005 1:54 PM