Inflation, Milton Friedman first counseled all those years ago, is a monetary phenomenon. But in the here and now, inflation suddenly seems to be something less than threatening.
Consumer prices fell 0.1% in May, the Labor Department reported today. That’s the first drop in 10 months. Wholesale prices retreated by an even greater measure in May, falling 0.6%, we learned yesterday.
Putting the two price reports together has made the cries of the inflation hawks look a bit melodramatic. Indeed, it’s tougher to get worked up over inflation after the two price reports. Fair enough, so then why isn’t the bond market conspicuous by its lack of celebration?
Some of it may be the market living up to the old saw to buy on the rumor and sell on the news. Regardless, the yield on the benchmark 10-year Treasury Note was essentially unchanged today, closing the session at 4.11%. That’s up from less than 3.9% touched earlier this month.
Rising yields and falling inflation? Sure, why not?
Then again, perhaps the fixed-income set’s worried that the fall in CPI and PPI was but a temporary bump on the road to dark things, largely driven lower energy prices in May. According to the CPI report, energy slid 2% last month, the first monthly decline for the data series since January. For wholesale finished goods, energy costs decreased 3.5% in May.
Indeed, the core CPI for May (which extracts food and energy costs from the mix) rose 0.1%, as did the core PPI last month. Although that’s modest, it’s a notable difference from the declines posted by the broad CPI and PPI measures.
But energy prices have a notorious history of late of marching higher after any and all declines, and June is shaping up to be merely the latest chapter in that history. Oil today closed at $55.55 a barrel, which is just under the all-time high set back in April, and no trivial hazard for future inflation reports.
There are even more ominous gremlins lurking, charges Peter Schiff of Euro Pacific Capital. “Despite May’s benign figures,” he writes today in an essay posted on his firm’s web site, “which were driven mainly by falling energy prices, so far 2005 is on pace to achieve the largest CPI increase in fifteen years.” He goes on to point out that oil prices are up 18% in the last four weeks. If the dollar’s new-found strength reverses, that’s likely to translate into higher commodity prices, he explains. The bottom line for Schiff: “I except CPI gains in the second half of 2005 to push the year’s total increase to over 4.6%, its second largest gain in twenty-four years.”
Monetarists may not care either way, invoking the world according to Friedman as a defense. On that score, the growth rate in the M2 money supply continues to downshift, according to data from the Fed. For example, looking at a four-week average of M2 reveals that the rate of change has slowed dramatically to a week-over-week increase of around one-tenth of one percent for the week ending May 30, down from six-tenths of one percent for the week of April 4. The proverbial tightening of the monetary strings, in other words, is alive and well at the moment.
The question is whether applying the monetary brakes will neutralize other forces, such as oil prices, that are thought by some to contribute to higher inflation.
Monetarism, it seems, is being put to the test. So far, it seems to be winning. Nonetheless, two questions loom. One, will the Fed’s newly acquired miserly ways prevail when it comes to the money supply? Two, even assuming that money supply expansion remains relatively constrained, will that overcome what some say is advancing inflationary pressures from other corners of the economy? Inquiring minds, and trigger-happy bond investors, want to know.