Inflation jumped in July. But then that should come as no surprise for anyone watching the energy markets. The price of crude oil, for instance, rose more than 7% last month, based on the near-term futures contract traded in New York. The bull market in oil flowed through to consumer prices, with the CPI advancing 0.5% last month, reports the Bureau of Labor Statistics. That’s slightly higher than what the consensus estimate called for, and far above the unchanged consumer prices that prevailed in June.

But once you strip out food and energy prices, CPI continues to look like a toothless beast. So-called core CPI rose just 0.1% in July, less than the 0.2% that economists were generally predicting. In fact, July’s core CPI rise was the third straight month that the index advanced by a spare 0.1%.
The bond market prefers to ignore the energy component when it comes to inflation. To the extent that energy’s the source of the inflationary pressures haunting the CPI, that’s not a threat for the fixed-income set. And not without reason, say some traders of debt. High oil prices may stoke inflation fears, but the same elevated prices in crude also raise the specter of an economic slowdown. Which side has the upper hand at the moment? Once again, the recession-is-coming crowd does. Indeed, the bond bulls were again out in force in today’s trading, chasing the government’s paper anew. The yield on the 10-year Treasury Note fell today for the fourth time in the last six sessions. The 10-year’s current yield of roughly 4.2% is now the lowest since July 28’s close.
But why tie up your money for ten years when you can get virtually the same yield on a two-year Treasury? A slim 20 basis points is all that separates the two-year Treasury from its 10-year counterpart. If you buy the two-year Treasury in the here and now, you can lock in a yield of around 4.0%. The 4.0% on the two year is all the sweeter when you learn that the iShares Lehman 1-3 Year Treasury Bond ETF (Amex: SHY) yields a trailing 2.7%.
Logic may not be bursting the buttons in bond land, but there’s plenty of relative value to pass around.



    I have to wonder why on earth one would exclude energy prices from an analysis of inflation. Energy prices are certainly at the HEART of the issue and it would require an exquisitely complex rationale that only Greenspan is capable of to argue that otherwise. If life were only about imported goods from China your analysis might hold! It seems to me that oil will overwhelm the deflationary impact of Chines imports and install stagflation in the OECD economies.

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