The widely watched monthly inflation report is in and according to government economists, inflation is not a problem. At the same time, the bond market is sending a conflicting signal by selling bonds, which results in higher yields. This action usually means that bond investors are worried about inflation.
The headline inflation number showed a month-over-month gain of 0.7 percent in consumer prices. This was immediately dismissed as a cause of concern because it was largely due to an increase in gasoline prices.
Since the time that the data was gathered for the report, gas prices have fallen by an average of about 20 cents a gallon at the pump, and analysts expect this trend to continue. Bloomberg is reporting that some analysts are forecasting a price of $20 a barrel for oil, a decline of 85 percent from last summer’s highs.
Another readily dismissed part of the greater-than-expected inflation was an increase in automobile prices. With the introduction of the “cash for clunkers” program and incentives from bailed-out automakers likely to be seen in coming months, the price of cars is likely to fall in the coming months.
More good news for those looking for lower inflation over the rest of the year was found in the less publicized industrial production report. Capacity utilization was reported at 68 percent, a slight decline from last month's dismal 68.3 percent.
Capacity utilization is the amount of stuff a nation is producing compared to what it is capable of producing. In this case, the United States is only using 68 percent of its economic capacity. That means almost a third of the factory space and transportation infrastructure is sitting idle, and manufacturers will have a hard time raising prices when competitors are actively seeking new work.
Bond investors acted as if they were not buying all the hype associated with the reports. They sold bonds which led to higher interest rates. Rates on the 10-year Treasury notes jumped to a one-month high on the news. The trend in interest rates has been upward for all of 2009.
It is widely believed that the interest rate on government bonds reflects the inflation expectations of some of Wall Street’s smartest investors. The difference between short-term and long-term rates is used as a measurement of the inflation premium. At current levels, this difference is higher than average and might be indicative of extreme inflation concerns.
In recent weeks, however, the Treasury markets have been driven by extraordinary events. On the short end, the Federal Reserve has been struggling to keep the financial system afloat, resulting in very low yields near zero.
On the long end, there is likely to be some degree of inflation fears built into the price. However, foreign governments have been selling bonds. While the reasons are unclear, it is more likely a concern about the long-term value of the U.S. dollar than concerns about impending inflation.
The bond vigilantes may be driving the yield on long-term Treasuries higher, but this may not indicate inflation concerns as much as it is telling us they are worried about the U.S. dollar. The inflation reports should stay low for a while, but eventually all the stimulus money is likely to lead to higher prices. In the meantime, dollar concerns are likely to lead to higher interest rates.
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