Where’s the Inflation? Your Weekly Market Update

We’ve been hearing a good deal lately about inflation, or should we say, the lack of inflation. But what is the true story?

This week’s update focuses on the subject, which we think is one we will all be paying closer attention to in the years to come.

In addition, we think you’ll love reading about the serious boost the markets received from our friends at the Federal Reserve last week. Wow.

All the best,
Lee and Jeremy


This Week’s Quote:

“The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.” ~ Vladimir Lenin

JL Davis Thoughts This Week:
All of us need to remember that the Federal Reserve’s primary mission is to keep inflation low and employment high. It’s true the employment situation has improved a bit recently, but how well are they doing on inflation?

According to the Federal Reserve’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index maintained by the Bureau of Economic Analysis1, inflation hit a 50 year low this past summer and is up very modestly since then. While the PCE price index measures household purchases, the core PCE index does the same thing without including food and energy prices (at this writing, gas is down a bit while food is certainly not). The broad PCE index hit 0.74% back in May, with core PCE at 1.05% - the lowest ever on record. The previous low was in 1963!

Your authors weren’t focusing on inflation in 1963 since one of us wasn’t born and the other was in the second grade at the time. So let’s look at the issue from today’s perspective. Currently, the Fed is still “printing money” to the tune of $85 billion a month to allow for their asset purchases, but the headline PCE index has actually fallen since last year. The Consumer Price Index only advanced 1.1% between May 2012 and May 2013 and “core” CPI rose just 1.7% in that period.1, 3, 4

Why? We think that somewhat unusual circumstances are the reason. Short-term interest rates persist near zero. Fed Chairman Ben Bernanke has essentially shouted from the rooftops that U.S. benchmark interest rates will be at rock-bottom levels until our jobless rate dips below 6.5% or inflation tops 2.5%4 – whenever that is.

Another reason could be confidence: Economists, analysts and investors alike appear confident the Fed can and will capably fight inflation. So, while the Fed creates money and purchases bonds from banks via its ongoing stimulus, the bulk of that money has turned into bank reserves. As lenders, banks are still routinely “sitting” on these reserves, seemingly happy earning interest while not aggressively lending. Hence relatively slower growth and less inflation.

If the Fed were to raise its own inflation target, expectations would likely change a great deal. However, virtually no one sees that happening anytime soon. Recent rumblings of a fed taper (slowdown in asset purchases) sooner rather than later will have a say in the matter as well as near term stock market volatility, from our perspective. That said, as recently as last June, the Federal Reserve Bank of St. Louis President James Bullard was a proponent of sustaining an “aggressive” stimulus given the “surprisingly low inflation readings” of recent months, markedly below the central bank’s target.5 “Inflation in the U.S. has surprised to the downside” were Bullard’s comments.

More recently, the Federal Reserve that they intended to keep the bond buying program at the current pace, and Mr. Bullard opined that interest rates shouldn’t rise as long as inflation is under 1.5%.6. Though these comments seem to have propelled the markets, we’re not certain that inflation stays in check forever; quite the opposite. But for now, yes.

1 - advisorperspectives.com/dshort/updates/PCE-Price-Index.php [5/31/13]
2 - bea.gov/faq/index.cfm?faq_id=518 [6/13/13]
3 - bls.gov/news.release/cpi.nr0.htm [5/16/13]
4 - theatlantic.com/business/archive/2013/06/the-biggest-economic-mystery-of-2013-whats-up-with-inflation/276772/ [6/12/13]
5 - bloomberg.com/news/2013-06-10/fed-s-bullard-says-low-inflation-may-warrant-longer-qe.html [6/10/13]
6 - http://www.businessinsider.com/feds-bullard-introduces-bullard-rule-2013-9


Market Week: September 23, 2013

The Markets

What the Fed giveth, the House taketh away: Jubilation on Wall Street after the Fed decided not to begin tapering immediately gave way to concerns about the potential impact of renewed battles over the federal budget and U.S. debt ceiling. The Dow and the S&P 500 hit record closing highs after the Fed announcement only to give back most of those gains by week's end. The small-cap Russell 2000 also rose post-Fed but was more resilient than its large-cap brethren after the House of Representatives passed a budget that virtually guarantees more fiscal infighting. Meanwhile, investors took advantage of the reprieve from Fed tapering to boost bond prices, sending yields down.

Last Week's Headlines
• The Federal Open Market Committee said it will continue to buy $85 billion worth of bonds, at least until it sees whether the threat of fiscal gridlock in Washington will threaten the economy.
• Increases in the cost of housing and medical care were largely responsible for a 0.1% increase in consumer prices in August. The Bureau of Labor Statistics said that put the consumer inflation rate at 1.5% for the last 12 months, which is well within the Federal Reserve's target range.
• Housing starts on single-family homes--the largest segment of the residential construction market--rose 7% in August, putting overall housing starts up 0.9% for the month and 19% ahead of August 2012. However, the Commerce Department said building permits--an indicator of future construction--were down 3.8% for the month, though they were still 11% ahead of last August.
• A 1.7% increase in sales of existing homes in August put home resales at their highest level in more than six years. The National Association of Realtors® said the nearly 15% increase in the median sales price since August 2012 represented the ninth straight month of year-over-year increases.
• The nonpartisan Congressional Budget Office said the current level of federal debt relative to gross domestic product is higher than at any time since World War II. The budget deficit has declined to its lowest level since 2008--about 4% of GDP. However, the CBO projected that though the deficit would fall to 2% of GDP in two years, deficits would then gradually begin to rise again, primarily because of higher borrowing costs due to rising interest rates as well as the growing costs of Social Security, Medicare, Medicaid, the Children's Health Insurance Program, and subsidies provided through health insurance exchanges.
• German Chancellor Angela Merkel handily won reelection, though her political party will still face a challenge in forming a coalition government with political opponents. The vote essentially ratified Merkel's strong support of financial assistance for troubled eurozone countries.
• Industrial production rose 0.4% in August, according to the Federal Reserve Board, and was up 2.7% from a year earlier.


Eye on the Week Ahead

In the wake of last week's announcement, individual Federal Reserve Board speakers are likely to begin elaborating on the thinking behind the decision. Final Q2 GDP numbers will be in, and data on housing and household incomes and spending could suggest how the economy might fare in Q3.

Key dates and data releases: home prices (9/24); durable goods orders, new home sales (9/25); final estimate of Q2 GDP (9/26); personal income/spending (9/27).

Data sources: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. News items are based on reports from multiple commonly available international news sources (i.e. wire services) and are independently verified when necessary with secondary sources such as government agencies, corporate press releases, or trade organizations. Market data: U.S. Treasury (Treasury yields); WSJ Market Data Center (equities); Federal Reserve Board (Fed Funds target rate); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold, NY close); Oanda/FX Street (currency exchange rates). Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results.
The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell
2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indexes listed are unmanaged and are not available for direct investment.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2013