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Tea Leaf: Markets look forward to Fed Friday

Published: Tuesday, Aug. 23 2011 3:50 p.m. MDT

Federal Reserve Chairman Ben Bernanke will deliver a critical speech Friday in Jackson Hole, Wyo., at the Federal Reserve Bank of Kansas City Economic Symposium. The speech is tentatively entitled, "Near- and Long-Term Prospects for the U.S. Economy."

Domestic and global financial markets will be tuned to every word, every nuance, as to what types of new monetary stimulus, if any, will be considered by the Fed in coming weeks and months to help a lackluster U.S. economy. In the interim, a review of current inflation pressures and interest rates seems timely.

Consumer prices

The most familiar of consumer inflation measures rose a disturbing 0.5 percent in July, exceeding forecasts. Such prices are up 3.6 percent during the past 12 months, exceeding the 2.3 percent rise in average hourly earnings for all employees on private nonfarm payrolls.

No surprise here: higher energy costs led the way, with overall energy costs rising 19 percent during the past 12 months. Expectations that sluggish domestic and global economic growth could lead energy prices even lower than what has developed in recent weeks helps sooth some of the inflation anxiety in financial markets.

Food costs rose an estimated 4.2 percent during the past year. Apparel costs rose an estimated 3.1 percent, with the entire rise occurring within the past three months. The finger of blame here is focused on cotton prices, which hit a record high earlier this year. The weak U.S. dollar hasn't exactly helped either.

The "core" measure of consumer inflation (which excludes volatile food and energy costs) rose 1.8 percent during the past 12 months. This measure is within the Fed's perceived long-term "core" target range of 1.5 percent -2 percent annually. At the same time, the 1.8 percent core rise is three times what it was as recently as last October.

Most forecasters, including the Fed, expect consumer inflation pressures to moderate in coming months as economic growth most everywhere seems to be slowing. Should inflation pressures not moderate, any new stimulus from the Fed would be limited.

Producer prices

The Producer Price Index (PPI), a key measure of wholesale inflation, rose 0.2 percent in July, in line with forecasts. The PPI is best described as an index that reflects price changes in various categories of goods before they reach the consumer. Exciting categories of crude, intermediate and finished prices for food, energy and "core" materials likely appeal only to the most die-hard (dare I say "geeky?") economist.

Two items were of concern within the index. Prices of finished goods were up a worrisome 7.2 percent during the most recent 12-month period. In addition, "core" wholesale inflation was up 0.4 percent in July, the largest rise in six months. The rise of 2.5 percent during the past 12 months was the most since June 2009.

Despite these increases, weak domestic and global economic growth is likely to keep oil and energy prices under control. Oil remaining in the "mid $70s to mid $80s" would help lead producer prices lower in coming months. A likely return of Libyan oil production will also help.

Record low U.S. Treasury rates, and the flight to quality

Standard & Poor's downgrade of the quality of U.S. debt last Aug. 5 in theory would lead essentially all U.S. interest rates just slightly higher than had no downgrade occurred. However, theory was trumped by real-world anxiety since early August.

An increasingly scary European debt situation — and European government leaders who are constantly shortchanging what needs to be done — have been the primary contributors to painful stock market weakness around the globe and in the U.S. A rising view that European financial anxiety could lead the U.S. back into recession has not exactly helped.

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