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Have you noticed that no matter who you talk to, yours truly included, every time you ask their opinion on interest rates, it's likely to change from one day to another. There's two reasons for that: Not enough data out there, and we don't know how the Fed is going to prioritize.

Let's start with the second one first: Prioritization of the Federal Reserve. I'm more inclined to believe that this Federal Reserve will push for a contained rate of growth in inflation. Mr. Bernanke is an inflation targeter. He wrote a book on it and explained its benefits. I'm inclined to believe that he's likely to pursue that very policy now that he is sitting in the driver's seat of the U.S. economy. He'll get his one chance to show America the benefits of containing inflation within a tight comfort band. You don't write a book one day expounding the benefits of a policy, then get nominated to the one position that allows you to implement that policy and not go through with it. I can't imagine there was a change of heart since all the way back in 2001.... especially since the former Fed chairman was implementing policies of his own that led to overheated inflation at the time of the writing of the book. I'm almost wondering if he was sitting there stewing in his juices watching in disbelief as policy was unfolding.

The second part of the quandary is the lack of economic data showing a clear sign. The Federal Reserve gets the same information as we do. They are just as dependent upon the same data that we are. Their interpretation is based on the same data that we have available to us. So, when your data gets revised frequently, or followed up by contradictory data the very next day, dispensing clear policy gets to be a challenge. Some of the data I get either spells doom and gloom, or shows signs of continued improvement. We'll get data one day that tells one story only to be dispelled later that very morning.

The logical culprit to this malaise is that we are in a transition period. Some data is likely to precede other data in moves. Not all elements of the economy are going to shift at exactly the same time. This is natural. So, how do you base your decisions with the data that we have?

Ask yourself what the most likely outcome for our economy is going to be. We've already heard the term “soft landing” being applied to today's economy. Fine. There's your answer. The Federal Reserve is going to try its best to engineer a soft landing. That, to me, seems like a good starting point in evaluating the future outlook of the economy. Let's assume that there is success in that policy.

A soft landing implies that we are likely to see the real estate bubble deflate. Not pop... but deflate back down to what would be considered reasonable growth. Inflation is also likely to deflate in its rate of growth. I've gotten myself into a number of thinking debates as to what we'll see first: $50.00 or $100.00 oil. Eventually, any aggregate demand that moderates will have the same effect on the pricing of oil. However, that is where any soft landing scenarios cease to hold merit.

Oil has ignored the basics laws of supply and demand. Perhaps the conspiracist in me believes that that's what the current executive administration wants. What, you think it's not coincidental that aside from the effects on price during the recession of 2001, the price of oil has gone up in almost a straight line since Bush got in office? He's an oil man. He got elected with oil money. That's no big secret.

So, if oil continues as it has, to ignore fundamental laws of supply and demand, and continues to push higher, then the Fed is going to be forced to push more aggressively to contain inflation. It's what inflation targeter's do. In the meantime, businesses can't continue to swallow the pricing increases in energy. As we've just started to see, the pass-through effects are beginning to show up on the consumer's purchases at the core rate.

A pause may happen at some point in the future. But, I think it might be just that.... a pause. Pausing is usually followed by hitting the play button at some point later on. All you are doing is getting up to get some more beer out of the fridge. You'll still want to see the show without missing anything.

If the Fed is forced into a war on inflation targeting, then the soft landing is out of the cards as well. It's just not a logical conclusion to that scenario. Interest rates may very well move close to the double digit level in order to get the deal done.

Then... then... THEN... the data will be consistent.

While you're enjoying that chopped salad, keep an eye on the price of energy as it continues to move higher (up another buck today). That is probably the number one indicator to be following at this point.

Source: Why It's Hard To Predict Interest Rate Shifts