Inflation Taking a Breather (For Now)

by: David Andrew Taylor

Inside the personal income was the PCE (and core). The headline PCE moved down from 3.5% to 3.4%. The core rate moved up from 2.3% to 2.4%, both on y/y levels. This is what the knee-jerk reaction was about in the market. But, we kind of knew this information seeing how the same exact thing happened with CPI just the other day.

So, inflation appears to be contained at this moment. There's a slight move down at the very end of the chart. We've got a ways to go before there is any confirmed controlling of inflation

Then there is consumption. There's a slight pause at the bottom of this chart as well. Perhaps consumption may start to move higher. It's tough to tell right now. Every month I have to do revisions that go all the way back to December. So, it may take a few more months until we see what is going on.

This indicator is showing an ever so slight pause as well. Again, revisions, so I won't be quick to call anything out. Next month, this chart could be shooting for the moon. Or it could be in Hades.

Regardless, real personal consumption is based on two things: Personal income and the deflator (very complex mathematical formula that only the government's top scientists understand). Consumption has been lagging for some time the up-move in personal income:

Never the twain shall part ways. If both real personal income and average hourly earnings are showing strong signs of improvement in their rate of growth, then you can bet consumption will follow suit. Lately I've been racking my brain trying to figure out a scenario where that couldn't happen. Just not coming up with anything. So, consumption should follow.

That's where my earlier "recession" piece came in. See, consumption would mean aggregate demand. Aggregate demand will translate into higher prices going forward. I think the Fed may have to deal with this scenario in the early part of 2007.

My FX Trading Plan:
Higher overall demand will mean higher interest rates moving forward. I'm looking at the most recent pause as exactly that: A pause. I don't think that the Fed will be lucky enough to have hit the head on the nail with rate increases and be where they need to be. The dollar will improve because of this.

My S&P 500 Trading Plan:
I've been bullish on the equities market ever since I've adopted the Fed's stance on our economic position. Now, however, I'm seeing things that I don't think the Fed is seeing. Sure, we're probably seeing the "soft landing" the Fed hoped would occur right this very quarter. But, once consumption kicks in, the Fed will have to do the same. For that, I am moderately bullish on equities as of right now. Eventually, I will become very bullish. Then, I will be a bear. That is my three-quarter outlook as of where I sit right now.