However, inflation levels remain "elevated," likely because of strong wage growth, increased skilled labor needs, and high resource utilization. Demand in many industries meets/exceeds production capacity, allowing producers to raise prices, and consumers/businesses will accept them. It's especially true in the gasoline markets, as increasing demand forces refineries to test their upper production limits.
Overall, I expect both current short term rate levels and inflation to stick around for a while, and I agree with Bob Pisani that the Fed remains in neutral for a couple of reasons:
1) Developing economies continue to grow between 5-7% and will compete for raw materials and energy. I know that some anticipate $40 oil prior to $70, but, because of continued global unrest and declining production rates, I think that $50 may be a floor. At $70, oil prices would cause an economic slowdown, but in the 50's, it will help maintain current inflation levels.
2) Increased oil and exploration costs will help support inflation levels. Chevron (CVX), ConocoPhillips (COP) and ExxonMobil (XOM) may each allocate upwards of $20B for capital expenditures, and skilled labor in the energy sector remains scarce. Sounds like a possible investment consideration in oil services/drillers.
I'd focus on Transocean (RIG), as they're doubling rates for use of their deep ocean drilling equipment. Also, one of the brightest investors today, Leon Cooperman at Omega Advisors, owns a big chunk of it. I think that Cramer likes it, too...
3) Strong demand for many goods and services outside of some manufacturing and autos, including travel/leisure, aerospace, and financial services, and the aforementioned gasoline demand into the summer driving season will also augment inflation readings.
4) Everyone expects the declining housing market to force inflation downward, but I do not believe that it will do so. Those with little equity, adjustable rate loans may feel some pain and cause dampened consumer spending, but I do not expect any panic or crash. The industry remains well-funded, and lots of capital exists to bolster the mortgage market and its bonds.
Most Americans will continue to normally live their lives without a significant spending pullback. I would watch Wal-Mart (WMT), though, as its core customers live on the margin, spend 25% of their budget on energy, and may see some pain from sub-prime mortgage troubles.
Overall, outside of a real panic in the housing market, I don't expect the Fed to reward borrowers and lenders for their risk activity by lowering rates anytime soon. Alternatively, if necessary, they can drop rates by 50 basis points in an instant, so their rate neutrality won't hamper any emergency action. Bernanke and crew remain focused on their mandate - stable prices and max employment. Employment could improve, but they're doing a good job preventing inflation from affecting the economy.
Inflation distorts consumer and business activity, diverting capital away from productive uses to those activities that help consumers/businesses avoid inflation's effects. Hoarding, abnormal, unproductive capital spending, stuff like that. This potential behavior forces the Fed to remain focused on controlling it. All said, inflation shouldn't be bad for stocks - savings that would have been allocated to bonds and real estate will be allocated to equities of firms that have pricing power, competitive moat, strong operating margins and sales growth.
Starbucks (SBUX), J Crew (JCG), Apple (AAPL), Brown-Forman (BFB), Diageo (DEO), Chevron, ConocoPhillips, US Bancorp (USB), Wells Fargo (WFC) and Berkshire Hathaway (BRK.A), (BRK.B) all fit this strategy.