Inflation: Could the Markets Have It Completely Wrong?

by: David Andrew Taylor

We got some important information on the economy on Friday: Non-farm payrolls. In that, we saw the economy created another 113k jobs with a 4.8% unemployment rate. Not bad. Except, aren't we supposed to be seeing new jobs numbers that are smaller and smaller and smaller.... getting closer and closer to 0 if not eventually negative? Shouldn't the unemployment rate be somewhere around the 5.5% At the current numbers, we're still beyond full employment.

Since the economy recovered fully in 2003, the average number of new jobs added during the economy was 149k. At 113k, we're moderately below average. I would think in order to get to levels where aggregate demand would have an affect on inflation, i.e. slack in demand to bring down prices, we would need to see levels far below average, if not negative.

As for growth in the economy, we saw the GDP come in at 2.5% increase from the year prior. Traders declared the economy as slowing and mentioned that a pause is in order. We saw an increase of 1.8% two quarters earlier. So, at 2.5% that's improving!

You've heard members of the Fed mention that aggregate demand would help assuage the economic forces pushing up inflationary pressures. With growth at 2.5% and an increase of another 113k jobs, how is that going to put slack in demand to help bring down the price of gasoline? It's not.

Here's the latest chart on CPI:

We've gone from 1.00% interest rates all the way up to 5.00%. You could very quickly point out that there are a few interest rate increases in the pipeline that haven't really been felt yet by the economy. Okay. It takes about over six months, which means we are sitting here waiting to see the moves from 4.00% to today's rate of 5.00%. That also means that we've gone from 1.00% all the way up to 4.00% without any real effect.

I need to see more. In fact, what some are calling "good news", I'm calling bad news. That chart on CPI hasn't come down. It's not moving to extremes on the high level, either, and so I don't see inflation being a huge problem. But, I also don't see that chart getting back to the range of inflation that would be comfortable from the standpoint of an inflation targeter.

Keep in mind, interest rates were at all--time lows for a long period of time. This was Greenspan's attempt to get the economy up and running again while simultaneously avoiding deflation. In the process, he pushed the economy into a situation that is having a small inflation situation. I think it's reasonable to believe that any economic plan from the Fed would include bringing the economy back up to full production possibility, while simultaneously containing inflation. We may be at an equilibrium level right now with inflation. We need to get beyond that level in order to bring inflation back into check.

Have you actually looked at the price of oil lately and evaluated the effects that interest rate increases have had on the price? The answer is none, and here's the monthly chart to prove it:

Sorry, but in order to get inflation back down, we're going to have to take some of these jobs off the table. A slowing economy is one thing. But, this economy looks more like it's got a mild case of hiccups.

I think the next two CPI releases have the potential to be real eye-openers.

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