Inflation Situation

Advance inflation indicators have dropped off during
February, notwithstanding today's short squeeze on the
price of crude following reports of an aborted attack on
the Saudis' largest production facility. With crude
supplies on an upswing, pricing may ease further in the days
ahead. Crude producers and pit traders are doing their best
to try and kite the price, particularly Iran and the world's
newest tin horn dictator, Venezuela's Chavez.

The longer term advance inflation indicators remain in an
uptrend and this is a continued concern. I do not for one
minute buy into the differentiation between "headline"
inflation and the popular "core" rate. No one who shops
for all the goodies we need can help but notice that the
"core" rate is going up, too. But, you cannot ignore it
since the bond and currency traders are among the official
"core" rate "believers."

Stock Market And Monetary Liquidity

The stock market has been sensitive to changes in the
levels of Fed Credit and the Adjusted Monetary Base (AMB)
since mid-2003. This has been so because traders have
taken to monitoring The Federal Open Market Commitee's
doings carefully as the economy has expanded to glean
changes in monetary policy. The Fed has tightened up
gradually on liquidity since late 2003, and took a
tough line in 2005, until Katrina etc. forced it to
ease up some. The periodic increases to Fed Credit
via reserve injection have led stock and gold traders
particularly to celebrate. Each stock market rally
since Half 2 '04 has been triggered off by FOMC
Treasuries purchases which have quickly showed up in
the AMB.

It is too early to tell yet whether the Fed will extend
the moderate net easing of recent months, although
seasonal factors mitigate against it. Moreover, traders
should note that the stock market is about as extended
as it has been against the trend of the AMB since traders
jumped on the monitoring program after late 2003. Fed
Credit and the AMB do go out of favor as key variables
from time to time, but traders should keep them in mind
now, since the inclination to determine an interim top
in market short rates is running strong at present.

Well, with this piece, I am content to leave the monetary
data alone for a few weeks to look over some other stuff.

Monetary Policy Issues

The rapid drop in commodities price composites since
the end of 1/06 almost broke the longer term uptrend
in place. But, as this week wanders to a close, the
basic fuels group has been able to stabilize, thus
holding the positive edge for the broader composites.

Now since the acceleration of inflation in recent years
has been driven by commodities and oil and gas in
particular, new Fed chair Bernanke will be watching the
action here with special attention. For example, if
fuels remain stable, the threat of accelerating
inflation will begin to wither as there is still goodly
excess productive capacity in the entire US system.
Such a development would leave the Fed room to stop
raising short rates after another couple of boosts.

So it is heads up time for investors and traders, since
for example, the KR-CRB Commodities Index ($CRB) is
once again right down on trend support. Just keep in
mind what a devilish issue this is, since the CRB has
continually held and rebounded off trend support in
each of the past five years. So, a break and hold below
support would be a big deal for macro policy.

As all know, the US economy absorbed some heavy shocks
over the last four months of 2005, with real GDP dropping
to a puny 1.1% AR in the final quarter of the year. In
response Uncle Al had the FOMC spike the punch bowl with
a full quart of 100 proof rum late in the year. That
plus milder winter weather produced a strong January,
leading FOMC to quickly dilute the bowl by blowing out
about $20 billion in Treasuries from its portfolio.
On balance, the advance liquidity measures such as
Fed Credit and the Adjusted Monetary Base now have a
slightly positive bias, with the leader -- Fed Credit --
now stabilizing after a patented Greenspan roller
coaster ride. Bottom line, if the CRB et al take
a stable path, the Fed may slowly ladle more punch
into the bowl even as it raises short rates and talks
tough.

As discussed a week or two back, the cyclical case
for raising rates somewhat higher remains in place for
now. With Katrina relief and more defense spending
expected to produce a larger budget deficit this year,
It is doubtful the Fed will unrelievedly raise rates.
At some point, revenues would slow or crack, and then
there would be a fine mess. A politically astute Fed
chief would likely cut off pushing up rates well
enough ahead of this very important off-year election
to keep the Fed out of the headlines and the line of
fire. Again, a more gentle movement in commodities
prices would be a boon to Bernanke.

BB did field inquiries at the HH hearings about the
Fed's decision to stop reporting M-3 data. He
politely gave the lame excuse about bankers' complaints
regarding costs they must absorb to gather and submit
the data. By this subtrefuge, Bernanke buys time to
study over what should be done about Greenspan's
foolhardy decision to cede so much of Fed control over
reserves back in 1992 in exchange for having commercial
banks take on much of the burden of the splintered S&L
industry.

M-3 has been zipping along at a 10.8% AR over the past
six months. The liquidity cycle is credit driven and
not monetary driven. In fact, there has been enough
excess liquidity not only to fuel housing prices, but
fuels prices as well! (Glad you are gone Al.) The M-3
phenom keeps the economy and profits rolling, but it
has impaired the Fed's ability to slow inflation. This
issue can play hob with policy, and it will be a good
test of Bernanke's courage and ingenuity as well.

Stock Market -- Technical

S&P500: 1275

Well, the market has rallied a little off the 1260 level
of the recent post, as anticipated. As well, I have not
tried to play it, either.

When trading a bull market, I like to go long on deep
oversolds with a significant $ commitment. No such
event occured this time. In fact, when I look at the
broader market viewed weekly, to include small and mid
caps, I see a market that's still overbought when put on
an equal $ dollar weighted basis. The same holds true for the
cumulative NYSE A/D line. So, I am on the sideline for
now.

I keep a proprietary index of the cumulative NYSE A/D line
which I adjust econometrically for the daily TRIN. I feel
it gives me a good picture of internal supply and demand.
Like most of the indices, the proprietary one also features
an ascending triangle, with the base extending back to the
July, 2004 lows. Advancing this triangle gives me an apex
in April, 2006, which will automatically close this chapter
of the market's more recent history. I see that as an
important heads up for all as it may well be make or break time
for 2006.

Stock Market -- Brief Technical Note

S&P500:1260

The S&P caught bids today off a mild oversold and at short term support.
I have passed on it. Looking at the broad market, there are still
too many stocks that are extended on the upside. The S&P fell a
little short of my Jan. 2006 target of 1310, but the broader market was
lit up pretty well in the latter part of the past month, and the
consequent pullback leaves too many stocks still hanging high. So
as a guess and as a conservative gesture, I am not putting on any
long trades just yet.

Economic Indicators

Leading indicator sets are pointing to an acceleration of
economic growth a little down the road.

Dollar order rates have been bouyant in recent months, but
there is upward bias there reflecting sharp increases for
commercial aircraft.

Breadth of new orders for businesses remains in a downtrend,
but the readings are still nicely positive nonetheless.
Although housing has been the media headliner, manufacturing
and service sector order rates were tremendously strong in
late 2003 - early 2004. Understandably, these sectors have
lost zip, but continue to signal moderate growth ahead.

Sensitive materials prices are trending up and unemployment
insurance claims are low and trending down.

One worrisome element remains the real or inflation adjusted
wage. It is not growing. Business is pocketing the income
gains from productivity and not sharing with the labor force.
Continuation of this trend for an extended period will backfire,
leading to lower returns on capital.