Inflation Potential

The broad CPI made an historic peak of 220.0 in 7/08. Then,
deflation set in and the CPI made an interim cyclical low of 210.2
in 12/08. Since then, prices have risen. The CPI hit 216.2 in 10/09.
Still, this latest reading is below the all - time high by 1.7%. So,
even though the economy is inflating here in 2009, we are still
in a deflationary period, and will not be out of it until the CPI takes
out the 220.0 all-time high.

Now, the markets closely observe inflation momentum on a trend
basis. Inflation often restarts even after a severe recession period,
and for now, the shorter term trend is for more inflation when
measured yr/yr. My inflation thrust indicator, which fell the
most steeply in many years from mid- 2008 through mid- 2009,
is now rising quickly and suggests the inflation rate is going positive
yr/yr now and that it will reach around 3.0% on a 12-month basis
through 1/10. A broader cyclical measure I follow from the
Economic Cycle Research Institute turned up early in 2009 on the
first signs an economic recovery may develop. It has moved up
rapidly and is also signalling a crossover in the CPI% yr/yr from
0.0% to a plus reading.

Looked at month to month, my pressure gauge is losing positive
momentum, reflecting a slowing in the progress of recovery in
commodities prices (chart). In fact, the CRB composite shown in
the chart is now "stuck" in long term resistance zones of 265 - 280.
Now without a fresh surge in commodities, any advance in the CPI
through mid - 2010 is likely to be tepid, and the old 220 high would
stay safe for a good several months. There is too much slack in
the US economy to expect a more rapid rise of inflation pressure
without another strong surge in fuels and other major commodities
sub-groups. It would be easy to question whether inflation would
be more than very mild except that there are two newer forces
to contend with: The growing importance of China and its satellites
as an industrial power, and the much heavier influence of pure
financial speculation in the commodities markets (viz. the oil price
bubble of 2007 - 08).

So, commodities will remain the key variable in the inflation
outlook. For now, it looks like expectations in these market sectors
have grown more subdued. But, let's not kid ourselves. Speculative
interest in fuels and other commodities loops back into the
economy just as readings of the economic indicators can feed into
speculative interest in commodities. So, you have to watch both
processes carefully in assessing the inflation outlook.