Inflation Potential

I am looking for the 12 month CPI measured yr/yr to be about 2.5%
for 12/10. It was 2.7% for the comparable period over 2009, but
that is primarily because of the slide in prices over Half 2 '08 that
brought the CPI to depressed levels.

The inflation pressure gauges I use did recover strongly over the
course of 2009, but will have to rise much further over the course
of this year for the CPI to reach the 2.5% by year's end. The CPI,
when measured without food and fuels prices, is in a significant
downtrend presently, and this trend could last through at least Q 2
'10 if not longer (The yr/yr reading through 1/10 is 1.6%). Post
recession downtrends of inflation excluding foods and fuels can wear
on for 15 - 24 months. As matters presently stand, it appears that
commodities prices are going to have regain substantial upside
momentum as 2010 progresses to offset the drag effects of other
components if the 2.5% target is to be reached.

The broad CRB commods. composite rose sharply over much of
2009 but has been on a plateau since Nov. and has been losing price
momentum since mid-2009. Chart. So, we are going to have to see a
revival in the speculative juices of commodities traders to get this
index moving up again.

Another measure I watch closely is capacity utilization. That has been
rising sharply in recent months from very low levels to reflect
inventory rebuilding and strong export sales. Hefty rebounds in
both US and China maunufacturing remain in force and that is a
supportive force for inflation. Heavy inventory speculation in China
helped power commodities prices in 2009. A recent tightening of
credit standards by China banking authorities has cooled speculative
interest in raw materials both within and beyond China, but the
mandate from the top is to maintain strong growth there.

The CPI made its all time high in Jul. '08 and has yet to surpass that
level. So, technically, the US is still experiencing deflation. I use a
smoothed calculation of the CPI to drive my 91 day T-bill interest
rate model. The deflation the US experienced has not been steep
enough to warrant a ZIRP policy. The model currently implies the
"Bill" should be 2.1%. Clearly, then the Fed has waived off a
recovering CPI to support the financial system and an economic
rebound.