Inflation, what inflation?

Last night Wall Street took a turn for the worse, it seemed to come, as corrections usually do, when they are east expected. Analysts this morning attribute the fall to comments from a Fed official apparently pushing for further tapering, and others attributing the fall to concerns ahead of the earnings season. One thing I have noticed is the very different reaction the US treasury market has given to the news that the Fed are reducing the bond purchase program from the reaction to the possibility of it happening last summer. In the summer the yield curve steepened sharply as 10 year yields rose, in the last month the US yield curve has flattened slightly (shorter yields have risen and longer yields have fallen). A steepening yield curve is considered to indicate economic growth and a flattening yield curve indicates a weaker growth outlook. One issue that will face the Fed is what to do if the economy does weaken in the coming months. Reversing the tapering decision will feel like a defeat. Personally I think equity markets, particularly the US one had become a little stretched, everyone entered 2014 in a very bullish mood for equities, perhaps overly confident and a period of consolidation will be no bad thing in the long run. The fall in America was despite the Senate agreeing a trillion dollar bill to fund the government for the next eight and a half months.

Yesterday saw three reasonable sized deals announced, I am sure this is a sign that CEOs are getting more confident on the outlook for the economy as well as the realisation that interest rates may not stay at this level for ever.

Today we got UK inflation data in the form of the consumer price index and the Retail Price Index. So far this year inflation in China and the eurozone has come in below analyst expectations, my suspicion was that the UK may do the same, and so it has come to pass. UK consumer price index for 2013 came in at the Bank of England's target of 2%. The question is where is all this money that central banks are continuing to pump into the global economy going? The only conclusion must be that not into the real economy. Proper inflation is caused by wage growth driven by falling unemployment. This is why central governments are focussed on driving down unemployment levels. This is why Mark Carney in my view will lower his forward guidance from 7% to 6.5% in the coming weeks. What we don't want to see is inflation and no growth, stagflation as it is known.

Posted on January 14, 2014 .