Let's Play Numerology - 31.2, 10.8, 12.0, 4.8
Scratching your head, wondering what these numbers mean? They should mean a great deal to you, and you're likely feeling them each day. These are the ANNUALIZED inflation numbers (PPI, CPI) from Nov 2007 and Jan 2008. I picked these out specifically to show how bad inflation is right now, and it may only get worse. The irony here is that the Fed has seen these numbers and continues to ease policy and provide accomodative conditions. At some point that will have to end, but perhaps it will be too late.

How about the Core?
It's widely held that energy and food prices are volatile, thus the 'real' inflation comes from the 'core' rate, which strips these out these components. But, higher oil tends to leak into other areas of production and has a tendency to push numbers higher. The Fed is sanguine on the issue of core vs. headline inflation, refusing to accept the notion of higher costs at the pump and the supermarket will de-stabilize prices. However, it's hard to argue the fact prices are rising everywhere; the numbers up there show it.

Future Inflation
It's hard to fathom the Fed had even a small inkling of thought that inflation numbers would be so high, even at the headline level. The ugly numbers? Wholesale inflation headline is up 7.5% year over year, consumer inflation headline is up 4.3% year over year. While they have been accommodative to try and put growth back on track, their overall mandate is clear: price stability and controlling inflation. On this front, their credibility can be questioned.

Besides oil, gold and other commodities continue to rise precipitously as the dollar plunges to lower depths....this week an all-time low for the greenback. How is this tied into inflation? Products brought in from overseas are price-inflated, so we are importing inflation. How does the future look? TIPS are inflation-protected securities, basically allowing you to buy bonds that factor inflation. These securities have been rising for months and are near all-time highs, signaling higher inflation on the horizon. The real measure of these securities is the TIPS spread with 10 yr treasuries: the wider they are the higher inflation expectations. Currently the spread is as wide as it's been in years. Gold is another indicator of inflation, and it continues to make new all-time highs, currently at $950 and rising toward $1K and ounce. Gold is up 13% already in 2008, but up near 40% for the last twelve months.

Bond Market
The bond market was screaming for rate cuts. That was over two years ago. The Fed finally got the lead out but moved passively at first, not good enough for bond traders. The long bond continued to yield well below Fed Funds, refusing to give up the rant until completely satisfied. And when will that happen, or has it already happened? When yields start rising, they'll say FINE.

Don't look now, but 10-year rates are above the Fed Funds rate for the first time in years, this caused by the aggressive Fed in January. Well, it's been about a month since, and rates are rising, bringing the inflation concerns to the fore. With long rates low, it's not inflation that's a concern, it's growth. Now with an accommodative Fed, the concern is too much money in the system that will spur rampant inflation.

Bottom Line
However you want to slice it, the recent inflation numbers are awful. They portray a picture of rising prices, and with such a weak currency, the wealth affect is in reverse....paying more for items with dollars in our pockets that is worth less. We cannot deny the Fed's forecast did not include this chance. How does this affect the future? Inflation just doesn't 'disappear' into thin air. It's more like a tornado that grows and grows until it's out of control, leaving devastation in its wake. Stomp it out? RATE HIKES, just like in the late 1970's. This act would send shivers up the spines of investors and traders, of course....painful medicine. Let's keep an eye on the future inflation numbers; perhaps the Fed will 'give it up' after a splash of 'cold water' on the face.

Price Headley is the founder and chief analyst of BigTrends.com.