What inflation? The US CPI came in at a refreshingly modest 0.2%, with adjustments of course. You have to keep an eye on those sneaky adjustments. For April the featured statistical sleight of hand was the “seasonal” energy price adjustment which argues that energy demands will be higher at this time of year so the statisticians at the BLS need to heavily discount the headline number, just so investors don't get all confused and panic. Never mind $4 a gallon gasoline, energy prices actually 'fell' by 2% in April after that neat little adjustment. Strange, because the Energy Department reckon that gasoline prices rose 9.5% in April over March. The IMF’s global food price index rose 43% over the last 12-months, but the US consumer price index for food is only 5.1% higher yoy. Are they eating what we're eating? For the 12-months through April, prices for US imports were 15.4% higher, and freight shipping costs 70% higher, but never mind. After all, nobody else in the world uses statistical conjuring tricks like 'hedonic pricing' to compute their inflation figures (adjusting prices for imputed quality improvements so a new computer is 20% more powerful this year but costs the same, hey presto, it's actually 20% cheaper.) Or the substitution trick; new cars rise in price? No problem, let's assume (our perfectly rational) consumers substitute second hand cars for new and adjust prices down accordingly. Switch mortgage costs for rents by the same logic. The possibilities are endless. The combination of substitution, the re-weighting of goods rising in price, hedonics and seasonal adjustments explains why US reported inflation has remained suspiciously subdued.
The problem is that the credibility gap with consumer's real world experience is yawning dangerously wide. The BOE and the ECB may be warning of an inflationary breakout and the need for monetary vigilance, but not the Fed thanks to their ever inventive friends at the BLS. Wall Street cheered of course, suspending disbelief to push this strangely lifeless rally a little further into the reaches of the bizarre. Trading volumes and shorting activity have been low and declining since the rally began, a reflection I believe of the fact that hedge funds have withdrawn from the fray, facing tighter prime broker margin requirements and the need to hoard capital ahead of potential redemptions after a generally dismal YTD performance. Bonds weren't quite so impressed by the benign data, pushing through key resistance at 4% (I've posted before on here that government bonds are the worst long term investment in the new inflationary environment we face). US M3 money supply growth is now running at an annualised 34%. The Fed has already pumped half-a-trillion dollars into the financial system in the form of open market operations and its special emergency lending measures. Much of the excess cash in the financial system has not yet shown up in the economy because the banks are afraid to lend the money. But once the credit crunch eases, the excess liquidity could not only expand bigger bubbles in the commodity markets, but also fuel inflation in the US economy, if not drained out again quickly. On May 14th, upon hearing the report of a scant 0.2% inflation rate during April, former Fed chief Paul Volcker raised doubts about the way the government measures inflation. “It doesn’t feel right. I think the bias clearly is more towards higher inflation, offset by the weakness of the domestic economy,” he said. Too right. Can somebody ask him to come back before it's too late?
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