Merk Market Outlook

The recent rise in inflation has not yet been properly captured by the variety of inflation indexes used by the market to assess the pricing environment. The publication of the April Consumer Price Index elicited howls of derision from the market due to the very dubious -2.0% decline in the price of gasoline suggested by the report. At the time, our reaction was that it did not pass the “laugh test” and that once the seasonal adjustments made by the Bureau of Labor Statistics are “adjusted” we are quite confident that the actual increase in headline prices will be accurately accounted for and the increase in core prices that most individuals have observed will also work their way into the data.
All of this has not been lost on the Federal Reserve, which has over the past number of weeks has moved to begin rhetorically addressing the upside risks to inflation and was one of the paramount concerns that drove Fed Chair Ben Bernanke to verbally intervene in the currency markets on June 3. The hawkish contingent at the Fed led by Dallas Fed President Richard Fisher and Richmond Fed President Jeffrey Lacker have been quite forthright in their criticism of the accommodative policy out of the Fed, with Mr. Lacker making an unusually strong critique of the unorthodox temporary auction facility put forward by Mr. Bernanke. Moreover, Mr. Lacker’s pointed jab at the Fed for moving out of the monetary realm into the fiscal realm occupied by the US Congress, provides a real glimpse into not only the moral hazards created by the bailout of Bear Stearns, but the real dangers created by the very accommodative policy that has characterized Fed policy for much of the past several years.
The most obvious result of the Fed monetary policy has been the recent run up in headline inflation. Our forecast for the upcoming core inflation aggregates imply that the consumer price index and the Fed’s preferred inflation gauge, the personal consumer expenditure deflator, will continue to trend towards the upside and reside in terrain above the implied target range of the central bank.