One of the supporting pillars in the recent rally is the recognition that inflation isn't a problem. Last year's financial crisis knocked the stuffing out of the system's tendency to devalue the purchasing power of fiat currencies over time. The net result is an unusual level of economic cover for keeping interest rates low--really low. Indeed, the primary goal of the Federal Reserve and its counterparts around the world over the past year has been the unbridled pursuit of
higher inflation, though not necessarily
high inflation.
In the depths of the crisis, the immediate objective was simply to deliver some level of inflation, which is to say something other than deflation. Allowing deflation to fester is simply too great a threat. The basic prescription has been printing money. How's it working?
The good news is that deflation is no longer a clear and present danger, as it appeared to be late last year and into early 2009. Measured by the consumer price index (CPI), the official benchmark of inflation in the U.S., the last monthly decline in consumer prices overall was in March. There have two months with flat prices, but the general trend since the spring is up, if only marginally. In September (the last reported month), CPI advanced 0.2%, down from August's 0.4% rise, the Labor Department reported. The latest CPI reading shows that consumer prices fell on a year-over-year basis, but that statistical quirk will soon fall away as we move beyond the events of 2008.
The October update on CPI arrives next week (November 18), and the consensus forecast is looking for a 0.2% rise, according to Briefing.com—unchanged from September.
Meantime, the Treasury market's outlook for inflation is climbing. As our chart below shows, the implied outlook for inflation based on the spread between nominal and inflation-indexed 10-year Treasuries is now above 2%. This is the first sustained move above 2% since the financial crisis of 2008, save for a brief rise over this level back in June.
A 2% inflation rate is hardly the end of the world, of course, assuming the forecast proves accurate. Indeed, before last year's crisis, the Treasury market was consistently predicting inflation in the 2.5% range.
