Expected Inflation

The one-year expected inflation rate jumped to a 27-month high of 3.4% in January, more than a percentage point above last September's 2.2%. The 5-year expected inflation rate edged up 2.9% from 2.8% the prior three months. It has hovered in a tight range between 2.7% and 2.9% for just over a year.

The spread between the 10-year bond yield and the TIPS yield is considered to be a measure of expected inflation. It is up 40bps from 1.96% on October 8 to 2.36% on February 7. It was near zero at the beginning of 2009. The expected inflation rate in the TIPS is a good leading indicator of the actual PCED core inflation rate, which dropped to 0.7% in December, the lowest on record going back to 1960!





Global Liquidity

One measure of global liquidity is non-gold international reserves (NGIR), which is compiled monthly by the IMF. It rose to a record high of $9.59tn during November 2010. It is up 33% over the past two years. It has doubled since June 2006. NGIR does not include the Fed’s holdings of US Treasury and Agency securities. Adding these to NGIR shows that the Global Liquidity Supply (GLS) rose to a record $11.6tn during November of last year. It is up 51.4% over the past two years, and has doubled since October 2006.



The holdings of US Treasuries and Agencies by all central banks rose to a record $5.59tn last week, up 82.3% over the past two years.



Raw Materials Prices

Professor Copper is among the economic forecasters with the best track record. The Good Professor isn’t fazed by all the commotion in the Middle East. The price of copper rose to yet another record high yesterday. When it was around $4 eight weeks ago, I suggested that it might start behaving like a rare earth metal with a vertical ascent in its price causing it to maybe double over the next 18-24 months. There are a few other base metals that may also perform like rare earth metals, making them more precious than even precious metals.

 

The latest survey of manufacturing purchasing managers showed that the prices-paid component rose to 81.5 in January, the highest reading since July 2008. While rising costs had a limited impact on the fourth quarter’s earnings, more companies are warning that profit margins may narrow in coming quarters.

Purchasing Managers Surveys

UK manufacturing activity outpaced US activity for the third straight month, though both accelerated sharply in January.

German PMI plunged along with the Ifo business expectations index in 2008. Both rebounded during 2009, and continued to climb in 2010. The Ifo index is at a high for the series going back to 1991.

Grain Prices

The end of the Cold War led to the integration of national economies through freer trade, which has boosted prosperity around the world. However, the distribution of that prosperity has been lopsided, especially in emerging economies ruled by autocratic regimes. On the other hand, enough people are enjoying rising standards of living to boost the demand for consumer staples and to lift commodity prices. Rising food and fuel prices reflect the success of Globalization in spreading prosperity. They also pose a threat to this prosperity by causing central banks, especially in emerging economies, to tighten their monetary policies in efforts to keep inflation rates from rising.

The riots in the Middle East have been sparked, in part, by widespread discontent over rising food and fuel prices. Governments around the world are likely to respond by hoarding food commodities. That would only exacerbate the inflationary pressures in the grain pits. Indeed, Friday’s FT reported that countries in North Africa and the Middle East have been accelerating their purchases of wheat recently. On the other hand, the Saudis may respond to the upheaval in their neighborhood by pumping more oil in a desperate attempt to relieve the inflationary pressures that are sparking social and political instability on a global basis.