Inflation fears remain high as the Fed's extremely generous supply of reserves and policy stance provides the risk. However, the overload of economic slack (10%+ unemployment, sub-71% industrial capacity use) and a sharp -3.6% annual decline in labor costs provides the forecast direction for the Fed and private forecasters despite the rise in commodity prices.
Today's consumer price report and even more so, the November CPI report, may heighten market fears. From a deflationary rate of -2% in July the annual rate rose to -0.2% in October and is expected to reach almost 2% yoy in November -- all due to the run off of the year ago drop in energy prices.
In short, the brief drop in annual CPI deflation will end in November as the sharp drop in year ago energy prices is removed from the annual calculations and drifts off in to history. While energy costs amount to just 8% of the CPI, its effects have been large given the collapse of energy prices in the fourth quarter of 2008.
The downward trend in core (ex food and energy) prices sets the stage for overall inflation growth as volatile food and energy prices provide some noise. While few seem to believe the forecasters, the group the Philadelphia Fed surveys expects sub 2% consumer price growth throughout 2010 as core growth expectations are centered near 1.5%. Even the 5-year expectations stand below 2%.
The Federal Reserve's official estimates for personal consumption inflation also stand below 2% through 2011 and over the "longer" term. These are the folks with the inflation insight and the ability to direct price growth -- their chief objective.