Steering in fog

If we look at last week's PPI figures and today's CPI results, inflation fears should be receding. The Fed has made its position clear by stating that although its policy retains an inflation bias, it is well aware that the economy is slowing down and is hoping that this will be sufficient to contain inflation. It is a tricky game because the other statistic that the Fed is particularly sensitive to is unemployment, and recent figures paint a deteriorating picture on this front. As we mentioned earlier, in the current environment, Fed policy is at crossroads. On the one hand, they can't really tighten any further as the economic slowdown continues to unravel. On the other hand, they can't loosen as long as core inflation is above the 2% upper limit of their comfort zone. With gasoline prices where they are and as the housing slump continues to take it's toll combined with a deterioration in employment, household consumption is set to drop further. This will be partially offset by the export effects of a weaker dollar and a global expansion that is in better shape. We could also add to this a pick up in capital spending but it is still premature to consider this as a given.