The Street Gets Inflation Threat Backwards

In my opinion, the majority of economists, strategists and financial media -- the full "punditocracy" -- are exactly wrong on inflation. Indeed, I am hard pressed to think of another item of such grave economic consequence that most of the Street has so backwards.

The problem is, they are looking for inflation in all the wrong places. The inflation (ex-inflation) crowd has managed to ignore robust price increases across a variety of goods and services. Yet somehow they seem to have found inflation in the one part of the economy where there is almost none: wages.

One only had to see the market reaction to last week's data on non-farm payrolls, hourly wages and unemployment rate to realize how much the Street has gotten its panties in a bunch.

The Federal Reserve is acutely sensitive to wage pressure -- much more so than to the commodity price increases we have seen over the past five years. Maybe that's why the FOMC quietly announced that the upcoming meeting, previously planned for March 28, has been expanded to two days. It will now begin on March 27. (I'm sure the extra day isn't for more time to welcome aboard Ben Bernanke.)

If the Fed falls prey to the erroneous interpretation of wages and jobs, we could see a tightening cycle that goes far beyond what many on Wall Street currently expect. And that would bode extremely poorly for market prospects, both this year and next.

Recent Inflationary History

Recall the 2001-02 period. The economy was essentially a flat line. Tax cuts hadn't helped, spending down the surplus was of no avail, nor was the war in Afghanistan all that stimulative. The Fed had seen the Japanese debacle and was in no mood for a decade or more of zero growth. With Bernanke providing the intellectual rationale, it made a concerted effort to "reflate" the economy by cranking up money supply and radically dropping rates to half-century lows.

The prime risk of artificially reflating any economy is inflation. And that is precisely what has followed this Fed orchestrated "reflation." With the exception of wages, prices for just about everything else have risen, as detailed here and reflected in the Reuters/Jefferies CRB Index.

CRB 6 years