What to Watch: Macro Movers

Inflation/Deflation

The justifications for the Federal Reserve's tightening cycle have morphed. When it began in June 2004, the rationale was a "measured removal of monetary accommodation" -- i.e., ultra low rates. Since then, the Fed has been quite cognizant of the threat of inflation. "Pressures on inflation have stayed elevated, but longer-term inflation expectations remain well contained," the Fed's policymaking body said on June 30.

The question is not whether there's inflation -- with nearly everything we buy up significantly in price, there can be little doubt inflation is robust. We also know that the inflation rate is significantly understated by government statistics. The key for investors to consider is twofold: How long will the present inflation continue, and when might it reverse and head toward deflation?

Depending upon its source, inflation can be good or bad. When the underlying cause of inflation is increasing demand for goods and services, that reflects healthy growth. We are willing to tolerate a modest amount of this inflation as a natural part of economic expansion. On the other hand, inflation caused by the government -- federal deficits or sloppy monetary policies (i.e. too much liquidity) -- is problematic, with far-reaching consequences.

Interest Rates

Interest rates are a corollary to inflation. They are so intimately tied together, we can hardly talk about one without referencing the other.

The story of the 2003-05 expansion is nearly exclusively a tale of rates.

In the aftermath of the market crash, recession and 9/11, the Fed brought rates down to half-century lows. That sparked an entire global refinancing cycle whereby both consumers and businesses cleaned up their balance sheets.

Homeowners have been the key driver of spending, as ever-lower mortgage rates allowed serial refinancing. Some have criticized treating homes as ATMs, and their arguments have some merit. One can hardly find much wisdom in exchanging long-term equity for short-term nondurables. But consider this: A very high percentage of consumer spending, job creation and economic activity has been directly tied to this stimulus. While long rates staying low despite a year of hikes may be a conundrum for Alan Greenspan, there's no argument it's been a windfall for the economy