May 13: The Inflation Debate – Economic Highlights

Inflation has reared its ugly head in a number of places around the world, such as China, India and even Europe. This is prompting monetary authorities to take corrective measures before pricing pressures reach threatening levels. But that is unlikely to happen here in the U.S. anytime soon, as today’s inline CPI report shows.

Only the other day China raised its reserve requirements for the 8th time in as many months after its April CPI came higher than expected. The European Central Bank (ECB) became the first monetary authority in the developed world last month to raise interest rates in the face of rising inflation expectations, particularly in the core EU economies of Germany and France. And with today’s better-than-expected first-quarter GDP growth rates in the Euro-Zone (more on that a little later), the ECB will likely have to do further tightening in the coming days.

This is the backdrop for the raging debate here in the U.S. as inflation readings have spiked lately. Today’s April CPI report, which came inline with expectations both at the headline and core level, comes after a hotter-looking report at the wholesale level on Thursday.

The Fed has been arguing consistently that the recent spike in inflationary readings was due to transitory factors that will reverse going forward. The Fed’s position appears to have plenty of takers in the bond market, where inflation expectations have remained anchored around levels that are non-threatening for the economy. That said, the core CPI, which strips out food and energy prices, has has roughly doubled since October, but still remains below the Fed’s target level.

The sharp declines in a number of key commodities over the last few days appears to be bearing the Fed out. As such, the Fed can afford to maintain its easy-money policy for quite some time. But the ECB may not have that luxury.

Europe posted better-than-expected first quarter GDP numbers overnight, helping improve the growth outlook for the global economy. The Euro-Zone economy expanded at a 0.8% rate — the fastest in the last three years — driven by strength in Germany and France. Italy and Spain lagged other members, while Portugal went into a recession.

The strong report increases the odds that the European Central Bank will raise rates further in the coming days. This expectation should help the common currency, which had been losing ground in the last few days as renewed concerns about Greece took center stage. This will likely have a net negative impact on the greenback’s exchange value, which should benefit commodity prices.

With the first quarter reporting season almost over, we don’t have that many earnings reports any longer. Upscale retailer Nordstrom (JWN) came out with better-than-expected adjusted results after the close on Thursday. But the extent of its gains lagged what we saw with Macy’s (M) a few days back. We also got a solid top- and bottom-line beat from Agilent Technology (A) this morning. The maker of electronic measurement instruments also raised guidance for the year.

Today’s benign CPI report and strength in Europe should reassure the markets about the growth momentum of the global economy. This should help stocks end this volatile week on a positive note.