Inflation expectations are rising. While the monthly consumer inflation numbers are running as hot as they have in years, that's not what really worries the Fed. Inflation can surge, but as long as people expect it to subside in time, it's not such a big deal to policymakers. But if prices keep rising, then employers, consumers, and workers begin to anticipate higher inflation and start to factor it into what prices they charge or what salaries they expect. It's that inflation psychology that the Fed really fears. One way to measure inflation expectations is to look at the difference in yields between 10-year treasury notes and 10-year treasury inflation-protected securities. The gap between the two, a widely watched proxy for long-run inflation expectations, is up from about 1.9 percentage points in late 2006 to around 3.2 points today, as calculated by the Cleveland Fed.
The dollar is anemic. It seems that every day the dollar is marking a record low against the euro. Since the start of 2007, the greenback has lost about a fifth of its value against its chief currency competitor. As economist John Ryding of Bear Stearns puts it, "The foreign exchange value of the dollar is, in some sense, a reflection of the relative confidence in the monetary policies of the Fed and the [European Central Bank], and the dollar is falling victim to U.S. easing." Indeed, while the Fed has been debating how far to cut rates and how quickly, the ECB has held fast, as it's focused more on rising inflationary pressures in the Eurozone than on slowing economic growth.
Commodity prices are soaring. Both food and gasoline prices keep surging, thanks in large part to the rising price of oil. But while geopolitical tensions, trader speculation, and global production problems all have a role to play in oil's ascent—which, in turn, is pushing crop prices higher—so does the weakening dollar, since investors have looked to commodities not only as a hedge against inflation but as a hedge against the tumbling greenback. Indeed, one recent study shows that if the dollar had remained stable since the beginning of its decline in 2001, the price of oil would be nearly 50 percent lower than it is today. And higher energy and food prices have served to work against a good portion of the Fed's monetary stimulus, plus making a hash of the Fed's hopes that declining energy prices would relieve inflation pressures.
