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Inflation risk is heating up

This chart shows the market's 5-year, 5-year forward expected inflation rate. Today it is making a new multi-year high. Gold has perked up today as well, gaining $23 to $1104/oz. These facts square with the ISM's January price index reading of 70. Deflation is history, inflation is making a comeback. None of this squares with the skeptics' call for a double-dip recession or even 2-2.5% growth. The key inflation fundamentals are very accommodative monetary policy coupled with declining money demand. Money demand, in turn, is falling because confidence in the economy is returning; money that was hoarded when the outlook was disastrous is now getting put back into the economy. Check out my post last Friday on money velocity for more details. Every day the Fed delays a reversal of its quantitative easing is another day that inflation risk rises.

The market is not entirely unaware of this, as this next chart shows. Despite the Fed's continual assurances that short-term rates will not budge for a long time, the yield on 3-month T-bills has been rising. I don't want to make too big a deal of this, because the rise in yields is still miniscule, but all important changes happen on the margin, and this one looks like it's just getting underway. If bill yields continue to rise, the Fed will eventually get the message that it's time to tighten.

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