Updated Outlook: Inflation Is on the Rebound. Formal CPI-U deflation, defined as negative year-to-year change in consumer prices of goods and services, and as reported for the last seven months, has about run its course. The deflation numbers were driven by a collapse in oil and related energy prices in the latter part of 2008. Annual inflation has been ticking higher (less negative) since July, as oil prices bottomed and then began to rise anew in response to Mr. Bernanke’s efforts to debase the U.S. dollar and to impair the dollar’s foreign exchange rate. Positive annual inflation will be in place by next month’s reporting of the November CPI. Inflation induced by a weakening dollar tends to reflect higher import and commodity prices that are not driven by a pick-up in U.S. economic demand.

Recent reporting indicates continuing credit contraction and a widening trade deficit. Both factors have negative implications for broad economic activity, as discussed below. The economy remains in its most severe economic downturn since the onset of the Great Depression, and the systemic liquidity crisis is ongoing. As mentioned in the prior Commentary, the general outlook is unchanged. Equity markets remain highly vulnerable to minor shocks, potentially with extreme instability. Such is due partially to market expectations being removed so severely from underlying economic and financial-system reality. 

Irrespective of near-term market gyrations, the long-term outlook remains extremely bearish for U.S. equities and the U.S. dollar, and extremely bullish for gold and silver. The economy still faces an eventual hyperinflationary great depression, with high risk of that circumstance beginning to unfold in the year ahead.

Credit Contraction Pulverizes Recovery Hopes. The latest numbers on consumer and business borrowing all are declining month-to-month and year-to-year and are getting worse, offering no immediate prospects of an economic recovery. Income growth generally is not keeping up with inflation, and without more-than-offsetting debt expansion, the chances of near-term real growth with any short-term sustainability are nil. 

As shown in the following graph, year-to-year change in consumer credit outstanding fell at a 4.8% annual pace, the deepest annual decline of the post-World War II era. Such followed annual declines of 4.1% in August and 3.9% in July.

The year-to-year contraction in September commercial and industrial (C&I) loans also set a post-World War II record decline, and October’s drop will be even worse. Based on 28 days of reporting, October C&I loans fell by about 16.2% year-to-year, following annual contractions of 10.6% in September and 7.1% in August.

Commercial paper outstanding, which has been in the throes of negative volatility for more than a year, with some resulting year-ago annual distortions, fell 24.8% year-to-year in October, against a 21.2% annual contraction in September, a 34.8% contraction in August, and a peak annual decline of 37.9% in July.

Week Ahead. Given the underlying reality of a weaker economy and a more serious inflation problem than generally is expected by the financial markets, risks to reporting will favor higher-than-expected inflation and weaker-than expected economic reporting in the month ahead. Such is true especially for economic reporting net of prior-period revisions.

Retail Sales (October 2009). Due for release on Monday, November 16th, October retail sales are expected to jump month-to-month by 0.9% (Briefing.com), following September’s 1.5% monthly decline. Monthly growth likely will not exceed the pace of inflation, so the headline number is of some risk of a downside reporting surprise. 

Index of Industrial Production (October 2009). Due for release on Tuesday, November 17th, October industrial production is expected to rise by 0.3% for the month (Briefing.com), versus a 0.7% gain reported in September. Risk is fairly high of a downside surprise here, too, including a possible downward revision to the September estimate.

Producer Price Index (PPI) (October 2009).  Due for release on Tuesday, November 17th, the monthly PPI change is irregularly volatile. Expectations appear to be on the negative side of flat for the month-to-month number, but annual inflation should see some pick-up (less negative) in October, turning positive in November or December reporting.

Consumer Price Index (CPI) (October 2009). Due for release on Wednesday, November 18th, the month-to-month CPI-U is expected to show a 0.2% increase, per Briefing.com. Due to the sharp reversal of oil and gasoline price trends — in collapse one year ago — annual CPI-U inflation should come close to flattening out in October reporting, though remaining in negative territory. With an upside surprise to the monthly inflation number, which is possible, annual inflation could turn positive, once again, as early as the October report.

More likely, though, annual CPI-U will surge back into positive territory with November’s reporting. For October 2009, gasoline prices were down about 16% year-to-year, per Department of Energy estimates. November is shaping up as a 20% year-to-year gain. Even with no month-to-month inflation in November 2009 (a positive monthly number is likely), the annual CPI-U inflation should jump from slightly negative territory in October to more than a 1% annual gain in November.      

Annual inflation would increase or decrease in October 2009 reporting, dependent on the seasonally-adjusted monthly change, versus the 0.82% adjusted monthly decline seen in October 2008.  I use the adjusted change here, since that is how consensus expectations are expressed. The difference in growth would directly add to or subtract from September’s annual inflation rate of negative 1.29%. Consensus results would push annual inflation to roughly a negative 0.3% in October from the negative 1.3% reported in September.

Housing Starts (October 2009). Due for release on Wednesday, November 18th, the pattern of statistically meaningless monthly changes, with the level of activity holding at historically low levels, should continue.