Kudlow Fears Inflation

OK, you might ask what else but let’s check out the latest from Lawrence Kudlow:

Right now, gold, the dollar, bond spreads, and commodities all point to inflationary money from the Fed … Some of my supply-side colleagues have been warning of higher inflation for the last few years on the basis of three dead bodies: rising gold and commodity prices and a soft dollar index. But I have avoided the inflation call because the bond market hasn’t signaled a move to higher price indexes. Frankly, the bond market is a far more broad, deep, and resilient indicator than gold, commodities, or the dollar. Hence, it deserves a disproportionately high ranking in the body-count scheme. Additionally, the Treasury bond has even greater analytical meaning because of the inflation-adjusted bonds (or TIPS) that trade in the open market. Basically, the 10-year Treasury bond can be deconstructed into a growth component (the real rate) and an inflation component (the TIPS spread). And so far this year the 10-year TIPS inflation spread has risen about 21 basis points, putting it above its 5-year average. So is it the fourth dead body? Well, the modest widening of the TIPS inflation spread may be a weak signal of inflation risk.

We could be mean here is note that Kudlow has fretted over rising commodity prices and then explain to him why this is a silly measure of inflation expectations. But let’s agree with his emphasis on the spread between nominal interest rates and the 10-year TIPS. Our graph shows the monthly averages of the 10-year Treasury bond rate and the 10-year TIPS or real interest rate from January 2003 to March 2007. This spread has displayed a little noise over this period reaching 2.71% in March 2005 and was only 2.38% in March 2007. I just checked here and saw the on April 11, 2007, the nominal interest rate was 4.74% and the real interest rate was 2.28% implying a spread equal to 2.46%. Yes, this is a really weak signal of rising inflation.