Industrial Production

The drop in industrial production has been weaker than expected with most consumer durables experiencing cutbacks. This has been particularly true in the auto segment but also extends to building materials, furniture and appliances. Overall retail sales have been weak and we suspect there has been some undesired build in inventory.

So why are the markets worried about inflation? Some of this reflects the way the consumer inflation measures are calculated. The primary input to consumer prices is housing but it doesn't really measure housing prices. Rather, it measures owners equivalent rent. Since rent didn't keep pace with house inflation over the past 5 years the housing portion of the inflation numbers actually underestimated true inflation. Interestingly, now that we are seeing a flattening of housing prices there has been some upward pressure on rents. Some of this is due to the reduced stock of rental units as a result of condo conversions and a general rise in home ownership rates.

Ironically, we could see rents continue to increase in the face of additional slowing in the economy. People have to live somewhere - if their house is foreclosed on they may move to an apartment.

We see temporary respite in the drop in auto sales but look for a continued slowdown in consumer spending. This will likely begin to increase the savings rate, reduce the trade deficit and stall job creation. It also means true inflation is not a problem. In fact, we believe inflation momentum peaked last September. We look for intermediate to longer-term bond interest rates to begin a moderate drop later in the third quarter.

Strategy Update: Fixed income strategies continue to be longer maturity or in the process of looking for appropriate opportunities to lengthen duration.