US CPI August 2010 and real interest rates

These charts are important:

Commentators I have read seem a little concerned that yearly inflation (chart 2) is still too low for comfort, but the first graph (chart 1) clearly shows that prices for July and August have increased significantly after a three month deflationary period through April to June. The July and August price changes actually represent annualised inflation of 3.70% and 3.05% respectively and are the highest recorded since August 2009. I wouldn't be surprised if US GDP in Q3 was positive now, though there is still room for a decline in Q4.

Download the CPI release here.

My own charts:

The Real Interest Rate chart above (10 year bond rates minus annual inflation) shows that interest rates have declined faster than inflation in the past two months, so while bond rates are historically very low, deflationary effects have been minimised. This means that real interest rates continue to be expansionary.

The spread between 10 year bond rates and the Federal Funds Rate can be used to determine recessionary environments. When the Federal Funds Rate exceeds 10 year bond rates, and the spread is negative (as shown in the middle region of the graph), historical data indicates that a recession will follow, which of course it did in December 2007. In August the spread fell to 251 basis points (10 Year bonds averaged 2.70% while the Federal Funds Rate averaged 0.19%), which indicates a movement towards contraction. Assuming that the Fed won't raise rates and can't lower rates any more than what they already are, any reduction in this spread will be due to a further fall in 10 year bond rates.

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