U.S. financial markets have been buffeted by an intensification of risks attributable to rising oil prices, slowing growth, political uncertainty, tech-sector revaluation, and Middle-East bloodshed. Fortunately, though, contemporaneous inflation remains a non-issue. Today’s report of a 0.3% gain in core producer prices for September is being interpreted in some quarters as evidence that the 18-month-long run-up in oil prices is finally showing spill-over effects in the general price level. It isn’t. We spoke with a BLS analyst who explained that the core PPI gains were largely attributable to a statistical glitch in the seasonal adjustment for auto prices. At this time of year, the seasonals essentially assume that manufacturers discount current model-year cars to make room on the lots for new models. But auto prices are not conforming to the seasonal assumptions. As a result, what was actually a flat month for auto prices was recorded as a significant gain in the seasonally adjusted index. Correcting for this distortion, the core rose by a scant 0.1% last month, exactly in line with expectations. The 0.9% headline gain was also skewed higher by this quirk, but was primarily explained, of course, by the oil-price surge. As we have noted on several occasions, the higher oil price represents a tax on producers and consumers rather than a loss of monetary value.
 

Today’s extraordinary 8% NASDAQ bounce-back also suggests the market saw much more to cheer in this morning’s robust retail-sales data than to fear in all the inflation hand wringing. Indeed, the shrugging aside of inflation concerns in the face of the PPI and sales data, as seen for example in the long bond’s recovery from an early half-point loss, came as a rude shock to many. “The numbers were strong. The market should be substantially weaker,” said an incredulous trader at one major bond house. Whether the NASDAQ is now poised to sustain a rally from these levels will still depend critically on exogenous factors, including oil prices and the Middle East conflict. But the string of stronger-than-expected earnings reports from a number of high-tech vendors the past few days, supported by the retail sales figures, seems finally to be chipping away at a mood of relentless pessimism. Recognition that the selling of the past six weeks was overdone, as observed today by Goldman Sachs’ Abby Joseph Cohen, should continue to provide head room for recovery, at least in the near term.
 

A tricky set of risks to the environment bears watching going forward, though. Unless and until oil prices retreat significantly, the Fed will continue to be boxed in in its ability to reverse its earlier round of rate hikes. Notwithstanding protestations to the contrary, including a Wall Street Journal op-ed this week by usually reliable supply-siders Alan Reynolds and Brian Wesbury, this would be a particularly inopportune moment for the Fed to signal monetary ease. For some reason, Wesbury and Reynolds have chosen to ignore the experience of the 1970s, when Fed ease to counter the effects of rising oil prices in a slowing economy contributed significantly to the worst inflationary outbreak since the Civil War. At the same time, though, there is little doubt that maintenance of the Fed’s current deflation-biased stance will exact a mounting price over time. Indications of deteriorating credit quality now being reported are the inevitable consequence of central bank policy increasing the real burden of debt repayment through sustained appreciation of the unit of account.