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So here's a little tidbit: Inflation may be runner hotter (or colder) than the government says. It's a matter of rounding digits.

The story goes like this.

When the Bureau of Labor Statistics presents the Consumer Price Index and Producer Price Index each month, its figures are raw numbers benchmarked against a 1982-starting value of 100.

In 1982, CPI was 100.  Last month, it was 215-and-change.  This tells us that the "Cost of Living" has more than doubled over the past 27 years.

Unfortunately, though, when the government makes it press releases, it doesn't talk in terms of those raw numbers. Instead, it shows inflation in terms of the change from the month prior, expressed as a percentage, rounded to one decimal.

According to the government, consumer inflation fell 0.1% last month.

This is where the problems set in.

Rounding to one decimal place is amazingly imprecise and outright unacceptable for measurements in need of precision.  Economic inflation is one such measurement.

Think about what rounding to one decimal place would do to baseball. Both Ted Williams and Delino Deshields would be career .300 hitters.

Or to math. Solving for Pi would be a piece of cake at 3.1.

Because the government's reporting of inflation is imprecise, Wall Street's perception of the economy is imprecise, too.  This influences the stock market, currency trading, and bonds.  It changes mortgage rates, too.

Inflationary pressure correlates to higher mortgage rates.

Since September 2008:

• Sum of monthly CPI data from the government : +1.8%.
• Sum of non-rounded CPI data from the government : +1.613%

Therefore, consumer inflation is 12% less than what many on Wall Street believe.

If investors were paying attention to this, we would expect mortgage rates to be falling. They're not.  Rates are up again this morning and are now posting 5/8 percent worse from just 3 weeks ago.

Meanwhile, on the other side of the coin, PPI is running hotter than what the government reports.  Few people are watching that, either.

You can't make precise decisions without precise data so remember to look deeper than the headline.  Sometimes, you have to do your own math.  It gets geeky at times, but watching the right data is what separates the accurate analysts from the merely average ones.

If you're watching mortgage rates and need help finding the right time to lock, enlist my help as a loan officer. and we'll map out your plan.

Members of the Federal Reserve turned up the inflation chatter since late-May and mortgage rates are suffering.

Even worse, it's creating a confusion among home buyers because lender pricing is expiring multiple times daily.

As a general rule, inflation is bad for mortgage rates because it cause the dollar to lose its value.  When the dollar loses its value, mortgages repayments their lose value, too -- after all, we all write our checks against U.S.-based bank accounts.

So, when inflation is present, mortgage rates almost have to increase in order to compensate for devaluation.

With the frequency that Fed members are addressing inflation head-on, traders speculate that Ben Bernanke & Co could increase the Fed Funds Rate as early as its next meeting, June 24.

This may help stabilize mortgage rates, but it would cause credit card and home equity credit line to payments to rise.

If you're shopping for mortgages right now, or are in the process of buying a home, this week was not your buddy.

In early-January -- right up until the surprise 0.750% cut to the Fed Funds Rate January 22 -- mortgage rates were the lowest that they'd been in three years. 

At the time, market participants were fearful of an economic recession and mortgage rates moved lower with each added ounce of recessionary conviction.

Since that cut, though, and through every week since, the fears of recession are ceding to economic hope and recovery.

As a result, the recession-fueled drop in rates from early-2008 is getting ever-smaller in the economic rearview mirror.

Author's note: Eddie Vedder just doesn't look the same without those long, 1991 grunge rock bangs. 

Here's a brief synopsis of what drove rates higher this week:

• The economic stimulus package passes
• A Federal Reserve president says recession won't happen
• The World's most respected investor implied that the mortgage market is not so bad

Then, most importantly, it turns out that the American consumer is still spending after all.

Each of these four points show more economic health than Wall Street had expected.  That has forced investors to reshuffle their investment portfolios.

The biggest loser through all of this is the bond market; over the past five days, 30-year fixed mortgage rates have increased by as much as 0.375%.

With more Fed speakers and key inflation/recession data coming down the pipe (or it is pike?) next week, expect the volatility to continue. 

When in doubt about mortgage rates, stop shopping and start locking.  There is very little good that can come from "waiting out the market".

Saving $50 a month won't change your life but wasting $50 a month will eat at you forever.

Because of technical trading factors, prices on mortgage bonds plummeted last week, dropping more than 50 basis points overall.  Mortgage rates are now at their highest levels in several months.

And, unfortunately for home shoppers, it looks like the trend will continue for some time.

Traders took special notice of last Thursday's Initial Jobless Claims figures.  Normally, this weekly release is as much of a non-event as a Purdue-Indiana football game. 

But this week's surprising strength dropped the one-month average of Americans filing for unemployment to a one-year low.

This is the now the third of three major data points that may be pointing to wage inflation in the US:

1. New unemployment claims are at their lowest rolling average in a year
2. The unemployment rate's steady decline continues
3. Hourly workers are earning more money for their labor

Here's why wage inflation concern markets:

More people working means higher costs for business.  Eventually, those costs get passed on to consumers (who ironically don't really mind/notice because they're taking home a bigger paycheck).

So, consumers pay more for everyday items but that higher cost is offset with their higher income. 

More dollars to buy the same goods -- this is inflation in action.  In an inflationary environment, each dollar is worth less versus the value of the item being purchased so it takes more dollars to buy the same item.

Inflation is universally bad for mortgage bonds because mortgage bonds pay out to investors in U.S. dollars.  When the dollare are "less valuable", the demand for the bonds drop and with reduced demand comes higher rates.

This Thursday, we'll see where Initial Jobless Claims registers.  If it's less than 305,500, that moving average will drop again.

With a plethora of impactful economic releases on tap for this week, don't be surprised if mortgage rates are as random as the Eagles' 4th-down playcalling while traders try to figure out the 2007 direction of the U.S. economy.

Wednesday morning, the Producer Price Index will tell us if business is paying more to do business.  PPI helps us to understand the cost pressures on corporate America.  Then, following PPI's release, is Industrial Production.  This report will tell us just how much business is producing.

Both PPI and Industrial Production are expected to be lower than from November's readings and that may be related to December's "holiday hours".

Next, on Thursday, we'll get to see December's Consumer Price Index (CPI) figures and the month's Housing Starts.  CPI tells us whether the Cost of Living is increasing or decreasing for Americans and Housing Starts will give insight into builders' mentality. 

If Housing Starts is higher than expected, it may signal that builders feel the Housing Slump is in its last years.  Given that weather nation-wide was fairly temporate until about three days ago, expect a higher-than-expected number and the subsequent cries of "The Bubble Popped!  The Bubble Popped!".

Ahead of this week's data, markets put a 72% chance that the Fed Funds Rate will still be 5.250% after May's FOMC meeting and a 17% chance that it will drop to 5.000%.  We'll see what those percentages look like at the end of the week.

This week is shaping up to be The English Patient -- slow and boring.

Not much news other than weak housing data.  Of course, markets are using the information to shore up the "Inflation is Dead" mentality that seems to settling over the markets.

Chicago Fed President Michael Moskow said in a prepared statement yesterday that "additional firming of policy" may be needed to lower inflationary pressures.

"We need to balance the benefits of gaining new information against the costs of waiting too long. If inflation stays stubbornly high while we wait to see the effects of earlier policy actions, inflation expectations could increase -- and that would be very costly."

The Fed has repeatedly told us all that it is "data dependent", meaning it can't make absolute decisions about the Fed Funds Rate and the economy until information becomes available.  The FOMC voting members walk a fine line between accelerating the economy, and grinding it to a halt.

Therein lies the subtlety in Moskow's remarks.

The Fed's job of managing the Fed Funds Rate is akin to shooting foul shots.  Most of us can shoot, wait a half-a-second, and see if our shot went in.  If we missed, we make adjustments and then shoot again.

The Federal Open Market Committee doesn't have that luxury.

The Fed has to wait nine months to see out if its "shot" went in.  And while they wait, they have to step to the line six more times to shoot (or not shoot) again.  It's nearly impossible to know if the shots are "on target" until it's too late.

Not all of the Fed Presidents are speaking publicly about inflation, but Michael Moskow is.  If inflation is present, mortgage rates will rise as markets make adjustments.

Source
Fed's Moskow: More rates increases may be needed
Reuters.com, August 24, 2006

http://today.reuters.com/news/articleinvesting.aspx?type=bondsNews&storyID=2006-08-22T170247Z_01_N21102525_RTRIDST_0_ECONOMY-FED-MOSKOW-URGENT.XML

In July, both the Producer Price Index and the Consumer Price Index fell short of market expectations.  This reduces some inflationary pressures on mortgage bonds. 

Predictably, mortgage rates are improving and markets are beginning to convince themselves that inflation is contained.

This is a scary thought along the lines of wondering what the offspring of Martha Stewart and Burt Reynolds would look like.

See, once traders convince themselves that inflation is contained, they begin to change the environment variables surrounding their market positions. 

This opens the window by just a smidgeon for every trader on the face of the Earth to get a healthy dose of hubris.  Especially in securities markets.

And why is all of this happening?

1. Last week, the Fed held the Fed Funds Rate at 5.250%, signalling that the economy may be retreating from its torrid growth
2. PPI reported weaker than expected
3. CPI reported weaker than expected

The new information is causing traders to alter their inflation expectations and how the strongly the FOMC will fight inflation throughout 2006.

As an example, Monday morning, markets predicted with 90% certainty that the FOMC would increase the Fed Funds Rate to 5.50% by the end of 2006.  Within two days, that probability fell to 43%. 

Ladies and gentlemen -- that's a huge swing.

I am not saying that markets are now leaning too far away from inflation, but it's important to recognize that we are all just one strong jobs report away from nasty whip-saw action in mortgage rates.

Get it while the gettin's good, folks.  Lock your rates today.

The Big Picture makes a funny point about the drop in core PPI and how it can be directly linked to the weakening sales of SUVs and Light Trucks.

From the blog:

The great irony here is that because GM can't move their trucks due to their lousy fuel economy, they have to offer big discounts -- i.e, rebate/mark them down.

The sale prices of poor selling trucks makes it appear that there is no inflation, when what we actually have is everyone thinking inflation is going away -- so naturally the markets rally.

Hence, by being unable to sell their 10MPG trucks, GM's stock price actually rises!

Good stuff.

In a prepared speech Monday, Federal Reserve Chairman Ben Bernanke took special care to remind reporters that fighting inflation is a Number 1 priority of the Fed.

From his remarks:

"While monthly inflation data are volatile, core inflation measured over the past three to six months has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth."

In English: If inflation continues at its current pace, it could be damaging to the economy as a whole.

And then, the bombshell:  "These are unwelcome developments."

For some idea on how powerful those four words were, take a look at how many times the phrase showed up after just 36 hours on a few popular search engines:

• Google: 498 listings
• Yahoo: 309 listings
• MSN: 628 listings
• Technorati: 70 listings

Those four words are why the Dow is off 246 points so far this week.

For a Fed Chairman who promised to be more open and plain-talking, traders are repeatedly caught off-guard by the Chairman's remarks.  This tells me that "openness" does necessarily quell "uncertainty" in the market.

In the wake of Bernanke's remarks, traders flipped (AGAIN!) on their sentiment about inflation and are now expecting at least a 0.250% increase at the FOMC's June 28-29 meeting.

Source
Deciphering Ben Bernanke
Jeannine Aversa
MiamiHerald.com; June 07, 2006

http://www.miami.com/mld/miamiherald/business/national/14756410.htm

FRB: Speech, Bernanke--Panel Discussion: Comments on the Outlook for the U.S. Economy and Monetary Policy--June 5, 2006
federalreserve.com

http://www.federalreserve.gov/boarddocs/speeches/2006/20060605/default.htm

The Chicago Tribune's Rick Morrissey wrote a piece about steroids in baseball this week.  In it, he talks about the 1990s and how many home runs were being hit.  At the time, writers concluded that the baseballs were "juiced".

A few of the theories floating around at the time were kind of bizarre:

• The economy was good in the Dominican Republic and so the people were happy.  Because they were happier, workers were winding the baseball's core a little tighter, which caused the ball to jump off the bat faster. 
• Colorado's thin air contributed to the uptick in dingers.
• Weather patterns and El Nino caused a change in the jet stream so that baseballs get held up longer (and always out towards left-center).

And that brings us to Ockham's Razor.  Ockham's Razor states that the simplest answer is usually the right one.  According to this theory, the real reason why so many home runs were hit was because athletes were cheating.

Stories like this tell us a lot about Human Nature.  Even though the answers to our most burning questions can be in front of our faces, we ignore them because they're not the answers we're looking for.

So, let's relate it to mortgage rates because I read a lot of news sources every day. 

To hear the experts tell it, inflation is not impacting our economy because of this reason, or that reason.  It's a natural progression for the economy, they tell us; data is cyclical and we're on an uptick.

At face value, though:

• Yes, consumers are experiencing rising costs. 
• Yes, businesses are facing higher material costs. 
• Yes, the real cost of borrowing money is higher. 
• Yes, labor markets are tightening.

And yet, writers ignore these signs because inflation is the ultimate economic evil in America. 

Inflation is the answer that nobody wants to hear.

So, Rick Morrissey tells us the story of how baseball writers blinded themselves from the truth because it wasn't the answer they wanted.  Instead, 101 theories were tossed out for public consumption.  In hindsight, it should have been obvious. 

Someday, I can't help but wonder if we'll all feel the same about the economy.

Sources
It's naive to think cheating's out of baseball
Rick Morrissey
Chicago Tribune, Friday, April 14, 2006

http://www.chicagotribune.com/sports/columnists/cs-060413morrissey,1,5926154.column?coll=chi-sportscolumnist-hed

Ockham's Razor
Wikipedia

http://en.wikipedia.org/wiki/Ockam's_Razor

Friday, for the first time since February 1983, Gold touched $510.80 per ounce.  This caps a 16 percent rally dating back to September. 

In October, we talked about gold's status as an inflation hedge. 

As local currencies loses value, gold doesn't.  That makes it an attractive "safe haven" investment.

And it appears to work in the long-run:

• In 1895, the price of gold was $20.70 per ounce. 
• In 1995, the inflation-adjusted price of gold should have been $379 per ounce.
• In 1995, the actual price of gold was $387 per ounce.

But, across a smaller set of years, the price of atomic element 79 swings wildly from point to point.  In the short-term, gold appears to be as volatile as any other investment security.  The recent gold rally illustrates this point well.

The issue worth watching watch, though, is how much of gold is trading on speculation, and how much is trading on fundamentals?

As the price of gold continues to grab newspaper headlines, its allure may spill over to lay investors who may not understand that gold can lose value, too.