Inflation tame, labor market heating up

INDICATOR: July Consumer Price Index/Weekly Jobless Claims

KEY DATA: CPI: +0.2%; Excluding Food and Energy: +0.2%/Claims: 320,000

IN A NUTSHELL: "Inflation remains tame but it really looks like the labor market is starting to heat up."

WHAT IT MEANS: To taper or not to taper, at least in September, is the question. If inflation is a concern, it shouldn't be. Consumer prices rose moderately in July but there really is not a whole lot of pricing pressures. Energy costs surged, as expected, but they are starting to ease this month. The second largest rise was in clothing. That is truly strange as we get most of our apparel from overseas and it is doubtful that foreign suppliers are going to keep raising prices. But for me, the key to the inflation picture is the commodities less food and energy component. The cost of the goods, not services, that people buy is going absolutely nowhere. Whatever inflation we are getting is coming from services, health care, rent and insurance. It is not clear how closely any of those are related to the strength of the economy or can be controlled by Fed actions.

On the labor front, jobless claims fell to the lowest level since October 2007. The trend is clearly down and we are nearing a pace of claims that would signal solid to strong job growth. I would not be surprised if the August payroll gain was at least 200,000 and probably higher.

MARKETS AND FED POLICY IMPLICATIONS: The Fed's decision on tapering is not clear. The bleats from the inflation paranoids notwithstanding, pricing pressures are not great and there really is no reason to think that inflation will accelerate much over the next year. As for the economy, we are still not seeing exuberant consumer spending and that is not likely to happen until wage gains accelerate. And we are not likely to see a faster rise in compensation until firms have to bid for workers. The unemployment rate has to fall about one percentage point from the current level to get there and that is not likely to happen until near the end of next year. So the Fed has time to wait. Will it? I can only hope so.