For an agency that has been talking about the globalized economy and how technology driven market efficiencies have contributed to a new anticipatory gradualism in the movement of economic and financial variables, the Fed’s latest FOMC statement showed a dramatic turn in views regarding the economy. From a persistent fear of deflation and recession, the committee has suddenly changed its view to the notion that "the probability of an unwelcome fall in inflation appears to be equal to that of a rise in inflation." Despite the Fed’s grave concerns about deflation, except for some anecdotal evidence in the Fed’s beige book, evidence of falling prices have not been evident for some time. On the contrary, the CPI has actually been on an upward path for some time.

The recent revision to third quarter GDP growth to 8.2 percent confirms that the economy is on an expansion path. The strongest growth was in consumer durable goods spending, up 26.5 percent, with purchases of motor vehicles up 38.3 percent and furniture and household equipment up 21.5 percent. Non-durable goods consumption was up a higher than usual 7.6 percent. Business investment also showed an encouraging rebound, up 14.0 percent, particularly investment in equipment and software, up 18.4 percent. We think the economy will post a healthy fourth quarter growth of about 4.0 percent, before cooling off during the first half of next year to about 3.5 percent. As the U.S. locomotive gains momentum, the global economy is bound to get a healthy boost.

The initial fourth quarter data support the diagnosis of healthy growth for the economy. Industrial output was up 0.2 percent in October. Housing starts shot up by 2.9 percent, mostly single family residential. With corporate profits up 30.0 percent in the third quarter, we think business investment will continue to expand in the fourth quarter. Preliminary sales figures for the Holiday Season also bode well for a Merry end to the year. There are also signals that the employment situation may soon turn for the better; although as we have said before, the unemployment rate will not fall to pre-recession levels due to structural factors.

We continue to expect somewhat higher inflation in the short term horizon. The CPI is currently running at a 2.3 percent annual rate (based on a moving average). Healthy productivity growth of 4.7 percent during the third quarter of this year, compared to the same quarter in 2002, implies lower unit labor costs and hence reduced inflationary pressures. However, we think the pick up in demand will begin to nudge prices in the upward direction. Oil prices are still in the $30 dollar per barrel range – of course many analysts argue that energy prices are irrelevant in determining the inflation rate. A weakening dollar with our incessant appetite for imports will also contribute to higher prices. The University of Michigan’s October survey of consumer inflation expectations was at 2.6 percent, down from 2.8 percent in September. Nevertheless, we expect inflation to move closer to 3.0 percent towards the middle of next year.

With respect to the currency market, our long-standing prediction of the value of the Euro at $1.30 / Euro by the second quarter of next year still holds. The rate is currently at about $1.20 / Euro. In a recent speech, the Fed Chairman asserted that with globalization, huge external deficits in the U.S. will have minimal impact on the value of the dollar. We note a trace of "irrational exuberance" in that assessment. Unfortunately, the history of international financial markets shows that currency markets are ruthless when it comes to correcting unsustainable deficits and thus the dollar will continue to fall in value.

Modest growth of less than 2.0 percent is officially expected in Mexico this year. GDP growth for the first nine months of the year reached only 0.9 percent.