The economy continues to expand at an unusually strong pace, while inflation remains at a lower than expected rate. We think these two trends are not sustainable, either one or the other must change: an economic slowdown with continuing moderate inflation rates, or an acceleration in the inflation rate, with a still strong expansion. We think the outlook for the short-term points in the latter direction, strong growth with rising inflation.

We think the Fed is likely to raise the Funds Rate by 25 basis points at the next FOMC meeting August 22. If so, the Fed could then wait out until January 2001. The economy is still quite strong, and while some easing has been noted, it is not enough to calm inflation fears. On the other hand, abstaining from a rate increase could now be interpreted as politically motivated, just as if they were to increase the rate in September or October. Election year politics may distort their actions.

The economy is still very strong: a) Industrial output up 0.4 percent in July, or 5.8 percent year/year; likewise for manufacturing, up 0.5 percent and up 6.4 percent, respectively. The July growth in manufacturing included a seasonal decline by autos due to retooling. b) Factory orders soared 5.5 percent in June. c) Retail sales up 0.7 percent in June. d) Pattern of GDP growth has been zig-zag: very strong one quarter, less strong the next, but on a fast growth track, and no significant slowing in sight. e) Consumer sentiment at an all time high, this is the demand driver.

Clearly the interest rate sensitive sectors have responded to the 1.75 percentage points increase in Fed Funds since mid-1999. Housing has started to weaken, starts slipped 3.3 percent in July. Demand for consumer durable goods somewhat slower.

Inflation is still a menace to the economy. We disagree with analysts’ optimistic assessment following today’s CPI release. Oil prices were up 14 percent during the past two weeks and will affect the September CPI. We think that energy prices matter, and that their increase will have a somewhat lasting impact on inflation during this phase of the business cycle. Since the core inflation rate is a misleading indicator, we use the 12 month moving average CPI, which is now at 3.0 percent, and we expect it to reach 3.2 percent by December.

Growing public dissatisfaction with the sluggish pace of economic activity in Argentina. Industrial production fell in July for the fourth consecutive time on a month to month basis., which indicates continued weakness. Industrial production rose only 2.0 percent when compared to July of last year, at the height of the recession.

Brazilian economy continues to grow at a dynamic pace. Consumer spending is booming. Retail sales in the first semester were the highest since 1990. At the same time, the currency remains stable, helped by the low inflation rates.

Venezuelan voters gave another solid victory to Hugo Chavez. As we have predicted, the economic and political situation will worsen considerably. When oil prices begin to fall, pressures on the currency will heighten. This could trigger foreign exchange controls and a maxi-devaluation.

Ecuador goes through yet another political crisis, while economic problems persist. Congress continues to oppose the dollarization. Rising inflation may put in question the viability of the current fixed exchange rate.

The economies of El Salvador and Guatemala are growing at a moderate pace. Both countries have been afflicted by weakening leadership of the majority party. In El Salvador the recent electoral gains by FMLN have shaken the ruling ARENA party’s lock on the political process. In Guatemala, President Portillo is facing congressional opposition from his own party from a faction that is sympathetic to Mr. Rios Montt.