Deflationary Pressures Out There?

I'm sure the folks at the Fed are watching the commodity selloff of gold, silver, and various energy areas. And I'm equally certain they are watching the drubbing of metals and mining stocks, where Freeport-McMoRan was off yesterday around 5 percent and Phelps Dodge, U.S. Steel, and Alleghany Technology were down about 3 percent. The CBOE gold index was off 4.5 percent in yesterday's trading and 26 percent since May 10.

Money is tight. That's the message of the inverted yield curve where the 5.25 percent fed funds rate is way above most other maturities that are around 4.70 percent. The monetary base hasn't grown all year; it's been flat-lined by Fed actions to withdraw cash and raise their target rate.

The core PPI has dropped two straight months. Housing and autos are deflating. Yahoo is complaining about a big slowdown in ad revenues.

Working through the TIPS bond market model, the real fed funds rate is 2.85 percent, about 50 basis points above the real TIPS bond rate of 2.35 percent, which represents the economy's so-called natural rate.

The dollar bottomed two years ago and a combination of tight money plus reduced terror risk premiums are hauling in gold and oil prices.

As somebody who thought a couple of months ago that a neutral fed funds rate would be 5.5 percent, I am now coming to believe that a neutral rate would be 25 or 50 basis points lower.

Believe it or not, there are deflationary pressures building up out there.