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During our Q3 themes call we talked about inflation returning in Q4.  We are not calling for STAGFLATION but the possibility is there. 

As a result of sharply higher energy and food price increases, the headline producer price index rose for the third consecutive month.  After gains of 0.3% in April and 0.2% in May, the PPI rose 1.8% in June. The increase was above the consensus projection of 0.9%.  June's 1.8% advance is the largest since the 2.4% gain posted in November 2007.  The 6.6% rise in energy prices suggests that there is upside risk to June's consumer price index reading.

DIRTY WORD - USPPI

While the core PPI surged 0.5% -the biggest increase in almost a year,  almost all of this upside reflected a surge in car & truck prices which can be an unreliable indicator.  Not including autos, the core was up only about 0.1%.  Not so bad!

A Commerce Department report today showed U.S. retail sales rose in June, helped by incentives on autos and higher gasoline prices which boosted service-station receipts. The 0.6% increase was larger than forecast and was the biggest gain since January.  Importantly, excluding automobiles and gasoline, sales dropped for a fourth consecutive month.  

The headline retail sales number in June looks positive on the surface, but the recession has limited retail sales increases to only four of the past 12 months.  Most consumers continue to be cautious in the face of rising unemployment and falling home values.

So where do we go from here?  According to Bloomberg, GDP growth will average 1.5% in 2H09 after declining in 2Q09.  Betting that the consensus is nearly always wrong, the 1.5% GDP figure looks aggressive and the risk is to the downside. 

A soft economy in 4Q, coupled with our 4Q inflation call and the possibility of stagflation cannot be ruled out yet.

Howard W. Penney

Managing Director