Overnight the US Fed left interest rates unchanged. Its words, however, show the Fed remains vigilant against inflation, ready to mop up excess liquidity in the US financial system:

Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

In these circumstances, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

The US markets overnight continued their recent volatile run. The Dow Jones ended flat after having been 70 points up just after the Fed minutes were released. Investors considered the Fed’s approach to be middle-of-the-road; not wanting to paint a too bad a picture of the US economy, but not wanting to declare victory over inflation. In a worrying development, light, sweet crude for August delivery traded as high as $70.52 overnight, before closing the day’s trading up 60 cents at $69.57 a barrel on the New York Mercantile Exchange.

The relevance of the continued hike in oil prices cannot be overlooked. For an interesting account of some of the difficulties of measuring (goods and services) inflation, see the relevant leader from the latest Economist:

After a jittery few weeks, bond markets rallied on June 15th on news that America’s core consumer price index rose by just 0.1% in May. The data were warmly greeted by stockmarkets too. The Dow Jones index rose by 86 points on the day. Investors decided that the absence of price pressures would calm the nerves of rate-setters at the Federal Reserve, who have been worrying out loud about “elevated” core inflation.

What the markets blithely ignored was the day’s bad news. Headline consumer prices rose by 0.7%, the biggest monthly increase for nearly two years. Unlike core inflation, the headline measure includes fuel costs, which rose sharply, as well as food prices. For bond prices to rise on such a big jump in inflation, markets must be placing a great deal of faith in the core index as the true gauge of price pressures. Is that wise?

Good question, and an interesting answer, important for financial market policy wonks as well as market players.

Read more at Henry Thornton.