Watch Tomorrow's Report on US Business Inventories

The US reports the October business inventory data tomorrow. Economists are likely waiting for the report before revising Q4 GDP forecasts. Previously the consensus was coming in around 3% GDP for Q4 and the risk is that estimates are revised higher.

A little more than half of the business inventory raw data is known. Wholesale inventories released earlier this week account for about a quarter of business inventories. With the factory orders data is an inventory estimate of factory inventories, which account for about a third of business inventories. Wholesale inventories rose $1.3 bln in Oct. They had fallen for a little more than a year with the average drop being around $5.3 bln per month. Factory inventories, reported last week, rose $1.8 bln in Oct. They too had fallen for a little more than a year and the average monthly drawdown was for about $5.5 bln.

Some of the increase in wholesale and factory inventories may be related to price and we recognize that separating the nominal from the real is difficult. Nevertheless, on balance there does appear to be something real taking place.

In tomorrow's business inventory report, the new information will be with retail inventories. Retail inventories account for about 40% of business inventories. The consensus calls for about a 0.2% decline in business inventories, which would be the smallest decline since the dramatic liquidation began in September 2008.

The inventory data is reported with a lag and this is only Oct data, so it is still very early data. Inventories fell $133 bln in Q3 and in Q4 they may decline in the neighborhood of half as much and this would be a positive boost to GDP. Today's trade figures also suggest, all else being equal, also small upward revisions in Q4 GDP forecasts. If the consensus was near 3%, there is potential for a conservative 0.5%-0.7% upward revisions to forecasts.

Even though stronger growth means that some unused capacity comes back on line, the key to Fed policy seems to be inflation expectations, more so than inflation itself or growth numbers in and of themselves.

Looking at just one measure of inflation expectations, the 5-year/5-year forwards is implying 2.61% inflation, which is just below the similar French (proxy for the euro zone) measure (2.68%) and down from almost 2.9% a month ago.

The June 2010 Fed funds futures had ticked down to imply a 32.5 bp average effective rate in response to the better than expected Nov jobs data. At 28 bp currently, the June contract is implying a lower yield than the day before the employment report. A similar pattern is evident in the Dec 2010 contract as well. Last Friday the contract closed at an implied yield of 94.5 bp. It is now implying a yield of 79.5 bp.