The Commerce Department announced that Q3 GDP growth was 1.6%, a level not seen in three years when we were recovering from recession. Compared to a Street estimate of 2.0%, this led to a rise in bond prices, on the expectation of reduced Fed rates. Stocks declined as fear of recession mounted. There was even praise for the Fed for not increasing rates last Tuesday.

It could prove, as we said earlier this week, that this so-called "goldilocks" economy is in fact wearing a wig! Things are nowhere near as good as most market commentators say.

In its recent statements, the Fed has been keen to warn of mounting inflationary pressures. As we reported, well known outside commentators, such as former Fed Chairman Paul Volcker, have also cautioned on inflation, even hinting at political pressure to keep rates on hold.

In the face of these pressures and even published inflation above the Fed’s "comfort zone," the Fed has held rates.

Although we have been urging the Fed to pay far more attention to what we term as stealth inflation, we can understand why the Fed (with one dissenting vote) would want to hold rates as the November elections loom.

We also believe that, with its most sophisticated analysis and access to official information, the Fed, while perhaps not seeing the final figure, had at least a "strong indication" of the way things looked on GDP growth. We can now well understand that the Fed would not want to spook voters or the bond and stock markets at what looks increasingly like a most delicate economic turning point-a turning point where we believe we are facing not just recession but stagflation.

The 10-year bond now stands at a yield at some 60% of the Fed rate of 5.25 %. If the Fed had raised its key rate to 5.50% the differential to the 10-year bond would have risen to almost 1.00 %. Historically, such a wide differential has heralded recession.

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Today, CNBC announced that the fall in house prices had cut some one trillion dollars from the wealth of U.S consumers. The Fed knows that the "property centric" position of U.S. consumers is still uncertain. But, it remains a major concern.

So far, some 60% of the Dow 30 industrial component companies have reported quarterly earnings. A heartening 74% of them came in ahead of Wall Street estimates, with only some 15% disappointing on the downside.

This was good news, but the stock market hardly "roared" as it lurched to what the media describes enthusiastically as, "new record highs."

With geopolitical tensions having appeared to lessen of late. With oil having dropped considerably; with good figures on corporate earnings, jobs and on government revenues, why is it that the stock market has failed to roar?

We believe the market is secretly more concerned about inflation than most financial commentators admit. Every portfolio manager and private investor knows that inflation in his or her own personal expenses is way above the official CPI.

Despite the good news, investors are privately and increasingly concerned about inflation and a resultant rise in Fed rates.

Of course, readers of FIR and MoneyNews will know the CPI is based upon officially "cooked books" (the inflation lie), with a heavy bias to the downside. They will also realize that what the media now describes as new historic stock market highs are not what they appear.

Even discounting for official inflation, the Dow would have to reach some 14,000 to equal its January 2000 peak. To reach its 2000 peak, measured in terms of "real" money (gold) the Dow would have to reach some 23,000! Our readers will ask, "Then what sort of a record is a mere 12,000 on the Dow?"

We believe that an increasing number of investors share our concern about stealth inflation.

[Editor's Note: The government is manipulating inflation data. Read this free report.]

We believe the Fed faces an agonizing choice between stock markets entertaining low morale, the increasingly clear prospect of a slowing economy and the outlook for increasing inflation, even measured by the official CPI. We believe the reality is worse, much worse, as stealth inflation is far higher than most investors, businessmen or politicians can face, without panic.

In short, we feel the Fed is staring right into the face, not of a soft or hard economic landing, but of the most worrying of economic conditions, that haunted us in the 1970’s-STAGFLATION!

So what will the Fed do? We think the Fed will hold rates until after the election. Then, it will gradually raise rates, while talking markets up.

As we go to print, the new Treasury Secretary, Henry Paulson, has just been interviewed on CNBC. To one early question, he replied, "Well, I’m certainly no political expert. …" He then went on to talk up the dollar, the U.S. economy and financial markets in a masterfully political manner. [You don’t rise to the top of a modern investment bank, like Goldman Sachs, without a great expertise in politics!]

Interestingly, Mr. Paulson is now in charge of the most important "President’s Working Group." This group, sometimes referred to as the "Plunge Protection Team", included the heads of the Federal Reserve, Securities and Exchange Commission and the Commodity Futures Trading Commission.

A major Wall Street Journal article (Oct 23) described this committee as, " a significant lever of influence outside the Treasury bailiwick," The article went on to quote Rob Nichols, a former Treasury spokesman as saying This committee is, " where he [Paulson] can shape the debate," on keeping the U.S. economy and capital markets competitive.

According to the article, Mr. Paulson has stepped up activity on this important committee very considerably.

We feel this increased emphasis is well advised in order to cope with the troubled economic time we see looming ahead - a time when markets could easily become spooked and panic.