Federal Reserve Chair Janet Yellen is playing a dangerous game, willing to accept higher inflation in the expectation that she’ll get a payoff in the form of better growth.

That trade-off isn’t nearly as neat as she seems to think. These big and fairly rapid moves in the dollar and commodities are destructive and hard for businesses to navigate.

Lower oil prices haven’t been the boon everyone believed, something that doesn’t surprise us and shouldn’t surprise anyone who’s heard of the permanent income hypothesis. And higher prices won’t automatically restore the shale industry either as it isn’t just a matter of turning the spigot back on.

The economic reports since the last update present a dichotomy. While there has been an improvement in the surprises – more better-than-expected reports – the overall tone of the reports has been fairly negative.

Part of the explanation for that is the plethora of reports from the Fed’s regional banks in the past two weeks, almost all of which showed significant improvement. That contrasts somewhat with the real manufacturing data we received.

The durable goods report was quite weak, down 2.8 percent – and better than the estimate of a 3 percent decline. Ex-transportation orders were down 1 percent and core capital goods orders were down 1.8 percent (but down just 0.1 percent year over year).

The personal income and spending report was also disappointing. Income was soft, up just 0.2 percent with the wages and salaries portion turning negative. The spending portion was also a disappointment but more for the revision than the current month.

Existing and new home sales figures were consistent with the flattening trend. Real estate appears to be suffering from price shock to some degree as prices are rising fairly rapidly, up around 6 percent from a year earlier. With rents also rising rapidly, shelter is one area where deflation doesn’t appear to be a concern. Construction spending was a bit less than expected but is still rising at double-digit rates.

Stagflation Indicators

Our market-based indicators continue to reflect that weakness and are generally pointing toward some mild – so far – stagflation. The yield curve has stopped flattening as Fed action looks further away – although the employment report may have changed that ever so slightly. Credit spreads resumed widening as the oil price recovery appears to have run out of gas.

High-yield prices haven’t fallen much since my last economic update but Treasury prices have outpaced them handily, bonds rallying along with stocks.

But the real action has been in the TIPS market where the 5-year moved deeper into negative territory. The difference in the rate of change between nominal and and inflation protected bonds means inflation expectations continued to rise.

So with nominal and real yields falling the market is signaling a general slowing of economic activity, nominal and real, while inflation expectations continue to rise. The changes are fairly small so far but that is the dreaded stagflation, a nasty combination that is hard to defeat. The weakening dollar is either causing that change in expectations or a result of it, take your pick, but with Yellen leading a chorus of doves, the buck is taking it on the chin.

The commodity rally appears to be resting, correcting a bit since the last update. With little expectation of a Fed tightening at the next meeting I don’t expect that to last. A countertrend dollar rally and commodity correction would be perfectly normal after pretty big moves.

But the trend, at least for commodities, does appear to have changed from down to up. For the rally to accelerate and broaden though will likely require a further fall in the dollar. At this point it seems that what we are seeing is a shift in global growth expectations from the U.S. to the rest of the world.

Whether that shift is being driven by monetary policy convergence or as a consequence of coordination (don’t tell me that doesn’t happen; I’m old enough to remember the Plaza and Louvre Accords), or whether the currency moves are driven by the changing economic circumstances is impossible to know. But the shifts are happening and will have an effect.

Capital is flowing back to emerging markets as the dollar weakens and concern about dollar debts subsides. But recovery in those economies is not just a matter of rising dollar prices for commodities. They need someone to sell their goods to, a healthy U.S. economy being a primary necessity. And that is far from assured if the commodity rally continues.

We don’t have much experience with lower oil prices causing recessions – the mid-1980s boom and bust was at least as big as this one and we didn’t get a recession from that one – but higher oil prices are very different story. A spike in oil prices before recession seems almost a requirement.