The market had three main worries about the U.S. economy at the start of the year — dramatic slowdown, stagflation, and a dollar meltdown. All proved for naught.

It appears the U.S. economy expanded around 3.5 percent in the first half of 2005, which is slightly above the average growth rate during the 1991-2001 period. The slow patch some economists had been concerned about at the end of the first quarter were quickly put aside with news of a larger-than-expected rise in April non farm payroll figures, the outsized jump in aggregate hours worked, a smaller than expected trade deficit, and an unexpectedly strong April retail sales report.

Particularly noteworthy was that job creation in the U.S. through the first four months of 2005 virtually matched last year’s performance during the same period. This helps underpin income and spending during a period in which there is less monetary and fiscal stimulus.

There is little doubt that price pressures are building in the U.S. economy. Many businesses have indicated an ability to pass through price increases. Most measures of inflation have generally risen.

However, there appears to be counter-balancing forces that are keeping long-term inflation expectations in check — global competition and the reluctance of many foreign producers to pass along last year’s dollar decline.

Oil prices and other commodity prices have stopped moving higher and have finally begun easing. The fact that most market participants do not expect inflation to get out of control is partly a function of the credibility of the Federal Reserve. Over the passed year, the Federal Reserve has raised the target for overnight money by 25 basis points at every meeting. The rate has risen steadily from 1 to 3 percent, and the market continues to expect tightening at a “measured pace” (even if that precise terminology gets dropped from the Fed’s communiqu駸). The futures market and survey data suggest most market participants expect the Federal Reserve funds rate to rise to between 3.5 and 4 percent by the end of the year.

Another reason some observers are relatively sanguine about the inflation outlook is the subdued pace of money supply growth. The most liquid measure of U.S. money supply is called money of zero maturity (MZM) — basically the amount of money in the U.S. economic system — and at 1 percent year-over-year, its growth is the slowest in a decade. One need not be a rigid monetarist to suspect the increased price of money coupled with a decline in the supply growth helps underscore the Federal Reserve’s commitment to maintaining price stability.