Back to newsletter listDate:
Sat, June 17, 2006 12:00:35 PMFrom:
MoneyNews
Subject:
Wilkinson’s Edge: Bernanke Has a Conundrum of His Own
| To view this email as a web page, go here. |
Saturday, June 17, 2006 Dear MoneyNews Reader:
If former Fed Chairman Alan Greenspan was allowed to have one, then surely his replacement Ben Bernanke deserves one too.
For Greenspan the notion that he pondered, researched, assessed and analyzed was why long-term interest rates were lower than short-term interest rates - even when the Fed had embarked upon hiking official rates and then continued to raise them.
The conundrum was, therefore, yield-curve inversion.
You see, the economy during Mr. Greenspan's era was repeatedly and neatly summed up as "the Goldilock's economy." That parallel was in reference to the fact that the government and central bank had engineered an economic nirvana. Activity was neither too hot nor too cold - but always just right.
[Editor's Note: Andrew's Hedge Fund Investing service has picked up profits of up to 123% while sidestepping the stock market's inflation fears. Go here now.]
It seems that Mr. Bernanke has spent the early weeks and months in his new office working out how his comments have been received by both the press and the financial markets.
But the new Fed chair can't seem to hit the honey pot at the moment.
On the one hand, he says that the Fed may pause in its rate-rising activities. That comes across as too cold for inflation-wary investors.
Yet on the other hand, he says that the Fed will remain "vigilant." That statement has been construed as too hot for markets to handle and is the direct cause of the emerging-market rout, as well as the extreme volatility in U.S. equity markets.
And let's not forget the backdraft felt across global natural resource prices the last few days.
My conclusion is that, whether or not this performance by Mr. Bernanke and his Fed cohorts is intentional, the impact has created a new conundrum for the Fed chairman.
Namely, he's trying to determine what impact the tone of his prepared statements is having. Clearly the extreme volatility is unwelcome, but it's a result of the communication problem that the Fed apparently has thus far in 2006.
Let's get to the root of the problem, which is inflation.
It makes perfect sense for a central bank to approach the problem of inflation with a firm resolution.
Central banks have two distinct policy options. First, they actively set policy, and when growth and inflation need to be controlled, they raise rates. But they have to remain ahead of the curve and act with plenty of time to solve the problem.
Their second option is to talk tough and send a strong message to everyone from corporate America - where wages are set - to foreign investors, who buy dollar-denominated bonds. The message is that the Fed will maintain low and stable prices.
Having reached a Fed funds rate of 5% - a nice round number - some weeks ago, the Reserve began to float the notion that they may pause at one or more meetings in order to watch the reported data present evidence of some slowing in the economy.
However, while that last remark has held true, consumer and producer inflation readings have come in stubbornly higher than the Fed would like.
Prices paid components of business surveys are still expanding, which indicates that raw material and energy costs are still feeding through.
However, given the 12% slide in the value of emerging-stock market indices, the flight to quality (as evidenced by the spike in the U.S. dollar) and the slide in commodity prices, you'd be forgiven for coming to the conclusion that inflation is on the launch pad and scaring the heck out of investors.
The Bernanke Conundrum seems to be one of consistency and more about whether he's hitting the honey pot when it comes to actions and words.
You could also describe the problem as one of inconsistency between actions and words.
I went back through some charts of what happened to inflation during the last major rate-tightening period, which ran from February 1994 to January 1995. Short-term rates doubled from 3% to 6%. Inflation in the 1990s The graph shows the Fed funds rate in yellow plotted against annual consumer inflation (red line) and the annual producer price index (white line). Note that each colored series has its own scale on the right-hand axis.
Take a look at how the broad trend in both price measures was down prior to the Fed's decision to start its one-year-long assault on interest rates.
Focus on the white line depicting producer prices. It was the worst-behaved of the series.
As theory has it, the price rises that producers face are not always passed through to consumers, thanks to gains in productivity and competition.
Rather than try to stick the customer for their own price rises, producers invariably sacrifice margins.
You should also be able to see that, just as the Fed reached the peak in that cycle, core consumer prices were moving along at 3.1% - and at the time, that was its highest level in 18 months.
That had the market not only believing that producer prices were feeding through to consumer inflation, but also that the Fed would have to keep pushing rates higher.
It wasn't many months before the Fed actually loosened policy.
So let's update that same chart with a look at how inflationary pressures are moving alongside the policy actions the Fed is currently taking. Inflation Today It doesn't take a genius to recognize that interest rates have been rising longer and relatively further than they did in 1995. We have already risen from 1% to 5%.
At the same time, consumer prices have bounced from an extremely tame level. Yet the Fed can still take comfort in the fact that CPI is rising at 2.4% year-over-year and not 3.1%, as it was when rates peaked in 1995.
The more worrying trend is seen within producer prices, which are running at 4.4% compared to the 3.7% peak during the prior period.
However, compare the impact of rising interest rates back in 1995 to the ultimate decline in producer prices as growth was brought under control.
And that's precisely what we are staring at right now by just about anyone's definition.
With corporate earnings forecast to slow from 15% to 11% this quarter (down from their approximately 12% pace in the corresponding quarter one year ago) and a clear slowing in the U.S. housing market, it's undeniable that the world is slowing.
But I'm really not sure whether we are on the inflationary launch pad. There are two pieces of evidence that I showed in last week's column.
First is the renewed inversion of the yield curve, which continued this week.
And 10-year yields fell further below two-year yields this week in the face of the inflation data and renewed stock and commodity selling pressures.
Second is the reaction in the price of gold.
Traditionally, gold rises when investors perceive any hint of inflationary pressure. I'm not denying that inflation isn't with us today. What I am saying is that investors aren't reacting as though inflation is set to reach the stratosphere anytime soon. Gold Inflation The price of gold has slumped 25% since its mid-May peak despite a heating up of inflation news and debate.
[Editor's Note: Hedge Fund Investing's gold play is up a whopping 77% in two weeks. Go here now.]
Gold bears have been rewarded with the slide in global commodity prices at a time when you'd have bet the house that all of the necessary gold bull ingredients were evident.
Ultimately, the problem seems to be one of credibility, which is hardly surprising.
Fed members currently have a bad habit of stating that the recent blip in inflation is beyond their comfort zone. Then they qualify it with the usual acknowledgement that the economy will slow thanks to previous Fed action.
Comments from Sandra Pianalto, president of the Cleveland Federal Reserve Bank, caused a slide in stocks recently after she suggested in no uncertain terms that inflation was too high.
Yet she went on to report that the 5% Fed funds rate is consistent with a gradual improvement in the outlook for inflation.
She also added that a cooling housing market, flattening energy prices, strong productivity growth and an overall economic moderation were on the cards.
Her speech hardly hints that she is watching the rocket launch that other investors seem to be focused on.
Investors right now are putting the Fed into a box - one I'm not sure it deserves to be in. That box carries the label "inflation hawks." If you're concerned by inflation, you tighten and worry about the consequences on growth after you see inflation turn downward.
Unfortunately, the other label the Fed could be tagged with - that of "inflation doves" - suggests a less mechanical and more scientific approach, in that policy makers take an emotional reading of the economy and try to steer the best overall course.
The problem comes at times such as this, when investors aren't sure about what's ahead.
They read, hear and see a slowing economy in the distance. But any hint that the Fed isn't concerned about inflation ignites a threatening blaze across financial markets.
It's the Fed's job to walk the walk and talk the talk.
For now, they need to sound off about inflation fighting and not lose sight of where the economy is really heading.
Right now, transparency isn't good for the Fed. But I can't see many Fed members hoarding gold bars just yet. Have a great week!
Andrew Wilkinson P.S. Get exclusive access to million-dollar hedge fund strategies for the price of a newsletter subscription with my new service, Wilkinson's Hedge Fund Investing. Join today. |
Wilkinson's Edge
For information on advertising at NewsMax.com, please contact Corrine McNurlin via e-mail or call 888-766-7542.
If this MoneyNews Alert has been forwarded to you and you would like a subscription, please visit: http://www.newsmax.com/moneynews_signup.cfm?PROMO_CODE=1EF1-1 Sign up for MoneyNews e-mail alerts today!
|
|
To remove your e-mail address from our list or to modify your profile, Go Here. We respect your right to privacy. View our policy. This email was sent to: ***
|
