May 17, 2006
We all understand that the Fed's next move depends on incoming data. But what if the incoming data raise concerns of both higher inflation and slower output growth?
- New housing permits saw their third straight monthly decline in April, the biggest monthly drop since June 2004, and putting them 8% below their value of April 2005.
- The National Association of Home Builders Housing Market Index, based on a survey of builder perceptions, fell to 45 in May, down 6 points from April and down 23 points over the last 7 months. That represents the lowest value for this index since 1995.
Much of the housing slowdown can be attributed to higher interest rates from the Fed. Given the delay between the time the Fed acts and the time the effect shows up on the economy, further weakening in the housing market would be anticipated even if the Fed has no more rate hikes. So, this set of "incoming data" might lead you to think that the Fed would choose to pause rather than raise rates further at the June FOMC meeting.
Recent inflation data have not been very pretty, either. Today's release of the April consumer price index showed a 3.5% increase in prices since April 2005. The big story of course remains energy prices, with motor fuel up 21.4% from last year and fuels and utilities up 12.5%. However, it is less easy than it has been previously to dismiss these latest price increases as "just energy." For example, the medical care component of the CPI showed 4.1% inflation, and housing 3.8% inflation. The median dollar of the CPI bundle went to buy an item whose cost increased 2.8% over the last 12 months.
In any case, the big question for the Fed is what the public expects from all this for inflation moving forward, since those expectations form the basis for many wage- and price-setting decisions. In his testimony 3 weeks ago, Fed Chair Ben Bernanke stated:
The stability of core inflation is also enhanced by the fact that long-term inflation expectations--as measured by surveys and by comparing yields on nominal and indexed Treasury securities--appear to remain well-anchored.
The above graph shows the cumulative change this year in the yields on 10-year U.S. nominal Treasuries and 10-year inflation-indexed Treasuries. Real yields are up about 40 basis points, while nominal yields are up 80. The increasing gap suggests that investors may be anticipating about a half a percent higher long-term inflation rate than they were anticipating at the start of this year.
Bernanke may think we've got a solid anchor, but this boat seems to be drifting.
If the only incoming data had been the new indications of a pending slowdown in real economic activity, the logical call for the Fed would be to hold the rate constant. If the only incoming data had been the new inflation numbers, the logical call would be for a rate hike. But just what is the logical thing to do when both come at the same time?
I'm not sure, but just for fun let me hazard a guess of what the FOMC might do. The rising gap between nominals and TIPS is a hard number already in hand that we can point to, while the rest we see through a glass, darkly. So I'll throw my hat in the ring by predicting another hike in the fed funds rate to 5.25% at the end of June.
But then again, some of that there incoming data may make me want to take my hat back out again.
Posted by James Hamilton at May 17, 2006 05:43 PMdigg this | reddit
Listed below are links to weblogs that reference Stagflation:
» Opening Bell: 5.18.06 from DealBreaker.com
Stagflation (Econbrowser) It's simply too horrendous a word for the media to utter, so at the moment all you see are articles proclaiming that the markets are getting slammed on inflation worries. But let's be honest; a lot of this... [Read More]
Tracked on May 18, 2006 05:43 AM
» Stagflation? from Asymmetrical Information
Econbrowser has a good question: We all understand that the Fed's next move depends on incoming data. But what if the incoming data raise concerns of both higher inflation and slower output growth? Answer: nothing good. There is a school of thought tha... [Read More]
Tracked on May 18, 2006 12:33 PM
» The Carnival of the Capitalists from The Integrative Stream
Welcome to the May 22nd Edition of the The Carnival of the Capitalists!. For those visitors to the site who aren’t familiar, the the CoTC is a weekly roving roundup of the best business, investing and career management posts in the blogosphere, a... [Read More]
Tracked on May 21, 2006 03:53 PM
In this case predicting what Fed will do is not necessarily the same thing as predicting what they should do . . . Fed Chairman is one of the tougher jobs around; unhappily Dr. Bernanke is off to such a poor start it's worth wondering (just wondering, NOT deciding) whether or not he's up to the job.
Fed Chairmen are supposed to be stiff, dour hard-money lovers who "grew up pulling the wings off flies". They are most definitely NOT supposed to repeat allegorical references to dropping money out of helicopters, and once they've made that mistake they should forever more go thoroughly overboard in proving their bona fides as hard money men. Using Maria Bartiromo as a mouthpiece to convey nuances of monetary policy to the marketplace is just one more datapoint suggesting that Dr. Helicopter is not quite ready for prime time.
I had not been aware that the Fed Chairman had stated that "long-term inflation expectations appear to remain well-anchored" until our good professor called it to our attention. In the context of my discussion, it matters not whether the Chairman's observation was correct or incorrect, though he was of course incorrect. Fed Chairmen who understand the job know better than to ever speak of long-term inflation expectations being well-anchored even under the best of circumstances, because the mere act of a Fed Chairman saying such things can cause long-term inflation expectations to begin to rise. What Bernanke's supposed to be stating repeatedly are mantras such as, "though inflation expectations appear low we must remain vigilant to protect against . . . ." and "in uncertain times such as these the Fed's first priority is to err on the side of caution."
The housing market is definitely rolling over after an unsustainable boom period in 2001-2005 and the potential for serious economic drag from faltering new-era mortgages and HEL's is quite real. With much higher gasoline prices acting as a tax on consumers that hits low-income households especially hard, the U.S. economy does appear vulnerable to the downside just as long-term inflation expectations have cast anchors away and begun marching upwards. Stagflation is indeed rearing its ugly head.
So, Dr. Bernanke's put himself in a very awkward position and he's got a lot of work to do to rebuild credibility in a very challenging environment. It is a bit as Woody Allen put it, with humanity facing a crossroads with one path leading to despair and hopelessness and the other to total extinction. Let us all hope that Dr. Ben chooses wisely . . . . .
Posted by: Anarchus at May 17, 2006 08:25 PM
Whenever the Fed (Chairman, Reserve Bank President, FOMC member ) tries to be a good guy to the street and panders to them in public, they unleash the "animal spirits".
Given the massive worldwide liquidity gusher that has been running wide open since the GW crowd swaggered on stage, one would think the Fed members would have the good sense to at least appear hawkish toward inflation.
In the present case, I think it is the Fed inflationary expectations that have come unanchored. The public drivel issued by the Fed ( Janet Yellen, the Dallas guy again, the last FOMC statement) over the past month has been downright conciliatory. I think they are afraid what might happen if the housing market collapses. Methinks they protesteth too much, publically. The economy has been salivating for a 70's inflationary excursion for the past year. I'm with you, higher interest rates now are probably going to be required to put the beast back in it's cage and show the world Ben is no whimp.
Posted by: igor at May 17, 2006 09:24 PM
On the other hand... of all the candidates for the top Fed job, only Bernanke never crossed This president's agenda.
George W. also made a personal visit to congratulate Ben on his new post. Happened 5 times in U.S. history, I believe.
A good (expanding, inflationary) scenario helps the incumbent party...history shows that 9 of the last 10 midterm election years showed a stock market bottom. 5 in October.
Cheney, Rumsfeld, Wolfowitz, Zacharia, et. al...charter members of PNAC have showed a remarkable solidarity in promoting their agenda.
Perhaps it will continue.
Posted by: Outsider at May 18, 2006 01:12 AM
I agree with your analysis about what the market and the Fed are thinking, but personally I don't find it so hard to dismiss the CPI report. The whole problem can be attributed to just energy and rent. Both of those are special cases. Energy is externally generated inflation, which the fed could reasonably choose a policy of ignoring (not to say that it does). Rising rents are an artifact of rising interest rates: the value of housing services as a flow is rising, just as the value of housing services as a flow was falling (relatively speaking) during the period of falling interest rates, causing those reported inflation rates to be unusually low. Rising rents do not represent a fundamental decline in the purchasing power of the dollar.
If you look at the special CPI index for "services less rent of shelter," it has barely budged in three months. (The seasonally adjusted number was up in April, but the seasonally unadjusted number was flat, and the seasonally adjusted number was flat over three months.) The index for "commodities less food and energy commodities" was up only 0.1% in April, and only 0.4% over 12 months.
Posted by: knzn at May 18, 2006 03:47 AM
So, house prices going up? No problem for the CPI, it only includes owner's equivalent rent.
House prices not going up anymore, but rents are rising? No problem, rent should be excluded.
Buying a house is a lot more expensive than three years ago, if rent goes up a lot now as well, that is a very real increase in the cost of not living on the streets.
Posted by: Iasius at May 18, 2006 04:11 AM
dollar is having last drink to the ditch, it is worthless paper, it has no value, I believe we should be very honest and inform the public the reality. Still untill now 90% of American believe the Fedral Reserve is a govrenment Bank, they don't know this org belong to 12 cabals who rubbs America in the day lights, please see the master of money:
Stop Bush before he attacks Iran
I was very pleased to know the money master, it is an eye openning event,it has reminded me of little old story of wolf in a sheep dress while telling and warinning the sheep how the FOX is dangerous TO THE SHEEP, and the SHEEP did beilve that the FOX is No one enemy. Thats why we had all major wars, from our civil war to WWI , WWII , the Korean War, the cold wars, the Gulf wars,
their own word:
(?Never in her history has Israel had the luxury of having 500,000 foreigners fight her wars for her, until now.? --Abba Eban, Foreign Minister to Israel, in reference to the 1st Gulf War. )
lately the IRAQ war, and as the WOLF is so generous we planned more wars, like the coming Iran war,Syria, Labnon, Saudi Arab, Egypet, yr futur thinking and the sky is the limit.
I could not open the money master,WITH OUT the Google video player, I will add the address bar so it will help:
Historical shocking facts we r not allowed to know, c & let be seen please
The Money Masters - How International Bankers Gained Control of America - Part1 (Fixed Audio)
The Money Masters - How International Bankers Gained Control of America - Part2
The Money Masters - How International Bankers Gained Control of America - Part3
I hope you will be able to view this historical eye openning event, and remeber you will not become a WOLF, but a better SHEEP, who can recognises the WOLF, and knows the DANGER OF THE FOX
Collapse of U.S. Economy Imminent
Posted by: adam at May 18, 2006 05:57 AM
Does the FED have any policy?
Any one guesses?
Just see this:
Americans Must Act Now To Stop Greatest Economic Crisis
These are the fundamentals which we ignore, the Fed is the problem not the solution, I don't know how long we take to wake up, before the ship sinks or after. the Elite already pulling out their capitals, the poor SHEEP of 95% will remain onboard to witness the sinking. God bless America
Posted by: amsaar at May 18, 2006 06:10 AM
In the fabulously silly movie 'Mars Attacks' there was a scene where a Martian ran accross a street after a group of fleeing humans with an oversized translator box repeating, 'don't run, we are your friends.'
Each time a US central banker speaks I think back to this scene, but with the translator spiting out, 'don't be afraid, it isn't really there,' where the 'it' is inflation of course.
Well folks, United States central banking is little more than a con game where the tool of choice is inflation but only works well if the suckers in the con behave as though the tool does not exist and in fact is something to be resisted.
In an earlier fabulous film 'The Sting' the Paul Newman character states that the worst thing that can happen to a con man is when the 'mark' 'busts the con,' that is, sees through the illusion.
Well folks, a critical mass of players has just busted the con that underlies United States central banking.
Bernanke will be a failed Chairman.....and soon.
Posted by: esb at May 18, 2006 08:23 AM
Iasius, I'm not saying rent should be excluded in general; I'm just saying it's a cyclical phenomenon that responds to interest rates. A few years ago, there were some very low CPI readings, in part because low interest rates were holding down rents; today there are some high readings, in part because high interest rates are pushing up rents. An accurate picture of general inflation trends would smooth out these two effects and show that underlying inflation has not accelerated as much as first appears.
If rising interest rates cause rents to rise, and the Fed responds by raising interest rates, it will only tend to exacerbate the business cycle: when the Fed finally gets the rest of the economy to deflate, to make up for rising rents, it will then have to cut interest rates dramatically again, resulting in falling rents, which will then require it to cut interest rates more, and so on. Ideally, the Fed should target only that part of inflation that does not respond positively to interest rates.
Posted by: knzn at May 18, 2006 09:38 AM
The problem with FOMC stressing on the importance of "incoming data" is that it unduely puts too much attention on past and near-term inflation, which is a lagging indicator. In the most recent history, CPI peaked in 2000-2001 and core CPI peaked in 2001-2002. I for one, strongly believe that the current run up of inflation is the consequence of too easy a policy from spring 2003 till fall 2005. Focusing on current readings of inflation is the most direct way to lead the FOMC to overshoot.
The FOMC needs to make it clear that by "data dependent", they mean that their longer-term forecasts are currently very sensitive to data (which is usually the case when things are around a turning point). The danger is that the FOMC talks too much about things that are not quite relevant to the policy, such as outlook for the next quarter, and in doing so, focusing the bond traders' attention squarely to the rear view mirror.
Posted by: pat at May 18, 2006 09:42 AM
Pat's point is well taken. Statements from Fed officials suggest that they live at the intersection of forecast and reality. They know a lag when they see one, and work it into their forecast. If experience tells them that inflation will run ahead for a while in response to prior monetary stimulus, then slow within a reasonable period after policy is brought back to neutral, they won't ignore that. It becomes a forecast. To the extent that reality fits the forecast, they policy path they have chosen is correct. If reality contradicts the forecast, the forecast is wrong, and policy is adjusted. What's so hard about that - in theory?
As regards owners equivalent rent, knzn has a point. To the extent that higher rent is induced by higher interest rates, hiking rates in response to higher rents represents a positive feedback mechanism. Positive feedback mechanisms tend to exaccerbate swings. The Fed wants to mitigate swings. It should at least keep in mind that higher home owners equivalent rent is the result of its own efforts to control inflation. The other thing to keep in mind is that home owners equivalent rent, as you might guess from the name, is not a direct measurement of rent, or of home ownership costs. It is computed based on answers about what home owners think they could get from renting their homes. We are talking about a fairly naive answer in many cases. Respondents are not renters, nor are they landlords, for the most part. They don't have any direct knowledge of what they could get for renting their homes. The fact that the series was very tame for the period when home prices were escalating, despite rising mortgage rates, then began to rise when home prices stalled, still with rising interest rates, suggests some sort of wierd imputation of notional cash flow on the part of respondents. When home prices are rising, homes are seen as mostly a growth asset. When home prices are not rising, it feels better to think of them as helping to avoid paying high rent. The owners equivalent rent series not only represents a positive feedback mechanism for monetary policy, but it is a pretty shabby data series, to boot. The right answer isn't to look at it when it's soft and look away when it isn't. The right answer is to look away whenever possible. Fed officials say they prefer the personal consumption deflator. There is good reason.
Posted by: kharris at May 18, 2006 01:29 PM
I wonder if it's just a coincidence that the last time we saw stagflation, in the late 1970s (remember the "misery index", the sum of inflation+unemployment, which hit 22% in 1980), was immediately after a huge oil price rise, just like today.
I think conventional economic theory is that the cause of stagflation is continued money supply growth, which in the rational expectations model eventually comes to be anticipated and no longer has stimulative effects, instead producing only useless inflation. The only effective monetary stimulus is the unanticipated one. The lesson was to focus on inflation and not try to hard to stimulate the economy, since monetary stimulation is inherently something of a con job and you can only fool some of the people, some of the time.
We'll see if Bernanke and company have really learned that lesson. This will be the first test since the early 80s. Or are we doomed to repeat the 1970s?
Posted by: Hal at May 18, 2006 02:22 PM
Hal, this gang has learned the economic lessons of the late 1960s and 1970s about as well as they learned the geostrategic, geopolitical and military lessons emanating from the Vietnam misadventure.
In other words, minimally if at all.
What we seem to have here is a latter day LBJ/Nixon figure over at the White House with Bernanke stepping up to play an Arthur Burns role over at the central bank.
In other words, guns and butter all the way. Or maybe guns and guns and butter all the way.
Posted by: esb at May 18, 2006 02:55 PM
It's just a coincidence.
As market observer Jim Grant notes, "if history always repeated itself, then historians would have all the money".
Back in the 1970s, the real price of oil and gasoline rose much further faster and were much higher than today. Also, the U.S. economy was several times more energy intensive back then than it at present. Moreover, back in the 1970s the energy markets in the U.S. were tightly and rigidly regulated, which limited the ability of the market to efficiently allocate scarce oil, gasoline and natural gas supplies (natural gas was maybe the strangest case - because FERC regulated the wellhead price of natural gas sold across state lines at an uneconomic low price, natural gas producing states were swamped with excess natural gas while natural gas using NorthEastern states went without). Markets today are mostly deregulated and the price-allocation mechanism will function reasonably well if only Congress will keep its sticky fingers out of the pie.
Oh, and on top of all that, the U.S. came off the gold standard in 1972-74, Fed Chairman Burns monetized the debt that had burgeoned after LBJ's Guns AND Butter Administration and at the nadir, the U.S. had to issue "Roosa" bonds with interest NOT DENOMINATED in dollars.
We are so far removed from those days that it seems impossible that we'll go down a path anywhere close to the 1970s grand stagflation. That said, the incipient path we're tottering toward may be equally unpleasant, but different to be sure. Keep your eye on the dollar and on U.S. Treasury auctions. When the rubber chickens come home to roost, that's where they'll show up first.
Posted by: Anarchus at May 18, 2006 03:13 PM
You provide a good discussion of possible stagflation, however it seems that you've omitted the other half of the beast; unemployment.
Todays unemployment numbers are actually pretty good. In order for stagflation to really take hold, it seems that we would need some concrete evidence that unemployement is increasing -- otherwise, we're just talking about inflation.
If nothing else, the feds move will just light a fire under the bond market. Of course, once bonds go up pressure on rising interest rates will cause the fed to reduce interest rates.
This in turn will lessen the inflationary pressure.
Posted by: Barry S at May 18, 2006 08:55 PM
One indicator is money supply. The week that Ben took office at the Fed,the growth rate of M2 was 8.8% p.a. That proved to be the peak,as that growth rate has declined steadily. Yesterday (5/18),it was at 1.9% p.a. If that mini-trend continues things are going to happen.
I realize that money supply is mis-trusted by many folks as an indicator,but such a severe slowdown is too much to ignore.
Posted by: jim miller at May 19, 2006 05:00 AM
When Janet Yellen said ..."consumer's balance sheets are in good shape" she obviously does'nt know what the hell she should'nt be talking about.
Posted by: gordon at August 6, 2006 09:02 PM