Inflation hawks can point to all the positive economic indicators they like – a new high on the Dow Jones Industrial average, an upside surprise in labor markets, positive housing data.
They can beg, plead, even throw tantrums in an effort to convince the Federal Reserve to tighten fiscal policy lest their fears of soaring consumer prices turn into reality.
But it’s not going to work.
“The Fed will probably not raise (interest) rates until 2016, according to Bubbles Bernanke.”
That’s from Anthony B. Sanders, a finance professor at George Mason University, not-so-affectionately referring to Fed Chairman Ben Bernanke.
Same goes for the Fed’s massive bond buying programs known as quantitative easing which have flooded securities markets with cash and raised the Fed’s asset sheet to more than $3 trillion, a record.
“The Fed has pretty much drawn their line in the sand.”
- Bill O'Grady, Confluence Investment Management
The Dow reached an all-time high on Tuesday and has continued to climb ever since, jumping another 50 points on Thursday to nearly 14,350. Meanwhile, private payroll firm ADP on Wednesday reported an increase in 198,000 jobs in February, a nice upside surprise that could foreshadow a surge in the Labor Department’s monthly report due Friday.
Economists on average are predicting an increase of about 160,000 jobs in February, which would leave the unemployment rate unchanged at 7.9%. The ADP report has caused some analysts to rethink those figures higher and lower, respectively.
"Line in the Sand"
Yet asked whether any of these factors was likely to alter the Fed’s easy-money strategies, Bill O’Grady, chief market strategist at Confluence Investment Management in St. Louis, didn’t hesitate. “No,” he said.
“The Fed has pretty much drawn their line in the sand,” O’Grady said: the Fed won’t swerve until inflation rises above 2.5% and unemployment dips below 6.5%.
Bernanke, in testimony before Congress last week, and Fed Vice Chair Janet Yellen, in a speech earlier this week, both made it clear that they have no intention of steering away from their current policies.
“At present, I view the balance of risks as still calling for a highly accommodative monetary policy to support a stronger recovery and more rapid growth in employment,” Yellen said Monday in a speech to the National Association for Business Economics.
Bernanke expressed similar sentiments during two-days of testimony last week.
“Bernanke has said he believes the benefits (of loose fiscal policy) outweigh the costs,” said O’Grady. “But what’s missing is an explanation of what we should be watching for in terms of the costs. There’s a difference between explaining and selling a policy and what Bernanke was doing was selling the policy.”
The long-term fear among analysts who are calling first for an end (or at least a gradual slowing down) of the Fed’s bond buying programs and eventually higher interest rates is runaway inflation.
Already in evidence, they argue, is the short-term impact of asset bubbles caused by all that easy money flowing into securities markets.
Analysts point not only to the Dow hitting a recent high despite an otherwise weak economy, but also to a significant surge in Treasury prices brought about by historically low interest rates and the Fed’s bond buying programs.
The Fed’s policies are “forcing risk-intolerant investors to take on more risk by capturing higher bond yields,” according to O’Grady. Moreover, “some of that money (created by the loose fiscal policies) is now moving into equities,” he added.
Hence Sanders’ descriptive nickname “Bubbles Bernanke.”
“I would say that it is largely the Fed’s bubble machine that is sending stocks higher,” Sanders said. “Most economic indicators today pale in comparison to those in October 2007, the last time we saw a peak in the market.”
And therein lies the problem for inflation hawks. The economic indicators – primarily the unemployment rate – aren’t strong enough yet for the Fed to steer away from its loose fiscal policies. And core inflation numbers, which exclude food and energy, are nowhere near the 2.5% figure at which Bernanke has promised to shift gears and start raising interest rates.
Still, one aspect of the Fed’s plan is clearly working – the goosing of asset values.
O’Grady, however, doesn’t see that as a path to economic recovery. “No business owner is going to say 'I’m going to hire a bunch of people because the Dow hit a new high,'” he said.
The Fed, according to O’Grady, seems to be pursuing a broad policy in which rising stock markets will raise consumer confidence and lead people to go out and spend more. That will sharpen demand for goods and require employers to hire more workers.
That plan is flawed, however, because upper-income Americans -- or those who own stock portfolios that have benefited from Bernanke’s policies -- have continued to spend throughout the recent downturn. It’s lower- and middle-income people who need a lift, said O’Grady, and that lift will come through housing, when their homes start returning to pre-financial crisis values.
To be sure, the Fed has tied its policies directly to the struggling housing and labor sectors in recent months by keeping long-term interest rates low.
Skeptics of those policies -- ie., inflation hawks -- are hoping runaway consumer prices don’t wipe out whatever gains are made in those important sectors before struggling consumers ever feel the relief.
Regardless, the Fed isn’t likely to change its course any time soon.