June 11, 2006


Monday view: Storm clouds gather over a US economy heading for icebergs (Ambrose Evans-Pritchard, 12/06/2006, Daily Telegraph)

Fear is creeping into the markets that a hyperactive Federal Reserve run by a chatterbox novice, risks sinking the global economy by tightening too hard - supposedly to curb prices, in reality to combat his fatal reputation as an easy-money ideologue. [...]

Bernard Connolly, global strategist for Banque AIG, says the Fed, now chaired by Ben Bernanke, has already gone too far by raising rates sixteen times from 1pc to 5pc since June 2004, too much for an overspent economy running on fumes.

"Unless the Fed begins cutting rates by this summer, which it won't, then the US economy could be in for a nasty recession. The stock market has not yet woken up to the full gravity of this," he said. [...]

For now, Mr Bernanke seems determined to steam ahead with a quarter point rise to 5.25pc this month - and damn the icebergs. His pilloried "pause" talk in spring gave way last week to studied words about the "unwelcome" level of core inflation, now 2.1pc. Within hours the effects of this volte-face hit Turkey, South Africa, India and Thailand, all compelled to raise interest rates to defend their currencies and slow an exodus of foreign investors.

"He reintroduced testosterone to the inflation-fighting resolve of the Fed," said Diane Swonk, an economist at the US firm Mesirow Financial. She told the Washington Post: "This is a pure male thing. 'You think I'm a wimp? Take me on,' he said to the markets."

Yet the Fed's own staff said in May that inflation will peak over coming months before slowing later in the year. Hourly earnings are remarkably tame, rising just 0.1pc in April, down from 0.6pc in March. The Economic Cycle Research Institute's ECRI index, which signals future inflation, dropped 0.2pc in May and is now well below its peak in October.

Fed doves are pleading for caution. "We want to be looking through the windshield, we don't want to be just looking at the rear view mirror," said Governor Randall Kroszner.

Yet Mr Bernanke has buckled to the will of the Fed's monetary Ayatollahs - Dallas and St Louis come to mind - although he knows the risks of interest rate overkill all too well.

It was he, Professor Bernanke, who wrote the seminal 1995 paper - Inside the Black Box: The Credit Channel of Monetary Policy Transmission - describing how inflation lags the cycle, flashing amber long after the real danger has switched to recession.

And it was he - scholar of the Great Depression - who blamed the Fed for crushing the American banking system in the early 1930s by starving it of funds. "You're right, we did it," he said theatrically as a junior Fed governor at the 90th birthday party of Milton Friedman. "We're very sorry. We won't do it again."

Talk about hostages to fortune.

The onus was really on Alan Greenspan to reverse the disastrous course at the end of his term, so that Mr. Bernanke wouldn't have to prove his inflation hawk bona fides by further ill-advised hikes. But Mr. Bernanke has certainly done enough damage on his own now that he can stop fighting an inflation that does not exist.

U.A.W. Facing Tough Choices, Leader Warns (MICHELINE MAYNARD, 6/12/06, NY Times)

The president of the United Automobile Workers union told his members in a strikingly blunt report released Sunday that they cannot ride out the automobile industry crisis and should be prepared to make tradition-breaking decisions to help rescue the industry.

In the report, to be given to members at the union's convention, which opens here on Monday, the union president, Ron Gettelfinger, pointed to many causes of the industry's grave malaise, including "bad management" and declining auto sales.

But Mr. Gettelfinger acknowledged that the union's health care benefits helped create a ballooning health cost crisis that had become "unsustainable" in the face of the auto companies' declining sales. This, he said, was a reason why the U.A.W. agreed to substantial health care concessions last year.

"This isn't a cyclical downturn," Mr. Gettelfinger said in the report. "The kind of challenges we face aren't the kind that can be ridden out. They're structural challenges and they require new and farsighted solutions."

Why gasoline prices could ease soon: Demand for oil has dropped, sending its price lower. Another factor: an expected slowing in the economy (Ron Scherer, 6/12/06, The Christian Science Monitor)
For Americans tired of watching prices rise at the gasoline pump, relief may be on the way.

After the price of oil hit a high of $75.17 a barrel last month, demand in the United States dipped a few percentage points. Demand by other big developed economies has also eased in recent months, reaching a level that's actually lower than a year ago.

Inflation reports could tip balance (Sue Kirchhoff, 6/12/06, USA TODAY)
The government this week will issue two widely anticipated inflation reports that could determine whether the Federal Reserve keeps raising interest rates or stands aside. [...]

"The Fed apparently has made them (inflation reports) important. That's the corner that it's painted itself into," says Ken Mayland of ClearView Economics. [...]

Further, the yield on the 10-year bond fell below the Fed's short-term rate. The textbook definition of an inverted yield curve is that investors are expecting a sharp decline in the economy, says Bob Barbera, chief economist at ITG. The fear is "the Fed will get their slowdown and then some," he says. [...]

The overall consumer price index rose 3.5% in the 12 months through April. Core CPI was up 2.3% in the past 12 months and was running at a 3.2% annual rate in the past three months.

Other inflation measures used by the Fed also show inflation slightly above its range.

It might not take a big bump up in inflation to influence the Fed to raise interest rates for a 17th time. Analysts for Global Insight expect overall consumer inflation to rise at a brisk 0.4% pace in May. They predict core inflation will remain tame, rising 0.2%, but acknowledge risks.

Jim Paulsen of Wells Capital Management sees core inflation spiking above 3% this year before cooling. But he adds that in a world of low-cost competitors, "with all these new players coming on stream, there's no way we can have runaway world inflation. It's just not the '70s."

The Fed is like something out of a Star Trek episode, still fighting an enemy that no longer exists.

Posted by Orrin Judd at June 11, 2006 9:49 PM

Ha! You perma-bulls were gloating over Bernanke and telling Greenie not to let the door hit him on the ass on his way out, but now your white knight is stuck in the mire.

No inflation, eh? Look at the dollar lately? If the dollar sells off we'll get inflation on our imports due to the exchange rate. Read this article:

Alan Greenspan talked about a "conundrum," in his last year at the helm of the Fed. He was referring to the fact that although commodity prices continued to rise, long term bond yields remained low.

That scenario has shifted moderately over the last few weeks, but is still mostly intact, as gold, oil, and industrial commodity prices have rocketed, but the U.S. Ten Year note yield, has barely crossed the 5% barrier, and may soon fall below that key benchmark, if the economy shows sign of slowing.

So what's left? How about a new conundrum? Instead of buying U.S. bonds, the hoard of international savings, has been putting its money in what it understands, gold and tangible assets.

So we have two major dynamics at work.

Governments and banks, which are presumably more sophisticated investors have continued their purchases of paper assets.

But, for anyone else who has any money, and who has not been able to escape any of these calamities, there is only one thing to do, put their money in something that has stood the test of time, something tangible, such as gold, silver, or platinum.

What's the bottom line? Until Asia gets a big time corporate market, the huge savings glut of the Asian masses, will continue to buy what it knows, commodities.

Some inside the Fed are starting to get impatient with the progress being made on the commodity price front.

After fourteen rate increases, gold is still trading above $650, while the dollar is hovering near its five year lows.

In other words, the Fed's work has barely kept inflation from getting completely out of control, and has done little to add strength to the U.S. currency.


In our opinion, Ms. Yellen, and the Fed are slowly coming to grips with the gravity of the situation. Her remarks show that Ms. Yellen may just be starting to come to grips with the fact that despite the potential for an economic slow down, perhaps of some significance, the Fed may have to continue to raise interest rates indefinitely, just to keep the dollar from collapsing.

Ms. Yellen, dove or not, has been around the Fed along time. In our opinion, her recent remarks are a clear attempt by an old hand to sound out the market's possible responses to a very unpleasant set of circumstances that the Federal Reserve may have to unleash on the global economy, and the financial markets.

Posted by: Robert Duquette at June 11, 2006 10:35 PM

It's not a conundrum. No one believes in long term inflation so they aren't reacting to an artificial spike in a few commodities.

Posted by: oj at June 11, 2006 10:44 PM