Last week, headlines and pundits were hot and bothered about the potential for the Federal Reserve to fall behind the curve on inflation. While my on-going assumption is that the Fed will indeed chose much higher inflation rather than risk ending the economic recovery with higher rates, I think the current hand-wringing by some is premature. In fact, it seems more the result of either boredom with the Fed’s business as usual policy stance and/or the anxiety on the part of some stock market bears looking for any kind of catalyst to shake the market out of its low volatility slumber.
I was so surprised at all the hand-wringing over a “business as usual” policy statement that I rolled the tape on the press conference. I was wondering what I missed, I actually listened to the conference call a second time (yes, it was painful). The experience made me even more convinced the market over-reacted just as much as it did when Yellen carelessly suggested rates might increase earlier than the late 2015 market projection.
Recent inflation numbers apparently increased expectations that the Fed might show a more hawkish tone. This is reflected best in the first question of the press conference from Steve Liesman of CNBC:
“Is every reason to expect, Madam Chair, that the PCE inflation rate, which is followed by the Fed, looks likely to exceed your 2016 consensus forecast next week? Does this suggest that the Federal Reserve is behind the curve on inflation? And what tolerance is there for higher inflation at the Federal Reserve? And if it’s above the 2 percent target, then how is that not kind of blowing through a target the same way you blew through the six and a half percent unemployment target in that they become these soft targets?”
This was a leading question, especially considering that Yellen made it very plain in her introduction that the inflation readings remain benign. Moreover, long-term expectations for inflation remain tame (also see the Fed’s latest projections). Most importantly, the year-over-year change in the PCE, the Personal Consumption Expenditure, reached the 2.0% target in early 2012 only to quickly plunge from there. Not only might it be premature to project a 2% reading for next week’s release, but there is nothing to suggest that this time is different. The Federal Reserve has the least control over the non-core prices of food and energy, so the escalation of violence and turmoil in Iraq is definitely not the kind of event that the Fed would try to offset with monetary policy.
The Fed still can’t tease the market into sustaining pre-recession inflation levels…
Source: St. Louis Federal Reserve
Perhap’s Yellen’s poor response ignited the flames of disappointment. Yellen did not address PCE directly and instead talked about the noise in the Consumer Price Index (CPI) while reiterating the Fed’s standard guidance on inflation:
“So, I think recent readings on, for example, the CPI index have been a bit on the high side, but I think it’s–the data that we’re seeing is noisy. I think it’s important to remember that broadly speaking, inflation is evolving in line with the committee’s expectations. The committee it has expected a gradual return in inflation toward its 2 percent objective. And I think the recent evidence we have seen, abstracting from the noise, suggests that we are moving back gradually over time toward our 2 percent objective and I see things roughly in line with where we expected inflation to be.”
Ironically, Yellen could have just pointed to the longer-term trend in the CPI. This view dominates any shorter-term noise….
The overall trend on CPI continues to point downward
Source: St. Louis Federal Reserve
The most bizarre part of the buzz on the Fed’s supposed willingness to ignore inflation is that Yellen re-affirmed, re-emphasized that the Fed is all about meeting its price target. It will not tolerate deviations in EITHER direction for long:
“…we would not willingly see a prolonged period in which inflation persistently runs below our objective or above our objective and that remains true. So that hasn’t changed at all in terms of the committee’s tolerance for permanent deviations from our objective.”
This was Yellen’s response to Liesman asking about the Fed’s tolerance for higher-than-target inflation.
I feel irony in my skepticism about a Fed ignoring a budding inflation threat: this is the core scenario that has kept me long-term in the gold (GLD) and silver (SLV) trades. My thesis/assumption back in 2009/2010 was that the Federal Reserve would be extremely reluctant to tighten policy even as the economy strengthened out of fear that rate hikes would quickly kill the economy. By the time the Fed was ready to hike rates, the “inflation genie” would already be out the bottle. Granted, I am not nearly as rabid about this view, especially since I have come to appreciate the deep entrenchment of the lingering post-recession deflationist psychology in the economy.
So, overall, I am very skeptical that this episode is the long-awaited lift-off of inflation and a lagging Fed. I actually think the Fed is right to look through the current “warming” in inflation readings, and I think it will find vindication just as the Bank of England did during a similar episode under former Governor Mervyn King. When the Fed asks “what inflation”, I find myself surprisingly agreeing for now…
To me, the data do not support the notion that broad-based inflation is taking hold in the economy. We do not even have wage pressures, not to mention all the slack that remains in the economy as evidenced in part by extremely low levels of housing production. Just do a web search or read mainstream financial magazines to see anecdotally how many people are still worried about the sustainability of the so far very weak housing recovery. I find it hard to believe we will get strong inflation with all this weakness and deflationary fears. On the commodity side, copper and iron ore have experienced major price declines in recent months that also fly in the face of any kind of sustained inflationary pressure in the economy.
Full disclosure: long GLD, SLV.
The U.S. Postal service is raising prices in an effort to bring in enough revenue to avoid bankruptcy. Prices are going up for a whole host of shipping services including a 3.1% increase for priority mail. The price of a first class postage stamp is still increasing a penny from 44 cents to 45 cents as earlier scheduled for January 22.
For more details see AP story: “Postal prices going up for express, priority mail.”
On November 4, 2011, NPR’s Planet Money did a “blast from the past” podcast reviewing the course of events that led to the rice panic of 2007 and its eventual end. From India’s decision to ban rice exports to hoarding across Asia to corrupt government manipulation in the Philippines of a then vulnerable rice market, we get to reminisce about how rice prices doubled ad then almost doubled again in just four months. The panic finally ended after economists convinced the U.S. to allow Japan to sell its stockpile of rice that it maintains as part of a trade agreement that forces Japan to buy rice from the U.S. it does not want. Ironically enough, the rice was never sold but the psychological impact of the announcement was enough to end the hoarding and bring the market back to a semblance of sanity.
A truly fascinating tale of a completely avoidable bubble in the price of rice.
(Hat tip to a friend who pointed me to this article)
Under Alan Greenspan, the Federal Reserve was known to stand on the sidelines while bubbles in asset prices grew and grew. Greenspan had a lot more faith in the Federal Reserve’s ability to mop up the subsequent mess caused by a bubble’s collapse than in its ability to stop a bubble, much less identify one.
It seems times have changed. On October 13, Businessweek chronicled the Fed’s efforts to make sure that soaring prices in agricultural land do not lead to another messy bubble and economic calamity. Prices have indeed soared across the midwestern United States:
“The Kansas City Fed reported land values were 20 percent higher than a year ago. The Chicago Fed reported a 17 percent increase in its district, the fastest increase since the 1970s. Nonirrigated farmland in the Minneapolis Fed district increased 22 percent in price.”
The factors driving these increases are the same as I reported from a related Planet Money piece: “Land prices have doubled in Iowa over the past few years“: “elevated crop prices, soaring farm income, and record-low interest rates.”
As a result, nervous regulators are demanding rigorous stress tests of banks up to their gills in agricultural loans. Businessweek also reports that regulators are “…scrutinizing the lending standards, loan documentation, and risk management at the country’s 2,144 agriculture banks.”
I will be very interested in the outcome of all this scrutiny. The same Federal Reserve that helped create record low interest rates is working to ameliorate the impact of those very same interest rates. This episode is a reminder that flooding an economy with liquidity does not produce equal outcomes for all sectors. Recovery and prosperity does not even need to appear in the sectors most impacted by the malaise the Federal Reserve scrambles to repair. Instead, the money tends to collect where it will generate the highest returns due to other economic factors. Currently, it seems that the bet is on farming. I believe the Federal Reserve was aiming for housing…
Parking enforcement is one of the sneakier ways a local government can drive up to costs of living in a city without generating direct protest and sometimes without generating even much notice. The San Francisco Chronicle reports that in the last fiscal year, the city of San Francisco raked in $1.5M in additional revenue – $660K from meters and $820K from parking fines – from removing Memorial Day, the Fourth of July, Labor Day and Veterans Day as meter-free holidays. The change occurred July, 2009 and has produced eight holidays that are no longer meter-free.
While the city celebrates the extra money it makes, the citizens can only lament the extra inconvenience and hassle of remembering to pay meters on these holidays, not to mention the additional costs in parking. The disparity in fines versus collected fees likely demonstrates (or confirms for me) that parking rules are mainly about generating lucrative fines.
For more details see “Holiday parking enforcement: cash cow for the city“
The Argentine government says inflation is 9.8%. Everyone else thinks it could be as high as 20%. President Cristina Fernandez has decided to hunt down those reporters who dare challenge official government statistics which have been reportedly manipulated to lower the government’s borrowing costs. This is definitely a story that makes you appreciate the freedom of the press…and remind you how important it is not to let politics influence the collection of important economic data.
For more details see: “Argentina targets news reporting of inflation data.”
Part of the government’s motivation may also be to protect profligate spending that is boosting the economy at least in nominal terms. For more on the aggressive spending programs launched by Fernandez see “Argentine economic plan: Raise spending, salaries.”
If inflation levels remain higher than you like, simply regulate inflation out of existence, right? This logic appears to be the approach of the Venezuelan government as it seeks to curb what it sees as rampant speculation and unfair business practices. According to Nightly Business Report, inflation was 27% last year in Venezuela. The proposed Law for Fair Costs and Prices will create the Superintendence of Costs and Prices that will determine the prices of certain products in an effort to curb inflation. The law bolsters existing price control efforts.
Look for inflation to get worse, black markets to grow, and scarcity of goods to get more severe. It seems to me Venezuela is going after symptoms rather than causes.
For more detail, see “Analysts: Pending price-control law could backfire.”