The Fed Asks “What Inflation?”

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.

 

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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….

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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 UK’s CPI inflation to remain stubbornly high for the next two years

On February 7th, The Monetary Policy Committee (MPC) of the Bank of England (BoE) decided to leave interest rates at the rock bottom rate of 0.5%. In doing so, the MPC acknowledged that it was assuming that the current stubbornly high inflation would eventually return to the target 2%. The MPC is expecting productivity gains and the reduction in external price pressures to do the trick.

“Inflation has remained stubbornly above the 2% target. Despite subdued pay growth, weak productivity has meant no corresponding fall in domestic cost pressures. And increases in university tuition fees and domestic energy bills, largely resulting from administrative decisions rather than market forces, have added to inflation more recently. CPI inflation is likely to rise further in the near term and may remain above the 2% target for the next two years, in part reflecting a persistent inflationary impact both from administered and regulated prices and the recent decline in sterling. But inflation is expected to fall back to around the target thereafter, as a gradual revival in productivity growth dampens increases in domestic costs and external price pressures fade.”

I took particular interest in the claim that external price pressures will fade. To do so, the global economy would have to remain weak. If so, then it is unlikely that growth in the UK will fare much better, even at the projected “slow but sustained” pace. The other possibility is that the British pound or sterling – CurrencyShares British Pound Sterling Trust (FXB) – appreciates enough that external prices go back down. If so, then Mervyn King’s hopes of rebalancing the economy with a reduction in demand for imports and an increase in exports surely will not be realized.

Adding to this conundrum for the UK economy is the stubborn persistence of weak economic growth (mainly flat) along with strong employment growth. The UK economy is getting less and less productive and thus less and less capable of offsetting inflationary pressures. This is a dynamic that I will be watching ever more closely given the BoE projects a two-year horizon over which the economy will continue to suffer high inflation and weak economic growth (aka stagflation). The implication for the currency is mixed, and I continue to expect “more of the same” for the pound.


Bank of England Governor King continues to bet on inflation taking care of itself

On June 15, Bank of England Governor Mervyn King spoke at the Lord Mayor’s Banquet for Bankers and Merchants of the City of London at the Mansion House. The speech covered very familiar themes for King and the Bank of England.

King begins by acknowledging the squeeze on the current economy:

“The challenge facing monetary policy is obvious – the combination of high consumer price inflation and weak economic growth. Both of these might seem surprising given the large amount of spare capacity in the economy. But the rise in world energy and other commodity prices, and the need to reduce both the external and budget deficits, are squeezing real living standards, pushing up on consumer price inflation and slowing domestic consumption.”

Over the years, King has consistently hammered on the theme of rebalancing in the UK’s economy: a transition away from domestic consumption and toward exports and the business investment required to support this shift. King indicated that the rebalancing underway will continue for several more years. This process has necessitated the devaluation of the currency. Interestingly, King cleverly attributes the devaluation to market forces while indicating the Monetary Policy Committee (MPC) chose not to counter-act the pressures on the currency:

“A necessary precondition for that rebalancing was a fall in the real exchange rate. Markets anticipated that need. The nominal effective sterling exchange rate fell by around 25% between the start of the crisis in 2007 and the beginning of 2009, since when it has been broadly stable…

…We could have raised Bank Rate significantly so that inflation today would be closer to the target. But that would not have prevented the squeeze on living standards arising from higher oil and commodity prices and the measures necessary to reduce our twin deficits. And it would have meant a weaker recovery, or even further falls in output…”

In other words, the MPC decided to focus on the implications of a weak economy over the implications of high inflation, judging the former to be the greater threat. In doing so, King has frequently noted that today’s high inflation is temporary, thus rationalizing on-going accomodative monetary policy and low interest rates in the face of high inflation. The primary blame for high inflation has shifted from hikes in taxes (the Value Added Tax or VAT) to commodity and energy prices, both presumably out of the control of monetary policy. Internally, conditions do not exist for sustaining “domestically generated” inflation:

“So far, subdued rates of increase in average earnings, as well as remarkably – some might say disturbingly – low growth rates of broad money have provided strong signals that inflation will fall back in due course. Banks are still contracting balance sheets and reducing leverage. Spreads between Bank Rate and the interest rates charged to many borrowers remain at unprecedentedly high levels, if indeed borrowers are able to access credit at all.”

King really caught my attention when he provided two key conditions that would actually compel rate hikes:

  • A pickup in domestically generated inflation
  • A contraction in the spreads between Bank Rate and the interest rates charged to many borrowers

Given the dour outlook for the economy and an on-going reblancing in the economy, I continue to assume that rate hikes in the UK are somewhere off in a very distant future. King has proven quite adapt in coming up with reasons for maintaining loose monetary policy, and I continue to see strong evidence that he is reluctant to tighten for fear it could upset the rebalancing he so deeply desires. Indeed, King notes that there is no way to tell when the MPC may hike rates:

“Uncertainty inevitably surrounds both the speed of the rebalancing and the impact of today’s consumer price inflation on tomorrow’s domestically generated inflation. So it is simply impossible to know now at what point monetary tightening will begin.”


Housing prices hit new lows

CNBC reported on a study from Clear Capital titled “Clear Capital Reports national Double Dip“:

“Home prices have double dipped nationwide, now lower than their March 2009 trough…a surge in sales of foreclosed properties and a big push by banks to facilitate short sales…[forced] home prices down dramatically. Sales of bank-owned (REO) properties hit 34.5 percent of the market, according to the survey, resulting in a national price drop of 4.9 percent quarterly and 5 percent year-over-year. National home prices have fallen 11.5 percent in the past nine months, a rate not seen since 2008.”

CNBC goes on to indicate that the foreclosure problem has spread beyond just the “bubble” markets that were at the center of the housing crisis:

“…the mid-west is seeing a surge in REOs now, thanks to the plain old recession. 40 percent of the Chicago market is foreclosures, 43 percent in Cleveland and 51 percent in Minneapolis. Home prices fell 8.7 percent in the Mid-West during the past three months compared to the previous quarter.”

For more see CNBC’s article: “National Home Prices Double Dip” (or read the report).

It is once again important to note that housing was one of the big targets of the Federal Reserve’s dollar-printing campaign. Given that housing prices have not responded while commodity prices have soared, we must now wonder whether the Fed believes it simply did not print enough, whether there is a longer time lag than anticipated to seeing an impact in housing, and/or worry about the unintended consequences that have yet to be seen. The money had to go somewhere; so far, it has not been into housing.


Can the Oil and Gas Price Fraud Working Group Succeed Without Examining Monetary Policy?

Time for some comedic relief. On my main site “One-Twenty Two” I posted my own satirical commentary on the recent announcement from Attorney General Eric Holder about the formation of the Oil and Gas Fraud Working Group. This taskforce is supposed to ensure prices properly reflect “real” supply and demand factors from the marketplace. In my post, I ponder what the story would look like if Holder decided to go after the Federal Reserve’s role in generating higher oil and gas prices (mainly through killing the U.S. dollar). Click here to read it.


Service sector inflation at historic lows as the Fed “shoots blanks”

And now for a different perspective…

In CNBC article “Data Double Take: Inflation for Majority of Economy at Record Lows“, David Rosenberg, chief economist & strategist at Gluskin Sheff, argues that inflation is not a threat in the U.S. because the service sector’s rate of inflation is at historic lows. Moreover, companies in the service sector have no pricing power and workers are unable to earn higher wages. These arguments all run counter to other findings demonstrating that CPI from any angle is pointing to inflation in the near future.

The most interesting claim in the article is that the Federal Reserve’s printing press is, in effect, churning out fresh dollars at no cost:

“The Fed may be printing money, but it’s not multiplying through the economy like it once did. That’s because banks are not using it to extend credit, said the economist. Also, our economy has generally become more resistant to the Fed’s reflation powers because of productivity gains from technology and globalization, the doves say.

‘The money multiplier has been broken for quite some time, and recently it is going lower,’ said Brian Kelly, of Brian Kelly Capital, citing money supply data that for every $1 pumped into the economy only 76 cents is being created. ‘In effect, monetary policy has been losing its potency for 30 years. What the Fed is doing now is stepping on the gas while the tires spin in the mud.'”

I would love to see more data on that because over those same 30 years the Federal Reserve’s monetary accommodations have been credited with creating shallow recessions before 2008, averting a complete financial meltdown in the last recession, and, most recently, driving stocks on a 30% rally since late summer of 2010. Of course, easy money from the Federal Reserve has also been blamed for assisting and outright creating the our triple bubbles in tech stocks, housing, and credit.

It seems that one’s inflation expectations often hinge on the imagination: either you believe the generally accepted inflation data as indicative of a tame future inflation outlook, or you look at specific (even pervasive) examples of inflationary pressures as warnings of what is to come. I have clearly been in the latter camp.


The Federal Reserve debates inflation

With so much heated debate and discussion about inflation in the media these days, I thought I would focus on how the Federal Reserve discussed and debated inflation in the latest meeting minutes released today.

The Federal Reserve’s staff economists concluded that while commodity prices have increased substantially and near-term inflationary expectations have also increased, the outlook for medium and long-term inflation remained stable. In other words, current inflationary pressures should prove “transitory.”

“Sizable increases in prices of crude oil and other commodities pushed up headline inflation, but measures of underlying inflation were subdued and longer-run inflation expectations remained stable…

…According to the Thomson Reuters/University of Michigan Surveys of Consumers, households’ near-term inflation expectations increased substantially in early March, likely because of the run-up in gasoline prices; longer-term inflation expectations moved up somewhat in the early March survey but were still within the range that prevailed over the preceding few years.

…Measures of inflation compensation over the next 5 years rose, on net, over the intermeeting period, with most of the increase concentrated at the front end of the curve, likely reflecting the jump in oil prices. In contrast, measures of forward inflation compensation 5 to 10 years ahead were little changed, suggesting that longer-term inflation expectations remained stable.

…The staff revised up its projection for consumer price inflation in the near term, largely because of the recent increases in the prices of energy and food. However, in light of the projected persistence of slack in labor and product markets and the anticipated stability in long-term inflation expectations, the increase in inflation was expected to be mostly transitory if oil and other commodity prices did not rise significantly further. As a result, the forecast for consumer price inflation over the medium run was little changed relative to that prepared for the January meeting.”

Some Federal Reserve members expressed their concern that current inflationary pressures may still lead to upward pressure on long-term expectations:

“…participants observed that rapidly rising commodity prices posed upside risks to the stability of longer-term inflation expectations, and thus to the outlook for inflation, even as they posed downside risks to the outlook for growth in consumer spending and business investment.”

InflationWatch has chronicled numerous instances of companies that either plan to or already have passed on price hikes to consumers. The Federal Reserve is also noticing, but their “contacts” are apparently not confident that plans for price hikes can stick:

“A number of business contacts indicated that they were passing on at least a portion of these higher costs to their customers or that they planned to try to do so later this year; however, contacts were uncertain about the extent to which they could raise prices, given current market conditions and the cautious attitudes toward spending still held by households and businesses.”

I often whether in these circumstances whether the Federal Reserve passes on some “friendly” advise to these contacts…

The most common reason cited for assuming inflation will remain tame is that there remains a large amount of slack in resource utilization in the economy. Someone on the Fed recalled an important exception to such assumptions:

“Some participants pointed to research indicating that measures of slack were useful in predicting inflation. Others argued that, historically, such measures were only modestly helpful in explaining large movements in inflation; one noted the 2003-04 episode in which core inflation rose rapidly over a few quarters even though there appeared to be substantial resource slack.”

One way to keep inflation expectations anchored is to insist that it will stay anchored. Ben Bernanke has planned to do press conferences, and the rulebook assurances over inflation may be part of the motivation:

“A few participants noted that the adoption by the Committee of an explicit numerical inflation objective could help keep longer-term inflation expectations well anchored.”

Finally, the topic of the Federal Reserve’s balance sheet came up. I have long maintained that the Fed will find itself unable to wind down this balance sheet quickly or in a timely fashion. Some on the Fed are afraid that more people like myself will harbor these same doubts:

“…a few participants noted that if the large size of the Federal Reserve’s balance sheet were to lead the public to doubt the Committee’s ability to withdraw monetary accommodation when appropriate, the result could be upward pressure on inflation expectations and so on actual inflation. To mitigate such risks, participants agreed that the Committee would continue its planning for the eventual exit from the current, exceptionally accommodative stance of monetary policy.”

This path toward an exit is likely fraught with monetary perils and should provide a lot more volatility in financial markets. Stay tuned.


Still room for more rate hikes in China

In “China inflation may hit 6 pct, no end to tightening -paper“, Reuters reports that the official China Securities Journal insists fighting inflation is the number one job for monetary authorities. Given a consumer price index hitting 32-month highs in March and likely to rise as high as 6% this year, China will continue to hike rates to thwart these inflationary pressures.

Yesterday, China’s central bank increased interest rates for a fourth time in six months.


Battling inflation is a top priority in 2011 for China

In “China says cannot lower guard against inflation“, Reuters reports that “China’s Premier Wen Jiabao said on Saturday inflation was affecting social stability, and taming it was a top priority for this year…The government is aiming for annual average inflation of 4 percent in 2011, higher than the 3.3 percent rise in consumer prices last year.”

The article notes several measures Chinese authorities are taking to curb inflation, everything from increasing food supplies, reducing transportation costs, and controlling the money supply and bank lending. These measures seem to be working, but the Chinese are not declaring victory just yet…


Greenspan knows inflation?

Suddenly, former Federal Reserve chairman Alan Greenspan knows inflation. In fact, he now sees inflation as a real danger. Greenspan discussed a variety of economic topics with a crew from CNBC. I was quite intrigued, and VERY surprised, at his commentary on inflation and even gold. It is as if retirement has brought on an inflationary epiphany. Stepping away from the printing presses of currency has delivered some remarkable clarity…somehow.

Here are some highlights that were of most interest to me (bold emphasis mine):

  1. Inflation premiums are building up in the “out years”, but none of these indicators (TIPS, out year treasury yields) will tell you when inflation is about to take hold, and certainly not when the bond markets are going to move.
  2. In 1979, 10-year treasuries were yielding 9% and all the indicators told prognosticators that yields had peaked because the U.S. was not an inflationary economy – over the next 4-5 months, yields went up 400 basis points.
  3. Greenspan has always been somewhat skeptical of the output gap – the stagflation of the 1970s proved that “it is not an infallible indicator.”
  4. The general assumption about measures of core inflation is that food and energy fluctuate, but have no trend. That is incorrect.
    1. Rising incomes have shifted diets toward more protein, requiring more wheat crops while at the same time we are running out of arable land. This will create a long-term uptrend in food prices.
    2. Concerns over the security of oil supplies will also put oil prices on an upward trend.
    3. Over the counter derivatives (futures) have encouraged more storage of oil above ground in developed nations, providing a buffer. Otherwise, oil would be even higher right now.

Greenspan’s commentary on gold perhaps hearkened back to his pre-Fed days when he wrote “Gold and Economic Freedom” back in 1966. The quotes below come from CNBC’s transcript of the larger interview. He made these comments after pointing out that both the euro and the U.S. dollar are flawed fiat currencies (imagine what could have happened in currency markets if Greenspan made such an observation while he was Chairman!).

“What the price of gold is saying, is that there elements within the marketplace that feel very uncomfortable with respect to what is going on generally, and its not an accident that you’re finding that central banks are going in to buy gold and one of the reasons is gold is historically one of the rare media of exchange that doesn’t require any collateral or backing, counter signatures, gold is universally acceptable as a means of payment.”

“I’m not saying we can or should go back on the gold standard, that would be extremely difficult, and it would require such cast changes that this society has made no indication that it wants to do that, but I do think to get a sense of the stability of the system, watching the price of gold is not too bad.”

The overall discussion begged the obvious questions on monetary policy. It is not clear to me whether Greenspan’s characterization of existing inflationary pressures compels any changes, especially given these underlying forces are out of the Fed’s control.

http://plus.cnbc.com/rssvideosearch/action/player/id/1828868683/code/cnbcplayershare

Disclosure: author is long TIP and TBT


Fidelity notes stocks are benefiting from an inflationary boom

Great piece from Fidelity considering the implications of the inflationary boom that seems to be driving stocks skyward (“Is this bull unstoppable? The key is how—and when—the Fed exits its historic stimulus program.”)

I highly recommend reading the article as it contains excellent charts showing the relationships amongst monetary policy, earnings, stock prices, and commodity prices.

Here are some key quotes:

“I believe it is becoming increasingly clear that stocks are following the playbook of an inflationary boom. The Institute for Supply Management’s (ISM) January 2011 manufacturing survey is the highest in years, earnings are strong, and now money supply growth is picking up steam. Ultimately, I fear this inflationary boom scenario may be followed by an inflationary bust (or stagflation), but perhaps that day is farther away than I have been anticipating.”

“Food and energy prices have moved sharply higher in recent months and appear to be trending higher rather than mean-reverting. If this remains the case, I believe the Fed could misstep by focusing on core inflation rather than the perhaps more relevant headline inflation. After all, for most of the world, food and energy inflation are critical matters.”

“How long can this go on before the “rubber band snaps,” either by commodities plunging in a deflationary crash (like in 2008) or the Fed being forced (by the bond market) to tighten and thereby undermine the recovery? Or what if the Fed does nothing and the dollar falls further and sends inflationary expectations skyward?”


China’s holiday greetings: a 25 basis point rate hike

China’s scramble to battle inflation continues. On Saturday, Christmas Day in many parts of the world, the People’s Bank of China raised interest rates 25 basis points. The benchmark one-year lending rate is now 5.81%, and the one-year deposit rate is set to 2.75%. More details and analyst commentary on Bloomberg: “China Increases Interest Rates to Curb Its Fastest Inflation in Two Years.”


China continues to lose its fight against inflation

We have chronicled on these pages China’s struggles with inflation. It appears the pressures are only getting worse. Bloomberg reports “China Inflation May Be Too Hot for Controls Amid Cash Glut“:

“Standing near his 12-table noodle shop on Beijing’s Yonghegong Avenue, owner Liu Heliang says meat and vegetable prices have climbed 10 percent in a year and staff wages are up 40 percent.”

“Premier Wen Jiabao’s cabinet last week announced it will sell grain, cooking-oil and sugar reserves, ordered an end to tolls on trucks carrying produce and threatened price controls to rein in a 10 percent inflation rate for food. Because the measures would do nothing to counter the 54 percent surge in money supply over the past two years, the risk is they will prove insufficient to cope with the challenge.”

It seems consumption is declining in the wake of this inflation, but not fast enough to cool prices down. The Chinese government is worrying even more about what will happen to the many millions of poor people who may no longer be able to afford the little food that they currently consume.


Federal Reserve Surprises By Raising the Discount Rate

(A version of this post also appears on ONE-TWENTY TWO)

The Federal Reserve essentially warned us in its most recent written testimony to the House of Representatives that part of its exit strategy from emergency monetary measures is to increase the spread between the funds rate and the discount rate. This evening, the Fed did just that. In a surprise announcement, the Fed increased the discount rate from 1/2 percent to 3/4 percent and accordingly widened the spread with the funds rate.

Once again, the Federal Reserve reassured us this action does not change monetary policy:

“The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy, which remains about as it was at the January meeting of the Federal Open Market Committee (FOMC).”

This caveat probably means we should still not expect an increase in the funds rate until November/December at the earliest. However, I think the Fed’s surprise delivery of this message puts us all on notice and forces an attitude adjustment. The Fed is serious about normalizing monetary policy and moving away from emergency measures.

The Fed’s timing is particularly odd given options expire tomorrow. Typically, such timing is executed to squeeze shorts and force a market rally. There could be a lot of churn as market participants rush to adjust in the middle of dealing with expiring options. Already, the dollar has rallied sharply in the past several hours.


China Gets More Aggressive In Inflation Fight

China surprised financial markets by again raising requirements for bank reserves sooner than expected. More tightening is expected as Chinese banks continue to lend at a torrid pace. Read more at “China Lifts Banks’ Reserve Requirements Again.”


Federal Reserves Inches Ever So Slowly Toward A Rate Hike

Given the political firestorm surrounding the confirmation for Federal Reserve Chairman Ben Bernanke, you can be excused from forgetting about the next monetary policy action and statement.

This latest release tempered signs of economic resuscitation with causes for concern. The end result is an expectation for a casual stroll toward a balanced economy:

“Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.”

The Federal Reserve also reminded us that the first of many emergency measures will shut down next week. The last measure will shut down on June 30th (the Term Asset-Backed Securities Loan Facility). These activities will finally set the stage for a rate hike at some point in the future…assuming of course the economy does not experience a relapse. The Federal Reserve also assured markets that rates will remain low for an “extended period.” Now that we know “extended period” means no sooner than six months, we should expect no rate hikes until after the end of all emergency financial measures.

This statement did contain one surprise. One of the voting members objected to the latest policy action:

“Voting against the policy action was Thomas M. Hoenig, who believed that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted.”

We have witnessed members of the Federal Reserve wonder aloud about the proper time to begin raising rates. However, this is the first time that a member has voted outright against the current fund rate policy. Consider this one more inch toward a rate hike.


China’s surprise rate hike triggers selling in stocks and commodities

Apparently following through on promises to control liquidity and property speculation in the Chinese economy, China’s central bank raised interest rates on three-month bonds. The move surprised financial markets and various commodities and Chinese stocks promptly sold off on the news. However, disagreement exists over whether this move is a special action in response to a recent surge in reserves or whether this is the start of a protracted fight against inflation. From Reuters:

“The move, which was accompanied by the biggest weekly net drain from money markets in 11 weeks, prompted concerns that the central bank could be getting ready to use more forceful measures to cool growth and fight inflation, such as raising benchmark lending rates…

…analysts said the move should be seen more as an effort by the People’s Bank of China (PBOC) to even out the flow of liquidity into the system, in particular to press banks not to repeat the start-of-the-year rush to lend that marked 2009.”

Reuters also quotes a skeptical Robert Rennie, chief strategist for Asia at Westpac Banking Corp in Singapore:

“Over the past eight months, the PBOC’s assets, or its reserves, have risen by around 1.6 trillion yuan ($234 billion) while its liabilities — bills, bonds, repurchase agreements and reserve requirements — were roughly unchanged…So the fact that the PBOC has drained 137 billion yuan and raised rates by 4.04 bps suggests they are moving to withdraw some of this very rapid rise in liquidity…But it is very hard to describe this as a tightening in my view.”


World Bank on Inflation Watch in Asia

World Bank President Robert Zoellick is wary of heightened inflation risks in Asia as stimulus programs, easy monetary policies, and asset flows into commodities drive recoveries across the region:

“…in Asia the massive liquidity flowing into regional markets could push asset prices up dangerously high, Zoellick told a business forum on the sidelines of the Asia-Pacific Economic Cooperation forum. ‘In this region some care must be taken because as we get recoveries … we could see inflation or some flow into commodities markets or certain asset price markets,’ Zoellick said.”

(See “World Bank president: inflation a risk to recovery” for more.)

Related (from writejesse): “Taipei’s residential prices may rise 15 percent in 2010.