The Federal Reserve's risk assessment statement seemed to be lacking in one very important area ' the facts. So what is the true picture in the US?
The Federal Reserve pleasantly surprised the bond market late last month by indicating it was in no rush to raise short-term interest rates.
In a statement following the policy-setting committee's meeting, it acknowledged the strength in economic activity, largely the result of the swing in inventories, believe officials, and said the outlook for final demand was uncertain and risks to the economy balanced between weaker economic growth and higher inflation.
The Fed elected to leave the federal funds rate unchanged at 1.75%.
There was something awkward about the construction of the sentence containing the balance-of-risks statement. 'In these circumstances, although the stance of monetary policy is currently accommodative, the risks are balanced with respect to the prospects for long-run price stability and sustainable economic growth,' the statement said.
I had to read this sentence several times before I figured out what was wrong with it.
The idea in the dependent clause, 'although the stance of monetary policy is currently accommodative''sets up an expectation. Although policy is accommodative, we are not worried about over-stimulating the economy and producing higher inflation. It was as if the Fed did not want to follow the thought through to its logical conclusion.
'It sounds as if they wanted to put a favourable cast on their accommodative stance,' says Jim Glassman, senior US economist at JP Morgan Chase.
Evidently the Fed did not want to talk about the elephant in the room. Why mention the unspoken when the markets are already skittish about the path for short-term rates? Having cut the overnight federal funds rate to a microscopic 1.75%, Alan Greenspan is now faced with the unenviable task of having to raise rates to a level appropriate to an expanding economy.
He wants neither to abort the recovery nor upend the stock market. He does not want long-term rates to rise, fearing it would snuff out the strongest sector of the economy, housing.
Single family housing starts rose to their highest level since 1978 in February. The strength in housing is evident in the consumer price index for February as well. Shelter costs, which make up 31.5% of the CPI and 40% of the core CPI, rose 0.5%. The three-month annualised increase of 5% is the biggest in 11 years.
The overall CPI rose 0.2% in February, leaving the year-over-year increase at a 15-year low of 1.1% for the second consecutive month.
The core CPI, which excludes food and energy, rose a larger-than-expected 0.3%. The villains were apparel, tobacco and shelter, according to the Bureau of Labour Statistics.
The 3.8% increase in tobacco and smoking products was the result of a federal excise tax increase in January, which did not show up as it was offset by price discounts, according to Willmore. 'When they took off the price discounts (in February), the excise tax showed up,'' he said.
As far as apparel is concerned, huge declines in November, December and January (0.6%, 0.6% and 0.7%, respectively) never seem to count. It is only when prices increase that it is dismissed as a timing issue related to the introduction of the new seasonal line.
The tendency to ex-out everything that goes up has reached a new low, as reflected in this passage from Market News International.
'Had tobacco been flat, the core rate would have been 0.2%,' senior BLS analyst Patrick Jackman told the publication as the CPI report was being made public.
'Without the accompanying large increase in shelter costs, up 0.5%, the core would have been near motionless, since shelter costs make up about 40%of the core rate.'
Without shelter? Without the biggest single component? My friend Jim Bianco, president of Bianco Research in Barrington, Illinois, has aptly coined the phrase, 'pro forma' CPI, to deal with this nonsense. 'I've never heard anyone say, if you exclude the things going down the CPI would have been worse,' says Bianco.
New car prices declined 0.9% in February, the biggest drop in 15 years. Given the strength in auto sales, are declines of that magnitude likely to be repeated?
What about energy prices, which fell 0.8% in February and almost 16% in the past 12 months? The average price of a gallon of unleaded gasoline rose 15% from $1.12 in the last week of February to $1.29 in the third week of March.
The price of crude oil, from which gasoline is distilled, is up 14% Most economists expect core inflation, up 2.6% in the last year, to fall this year.
The TIPS market suggests just the opposite. The difference between the yield on the 10-year Treasury inflation protection security and the nominal 10-year note has moved out by 50 basis points in the past two months to 202 basis points.
While the break-even rate of just over 2% is hardly a rousing vote for inflation, the direction, along with rising long-term rates, suggests the Fed may need to adjust the independent clause of its risk assessment soon.
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