What Would Greenspan Do?
That’s the question the WSJ’s Greg Ip asks:
"Should the Fed worry more about rising inflation and raise rates further, risking a recession? Or should it worry more about growth and hold rates steady, risking higher inflation and a loss of credibility? The outlook for global stock and bond markets will hinge on the outcome of that decision."
As if we don’t know WWGD: The short answer is, he would flood the system with liquidity. The longer answer involves opaque speechifying about systemic risks and global resilience and blah blah blah, as he released the hounds of M3 into the ether. (more money supply! Faster! Faster!)
The column references an academic study co-authored by Bernanke that concluded "economic growth begins to slow roughly six months after the Fed
tightens monetary policy. But inflation doesn’t begin to ease until
about year has passed."
The net result of this is the conundrum we referred to last week, with the Fed painted into a corner.
Here’s an excerpt from Ip’s column:
"The result often is an uncomfortable period when growth is slowing, inflation rising and the central bank facing a tough choice between higher rates and watchful waiting.
That may be where the U.S. economy is now. After a first-quarter surge, growth is slowing, as higher interest rates and energy prices take their toll on housing and consumer spending. It "seems pretty clear that the housing market is cooling," Mr. Bernanke said Thursday, though the slowdown is quite "orderly and moderate." But core inflation, which excludes food and energy, reached a one-year high of 2.3% in April.
Markets have gyrated on the economic crosscurrents and bond yields reflect a rising concern about whether Mr. Bernanke will hold inflation low over the long term. "With core inflation crawling up, a new central-bank chairman is clearly not going to want to let inflation expectations go up," Mr. Gertler said.
With the Fed having raised its short-term interest-rate target in 16 quarter-percentage-point steps to 5% since June 2004, some at the central bank appear to favor pausing soon to assess the impact of those moves on the economy."
Today’s futures look like hell (glad I got stopped out of longs last week). If we see a serious whackage today — and it sure looks like we might — that will resurrect the possibility of a pause in June.
Here is everyone’s favorite faulty comparison: 1994 vs 2000 vs 2005
click for larger graphic
As previously noted, the better comparo is 1973.
Trade safe today — it looks like it could get ugly out there.
What Would Greenspan Do? Bernanke Weighs
Risks of Rate Increases and Rising Inflation
WSJ, May 22, 2006; Page A2