It’s all about the soft landing now. Ergo, will he or won’t he engineer one?
Fed Chairman Ben Bernanke is now engaged in what may prove to be the defining act, for good or ill, of his central-banking career. Having bet more than a little of his reputation (nascent though it is as the Fed’s leader) on the arrival of a soft landing, the world will be monitoring the associated economic data as it rolls in for confirmation or denial. The smallest deviation from the expectations that Ben has fomented could deliver more than a little volatility in stock and bond markets, which have recently become accustomed to believing that the Fed can deliver on its promises.
But the challenges on the road to economic perdition (or salvation) are many. For starters, recent converts to the faith in bull markets might ask themselves what exactly constitutes a soft landing? In general terms, the answer is obvious: an economic slowdown that avoids recession. But even a downshift in GDP’s pace that manages to stay north of zero isn’t problem free.
Consider that the U.S. economy advanced at an annual rate of 2.5% in this year’s second quarter. That’s sharply slower than the 5.6% logged in the first quarter. One might argue that the change represents a soft landing. But the concept of supple economic set downs must be housed in proper context with inflation. The main reason the Fed seeks a soft landing is because it wants a lesser inflation.
A noble ideal, and one that’s notoriously tricky to deliver. Although the pace of GDP has slowed considerably, inflation has yet to show a commensurate pullback. Yes, the core rate of consumer prices in July decelerated from its trend in March through June. But it’s not yet clear if the drop to 0.2% for core CPI last month from 0.3% for each of the previous four months is sustainable, or just a temporary pause.
The truth will out, of course, one economic release at a time. For this week, the highlights (or low points, depending on your perspective and the numbers dispensed) will come on Wednesday, with the July update on existing home sales, and then on Thursday, with last month’s durable goods orders and new home sales.
The price of oil will also doubt cast a heavy influence over investor perceptions as to what comes next in the economy. The September contract for crude oil dipped below $70 in New York last week for the first time since June, but if oil’s headed for sharply lower territory, the outcome remains the stuff of speculation.
Nonetheless, fundamentals suggest a sharp and extended selloff is coming, according to the energy group at Bernstein Research. In a report sent to clients this morning, Bernstein’s Neil McMahon advises that “crude prices are currently divorced from underlying supply and demand fundamentals.” Several trends (rising storage supplies of oil and new production sources coming on line, for instance) are afoot that may bring the price of oil sharply lower in the foreseeable future. Timing is unclear, however, in part due to the complex array of geopolitical and economic factors that drive the price of crude. Yet McMahon is undeterred from dispensing his warning:
“High prices are causing supply to grow faster than demand, increasing spare capacity,” McMahon writes. “As a result, the longer the pricing bubble lasts, the larger spare capacity will grow, and thus the more prices are likely to fall when the correction finally comes and prices re-link to the fundamentals.”
Oil’s price is always a critical component for influencing economic growth. As such, Bernanke’s fate to a degree lies with futures traders in the oil pits. Even so, a material change in oil prices, either or up or down, has several implications for the U.S. economy. If oil prices fell sharply, and for a sustained period, top-line inflation would likely slow, and so the potential for the same in core CPI would be considerable. In turn, that would help raise the odds of a soft landing. But how much of that trend would be offset by the economic stimulus that might come from dramatically lower energy prices?
Meanwhile, assume that oil prices keep rising due to, say, continued turmoil in the Middle East. In that case, the slowdown in economic growth could be more than Mr. Bernanke bargained for. Lower inflation won’t due much for Bernanke’s legacy if it arrives by way of a nasty recession.
Deciding what’s lurking around the corner is never easy, and in fact it’s getting harder all the time. Risk, in short, is in a bull market. Investors should recognize this, along with the fact that betting the house on a soft landing may be asking too much of fate and Mr. Bernanke’s capacity for engineering economic perfection. Anything can happen in the global economy, which is another way of saying that the odds of any one thing occurring is slim. If nothing else, your editor has an incredibly lucid grasp of the obvious.