The market hardly needed another piece of evidence to support the notion that the economy remains bubbling. Bonds, however, are another story, which we’ll get to in a minute. Meanwhile, Fed Chairman Ben Bernanke debuted his Congressional testimony act yesterday and added to the general suspicion that growth is still the path of least resistance for the foreseeable future, accompanied by all the usual risks for monetary policy that come with such a view.
The Federal Open Market Committee’s “central tendency” forecast of GDP growth in 2006 is about 3.5%, and slightly lower for 2007, according to the Monetary Policy Report Bernanke submitted to Congress yesterday. That compares with a 3.1% rise in GDP for 2005. Consistent with that outlook is FOMC’s expectation that the jobless rate will decline a bit in 2006 from 2005’s 5.0%. For the moment, that guess on the jobless level looks like a safe bet in light of the fact that January’s unemployment rate dropped to 4.7%.
Beyond Bernanke, there’s no shortage of statistical props for arguing that the economy’s humming along nicely. That includes this morning’s release of initial jobless claims for the week through February, which are running below 300,000 for the fifth consecutive week. Meanwhile, continuing claims for jobless benefits remain impressive too, with the fifth straight week of below-the-2.6 million level. Together, the two trends are putting labor-market pessimists on the defensive. As Nomura Securities chief economist David Resler writes from New York today, “As much as job and income growth are the key ingredients to a healthy consumer, the outlook remains relatively bright, peering into 2006.”
Another bullish report on the economy comes by way of today’s update on December’s new residential construction. Like the labor market, new-housing development continues to impress with strength, running last month at just below 2005’s best levels, or a bit over 2 million units in January.
Another upbeat report was dispensed on Tuesday via the extraordinarily strong retail sales numbers for January.
Yes, yesterday’s industrial production report for January from the Fed took a bite out of some of the cheery momentum. But on closer inspection, the 0.2% drop last month in this metric isn’t quite as gloomy as it appears. Indeed, the bulk of industrial production’s January decline is linked to the huge 10.1% descent in utilities (the biggest monthly fall in the 34-year history of the series) due to the unseasonably warm weather. By contrast, manufacturing activity moved up again in January, continuing a trend that’s been in force for some time.
If the trend you see in all of this inspires optimism, you’re not in sync with current thinking among the fixed-income set. Indeed, the bond market sees fit amid all the bullish economic news to keep the yield curve inverted. As such, the 30-year Treasury this morning yields less than the 10-year, which in turn offers a current yield below that of the 2-year.
In short, back to the future. One can rationalize the state of sagging yields as a function of a global savings glut (to use Bernanke’s phrase) that keeps the price of money lower than it otherwise might be. Or, if you’re inclined toward pessimism, perhaps you see a looming recession that’s something less than obvious in the recent economic data. But it’s clear that Bernanke still favors the former explanation. As he explained yesterday, an inverted yield curve is nothing to worry about:
“Historically, there has been some association between inversion of the yield curve and subsequent slowing of the economy,” the Fed chairman admitted. “However, at this point in time, the inverted yield curve is not signaling a slowdown.” Presumably, that means his global-savings-glut argument, which is shorthand for an excess of liquidity looking for a home, remains the prevailing theory in the chairman’s mind.
Excess liquidity, of course, raises the specter of inflation. Although Bernanke maintained the company line that inflation was more or less under control, he let on that the threat of something worse remains bubbling just below the surface. “Inflation pressures increased in 2005,” he said yesterday. “Steeply rising energy prices pushed up overall inflation, raised business costs, and squeezed household budgets.”
In fact, Bernanke warned that more of the same, and then some, might be coming, a point underscored by today’s import/export price report that shows the U.S. is importing inflation to the tune of 1.3% in January, or 8.8% over the past 12 months–about two-and-a-half times higher than domestic inflation’s overall pace. As he put it: “the risk exists that, with aggregate demand exhibiting considerable momentum, output could overshoot its sustainable path, leading ultimately–in the absence of countervailing monetary policy action–to further upward pressure on inflation.” The prescription? “Some further firming of monetary policy may be necessary, an assessment with which I concur,” the chairman explained.
Traders in Fed funds futures took the hint. The June 2006 contract is priced this morning at 4.875%, vs. the actual 4.5% that currently prevails.
Still, Bernanke faces no easy time in taking over the Fed. For all the talk of economic momentum, there are several ticking time bombs that may or may not explode this year or next. Calculating the odds may be the most important task for the central bank at the moment. Indeed, real estate bubbles, energy shocks, mounting red ink at the consumer and federal government levels all threaten to play havoc with monetary policy. Unless they don’t. Finding the sweet spot, in short, has rarely been harder for the Fed.
Bernanke admitted as much yesterday, and he reiterated the point today in his second-day of testimony: “There are two possible mistakes. One is to go on too long and one is not to go on long enough. And, it’s a very difficult balancing act.”
Alas, recognizing that one has to perform a balancing act–commendable as that is–doesn’t make it any easier.