There’s a school of thought in the investing world that believes in taking central bankers’ warnings at face value. Easier said than done. Fed commentary hasn’t exactly been surgically precise in the spring of 2006. The central bank has been inclined to suspend interest-rate hikes only to rethink such a halt, depending on who’s doing the talking.
But last week’s remarks from St. Louis Fed President William Poole seem to have put the matter to rest on what should come next regarding next week’s FOMC meeting and the related matter of the price of money. “If the inflation rate continues to be persistent like this,” he said last week, “the Federal Reserve will simply have to pursue persistent policies that will keep that inflation from increasing further.”
Poole was referring to last week’s release of May consumer prices, which, by any measure, are continuing to surprise on the high side. Consumer prices rose by an annual rate of 5.7% for the three months through May, the Labor Department reported last week. For those keeping score, that’s 70 basis points above the current Fed funds rate, a premium that amounts to an “ouch” for inflation hawks. Meanwhile, the so-called core rate of inflation (consumer prices less food and energy) advanced by 3.8% at an annual rate for March through May–the highest since 1995.
Taking it all in, there’s no longer reason to wonder if inflation is edging up–confirmation has arrived. The only question is how high is up? That depends on what the Fed does in coming months, starting with next week’s FOMC confab.
For perspective, keep in mind that some (if not most) of the uptick in inflation of late derives from the exceptionally loose monetary policy of previous years. Aggressively printing dollars for several years in the early years of this century is now coming back to haunt the system. Reversing the former liquidity boom will take time, probably years. Assuming, of course, the Fed has the stomach for the monetary fight that looms.
To be sure, no central bank exists in a vacuum. The willingness of the Fed to elevate the price of money for the world’s reserve currency may find some degree of support in central banks around the world. If the major overseers of currencies on the planet find reason to tighten, the Fed’s job will be that much easier, at least in a political sense.
Consider then last week’s economic news for Japan: first-quarter economic growth for world’s second-biggest economy was revised sharply higher to an annualized inflation-adjusted 3.1% from the previous 1.9% estimate, representing the fifth-consecutive quarter of growth in the Land of the Rising Sun. How high is 3.1%? Nearly twice as high as the 1.82% yield on a Japanese government 10-year bond. Rarely has the case for a rate hike in Japan been so clear and compelling.
The mind-set for similar action is taking hold of policy makers can be found in the U.S. as well, albeit in milder form. GDP’s rate of ascent for America in the first quarter was a sizzling 5.3% in the first three months of this year, or slightly above the 5.13% that currently defines the yield on a 10-year Treasury. Yes, a slowdown in economic growth is coming. But broad confirmation of that forecast won’t come until July 28. But the Fed doesn’t have the luxury of waiting that long.
Sitting on one’s monetary hands for more than a month, given the latest dispatch of inflation numbers, is the financial equivalent of fiddling while Rome burns. Fed Chairman Bernanke can’t afford a Nero complex at this juncture, and neither can the U.S. economy. In fact, sending a hawkish signal by way of a 50-basis-point hike next week might be just the thing to establish Bernanke’s credentials while the aura of economic growth still hangs in the air. Retreating later on would be easy, if GDP falters. By contrast, going soft now, and trying to catch the inflation train down the road only promises trouble by way of a diminished odds of success. Ergo, the June 28/29 FOMC may prove to be one of the more crucial meetings (for good or ill) in Bernanke’s tenure.