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The Philly Fed report on Thursday was a shot in the arm to what have been some weakening indications. The consumer is a problem as we have discussed the past couple of months, first with a reallocation of funds to discounters and now with the Q3 guidance from retailers, a drop off in purchases thanks to high energy prices.
The list of accomplishments is impressive. Even as oil has moved from $30 to $65 from the end of 2003 the economy has posted strong numbers. GDP 3.7% average growth per quarter. Consumer spending up 3.7% per quarter. Business investment averaging 12.4% growth per quarter. The 10 year note yield averaging 4.25% the entire time. The core chain CPI rising just 2%. Those are impressive numbers and a good run.
The question is whether these figures or even the expansion itself can hold up in face of sustained high energy prices (oil and natural gas) and the Fed’s rate hiking and money supply curtailment.
The Fed’s real fight.
That brings us to the Fed’s real fight. Is it really inflation led by rising oil prices as it suggests in the many statements by the Fed chairmen and various governors? If it is oil-based inflation that concerns it and is prompting the rate hikes and shrinking money supply that raises some serious questions. Namely, if the Fed slows the US economy (which is what rate hikes and falling money supply do), will that have that much impact on oil?
The Fed itself has said that oil prices would not hurt the US economy unless it moved to the $80/bbl range or better, supposedly because the economy depends less upon oil now and is more efficient in its usage. The recent data suggests that sustained prices above $50/bbl is already making an impact, however, as consumers cut back. Core inflation has remained steady as indicated above, but the consumer is pulling back. It does not appear there will be much if any oil-led inflation if consumers are already cutting back while the CPI remains under control. That will only diminish pressure on prices.
Moreover, what if the Fed’s goal was to slow the US economy because oil prices were too high and it truly feared inflation from that source? Would slowing us down here in the US help lower oil prices? Perhaps marginally, but China is the main driver of oil prices based on growth in consumption, with thus far only 25% of its population taking part in its economic boom. Slowing the US a bit is not going to alter that significantly. The US would have to be pitched into a full recession to really impact world demand.
Thus the oil-led inflation argument is pretty farcical. What the Fed is really targeting is something else just as in 1999 and 2000 when it was supposedly worried about the jobs market and wage-led inflation when it was really trying to slow the stock market (as was the 1929 Fed which succeeded in doing that as well as plunging the US and world into depression). It saw what it though was a bubble and panicked, attacking the stock market as the symbol of the alleged bubble. It dried up the money supply it had grossly overinflated in the six months leading up to Y2K. It yanked all of the money out of the system cold turkey, the market vapor locked as it saw the impact on the economy, and later the economy followed. Quite a nasty outcome as we all only too well remember.
The Fed thus equates perceived bubbles with that outcome. It does not view its actions as detrimental or even the cause of the ensuing collapse. That is a dangerous viewpoint. This time around it sees housing as a bubble. At first it was denied, but the Fed has made more and more comments about housing both in its testimony to Congress, its FOMC minutes, and the comments from regional governors. Once more the data does not support the Fed’s reasons for tightening, and indeed the recent guidance among retailers confirms our thesis that oil price increases outstrip any inflationary tendencies from the rise. The Fed has other plans that include slowing down housing and getting the Fed Funds Rate to better than 4% to provide some maneuvering room for any future problems.
The irony is it is likely creating the very problem it is raising rates to try and combat at some future date. The housing market is already peaking as we have discussed the past few months; without intervention it was going to have a gentle plateau and decline. If the Fed goes too far on top of high oil prices it is going to have a nastier drop and more people will get hurt. It will have some higher short term rates it can lower to combat the problem but that is about it.
We have nothing against the Fed raising rates after it pushed them so low in a vain attempt to start the economy (that did not happen until investment tax incentives were put into place). The issue we have now is that with sustained and still climbing oil prices the Fed is going to go too far. It typically always goes too far; the combination of oil price spikes accompanying rate hikes is a great unknown given the ‘new’ economy and its resilience to shocks creates an environment where the Fed will tend to be too aggressive. Hell, Greenspan has already said he is not afraid of a flat or even inverted yield curve because this time it is different. As we said a month ago, danger, danger, danger.
The list of accomplishments is impressive. Even as oil has moved from $30 to $65 from the end of 2003 the economy has posted strong numbers. GDP 3.7% average growth per quarter. Consumer spending up 3.7% per quarter. Business investment averaging 12.4% growth per quarter. The 10 year note yield averaging 4.25% the entire time. The core chain CPI rising just 2%. Those are impressive numbers and a good run.
The question is whether these figures or even the expansion itself can hold up in face of sustained high energy prices (oil and natural gas) and the Fed’s rate hiking and money supply curtailment.
The Fed’s real fight.
That brings us to the Fed’s real fight. Is it really inflation led by rising oil prices as it suggests in the many statements by the Fed chairmen and various governors? If it is oil-based inflation that concerns it and is prompting the rate hikes and shrinking money supply that raises some serious questions. Namely, if the Fed slows the US economy (which is what rate hikes and falling money supply do), will that have that much impact on oil?
The Fed itself has said that oil prices would not hurt the US economy unless it moved to the $80/bbl range or better, supposedly because the economy depends less upon oil now and is more efficient in its usage. The recent data suggests that sustained prices above $50/bbl is already making an impact, however, as consumers cut back. Core inflation has remained steady as indicated above, but the consumer is pulling back. It does not appear there will be much if any oil-led inflation if consumers are already cutting back while the CPI remains under control. That will only diminish pressure on prices.
Moreover, what if the Fed’s goal was to slow the US economy because oil prices were too high and it truly feared inflation from that source? Would slowing us down here in the US help lower oil prices? Perhaps marginally, but China is the main driver of oil prices based on growth in consumption, with thus far only 25% of its population taking part in its economic boom. Slowing the US a bit is not going to alter that significantly. The US would have to be pitched into a full recession to really impact world demand.
Thus the oil-led inflation argument is pretty farcical. What the Fed is really targeting is something else just as in 1999 and 2000 when it was supposedly worried about the jobs market and wage-led inflation when it was really trying to slow the stock market (as was the 1929 Fed which succeeded in doing that as well as plunging the US and world into depression). It saw what it though was a bubble and panicked, attacking the stock market as the symbol of the alleged bubble. It dried up the money supply it had grossly overinflated in the six months leading up to Y2K. It yanked all of the money out of the system cold turkey, the market vapor locked as it saw the impact on the economy, and later the economy followed. Quite a nasty outcome as we all only too well remember.
The Fed thus equates perceived bubbles with that outcome. It does not view its actions as detrimental or even the cause of the ensuing collapse. That is a dangerous viewpoint. This time around it sees housing as a bubble. At first it was denied, but the Fed has made more and more comments about housing both in its testimony to Congress, its FOMC minutes, and the comments from regional governors. Once more the data does not support the Fed’s reasons for tightening, and indeed the recent guidance among retailers confirms our thesis that oil price increases outstrip any inflationary tendencies from the rise. The Fed has other plans that include slowing down housing and getting the Fed Funds Rate to better than 4% to provide some maneuvering room for any future problems.
The irony is it is likely creating the very problem it is raising rates to try and combat at some future date. The housing market is already peaking as we have discussed the past few months; without intervention it was going to have a gentle plateau and decline. If the Fed goes too far on top of high oil prices it is going to have a nastier drop and more people will get hurt. It will have some higher short term rates it can lower to combat the problem but that is about it.
We have nothing against the Fed raising rates after it pushed them so low in a vain attempt to start the economy (that did not happen until investment tax incentives were put into place). The issue we have now is that with sustained and still climbing oil prices the Fed is going to go too far. It typically always goes too far; the combination of oil price spikes accompanying rate hikes is a great unknown given the ‘new’ economy and its resilience to shocks creates an environment where the Fed will tend to be too aggressive. Hell, Greenspan has already said he is not afraid of a flat or even inverted yield curve because this time it is different. As we said a month ago, danger, danger, danger.
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