Ben Reasserts “Extended Period”
Short-term policy rates are headed nowhere for now. That is the bottom line message from Chairman Bernanke’s Semiannual Monetary Policy Report. Why?
Inflation and the unemployment rate appear to be the two key factors. Inflation indicators, according to the Chairman, “suggest that inflation likely will be subdued for some time.” We concur. We expect the core personal consumption deflator to remain below 1.5 percent at least through the third quarter of this year. Our WTI crude oil estimate is near $80/barrel for all of this year.
Unemployment, as a proxy measure of the economy, remains disappointing. For the Fed, “the job market remains quite weak, with the unemployment rate near 10 percent and job openings scarce.” This is consistent with Bernanke’s assessment of a nascent recovery with growth at 3-3.5 percent for 2010. This is also consistent with our outlook.
“Normalizing”
For investors and business leaders, the Fed’s focus on normalization should be read as code words for upward pressure on short-term rates. While the direction may be clear, the speed and magnitude remains uncertain. Our bet is that the Fed is unlikely to raise short rates—the funds rate—until the fourth quarter at the earliest. We have two reasons. First, we agree that inflation remains low as indicated above. This buys the Fed lots of time to watch the recovery take hold. Second, Bernanke refers to the current recovery as “nascent” and this suggests to us that the Fed remains unsure about the strength of the recovery and its sustainability. Here we would watch the path of jobless claims and housing starts.
Jobless claims provide insight into the growth of jobs which, in turn, provides insight into the pace of consumer spending. Housing starts will provide a guide to the housing recovery. Both indicators will signal economic repair and therefore a green light on the Fed getting rates back to normal. As for long-term rates, there is always the federal budget outlook.
