Tuesday, July 15

Bernanke's Congressional testimony

Federal Reserve Board Chairman Ben Bernanke gave his semiannual testimony on the economy. I'll make this quick, sparing you the cut-and-paste of his various comments that I usually resort to in favor of some brief comments.

--Bernanke made it clear that no interest moves, up or down, appear forthcoming. He continued to talk tough on inflation but noted the various pressures affecting the economy as increasing the downside risk to the economy. He even stated that the FOMC needs time to monitor incoming information. Sounds to me like he doesn't want to paint, or talk, himself into a corner.

--Bernanke addressed oil prices at length but he didn't sound too optimistic about the ability to talk down oil prices by tightening the screws on speculators. He cited declining oil inventories as evidence that there is not an imbalance between supply and demand, as would be the case if speculation were driving the market.

--When asked for his thoughts on a second stimulus package, Bernanke pointed out that the main economic impediment is the housing market and efforts to aid the housing market should be the focus.

Jobs losses for 6 consecutive months

The monthly employment report was released this morning, uncharacteristically on a Thursday due to the holiday tomorrow. What it showed was more of the same -- the economy shedding jobs. The economy remains 0-for-2008 in the job growth department, with the economy posting job losses every month thus far. That makes six consecutive months of job losses.

For June, the initial glance shows a loss of 62,000 jobs. April was revised from a loss of 28,000 jobs to a loss of 67,000 jobs and May showed a revised 62,000 job cuts, instead of the 49,000 estimated last month. During the second quarter, the economy shed over 60,000 jobs per month.

When will it turn around? Anyone's guess. But don't look to the housing market for the answer. The true villian of the economy is rising oil prices. Any relief on this front would pump life into the economy quicker than dropping a wilted leaf into a glass of water. But the higher prices go (quick update: oil now at $145 per barrel), the greater the risk of a severe recession or outright depression, rather than the currently mild recession. And yes, I do believe we're in recession, as evidenced by the 6 consecutive months of job losses.

The housing decline, which started two years ago, has certainly had an impact. But the economy is still growing, albeit at a slower pace. It is that continued growth that is cited by those that assert we are not in a recession, as the traditional definition of recession is two consecutive quarters of negative economic growth. But six consecutive months of job losses is more than enough to tell me that we are in, and have been, in a recession since the beginning of the year.

The escalation in oil prices threatens greater damage to the economy because it impacts everyone, and to a greater extent than the housing market. If you live in a market where home prices have been relatively stable, both on the upside and the downside, and as a long-time resident in the home you have a substantial equity stake, the housing market has had limited impact on your well-being. But rising energy prices mean higher heating oil costs, higher gasoline costs, higher costs for travel and transportation and certainly higher prices at the supermarket and at restaurants. And these price increases don't discriminate. They impact everyone. In fact, you could make an argument that these price increases do discriminate because of the outsized impact on senior citizens and lower-income households. It's that widespread impact, beyond just gasoline prices (don't get me on a rant about people that sit in the drive-thru lane for 10 minutes in their SUVs, with the air conditioning blowing and have the audacity to complain about gasoline prices) that is the primary nemesis of our economy.

Let me know what you think. Please be concise and I'll use some of your comments in an upcoming blog entry.

Have a happy and safe Fourth of July.

Fed: Inflation risks have 'increased'

The Federal Open Market Committee left rates unchanged this afternoon (no surprise) and made it quite clear that the next move, whenever it comes, is likely to be up (again, no surprise).

There were some notable changes to the Fed statement, conveying the idea that rates will eventually move up.

In April, the Fed said economic activity "remains weak" but today it was a much sunnier "continues to expand, partly reflecting some firming in household spending." See what upward revisions to GDP will do?

The Fed still expects inflation to moderate (really?), but rather than saying "in coming quarters" they now say "later this year and next year." Of course, that won't happen without some cooperation from oil prices and the Fed notes the "continued increases" in energy and commodity prices and the "elevated state" of inflation expectations as adding to the uncertainty.

But the key statement is this one.

"Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased."

What the Fed is saying is that they're not going to cut interest rates again and are inclined to raise interest rates. But we already knew that. What we don't know, and what the Fed didn't say, is when. I still think it will be awhile. The Fed's tough talk is the only tool they can really use right now.

Readers' Fed comments and questions

While we all wait for the FOMC announcement this afternoon, here are some of the questions and comments from readers about the Fed. Some have been edited for brevity.

"Do you think the Fed will lower interest rates due to the price of gas?"

Not a chance. If anything, those higher gasoline prices could eventually prompt a Fed rate increase, but it won't come right away.

"Hi Greg, You say the Fed doesn't want to throw ARM holders under the bus but they seem to have no trouble throwing savers under that same bus, running us over, backing up over us and running us over again! All the while telling us that inflation is low. Why is it that competent people always have to be shafted to help the incompetent?"

Just wait for the housing bailout.

"Interest rates seem to be rising over their own accord at least in the short term. Reducing the bond prices yet overall all interest rates are still relatively low. Is it correct in assuming the Federal Reserve is standing by to see the pop in the oil, which might allow them to take their hands off the interest rates "levers of browbeating" to avoid rate increases in the fall? If oil prices do fall by 1/4 to 1/2 per barrel, as recent energy traders suggest, would that be similar to flushing cash back into the economy, adding strength in the dollar, and act as greater cushion through increased purchasing power for consumers? Do you feel that interest rates will go up or down this fall irrespective of who wins the election?"

Any pronounced decline in oil prices would be greeted with a cheer from the Fed, as this would take the edge off inflationary pressures and do some of the Fed's dirty work for them. It has been said that higher oil prices act as a tax on consumers, so a pullback in prices would certainly redirect a lot of cash into other discretionary purchases. This would provide a nice tailwind to economic growth because of the velocity of the money, as one person's dinner out becomes the waitress's tips, which becomes her discretionary purchase and results in a boost to someone else's income down the line. And so on and so on.

A sharp pullback in oil prices would be just what the doctor ordered for the economy, but it is impossible to know which way oil prices go from here.

I think inflation, the economy and conditions in financial markets will have a far greater bearing on the level of interest rates than the election outcome.

Be sure to check back at for the latest news following this afternoon's Fed announcement.

Time for a Fed reality check

The Federal Open Market Committee meets Tuesday and Wednesday and, for the first time since last September, they won't cut interest rates. Lately, the talk has been all about when the Fed will raise interest rates, with expectations calling for a rate hike as soon as August. But a rate hike is doubtful and that lack of a rate hike at the upcoming Fed meeting will serve as a reality check.

The prospects for Fed interest rate hikes are rooted in inflation data. The age-old recipe for combating inflation is to have the Fed raise interest rates. But this isn't your grandfather's inflation because it isn't due to an overheating economy or too many dollars chasing too few goods. This brand of inflation is instead, one that is largely the Fed's own doing and one they have little power or latitude to undo in the near future.

This inflation is one that is being imported via higher costs for commodities, most notably oil. Here is where the Fed's repeated and aggressive interest rate cuts have played a significant role by helping erode the value of the U.S. dollar. Oil, after all, is priced in U.S. dollars. But inflation isn't just a U.S. phenomenon right now, it is a global phenomenon. And as a result, the Federal Reserve isn't the only central bank looking at eventually boosting interest rates in response. The problem is this: The U.S. economy, the housing market, and yes even the looming presidential election all stand as barriers to the Fed taking action. Our counterparts overseas, most notably the European Central Bank, are more focused on inflation and don't have economic and housing environments comparable to what we're experiencing in the U.S. So the Europeans may well get a head start on Ben Bernanke in actually raising interest rates, likely bringing about another round of dollar depreciation.

So what can the Fed do? Talk. And that is exactly what the members of the FOMC have been doing plenty of, jawboning aimed at both the dollar and inflation. The rhetoric has been kicked into overdrive in recent weeks and has helped drive home the point that the Fed is not inclined to cut interest rates further.

The transition that has taken place since the last FOMC meeting concluded on April 30 is that we are no longer in a falling rate environment. With the Fed moving to the sidelines and inflation data taking over the spotlight, Treasury yields have rebounded mightily from the lows seen in March and April. Mortgage rates staged a sharp run-up while yields on certificates of deposit have been clawing their way back to respectability. But the Fed is not in a position to hike interest rates any time soon -- think December at the earliest -- and that will be a reality check when their meeting concludes June 25.

Job losses 5 straight months

The employment report for May was released this morning and the economy has a rather inauspicious streak going, with job losses posted every month since the beginning of the year. You might say job growth is 0-for-2008, to use the baseball parlance.

Specifically, payrolls shrunk by 49,000 jobs in May, with negative revisions to both April and March. In April, the economy shed 28,000 jobs and in March the job shrinkage is now 88,000 (revised from 20,000 and 81,000 losses, respectively). Hourly earnings increased 0.3 percent which, after inflation terms, is nada. The unemployment rate increased to 5.5 percent.

Bernanke sends clear message: Bernanke made two speeches earlier this week, but his remarks Tuesday validated the widely held belief that the Fed intends to move to the sidelines. How long the Fed stays there remains to be seen, but don't expect rate hikes any time soon, even with all the inflation ugliness.

Why? I see three reasons. First, the Fed spent the past nine months ushering homeowners with adjustable rate mortgages to safety by drastically cutting short-term interest rates. They did so to such an extent that many homeowners saw negligible rate resets in 2008, unlike the experience of their neighbors in 2007. This has prevented untold additional foreclosures and, given the significance of this relief, the Fed will be unwilling to throw those same homeowners back under the bus by raising interest rates too much, too soon.

Secondly, the weakness in the broader economy and the tenuous improvement in credit markets provides little latitude for the Fed to raise interest rates. And finally, the looming presidential election - although it shouldn't factor into the equation - makes this a particularly sensitive time for the Fed to consider any interest rate increases. Can you imagine the field day the candidates would have if the Fed raised interest rates prior to the election? One other tidbit: The decision to appoint Ben Bernanke to another term as Chairman of the Fed, or not, will rest with the winner of the upcoming election (Bernanke's term expires in 2010).

Don't get me wrong. I'm not saying the Fed shouldn't do whatever is necessary to tame inflation. (I personally think they should). But I am saying that it will be difficult for them to raise interest rates anytime soon, even if the inflation picture gets worse. The Fed continues to believe that inflation will moderate on its own, though you can sense some waffling in that stance as oil goes higher. Let's hope they're right.

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