The Fed tightened another .25 percent, and mortgage rates are unchanged in the high fives. Ten-year T-notes, the market driver, have actually improved, down to 4.22 percent. Thus far, the Fed’s cumulative action has added .5 percent to the cost of America’s home equity lines of credit, but no one seems to mind.
The rate hike was expected, but many were surprised by the stubbornness of the Fed’s post-meeting statement. “The Committee believes that, even after this action, the stance of monetary policy remains accommodative…The economy…appears poised to resume a stronger pace of expansion going forward.” Might a slowing economy cause the Fed to suspend its march to a neutral Fed funds rate, somewhere north of 2.5 percent? No chance.
New economic data show more points of slowdown, though none as severe as the new-job collapse in payroll reports. Retail sales in July failed to rebound from the June soft spot, trending flat, propped only by giveaway sales of cars. Consumer confidence has peaked, but there is no uptick in claims for unemployment benefits.
The bond market made its own statement after the Fed’s: when the Fed tightens and bonds stay put or rally, the bond market is whispering to itself, “Goody. The Fed is going to overdo its inflation-fighting act (again), and we’re all going to get rich when the economy falls apart.”
The Fed understands, but is cornered. Deep in the Fed’s institutional memory is knowledge that an incipient inflation problem in the late 1960s (Richard Nixon imposed wage and price controls when the inflation rate reached a then-stratospheric 4 percent) burst out of control during the ’73-’74 and ’79-’80 oil shocks because the Fed was insufficiently tough. The Fed induced nasty recessions in both cases, but before and between was too easy (the brief, disastrous career of Chairman G. William Miller is lost to popular history – but not at the Fed).
The oil apologists have been wrong: $45/bbl is not a terror result, nor speculation, nor Yukos, Venezuela, or Iraq, nor is it temporary. It may be a China problem that will fade as China’s economy slows, but that slowdown will be temporary. The world produces 84 million barrels a day, and there is a buyer for every drop at $45. Even if high prices create more production, in Dick Cheney’s dream of Christmas, the world can’t refine and transport any more than we do now.
Yesterday, the Fed released the minutes of its June meeting, and they made clear that Federal Reserve Chairman Alan Greenspan had a near-revolt on his hands. Absent his insistence, the “measured pace” language would have disappeared two months ago, and quarter-point hikes might have given way to halves, or more. Some in the markets have claimed that Greenspan’s determination to get to a neutral cost of money is a blind effort to get everything in perfect equilibrium for his retirement next year. This line is unkind nonsense; Greenspan knows that the Fed’s pursuit of equilibrium will always be frustrated by new risks, and his self-contained measurement of his own performance has no need for an exit under a “Mission Accomplished” banner.
It is little short of miraculous that a doubling of oil prices has only dampened economic activity, and as yet not begun to ripple into the prices of everything else. Greenspan has to get the Fed funds rate up as fast as he can so that he can fight that inflationary oil ripple if it appears (if that fight had to begin from here, we would endure 1 percent-per-meeting hikes, and shortly thereafter proceed through the windshield), but he cannot move to neutral too fast because of the damage high energy prices are already doing.
The term for this simultaneous dampening and inflation threat is “stagflation.” Though we are not yet either stagnant or inflationary, the prospect is at the heart of what is wrong with the stock market.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.
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