The financial market news this week was the markets themselves: their reactions to the increasing threat of inflation and to the Fed’s management of the threat.
The net effect for us: long-term rates rose to five-year highs, the 10-year T-note’s 5.19 percent taking mortgages to 6.75 percent. Going higher.
Trading since the Fed’s meeting on Tuesday has not been a pretty sight. A 16th straight hike (to 5 percent cost of money and 8 percent prime) was a given; the only variable was what the Fed would say in conclusion. One clause and one sentence had all the content.
“…Inflation expectations remain contained” was followed by this redundant horror: “The Committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information.”
We got the emphasis without the ‘importantly,’ and we had already guessed that the economic outlook would depend on new information. Language reflects the thinking of the author; if the writing is a muddle, so is the mind pushing the pen. This was not Fed Chair Ben Bernanke’s predecessor’s carefully crafted opacity; this was just a clumsy restatement of his April 27 testimony: our forecast says the economy will slow, and if it does then we won’t have to make any hard decisions.
Short-term rates, predictive of near-term Fed policy, have remained steady, consistent with a pause-leaning Fed. On the other hand, inflation-fearful long-term rates have risen steadily ever since the meeting in transparent unease with the Fed’s faith in its forecasting ability, or in its timidity. If you know someone out there who agrees that inflation expectations are contained, tell ’em to call. Lines are open.
Stocks ran well for two days after the meeting on legitimate pleasure with a hot economy and spectacular earnings, and with some foolish glee at a dovish Fed. The Dow touched its all-time high, and then global stock markets simply fell apart as commodities ran on in relentless exuberance. Commodities are not as central to inflation as they used to be (less steel, more software), but this volcanic episode is driving other markets crazy, and should. Gold and silver have nearly doubled, and $70 oil looks more a station on the way up than a soon-to-reverse spike.
The markets have been slow to understand (yours truly, too) what commodities have been telling us: the global economy is in its strongest growth phase ever, if you throw in the first-time participation of China, unimaginable fossil-fuel wealth now widespread, and Japan in its best shape in 15 years. It is not only running hot, but soaked in the combustible liquidity hosed out to float the world above deflation.
This growth is not stable, not just because of inflation, but because the American recycling machine is overheated. Our newest monthly trade deficit ran $62 billion: half of it to buy oil, the source of external petro-wealth, and half of the other half in deficit to China alone (which it recycles, using its dollar winnings among other things to compete with us to buy oil). We cannot sustain $700 billion a year, our external debt growing twice as fast as our GDP, yet the rest of the world is hooked on it.
This is a tough situation: the U.S. economy has to slow, and the world has to diminish its export-to-America habit. If we slow too fast, the whole world is at risk.
In the Greenspan era, the American Fed was the rock in global financial affairs. It could do little more than to insist on inflation control and to act as the world’s fire brigade, but it was absolutely determined to do those two things well.
Four months into the job, Ben Bernanke has yet to assert command in any way, and the longer he sits in the faculty lounge, the more this week’s market volatility will expand. Sooner or later, he must stake out inflation-fighting as the ground that he will defend at any cost.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.
