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Pause/Resume Scenario Increasingly Likely

As we previously observed, the Fed Halt is now baked into the cake; Going forward, we need to watch for what we previously viewed as the worst scenario for the markets:  The Fed appeases the markets, halts tightening, and gets behind the inflation curve. After letting inflation get away from it, they subsequently resume tightening, and its a debacle for the markets.

On the scale of hawkish/dovish past Fed Chairs, Bernanke clearly sits near "easy Al" Greenspan end of the spectrum, and far far away from the tough Paul Volcker / William McChesney Martin inflation hawks. So much for that vaunted muscularity we were going to see.

Ben Bernanke is now the Neville Chamberlain of Inflation Fighters . . .

I think Gold -- and most of the commodities -- just got a whole lot sexier . . .

Thursday, April 27, 2006 | 12:20 PM | Permalink | Comments (39) | TrackBack (2)
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Comments

Barry,

Any thoughts on what will happen in May if and when the Fed says they're done? My gut says we get an explosive rally followed by a monster fade. What say you?

Posted by: Bynocerus | Apr 27, 2006 12:38:24 PM

Little early to make the call on Bernanke, isn't it?

Posted by: royce | Apr 27, 2006 1:01:47 PM

and as an add on to another post. when was the last cycle where stocks rallied when the yield curve widened?
2000-2003 was ugly
1989-1991 stocks were ok but volatile and preceded a recession
both the 1994-2000 and 2003-current rallies were accompanied by +200bps flattening of 2s/10s

i thought this quote on bloomberg is important: ``Pausing amidst robust data contradicts earlier statements that they are data dependent,'' said Scott Gewirtz, head of U.S. Treasury note and bond trading at Lehman Brothers Inc. in New York. ``If you were someone who was looking for the Fed to protect your fixed-income investment, if they pause and they're wrong, inflation pressures can build in that period.''

that presents problems for holders of long term treasuries. a big GDP number tomorrow could really make things interesting.
i'm a bear so biased but it's hard for me to see stocks rally on a P/E multiple expansion trade when the yield curve is widening

Posted by: vfoster | Apr 27, 2006 1:07:59 PM

I don't think it's premature at all, although I understand the sentiment from the question. Ben can't exactly say that he's done for good, but he can say the Fed will pause, and then pause until they lower rates. I think Barry's analysis about Ben being a market appeaser is spot on.

Posted by: Bynocerus | Apr 27, 2006 1:13:42 PM

Or maybe he's just more liberal with the printing press. As much as we like to kick the Fed around I don't see why Bernanke is such a wanker.

Historically, the Fed in the US has been much more conservative than Canada & Europe.

Many central banks measure success by rising living standards & don't freak out every time they see wages increase.

If Bernanke would have kept raising he would've been slammed. If he stops now he's slammed as being weak on inflation.

Give the man with the luscious beard some credit. He's not starting a recession, he's taking into account housing slowing down & is working with all the structural problems there are in the US economy.

This is the best that we can hope from from a bald, bearded Princeton economist.

God Bless You Helicopter Ben. I'll always be on your side.

-Mike

Posted by: Mike | Apr 27, 2006 1:19:11 PM

Oh that's cold! Comparing Bernanke to Chamberlain.

Wouldn't it better to compare him too FDA and Big Pharma?

Posted by: David Silb | Apr 27, 2006 1:27:36 PM

Mike, you're out of your tree kid. The Beard needs to show the Ballz and raise until inflation is contained. You cannot abolish the business cycle. We are long overdue for an actual recession. Ass kissing the over leveraged speculating wanks is selling the USD, and my kids' future down the river.

Posted by: Alaskan Pete | Apr 27, 2006 1:27:46 PM

Perhaps ol' Ben is just looking a little further down the road...

There is plenty of research that shows "one & done" to be a canard; there is no historic precedent for a finished fed actually helping out stocks on the fundamental side. It's a bogus thesis, a reason to party here and now and nothing more.

When the fed's previous rate hikes kick in with lagged effect, as they surely will, the market is going to come down like a ton of bricks. Whether it screams higher between now and then matters not. There is a thin line between inflationary whirl-wind and deflationary death spiral, just as there is between love and hate.

Bernanke probably watches the dollar as closely as gold, and sees that now is as good a time as any to get the competitive devaluation train underway. By whacking the dollar early, while bullish optimism still abounds, the rest of the world's central bankers are sufficiently 'warned,' and prepped for later cooperation when the REAL fit hits the shan.

My humble opinion is that Ben is a very smart guy who knows exactly what's going on, which includes full knowledge of the fact that Greenspan basically handed him a suicide mission. So why did he take the job? Because he'd been preparing for it all his life... because he wanted the chance to play Churchill... because he is secretly thrilled at the idea of playing the tragic hero... who knows. Touches of Shakespeare no doubt.

At any rate, I don't think the fed is out of touch as many do. Odds are they are VERY in touch... and fully aware that their job is to manage the decline of empire, rather than make everything hunky dory again.

Bernanke is too savvy not to know the score. Boom always ends in bust, as Von Mises observed so pithily:

"There is no means of avoiding the final collapse of a boom expansion brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final total catastrophe of the currency system involved."

Posted by: trader75 | Apr 27, 2006 1:36:28 PM

trader75 has nailed it.

Alaskan Pete, inflation is the expansion of money leading to an increase in price.

The commodity bull market is not due to an expansion of money but a scarcity of resources & an increase in demand for those resources. As painful as it is for me to spend $40 on a tank of gas that is not inflation.

It is not inflationary because my wife & I have made modest cuts in other areas of our budget to accomadate for that.

The rise in cost for healthcare & education have also been very painful but are not due to Federal reserve policy.

On a whole we have had very benign inflation.

Your kids & my kids future are more jeopardized by the account & budget deficits than anything else.

The dollar is also in jeopardy because of the account deficit.

I think Bernanke realizes there isn't as much inflation out there as people say there is.

He also seems how much the economy is hanging by a thread and is trying to soften the blow.

We're in for a painful adjustment either way you go.

Helicopter Ben is the best thing we've got going for us.

The only thing Bush has done right is put this guy in charge of the Fed.

Yes Bernanke BS's and ideally the Fed would be more honest about matters but he's better than Greenspan.

Greenspan has gone on the record as saying he'd hike at least 3-4 more times. The Greenspan Put in action. A definitely inverted yield curve and definite recession.
Always overshooting.

Bernanke is dreamy.

Posted by: Mike | Apr 27, 2006 1:59:22 PM

I read the testimony at the Fed website, and then I read your excerpt and analysis, and, call me inept at reading comprehension, but my reaction to your posting is: Huh?

First of all, it would be helpful to quote the entire section from which you have excerpted your "money quote," or at least include ellipses where you have cut out text. The full section, with the parts you excluded in brackets reads:

[With regard to monetary policy, the Federal Open Market Committee (FOMC) has raised the federal funds rate, in increments of 25 basis points, at each of its past fifteen meetings, bringing its current level to 4.75 percent. This sequence of rate increases was necessary to remove the unusual monetary accommodation put in place in response to the soft economic conditions earlier in this decade. Future policy actions will be increasingly dependent on the evolution of the economic outlook, as reflected in the incoming data. Specifically, policy will respond to arriving information that affects the Committee's assessment of the medium-term risks to its objectives of price stability and maximum sustainable employment.] Focusing on the medium-term forecast horizon is necessary because of the lags with which monetary policy affects the economy.

[In the statement issued after its March meeting, the FOMC noted that economic growth had rebounded strongly in the first quarter but appeared likely to moderate to a more sustainable pace. It further noted that a number of factors have contributed to the stability in core inflation. However, the Committee also viewed the possibility that core inflation might rise as a risk to the achievement of its mandated objectives, and it judged that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance.] In my view, data arriving since the last FOMC meeting have not materially changed that assessment of the risks. [To support continued healthy growth of the economy, vigilance in regard to inflation is essential.]

[The FOMC will continue to monitor the incoming data closely to assess the prospects for both growth and inflation.] In particular, even if in the Committee's judgement the risks to its objectives are not entirely balanced, at some point in the future the Committee may decide to take no action at one or more meetings in the interest of allowing more time to receive information relevant to the outlook. [Of course, a decision to take no action at a particular meeting does not preclude actions at subsequent meetings, and the Committee will not hesitate to act when it determines that doing so is needed to foster the achievement of the Federal Reserve's mandated objectives.]

He then lanuches into a discussion of social security, medicare and the trade deficit, where, it is interesting to note, he admits to the possibility that his vaunted savings glut might disappear and that a disruption in the process of adjustment of savings and investment levels among the various countries might occur. (That, by the way, is the news in this testimony, IMHO.)

When I read the whole thing, I come to exactly the opposite of your conclusion that "His speech increases the odds that 'One & Done' will finally occur: the Fed is now more likely to stop at 5.0% than I previously believed." I read him as saying that, just because the risks to the employment and inflation objectives of the federal reserve are not "balanced" does not prevent the fed from pausing, and that, they might pause for the next meeting or two to wait for some more incoming data before resuming the upward march of rates.

Most respectfully, at a bare minimum, I think you need to do a better job of explaining how you arrive at your interpretation, given that (at least in my view) my interpretation is the one that arises from a straightforward and natural reading of the complete text.

Posted by: GRL | Apr 27, 2006 1:59:55 PM

Look the Fed's going to do what the Fed is going to do.

Stop bickering. You all know you better make plans for any one of the above scenerios. If they stop raising rates, ok expect inflation cause we've discussed how the CPI is flawed. If they don't stop raising rates, expect downturns because too many people are living on the margins as is and wages are not keeping up with inflation (refer to CPI). Either way there are going to be defined winners and losers regardless of what the Fed does.

Maybe we should look at Benanke as trying to steer a ship through very treacherous waters in the dead of night. It could be "what will do the least amount of damage," scenerio.

Posted by: David Silb | Apr 27, 2006 2:04:37 PM

Just a random thought that passes through my head... With the rather significant increases in debt levels as a result of the housing party, wouldn't inflation maybe be not such a terrible thing for all those folks who bought $750k houses with zero-down ARMs? Dontcha think that maybe that's another thing the Fed has to take into account as well? Isn't Ben a student of the Liquidity Trap and is well aware of how Japan's economy was coldcocked by nonperforming loans in their finance system?

Posted by: Chibi | Apr 27, 2006 2:13:40 PM

Thanks for the 3rd grade level lecture, Mike. I'm well aware that price increases are a symptom of inflation rather than the "thing" itself. Basic Austrian school stuff.

Now your claims that the FED are not responsible for the rising general price level...which would be the layman/MSM/FED defintion of inflation...is patently absurd. You contradict your own argument.

So tell me Mike, who exactly is reponsible for the robust monetary creation reflected by an 8% M3 growth, if not the FED. Get a clue.

Posted by: Alaskan Pete | Apr 27, 2006 2:17:49 PM

Where is the inflation that everyone keeps talking about?

Housing - yes. It has risen but is already correcting.
Stocks - well, not as high as they used to be.
Commodities - simple supply & demand at work here
Food - your grocery bill went up because you're buying organic food, bottled water & a bunch of crap for your kids. Real food prices on a whole have NOT gone up.
Education - Yes, but not due to monetary expansion.
Healthcare - Yes, but not due to monetary expansion.

So where is the inflation?

Rising oil prices are NOT inflationary. People have a finite amount of money to spend. If more of their budget is spent on oil based goods they will have less to spend elsewhere.

No inflation. Just chill. Big Ben is taking care of us.

Posted by: Mike | Apr 27, 2006 2:19:40 PM

I guess I'm just more cynical, but the way I see it, Bush has never made an appointment that wasn't intended to add his political position. Why would anyone think it would be different with Bernanke?

I'm pretty sure his first loyalty is to Bush and the Republicans. There's an election coming. Any further obvious deterioration of the economy will hurt the Republicans in November. So, the correct political thing to do is stop doing anything that might make people feel less rich - ie keep the markets and housing pumped up as long as possible. Especially past Nov.

After that, who cares. The election is won, the economy can go to hell. All the Fed has to do is just try inflate a new bubble some time in late 2008...

Posted by: foo | Apr 27, 2006 2:24:46 PM

I guess I'm just more cynical, but the way I see it, Bush has never made an appointment that wasn't intended to aid his political position. Why would anyone think it would be different with Bernanke?

I'm pretty sure his first loyalty is to Bush and the Republicans. There's an election coming. Any further obvious deterioration of the economy will hurt the Republicans in November. So, the correct political thing to do is stop doing anything that might make people feel less rich - ie keep the markets and housing pumped up as long as possible. Especially past Nov.

After that, who cares. The election is won, the economy can go to hell. All the Fed has to do is just try inflate a new bubble some time in late 2008...

Posted by: foo | Apr 27, 2006 2:25:18 PM

M3 is worthless. I think even Marc Faber admitted that.
M1 & M2 has been declining recently. Liquidity has been getting tighter for the last few months even under Mr. Greenprint.

If M3 were such a problem where has it led to price increases?

BTW, Europe expands M3 at a rate of 9% per year.

Posted by: Mike | Apr 27, 2006 2:31:24 PM

"No inflation. Just chill. Big Ben is taking care of us."

Err, no. He is actually taking care of Princeton. Or rather, the Princeton endowment. These ivy league guys stick together. When I said Bernanke was a smart guy who knows the score, it was a back-handed compliment.

Bernanke's great fear, and the fear of all central bankers, is deflation. Deliberately inflationary policy, by subtle behind-the-scenes means, is the key method of fighting off an onset of deflation.

Heck, its the only method left at the end of the day, once the debt burden exceeds a certain threshold. Thus the Hobson's choice as inevitably presented by Von Mises: ransack the economy or ransack the currency.

On the positive side, fighting deflation means helping your friends--if your friends are well connected money managers. Pumping paper is a beautiful racket for those with the means to milk paper assets. Consider this interesting tidbit from Chris Dialynas of PIMCO:

"The Clinton and Bush administrations, as well as the Greenspan Fed, have relied upon many internal and external advisors. Without doubt, most of these advisors are of Ivy League vintage. It is particularly noteworthy to understand that the endowments of most of those universities—endowments that substantially accrue to the benefit of the respective professors—are primarily invested in very high-risk assets and high-risk strategies (as are numerous other investors in their quest for high returns in a low interest rate world). It is, consequently, of little surprise that policy advice has tended to aggressive stimulus. A disciplined, "take-your-medicine/rebalance-the-economy" set of policies would most likely be detrimental to the endowments of many of this country's leading educational institutions. As long as these institutions maintain high-risk portfolios, the policy advice from the ivory towers will be highly stimulative based upon new, bizarre economic ideas. The global imbalances will grow.

"Professor Bernanke is a member of this fraternity. He is a very thoughtful economist who was an expert guest speaker at a PIMCO Secular Forum a few years ago. He was impressive then and impressive subsequently. There is an extraordinary challenge for a very high-quality person. My concern is his presumed pro-reflationary bias."

Posted by: trader75 | Apr 27, 2006 2:36:07 PM

Man, Chamberlain? You are cold! That is about as low as low gets. I'd say Volcker was the Churchill, Greenspan was Chamberlain and BB, well, we don't know if he's an appeaser or not.

Frankly, I'm very impressed with Bernanke to date. Maybe I'm easily amused. Two things to remember. All markets end in a blow off. If commodities tumble, where will the inflationary pressures come from? So, is a pause the end of the world? Gold is also a deflationary hedge. Maybe gold is most concerned about a global deflationary asset bust not inflation. Jives with low long rates.

He'll likely have a mess to deal with but I'd rather have Bernanke as chair than Greenspan.

Posted by: B | Apr 27, 2006 2:42:11 PM

Trader 75: Love your in-depth, long-term view and on-target literary/historical allusions. A little perspective in the midst of daily detritus always adds needed light.

Posted by: jcf | Apr 27, 2006 2:50:06 PM

Since foo repeated himself, one is from me.

Posted by: me | Apr 27, 2006 2:51:02 PM

and don't forget the on-target etiquette-constrained erudition of Alaskan Pete. thanks to all posters. this blog is cool.

Posted by: Ned | Apr 27, 2006 2:53:16 PM

We're a little crusty and cantankerous up here in the interior. Months of darkness and -50F will do that to a fella.

Posted by: Alaskan Pete | Apr 27, 2006 3:06:41 PM

Been there, Pete. I knew I was too far North when I could look South from Fairbanks and see the Northern Lights.

Posted by: Fred | Apr 27, 2006 3:27:44 PM

Pete-we are just thankful that you try to keep warm by blogging.

Posted by: Ned | Apr 27, 2006 3:35:35 PM

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