The Fed's Cautious Optimism Isn't Believable

Were it not for the latest set of data, I could agree that all is fine with the US economy as long as the military monster keeps destroying assets paid for by the taxpayer. An F-16 crashed in Iraq - wonderful, add a couple of 100 million to next quarters GDP in replacement costs. Other countries take a more peaceful road towards economic progress.
Other than that, 2007 will be remembered as the year when INFLATION became the buzzword all over the globe.

According to the BLS (pdf) the headline inflation figure rose to 0.7% (April 0.4%) in May which means that even official statistics despite all the hedonic changes now record an annualized inflation rate of 8.4%. In this context it has to be questioned whether the US economy isn't already in a recession that is only hidden by engineering a too low deflator for the official GDP figure which was only plus 0.6% (annualized) in Q1 2007. That official figure is anyway already within the statistical margin of error.

This may also be reflected in Friday's release of industrial production which showed no MoM gain at all after a bumpy ride in the first quarter.
Coming back to inflation, and I'm not talking about the core rate which applies to not one living consumer in this world, the BLS release also said that the CPI-U for urban consumers has risen to an annual rate of 5.5% in the first five months of this year, compared to a rise of 2.5% a year earlier. This means that the current Fed Funds rate does not cover inflation anymore. I would not be surprised to see the Federal Reserve opting for a rate rise at the next FOMC meeting in two weeks.

But the Fed sits between a rock and a hard place. Any rate rise would transform into higher borrowing costs for consumers who already cover an ever-growing part of their expenses with credit card payments. Revolving credit rose to $888 billion in Q1 or roughly 10% more than in the quarter before.
As home equity extraction has slowed down due to the turmoil in the subprime sector I take this as a sign that the US consumer has never before been so highly leveraged as he is now. For more insight into the daily deteriorations of the US private property market turn to Calculated Risk.

While the dollar is off its lows and gives the FOMC some leeway in their upcoming rate decision, a gradual withdrawal of foreign investors from the US bond market now also includes foreign central banks whose vaults are already full with US debt paper declining in prices. But seeing 10 year yields rise 50 basis points within four weeks, it looks as if the Federal Reserve is getting into a marketing problem with its currency that is only backed by belief (Latin: credit) but no assets.

It is also hard to believe that the problem in the subprime lending sector will be contained as is the Fed's hope. The Fed has also been hoping to keep inflation contained, but has not backed up its wish by real action. So shall we believe their cautious optimism for the mortgage/property sector? I don't.

Comments

[wixeywaxy]

Interesting to see someone telling it like it is. We are headed for stagflation thanks to GWB's following the lead of LBJ in mismanaging the economy by pursuing a fabricated war on credit. The chickens didn't come home until the Jimmy Carter days then, by passing R. Nixon, but it looks like the time table will be advanced giving the next president the coup de gras. (or however you spell it) The Fed has it's hands tied. It should be raising rates but is unable. Eventually we will need to find another Paul Volker and the pain will be far worse than it would be if Bernake would sacrifice himself for the good of the country now. (but he isn't likely to do it) Vic