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April 28, 2006
Strong economic data gave long-term rates a tough time this week, the 10-year T-note rising as high as 5.14% and mortgages threatening a lurch to 7.00%, but stabilizing in response to Mr. Bernanke’s we-may-pause remarks to Congress.
The long-term rate lid has been clamped down by bond market expectations for an economic slowdown, and trust in inflation vigilance at the Fed. Both expectations had less foundation at the end of this week than at the beginning.
The economy is accelerating -- roaring, really. 1st quarter GDP raced to a 4.8% gain on big spending by both consumers and businesses, its internal inflation indicator right at the 2% cliff-edge.
Housing was supposed to have faltered badly by now, leading a slowdown. Instead of falling, March sales of existing homes were steady; sales of new homes were supposed to flatten and instead surged 13%. Consumer confidence has sailed to a four-year high, consistent with a better and better market for jobs, ignoring three-buck gasoline. Orders for durable goods were supposed to rise by 1.6% in March and instead screamed to a 6.1% gain, plus a half-again revision for February.
That kind of growth has combined with $70-plus oil to produce the worst inflation risk in 25 years.
The bond market, waking from a bad dream to discover that it is no dream, but real, reaches for its security blanket... and can’t find it.
Not lost in the laundry, but retired for good. The new blanket, Perfesser Bernanke, reassured no one in the bond market with his testimony. Before he spoke, markets were pricing a June hike to 5.25% and preparing for higher. When Mr. Bernanke suggested a sit-still June meeting, short-term rates mechanically backed down, but bonds froze in evident skepticism. Only stock market loons were thrilled.
Perfesser Bernanke is a brilliant economist, but has no track record in his new job. Until he builds confidence with results, his only tools are rhetoric and attitude. Instead, he gave us this pause line: “Even if risks are not entirely balanced, the committee may decide to take no action at one or more meetings in the interest of allowing more time to receive information.” Even if risks are tilted to inflation, we may need some time to think things over.
The conclusion of a tightening campaign is reason for celebration, but a premature halt, last seen 1977-78, is a nightmare. The Perfesser is entitled to his own operating style, so long as he gets results, but despite his excellent credentials there has been one worry about the man (and the cause for my insolent references to the “Perfesser”): he is a life-long academic. Academic decision-making knows no urgency; rumination in search of truth is an end in itself. He doesn’t present as a ditherer, or timid, but a go-stop-go plan shows uniquely academic hubris: given enough information, we can predict the future and fine-tune the economy.
Mr. Bernanke’s predecessor allowed the Crash of ’87 to interrupt (briefly) one of his four inflation-fighting campaigns; in no other did he pause or make the slightest suggestion that he might, “to receive information” or for any other reason. That man raised rates until the work was done, and cut them later to repair damage.
Mr. Bernanke says that inflation is a risk, but under control. He made no mention of the wild run-up in commodities, or the absence of risk premia. He has all of his chips on a soon-to-appear economic slowdown, the kind of bet placed only by someone with great faith in his life’s work: the construction of economic forecasting software. If he wins, he’s a hero and credible in the bond market.
If he pauses, and the economy fails to follow his model, and he then has to play catch-up, there will be hell to pay. Inflation and rates the least of it.
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