Home   Logon   Mobile Site   Research and Commentary   About Us   Call 1.800.621.1675 or Email Us       Follow Us: 

Search by Ticker, Keyword or CUSIP       

Blog Home
   Brian Wesbury
Chief Economist
Click for Bio
Follow Brian on Twitter Follow Brian on LinkedIn View Videos on YouTube
   Bob Stein
Deputy Chief Economist
Click for Bio
Follow Bob on Twitter Follow Bob on LinkedIn View Videos on YouTube
  Fed Will Make Excuses About Inflation
Posted Under: CPI • Government • Inflation • Monday Morning Outlook • PPI • Fed Reserve
Inflation is tame. For now. The CPI (consumer price inflation) was flat in January and is up only 1.6% from a year ago. The PPI (producer prices) rose a small 0.2% in January and is up just 1.4% from a year ago.

And even though energy prices spiked in February, the year ago comparisons are likely to stay tame. The consensus expects the February CPI to rise 0.6% - the largest in 44 months. Nonetheless, it would still show just 1.9% inflation in the past year, which is still below the Federal Reserve's target of 2%.

This won't last. With the Fed loose; we expect consumer prices to rise toward 3% during 2013. Then rise to 4% in 2014 on its way to 5% gains, maybe even higher, in the next few years. In theory, the Fed has said that 6.5% unemployment and 2.5% or greater inflation would force it to tighten policy.

However, we believe the Fed will remain in denial about inflation. Ben Bernanke, Janet Yellen, and Bill Dudley – the power-elite – don't believe inflation can head higher, so when it does, they will either ignore it or blame it on temporary, one-off shocks as the Fed did in the 1970s.

The first excuse will be that higher inflation is due to commodities, and they are just not that large a part of the economy. Moreover, "core" inflation remains tame.

But when rising housing prices (and rents) push "core" inflation above the 2% target, the Fed will resort to its second excuse: housing prices are just bouncing back to normal...and that this is just a temporary phenomenon.

The third excuse will be that "it is not actual inflation that matters, but what the Fed forecasts future inflation will be" over the next year or two. And, as long as the Fed is forecasting a return to 2% or lower, then there's nothing to worry about.

If we are right and inflation persists above 2% and continues to rise, that excuse won't work anymore, either.

Enter excuse number four: this is when the troika of Bernanke, Yellen and Dudley will argue that "it's OK for inflation to exceed a 2% target because it has to make up for when inflation averaged below target during past years."

Finally, the Fed will resort to excuse number five, which will blame increasing price pressures, not on loose money, but on things like temporary weakness in the dollar or a temporary increase in velocity or the money multiplier.

And to top it all off, many at the Fed will probably start arguing that inflation of 3-4% is good for the economy. It was OK in the 1980s when Volcker ran the Fed, so it should be acceptable today, especially with the real economy so fragile.

We've seen this movie before, and it didn't end pretty. Back in the 1970s, the Fed blamed higher inflation on OPEC, or a weak dollar, or union wage deals, anything but overly loose monetary policy. As a result, the Fed lulled itself to sleep and inflation eventually got totally out of control.

We hope that doesn't happen again. But, if we start hearing excuses, like those listed above, then the odds of sharply higher inflation will rise. So, let's check the excuses off the list one by one, and see. The more excuses, the higher inflation will eventually go and with it, bond yields as well.

Click here for a PDF version
Posted on Monday, February 25, 2013 @ 9:02 AM • Post Link Share: 
Print this post Printer Friendly

These posts were prepared by First Trust Advisors L. P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. By providing this information, First Trust is not undertaking to give advice in any fiduciary capacity within the meaning of ERISA and the Internal Revenue Code. First Trust has no knowledge of and has not been provided any information regarding any investor. Financial advisors must determine whether particular investments are appropriate for their clients. First Trust believes the financial advisor is a fiduciary, is capable of evaluating investment risks independently and is responsible for exercising independent judgment with respect to its retirement plan clients.
First Trust Portfolios L.P.  Member SIPC and FINRA.
First Trust Advisors L.P.
Home |  Important Legal Information |  Privacy Policy |  Business Continuity Plan |  FINRA BrokerCheck
Copyright © 2018 All rights reserved.