What should the Fed do next? Something to consider: Economist David Beckworth correctly notes that a) long rates started rising several weeks before Fed Chairman Ben Bernanke’s “tapering” comments, and b) long rates on safe sovereign assets around the world are going up and are doing so in a similar manner. So what does the broad rise in rates mean? Beckworth:
How about an improved economic outlook? We are now halfway through 2013 and the U.S. economy has been relatively resilient to fiscal austerity and Japan’s first quarter growth has been better than expected. Maybe investors see these developments and are becoming increasingly more confident. If so, they would be rebalancing their portfolios accordingly and, in the process, driving up the natural rate of interest. … Note the implications of this understanding. If monetary policy does spark a robust recovery it should lead to higher interest rates, not lower ones. Higher yields mean, then, that QE3 is working. Chairman Bernanke made this very point at a prior congressional hearing … For him to even consider tapering implies he believes a solid recovery may be finally taking hold. But, by his own admission, a solid recovery means higher interest rates. Commentators, therefore, should be viewing his tapering talk and higher yields as a sign of progress, not as a sign of Fed tightening.
One data point: US monthly job growth averaged 178,000 in the eight months before Bernanke announced the latest round of quantitative easing and 198,000 in the eight months since. And that improvement despite the fiscal cliff tax hikes plus spending sequestration.
But the labor market is still healing, and as today’s benign inflation data showed, rising prices shouldn’t be much of a concern. IHS Global Insight:
The CPI firmed 0.1% in May as gasoline prices were unchanged. Food prices drifted down 0.1% and recovery in wellhead natural gas prices filtered through to push electric rates higher and lift the cost of piped gas. Core prices, excluding food and energy, drifted up 0.2% rather than the 0.1% gains of the prior two months, but a two-month average is still 0.1% as the acceleration is just noise and rounding effects. Indeed, it is a commentary on how tame the CPI is that anyone would even notice a 0.1% firming to 0.2% in the monthly core CPI. ..The overall consumer price picture is quite flat — near roughly 1.5% annual inflation, down from about 2% a year ago.
Again, given low inflation and the large job and output gaps (vs. the pre-recession trend), there seems little policy need for tapering of any sort.