Given the history of the past few years, it is remarkable that Ben Bernanke is so confident. While undertaking to manipulate the hundreds of billions of asset purchases leading to the liquidity injection known as “QE2”, the Chairman of the Federal Reserve hopes to further stimulate our economy while creating Goldilocks inflation – not too much, not too little – but just the right amount to inspire spending and investment. This is a tricky undertaking; Mr. Bernanke is not operating in a laboratory but rather in a messy and complex world, where things do not always go as planned.
Indeed, we have seen in recent days that yields on the long-term instruments the Fed is targeting have risen, not declined, as concerns about sovereign debt failures in the Eurozone have again driven investors to seek safe harbor in the dollar. Yields on 10-year Treasuries at the end of August were 2.47%; recently, yields had increased to 2.92%. Further, until yesterday, Bernanke’s expectation that adding liquidity would boost stock prices seemed to be heading off the rails.
However, the biggest surprise of all may not be evident for some time -- that the economy is actually gaining ground faster than expected. There have been numerous hints of better-than-expected growth which, taken together, should be raising red – and mostly happy - flags for our federal stimulators.
For instance, the four-week average of unemployment claims continues to drift lower. This week the tally fell to the lowest level since September 2008. Second, even in the miserable housing sector, which has been and continues to be a sizeable drag on our recovery, there are signs of life. The number of people behind on their mortgages dropped in the third quarter. True, newly initiated foreclosures rose, but that trend has almost certainly been distorted by widespread processing problems at the banks.
Also, the index of leading indicators from the Conference Board posted a hefty advance in October, the fourth monthly increase, doubling up on the gain in September. The Philadelphia Fex index, reported today, came in at 22.5 for November, its highest level since December 2009. In October the measure was only 10. Overall manufacturing industrial production has been climbing at an 8.2% annualized rate for the past 16 months.
Research firm ISI recently surveyed 118 companies, representing about 12% of GDP. Some 48% of CFOs plan to hike employment next year, up from 30% a few months ago. That’s wildly more bullish than the reading last year, when 66% expected to reduce hiring. Moreover, more than half of CFOs expect to boost capital spending, the highest percent since 2003.
None of these indicators on their own negates concerns about the sluggishness of the economy’s bounce-back. Collectively, though, they begin to paint a picture that may be rosier than that described by Mr. Bernanke.
What if he is wrong and the underlying recovery is more robust than expected? The risk is that inflation gains a foothold while eyes are elsewhere, and becomes the next big problem. A declining dollar has boosted commodity prices across the board, with inevitable consequences for producer prices down the road. Recent consumer price reports were benign, but partly because housing costs, which account for 42% of the Consumer Price Index, have been dropping. Food inflation is more concerning. The dollar price index tracked by the UN’s Food and Agriculture Organization is ahead 25% over the past year, and currently only 7% below the peak recorded in June 2008. Poor crop results are leading to expectations that higher prices for grains will boost food prices internationally in 2011.
In the U.S., meanwhile, October meat and egg prices were nearly 6% higher than the year earlier while dairy prices had risen 3%. A recent report from the Federal Reserve Bank of Chicago that farmland prices in its district, which includes Iowa, Illinois and other states growing staples like corn and soybeans, jumped 10% in the past quarter, suggests what insiders are expecting in the way of crop prices. Looking back to the 1970s, inflation, once loosed, was almost impossible to rein in.