Bernanke’s Inflation View Validated as Commodities Fall
A plunge in global commodity prices is tilting the balance in favor of Federal Reserve Chairman Ben S. Bernanke and colleagues who may seek further action to boost growth as the U.S. labor market falters and risks from Europe rise.
The Standard & Poor’s GSCI Total Return Index of 24 commodities has fallen 16 percent since May 1. Oil is down 21 percent, and corn has slumped 18 percent. Inflation, as measured by the personal consumption expenditures index, slowed to an annual 1.8 percent rate in April, below the Fed’s 2 percent goal. The consumer price index, another measure of the cost of living, fell by the most in more than three years in May, a report yesterday showed.
“The whole inflation backdrop has vindicated Chairman Bernanke’s view that a lot of these dynamics were transitory,” said Julia Coronado, a former Fed economist. “Inflation isn’t in any way restricting them from taking action” when policy makers meet June 19-20, said Coronado, chief economist for North America at BNP Paribas SA in New York.
When gasoline prices soared to almost $4 a gallon and annual inflation climbed as high as 2.9 percent, Bernanke said the increases wouldn’t last. That put him at odds with policy makers, including Philadelphia Fed President Charles Plosser and Richmond’s Jeffrey Lacker, who warned that the Fed’s record balance sheet risked igniting inflation and said the Fed should dial back a pledge to keep its key interest rate low at least through late 2014.
‘Hard to Argue’
“It’s hard to argue that an earlier tightening is warranted given what we’re seeing on inflation,” said Paul Edelstein, director of financial economics at IHS Global Insight in Lexington, Massachusetts.
The outlook for inflation is “subdued,” and price increases will probably remain at or slightly below the Fed’s 2 percent goal, Bernanke said in testimony to the Joint Economic Committee of Congress on June 7. Higher unemployment and retreating oil and gas prices “should continue to restrain inflationary pressures.”
Gasoline and oil have led the price indexes lower. Gasoline fell to $3.53 a gallon on June 13 from a 2012 peak of $3.94 in April, while oil was $83.91 a barrel as of yesterday after peaking at $109.77 in February in trading on the New York Mercantile Exchange.
“We will see inflation decelerate a little bit from here, but probably not massively,” said Eric Lascelles, chief economist at RBC Global Asset Management in Toronto, which manages about $250 billion. “The world’s looking a bit more grim. Demand is not quite as strong, and so consequently commodity prices are beginning to retreat.”
The so-called core personal consumption expenditures index, which excludes volatile food and energy costs, rose 1.9 percent in April from a year earlier, down from 2 percent in March. Economists predict core inflation will end the year at 1.8 percent, according to the median estimate in a Bloomberg News survey.
The economy added 69,000 jobs in May, the fewest in a year, and the unemployment rate climbed to 8.2 percent from 8.1 percent, according to June 1 Labor Department report. The Fed’s long-term goal for unemployment is 5.2 percent to 6 percent, according to the central tendency projection. Growth in average hourly earnings declined to 1.7 percent in May from a year earlier.
Payrolls increased in 27 states last month, while the unemployment rate climbed in 18, indicating progress in the U.S. labor market remains uneven. California led the nation with a 33,900 gain in payrolls, followed by Ohio with 19,600 more jobs, figures from the Labor Department showed today in Washington.
U.S. industrial production unexpectedly fell in May for the second time in three months as factories turned out fewer vehicles and consumer goods. Output at factories, mines and utilities decreased 0.1 percent last month after a revised 1 percent gain in April, the Fed reported today in Washington.
The Standard & Poor’s 500 Index rose 0.6 percent to 1,336.88 at 10:58 a.m. in New York. Yields on the benchmark 10- year Treasury note fell seven basis points, or 0.07 percentage point, to 1.57 percent.
Investors expect annual price increases of 2.1 percent over the next 10 years, as measured by the difference between nominal bonds and inflation protected securities.
“The decline in headline inflation is welcomed by the doves, but what is in play now is the prospect of pushing back the rate guidance, and that is being driven more by the growth than the inflation story,” said Michael Feroli, chief U.S. economist for JPMorgan Chase & Co. in New York.
Following the May jobs report, Feroli and his team at JPMorgan trimmed their growth outlook for the third quarter to 2 percent from 3 percent and said the Fed is now likely to act as soon as June by purchasing more bonds or altering its pledge in the statement to hold rates near zero through late 2014.
The Fed reduced its benchmark interest rate almost to zero in December 2008 and later bought $2.3 trillion in securities in a bid to push longer-term borrowing costs lower. In January, it said it would keep rates near zero at least through late 2014, extending an earlier pledge of mid-2013.
In September, the central bank started its so-called Operation Twist program intended to lengthen maturities of bonds in its portfolio, with plans to purchase $400 billion of longer- term Treasuries and sell $400 billion of short-term debt. The program is schedule to end this month.
Price pressures have been easing across the developed world, according to the Organization for Economic Cooperation and Development. Data released May 29 show inflation among its 34 member countries slowed to 2.5 percent in April from 3.3 percent in September.
Even so, a slight decline in inflation in the near term wouldn’t prove that members of the FOMC who favor an earlier tightening were incorrect in their assessment of the risks that prices might surge at a later date, Edelstein said.
“When most Fed hawks talk about inflation risk, they’re not talking about what we’re seeing now,” Edelstein said. “They’re more worried if we ease more and it becomes hard to get ourselves out of it further down the road.”
Philadelphia’s Plosser dissented from FOMC decisions in August and September of last year to add stimulus. In a May 3 speech, Plosser said he forecasts subdued inflation for now.
“My outlook is for about 3 percent growth in both 2012 and 2013,” Plosser said in Santa Barbara, California. “I predict that inflation will hover near or slightly above 2 percent over much of the period.”
Richmond’s Lacker has dissented from all three decisions of the Federal Open Market Committee this year, objecting to the 2014 pledge. Lacker has argued the Fed will have to raise rates next year as growth accelerates.
Declining inflation and a rise in unemployment rate are making those arguments less persuasive, said Eric Green, global head of foreign exchange, interest-rate and commodities research for TD Securities in New York.
“The pattern is working very neatly toward how the doves see the balance of risks,” said Green, a former New York Fed economist, referring to policy makers such as Chicago Fed President Charles Evans and Boston’s Eric Rosengren.
Evans, in a June 11 interview in Chicago, said he’s “been in favor of pretty much any accommodative policy I’ve heard about.”
“I’m sure that we’ll get the unemployment rate below 7 percent -- the question is when,” said Evans, who was the only member of the FOMC last year to dissent in favor of more stimulus. “It’s currently going to take longer than anybody would like. If we had more aggressive monetary policy, it would happen sooner.”
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