It's Time for a Rate-Hike Break
By Christopher Farrell
Wall Street is thrilled. Merger mania is back. Johnson & Johnson (JNJ ) and Guidant (GDT ). Oracle (ORCL ) and Peoplesoft (PSFT ). Nextel (NXTL ) and Sprint (FON ). Symantec (SYMC ) and Veritas (VTS ). Little wonder hardly anyone paid much attention when the Federal Reserve Board raised its benchmark interest rate last week for the fifth time this year. The increase in the fed funds rate to 2.25% was widely expected. In essence, it was a predictable nonevent.
Still, investors fear that inflation pressures are building. The Treasury market sold off after government statisticians reported first-time jobless claims declined to their lowest level since July. The underlying worry is that a strengthening job market will put pressure on wages and, therefore, prices. Core consumer price inflation (the CPI minus volatile energy and food) has accelerated to a 2.7% rate over the three months to November, compared to a 1% pace the previous three months. Phillip Morris is making it more expensive to light up. Hotels are lifting rates. OPEC is cutting back on production quotas to prop up the price of oil (see BW Online, 12/17/04, "All Eyes on the Inflation Watch").
SIGNS OF DORMANCY.
Taken altogether, it's hardly surprising the market is pricing several more quarter-point moves, to 3%, by the middle of the New Year. Some think the central bank will go further. "In my opinion, the Fed will continue with its 25-basis-point increases up to and including November of next year," says Gary Wolfer, senior portfolio manager with Univest Wealth Management & Trust.
Wait a minute. Alan Greenspan and the Fed governors should extend their holiday season and take a long break. Spend time on the beach. Visit family and friends over the next several months. Keep the hikes to some mountain trails. Meanwhile, let the staff assess the economic impact of monetary policy to date before making any additional tightening moves.
The evidence suggests overall inflation will remain dormant throughout 2005. The Fed's favorite inflation index, the core personal consumption expenditure deflator, is up only 1% in the three months to October, compared to a 0.8% increase over the prior three months, according to Haseeb Ahmed, economist at Economy.com. Many more businesses are complaining about their inability to pass along higher energy costs to consumers than those happily announcing price hikes.
WAITING FOR BARGAINS.
Manufacturers are under enormous price pressure from Chinese competitors. American service companies are turning to India to lower the costs of doing business. Despite OPEC's efforts to shore up oil prices, increased supply and diminished demand weigh on the market. Oil prices are down from a peak of $55.23 in October to the $40 level in December. "The new year will start with inflation reports showing big declines in energy prices, says Edward Yardeni, economist at Oak Associates.
Consumers aren't behaving as if they expect business to whip out the mark-up pen. Quite the contrary. At a recent Merrill Lynch event, Brit Beemer, chairman and founder of consumer research organization America's Research Group, noted that shoppers are procrastinating big-time. His surveys suggest that two-thirds of consumers are waiting for big discounts of 50% off before they buy holiday gifts. If retailers don't slash prices, these same consumers say they'll slice spending by as much as 70%.
As for the worry about wage pressures, relax. In most sectors workers are getting paltry pay hikes. Too many laid-off workers are looking for a job for employers to feel any pressure to increase take-home pay substantially. Also, the Wall Street mantra about an improving job market leading to an inflationary spiral makes no sense. The idea that the value of currency can be debauched by more workers creating value and earning a paycheck defies logic.
KEEPING THE SNAKES AWAY.
The global economic climate isn't conducive to rising prices, either. Central banks elsewhere in the world are worried more about faltering economic growth than higher prices. The European Central Bank is refraining from raising rates, as is the Swedish Riksbank. South Korea's central bank has eased by a quarter-point to 3.25%. And in the fast-growing emerging markets overall inflation is expected to average a mere 5% this year, the slowest pace for that sector since 1980, according to Mark Zandi of Economy.com.
The current Wall Street obsession over the need for its quarter-point rate-hike fixes is reminiscent of a twist on an old joke told by Peter Bernstein, the dean of finance economists, several years ago. A young boy keeps snapping his fingers. His family gets understandably worried, so they send the youngster to a psychiatrist. "Why so much finger snapping?" asks the doctor. "To keep the snakes away," replies the boy. "But there are no snakes here," says the doctor. "That's because I keep snapping my fingers," says the boy.
Wall Street investors and economists are snapping their fingers at inflation. But while the current economy has many things for investors to worry about, inflation isn't one of them.
Farrell is contributing economics editor for BusinessWeek. You can also hear him on Minnesota Public Radio's nationally syndicated finance program, Sound Money, as well as on public radio's business program Marketplace. Follow his Sound Money column, only on BusinessWeek Online
Edited by Beth Belton