U S Face Recession Forcing Fed To Walk The Line

[Realistbear]

http://personal.fidelity.com/research/stoc...ketsindex.shtml

News Story

Housing, inflation worries force Bernanke to walk the line

08:55 a.m. 04/18/2006 By Dr. Irwin Kellner Provided by

Commentary: Triggering a recession is a real chance for Fed

HEMPSTEAD, N.Y. (MarketWatch) -- With bond yields touching new highs lately, the Federal Reserve faces a new dilemma: Raise rates too much and housing takes a dive. Stop too soon and inflation flares up.

To avoid either outcome, Ben Bernanke, the new Fed chief, will have to walk the line between too much tightness and not enough.

Right now, the Fed's more worried about rising prices throughout the economy than about falling prices in the housing sector.

Slack in the labor force and in industry is being used up at a rapid pace.Meanwhile, prices of industrial raw materials are jumping; gold's at a 25-year high and oil is setting new records almost daily.

In reaction, long-term interest rates have surged to multi-year highs. The 10-year Treasury note has just broken through the 5% mark, while the reincarnated 30-year bond is well beyond this level.

Another way of gauging the fixed-income market's sentiment towards inflation is to compare the yield on the standard 10-year Treasury note with that of its inflation-indexed version, known as TIPS.

The spread or difference between these two yields has begun to widen as people have started piling into TIPS, sending their prices up and their yield down. This widening gap between these two issues suggests that the market is no longer sanguine about the prospects for the future pace of price hikes.

Not surprisingly, this week's U.S. inflation numbers will be scrutinized very carefully by central bankers to see if they herald the beginning of a new, higher rate, or are more of the same.

But wait a minute -- let's not forget the other side of the story.

It begins with the shift in monetary policy from accommodative to neutral -- if not slightly restrictive. This is the result of 15 quarter-point increases in the federal funds rate, from 1% in the middle of 2004, to 4.75% today.

It goes on from there to the one sector of the economy that's very sensitive to the Fed's actions: housing.

Housing prices bubbled up as interest rates fell. Now the rise in rates, by reducing the demand for homes, has caused inventories of unsold homes to rise and construction to fall.

In some parts of the country -- especially the so-called "hot" markets -- home prices are sliding as well.

Worse yet, most people are no longer able to use their homes as piggy banks to finance outlays that their incomes can't. This means that consumer spending, the mainstay of economic growth over the past several years, is about to take it on the chin.

If the consumer shows signs of staggering between now and the Fed's late-June meeting, Bernanke & Co. might well decide that recession is at least as much of a threat as inflation. In this case, they'll join the "one and done" club and stop the rate increases of 2006 after May's meeting.

And you thought it was tough for Johnny Cash to walk the line.

And then there is the BoJ to rain on everyone's parade

[Spring In The Air]

You just don't, or won't see it. Once housing stalls, MEW drops and consumer spending drops, all thoughts of interest rate increases vanish like a puff of smoke.

It's already happened here. Housing started to stall, MEW started to drop and consumer spending slowed and, just like that, an interest rate drop. And, if things get worse in the economy, they will go down again. Here and there.

[Lou G]

It's already happened here. Housing started to stall, MEW started to drop and consumer spending slowed and, just like that, an interest rate drop. And, if things get worse in the economy, they will go down again. Here and there.

and how many times can you drop rates!. Didn't help Japan...

[MarkG]

Housing started to stall, MEW started to drop and consumer spending slowed and, just like that, an interest rate drop.

Yeah, of course: just like that, when inflation is exploding and the rest of the world is raising rates in a desperate attempt to rein it in.

[Realistbear]

Alan "Big Al" Greenspan's philosophy when between a rock and a hard place was to burst the bubbles and rid the market of the froth. That was behind his series of hikes only the IR conundrum didn't resolve itself until after he retired from the Fed (Fed rates rose yet long term IR fell).

If Ben is following Al he will continue to hike for awhile yet and get the economy off of its HPI/MEW adiction which will end in grief whatever happens to IR.

With the BoJ hikes coming they will do the job for Ben and if any blame is to be taken for the recession they can all say it was Japan's fault in not controlling inflation sooner.

[MarkG]

With the BoJ hikes coming they will do the job for Ben and if any blame is to be taken for the recession they can all say it was Japan's fault in not controlling inflation sooner.

Maybe that's Gordon's plan too. Seems like a good way to play 'pass the buck'.

[jonpo]

fed should keep raising until gold is under control. i.e headed down.

thats what greenspan would do....

[BuyingBear]

fed should keep raising until gold is under control. i.e headed down.

thats what greenspan would do....

Err... Greenspan created this mess in the first place!

[Spring In The Air]

Yeah, of course: just like that, when inflation is exploding and the rest of the world is raising rates in a desperate attempt to rein it in.

You are seriously deluded. Inflation is exploding? Really? Where? The developed economies are going to struggle because of deflationary globalization pressures for the forseeable future. A few interest rate increases to control asset bubbles but, as soon as consumer demand is hit, back down they will come.