24 Feb 2006 Will Mr. Bernanke Make Monetary Policy More Transparent?
The year is progressing pretty much as investors anticipated. Analysts continue to lower their earnings expectations as many corporate managers downplay their guidance for the coming quarters. Mr. Bernanke of the Fed says he will continue to fight inflation as hard as his predecessor Alan Greenspan, yet he has some changes in mind. The steady supply of oil continues to be clouded by instability inNigeria,Venezuela,Iraq, and most recently,Saudi Arabia. But with current supplies high and prospects for slower global economic growth, the price of oil is down 4% for the year so far. The same is not true, however, for gold, up 7.5% for the year, likely on inflation and global security fears. But the best leading indicator of all, the stock market, is up. The Dow Jones, S&P 500 and NASDAQ indices are each up about 3.5% so far this year while our model portfolios are doing better than that. But, with all the uncertainty, the ride has been bumpy and should continue that way.
A major contributor to market uncertainty is what Fed policy will be going forward. But significant clarity may be closer based on a development earlier this week. Vice Chairman Roger Ferguson announced his resignation from the Fed on Tuesday. He represented the last significant obstacles for a stated inflation target at the Fed. The Fed’s new Chairman, Mr. Bernanke made it very clear during his time as professor atPrincetonand in speeches leading up to his taking over the Fed that he supported a published a numerical inflation goal for the Fed. The notion was resisted by Alan Greenspan and Vice Chairman Roger Ferguson for years as they said it would limit the central banks’ flexibility. Mr. Ferguson’s resignation virtually clears the way for Mr. Bernanke’s new policy should he decide to press it. According to Bloomberg, at least 21 central banks, including those inCanada, theU.K.andAustralia, have an inflation target, and Bernanke told Congress in November that such a strategy would make the Fed more open. The stock market voiced its approval quickly and positively when the news of Mr. Ferguson’s retirement was announced.
We also learned this week from Fed minutes of the January meeting that the Fed had become very data focused. They said that “all members agreed that the future path for the funds rate would depend increasingly on economic developments and could no longer be prejudged with the previous degree of confidence.” Members expressed concern about the risks to inflation from tighter labor markets, busier factories and higher energy costs. But even so, the effect of increased prices so far, on the cost of other goods “had remained subdued,” and any such “pass-through effects” may be temporary, provided they don’t push up inflation expectations.
But there are still major forces at work on the opposite end of the tug-of-war rope. Global competition and solid productivity growth in the view of our experts should continue to keep a lid on inflation. But if the Fed continues to express fears of inflation we have to remain concerned that their policy might at some point create an excessive drag on the economy. As Ed Yardeni puts it, “[Fed members] should beware of what they wish for. Core CPI inflation was only 2.1% year over year during January. If it stays that low, the Fed folks and all the rest of us will be worrying about deflation again fairly quickly during the next recession.”
With nearly 75% of companies in the Dow Jones Total Market Index reporting, the average of net income from continuing operations is up 13% for the fourth quarter of last year. These results are slightly better than analysts expected and suggest a resilient economy despite devastating hurricanes, historic oil price jumps, and rising interest rates. The quarter’s leading industries were General Mining, Oil Equipment and Services, Heavy Construction, and Biotechnology. Losers were Coal and Property and Casualty Insurance.
Our outlook remains the same; as long as the Fed fears inflation as a real threat interest rates will keep a lid on the stock market. But once they signal that rates are high enough we should see a significant boost in people’s opinions about stocks. They will once again become the asset category of choice as real estate and bond prices level off or decline.