A Word Of Caution To The "Vibrant Economic Recovery" Optimists

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Current price levels and related trends are similar today, Bloomberg's Rich Yamarone warns, to recent periods when deflation fears forced the Federal Reserve to ease policy. To determine the course of monetary policy, the Fed, Yamarone notes, looks at a number of indicators. What is worrying today is that several of them – production and employment – are moving in a somewhat softer direction (despite MSM propaganda). For those optimists leaning toward the potential for a more vibrant economic recovery, a word of caution: Comparisons to month-ago or even year-ago levels may be deceiving.

Via Bloomberg's Rich Yamarone,

Commodity prices have been on a steady decline since mid-2011 and non-petroleum import prices have contracted at a 1.2 percent pace during the last 12 months. Given personal consumption expenditure (PCE) inflation of only 0.7 percent and an associated core PCE of 1.1 percent – both of which are important in policy deliberations – Fed officials would be justified in their concern.

Other than the obvious 2008 contraction in the general price level, which coincided with a depression and a banking crisis, the two most recent bouts of deflation worries were in 1998 and 2002. In 1998, fears of deflation among policy makers escalated throughout the year. Then-Dallas Fed President Bob McTeer noted during the Sept. 29 FOMC meeting: “Our most recent Beige Book report shows that the price picture has turned deflationary in several sectors. Weak international demand has continued to add to growing supplies and falling prices. We see price declines in gasoline, petrochemicals, oil and gas services, semiconductors, computers, primary metals, paper and paper products, and softwood lumber.” The Fed then went on to ease three times for a total of 75 basis points, bringing the target rate down to 4.75 percent.

Deflation fears picked up again in the third quarter of 2002 when PCE inflation sank to 0.7 percent and the core PCE was lingering around 1.5 percent. We are essentially at those same levels today. Ultimately, the Fed cut its borrowing target rate by 50 basis points to 1.25 percent.

 

To determine the course of monetary policy, the Fed of course looks at a number of indicators. What is worrying today is that several of them – production and employment – are moving in a somewhat softer direction. The industrial production index climbed 1.1 percent in November from a lowly 0.1 percent increase during October. The year-over-year pace currently stands at 3.2 percent. While that may seem desirable, it is a far stretch from the better than 8 percent gains posted in mid-2010. Employment growth has also taken on a flatter pattern.

For those optimists leaning toward the potential for a more vibrant economic recovery, a word of caution: Comparisons to month-ago or even year-ago levels may be deceiving.


Month-to-month changes are going to be elevated since the government shutdown of Oct. 1-17 reduced output and activity.

Similarly, October and November levels versus year-ago activity are deceptively strong due to the impact of Hurricane Sandy, which crippled the entire eastern seaboard leaving millions without power or transportation. For example, total retail sales in October last year were flat from the previous month and up a scant 0.1 percent in November from October. That makes the current year-over-year gains of 4.7 percent and 4.1 percent in November and October, respectively, appear better than they really were.

Given the fragility of the economy and the Fed’s unprecedented policy actions, a renewed threat of deflation leaves policy makers with few options.