Commodity Rout Lends Credence to Bernanke’s Inflation Outlook

ppteam

Federal Reserve Chairman Ben Bernanke has gotten a lot of grief over recent months for his confidence underlying low inflation rates are likely to prevail despite a surge in commodity and energy prices.

The fundamental belief that surging gasoline, food and raw-material prices won’t undo what is at heart a benign inflation environment has earned the Fed chief critics both within and without the central bank.

The generalized fear motivating some investors and analysts has been that surging prices for all manner of basic materials will eventually infect price pressures, broadly measured. The Fed risks exacerbating, and may even be contributing to, the problem by keeping monetary policy highly stimulative as growth moves forward the unemployment rate falls, albeit from very high levels.

The Fed’s chief internal critic, Kansas City Federal Reserve Bank President Thomas Hoenig, has argued the maintenance of an emergency policy in the face of a truly recovering economy is setting the stage for future imbalances. He has advocated rate hikes and said Fed policy may be driving at least some of the commodity surge. He has also fretted rapidly rising farmland prices may be a bubble begat by overly easy monetary policy.

Critics of Fed action certainly had a lot to work with. Oil prices had surged from the just over $40-a-barrel level seen at the end of the recession to more than $100. While that was still short of the nearly $140 peak seen in 2008, the gains have been driving up gasoline prices and engineering a clear push higher in overall inflation. Meanwhile, food prices were on the march higher, and all manner of factory raw material prices seemed to know no direction but up.

But that started to change, in a big way, on Thursday. Oil prices, the most visible player in the commodity run-up, fell hard after a weak report on weekly jobless claims and signs the European Central Bank may not launch an extended campaign of rate hikes sent the market down sharply. Worries the U.S. recovery may not be as strong as expected signaled to many investors it was time to re-price oil for lower demand, and other commodities followed suit.

A respectable monthly jobs report Friday didn’t appear to change the calculus much, and renewed worries about the state of the European economy helped keep oil under $100 a barrel at the end of trading Friday.

All in all, it looks as if Bernanke’s oft-repeated view that the commodities surge, driven by supply shocks, political forces and overseas growth, may indeed be “transitory.” Of course, the issue goes beyond inflation, in that lower oil and food prices may help increase consumers’ spending power, which should help the recovery regain its step.

Fed officials thus far seem to be taking a cautious view of what has happened since Thursday, and that’s prudent. In a speech expressing his confidence the economy is undergoing a “soft patch” that won’t last, New York Federal Reserve Bank President William Dudley had this to say about commodities: “I think I would never comment on short-term market price movements, and I don’t think today’s a good place to start.”

The Fed official explained he is more interested in medium- to long-term trends, and he added, “I would be hesitant to put much weight on very near-term development in terms of that changing the picture dramatically in terms of the broader issues. We’ll see how things go.”

In the same speech, Dudley maintained he expects underlying inflation to remain low, and said the public’s expectations of future inflation isn’t showing any warning signs.

Capital Economics told clients they expect oil prices to fall below $90 a barrel by the year end, amid declines for other commodity prices. They also noted “this past week’s sharp falls in commodity prices of all types may have been exaggerated by wild speculation but are mostly consistent with our view of the economic fundamentals. One of the most striking features of the sell-off is that the declines are broad-based.”

With the outlook long held by Bernanke and core Fed officials moving back into vogue, it suggests the pressure on the Fed to tighten monetary policy will abate.

“During the second half of this year, we assume that the Fed will make gradual preparations for the first interest rate hike sometime in the first half of 2012,” IHS Global Insight chief U.S. economist Nigel Gault said. “But we see no reason for haste, especially with the latest news softer for both growth and commodity prices.”

金牛银熊