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More Of The Same... With "Thresholds"

 December 13, 2012 09:20 AM


Fed Chairman Ben Bernanke made it clear... again. Interest rates will remain low, even when the labor market shows stronger signs of growth. He said that if inflation doesn't exceed an annual rate of 2.5%, and unemployment stays above 6.5%, the Fed would keep its target rate near zero percent. Laying out "thresholds" is something new, but the basic message remains the same: low rates and no plans to change the status quo any time soon.

As Bernanke explained at yesterday's press conference:

First, as the statement notes, the committee reviews policy as likely to be appropriate at least until a specified threshold is met, reaching one of those thresholds will not automatically trigger immediate reduction in policy accommodation.
If unemployment was to decline at a time inflation and expectations were subdued... the committee might judge an increase in target for the federal funds rate to be inappropriate and ultimately in deciding when and how quickly to reduce policy accommodation the committee will follow a balanced approach in seeking to mitigate deviations of inflation from the longer run 2% goal and deviations of employment from estimated maximum level.

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The 2.5% ceiling for pricing pressure is a "conditional inflation targeting," as Menzie Chinn labels it. As it happens, the market appears to have been anticipating that level in recent days. Yesterday's inflation forecast via the 10-year Treasury yield less its inflation-indexed counterpart was 2.51%, about where it's been all week. It's also interesting to note that the Treasury market's assumption for future inflation has been inching higher this month after bottoming out at around 2.4%.late last month.

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It's also clear that inflation expectations and the stock market remain tightly bound. The new abnormal, as I like to call it, is still with us. Expecting higher inflation, in short, is still considered bullish, as this month's dual rally in equities and inflation expectations through yesterday remind.

Another observation: inflation expectations seem to have some upward momentum. Progress, one might say, from the central bank's perspective: convince the crowd that higher inflation is destiny. The market is inclined to agree, albeit on the margins, and only relative to a low base in recent years.

There are, of course, limits to everything, including the market's perception that more inflation is productive. Exactly when that limit will be reached is unknown, of course, but Bernanke is eager to reach that state of mind sooner rather than later. But the road for getting from here to there is still riddled with potholes. The Fed's new GDP growth projection is a bit lower for next year compared with its September outlook: a 2.3%-to2.5% projection via the "central tendency" forecast, or down from 2.5%-to-3.0% range previously published. The Fed also sees slightly lower inflation and unemployment in the new year.

The struggle to juice the economy goes on, with mixed results. One can make an argument that Bernanke and company are winning, but not enough to convince the man on the street. Perhaps a better way to see the big picture is that the Fed isn't losing, at least not any more so than in recent months. We are, it seems, still stuck somewhere in a macro never-never land, floating between a genuine recovery and a shrinking economy.
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