Two important reports on the U.S. economy were released on Friday September 14th. They came one day after a precedent-setting policy statement from the Federal Reserve.
Let’s talk about the numbers first. According to the Census Bureau, U.S. retail sales in August increased 0.9% from July and 4.7% versus August of last year.
Both numbers were improvements over July when the month-to-month change was +0.6% and the year-over-year figure was +3.9%.
Consumers are continuing to make a significant contribution to overall U.S. economic growth despite the sluggishness in the jobs numbers.
The other report referred to in the opening sentence sets out the latest inflation rate. According to the Bureau of Labor Statistics, the year-over-year change in August’s all-items Consumer Price Index (CPI) was +1.7%. That’s a little faster than July’s +1.4%.
The “core” rate of change, which omits the most volatile elements in the CPI – specifically food and energy – was +1.9% in the latest month. In July, core inflation was higher at +2.1%.
Food prices were +2.0% year over year in August and energy costs were -0.6%. The price of gasoline was +1.8% relative to August 2011.
The bottom line on inflation is that it remains well under control. The Federal Reserve has a double mandate, “to foster maximum employment within price stability”.
The latter doesn’t mean “no increase” in prices. Rather, the Fed – similar to most other central banks around the world – has chosen +2.0% as its target rate for inflation.
So where does this leave the Fed? Clearly too-rapid price inflation is not a problem at this time. It must focus on the second of its directives, employment.
Employment depends on the state of the overall economy.
On that score, it has recently seemed as if the economic outlook is being left up in the air until there is a resolution of who will occupy the White House after November 6th.
That isn’t good enough for Ben Bernanke, Chairman of the Fed.
At the September 13th meeting of the Federal Open Market Committee (FOMC), which sets monetary policy, the stance turned more aggressive.
The Fed will begin buying an additional $40 billion per month in mortgage-backed bonds, with no specified expiry date.
In essence, this is QE3 (Quantitative Easing Three). More money will be injected into the economy. The Fed will go into the closet and dust off the printing presses.
That might not take much elbow grease. It wasn’t long ago that QEs 1 and 2 were tried and the supply of money in the system was augmented enormously.
The Fed will also extend “Operation Twist” to the end of this year, a program designed to bring down long-term interest rates.
The Fed is also lengthening its termination date for nearly zero interest rates (0.00% to 0.25% for the federal funds rate) until mid-2015 from mid-2014.
The expectation is that the ultra-low interest rate environment will continue past when the economy is showing clearer signs of being on the mend. It’s believed the Fed would like to bring the jobless rate down to 7.0% from its current level of 8.1%.
Mr. Bernanke’s far more aggressive approach takes a leaf from the book of Mario Draghi, head of the European Central Bank (ECB).
Super-Mario, as he’s referred to overseas, has stated he will do whatever it takes to save the Euro. And that means buying the bonds of nations that are in financial distress.
Speculation about the imminent demise of the 17-member currency has driven up interest rates to an alarming degree. Already-distressed nations are being further burdened with interest charges that bear “to Mr. Draghi’s mind” an unwarranted extra risk premium.
He wants to put an end to such game playing.
He made his bold statement, well aware that Germany’s bundesbank might not approve.
His gamble appears to have paid off. German Chancellor, Angela Merkel, has sanctioned the move. And the yields on Spanish and Italian bonds have fallen dramatically, at least for the moment.
The tone of Mr. Bernanke’s press release is an echo of Mr. Draghi’s tough talk. The three key passages in the Fed’s statement read as follows.
1. The Committee (also) anticipates that inflation over the medium term likely would run at or below its 2 percent objective.
2. The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions.
3. If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.
It’s as if central bankers are becoming fed up with their politician counterparts. “If they’re not going to do anything about our economic situation, we will,” seems to be what they’re saying.
Meanwhile in Canada, a media interview with Prime Minister Harper elicited his opinion that we are now in an era when economies can only expect to muddle through.
Prior to the Fed’s most recent meeting, North American stock markets were already factoring in a QE3-type initiative.
They can only be expected to react with glee to the latest announcement.