High-yield/macroeconomics (fka YIELD)

[Preciouslife1]

Inflation Trap Looms For Fed
Paul Maidment, 02.20.08, 10:14 PM ET

http://www.forbes.com/2008/02/20/fed-inflation-notn-oped-cx_pm_0220fed.html?feed=rss_news

Those who feared the Federal Reserve was showing a reckless disregard of the risk of inflation in cutting interest rates to stave off a potential recession had their I-told-you-so moment Wednesday.

January's monthly inflation data showed consumer prices up 4.3% from the same month a year earlier, with core inflation-- which excludes volatile food and energy prices, and is one of the Fed's most closely watched indicators--up to 2.5%, a 10-month high. Both numbers are too high for the Fed's liking.

The question is whether beggars can be choosers. Fed Chairman Ben Bernanke has repeatedly said he stands ready to cut rates again if that is necessary to stop a slowing economy from becoming a shrinking one. But if he does cut rates again, up will go inflation.

If he doesn't cut, up goes the risk of recession.
While the economy is still growing, for all the widespread bantering about of the "R" word, Bernanke's margin of error around getting the decision wrong is shrinking.
The Fed made public Wednesday that it had lowered its quarterly forecast for full-year GDP growth, presented
at its rate-setting meeting in January, to 1.3%-2%, down from 1.8%- 2.5% at its October meeting.

So far Bernanke and his colleagues have cut and be damned, trusting that inflation will moderate over time thanks to soft demand and rising job losses. They have confounded the skeptics before with their inflation forecasting, but that was before the credit crunch and housing market's troubles produced the economy's current ailment.

At their January meeting, they upped their core inflation forecast for 2008 to 2%-2.2% from October’s 1.7%-1.9%. So they might just get away with it again.

The trap waiting for them is that if inflation expectations rise--and Bernanke has alluded before to the need to keep these in check--investors in the U.S. government's longer-date debt are going to expect higher yields, steepening the yield curve. With mortgages and other loans priced off such long-term debt, that would do little to shore up already fragile consumer confidence.

The betting must still be that at next month's interest-rate setting meeting, the Fed will continue to put more weight on boosting growth than reining in inflation, trusting its inflation forecast for the year is right, that it can manage public expectations and that it is on the money with some of its recent internal research that suggests the cost of getting it wrong is less expensive than once thought.

But surprises like Wednesday's inflation numbers only reinforce how loosely anchored inflation expectations are--and the risks of them slipping their moorings.