Friday, August 04, 2006

The Fed Will Likely Foolishly Choose to Pause

The monthly employment number have for a long time been one of the most important statistics published in America, but never have it been more important than this time. With several Fed board members saying earlier this week that the odds for another rate hike at next week's meeting is about 50-50, and with no other important statistics available before then, today's employment number was likely to determine whether there will be another hike or a pause.

Yet the report turned out to be somewhat inconclusive, meaning that it will not definetly settle the case of whether there will be a hike or a pause. But on balance, it looked weak enough to make it more likely (but not certain) that there will be a pauce.

The weak elements included primarily a slight fall in household survey employment, a rise in the unemployment rate from 4.6% to 4.8% and a relatively low increase in payroll survey employment. But on the other hand, average hourly earnings rose a higher than expected 7 cents to $16.76, following a 7 cent increse (previously reported as 8 cents) the previous month too.

Given that focus is usually on mainly the payroll survey employment number and secondarily on the unemployment rate, this looks likely to tip over the balance to the pause option.

Yet that is likely to be a mistake. Because while growth is slowing, there is no indication this will translate into lower price inflation . Instead, the economic numbers more clearly than for a long time reflects stagflation. In the latest 4 months, the PCE deflator have increased more than 5% at an annual rate and even the core PCE deflator have now accelerated and increases more than 3% at an annual rate. And everything indicates that these inflationary pressures remain strong.

Prices paid indexes for both the Manufacturing and non-manufacturing ISM rose to new near record highs, and commodity price indexes rose to new records. Rent increases are also accelerating. Meanwhile wage increases are accelerating even as productivity is decelerating. With growth being only 2.5% at an annual rate during the second quarter and with the hours worked index in this report rising at an annual rate of 2.8%, productivity was flat or slightly falling. And with wages rising at a 5% rate or so this indicates 5% unit labor cost increases.

For all of these reasons, consumer price inflation looks more likely to accelerate than decelerate, which in turn means that any pause now will only force Bernanke to raise even more later.

See also Peter Schiff's analysis of the subject.


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