With Fed Decision Nearly Certain, Attention Turns to Statement

For the first time in many months, there appears no doubt about the outcome of the Federal Reserve’s two-day policy meeting next week: Officials will almost certainly keep rates steady.

And amid uncertainty over the timing of any future rate increases, financial markets will scrutinize the accompanying statement even more than usual for any hint of the Fed’s intentions.

With officials striking a delicate balance between rising price pressures that argue for higher rates and a shaky economy that doesn’t, the tone of that statement may be best summed up with just two words: fingers crossed.

The Fed “is trying to buy some time,” said Paul Kasriel, chief U.S. economist at Northern Trust. “They’re going to try and word it in a way so as not to signal an imminent rate increase.”

J.P. Morgan economist Michael Feroli sees the FOMC reiterating that the Fed will resist an erosion of inflation expectations and stressing that any “unanchoring” would be a huge market setback. Still, while economists expect the statement to mirror the inflation rhetoric of late, they don’t expect anything drastic in the text.

Instead, the task for the Fed officials will be to highlight their inflation concerns, carefully — without suggesting that rate increases are imminent. Signs of consumer strength aside, the economy is still suffering. Recent economic data show accelerating weakness in the job market, with the jobless rate spiking 0.5 percentage point in May alone. At the same time, housing and manufacturing are still trying to overcome major challenges.

“I think they’re going to have to walk a fine line” between being cautious enough on the inflation front but not overly so, said MFR Inc. economist Joshua Shapiro, who sees the Fed holding rates steady “as far as the eye can see.” But overall, the statement will be “tilted towards more caution about inflation.”

The Fed can address those competing needs of emphasizing inflation vigilance without stressing markets with modest tweaks to its growth as well as inflation language, Fed watchers said.
Fed policymakers will probably describe economic conditions as weak or subdued as they have in the past, but also signal that the risk of a severe downturn has receded, which they haven’t done previously, economists said.

Chairman Ben Bernanke signaled as much on June 10, saying “although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.”

As for inflation, expect officials to ratchet up their concern about the potential for higher food and energy prices to boost inflation expectations, Fed watchers said.

In their last two policy statements officials referred to rising inflation expectations, something they hadn’t done before in rate statements. Feroli thinks the Fed could send an even stronger signal with Wednesday’s statement that it won’t tolerate any further increase by stating that it will “strongly resist” any further erosion.

Officials will likely continue to forecast a moderation in inflation during the coming months as the slower economy eases pressure on labor and other resources. Indeed, though overall inflation as measured by the consumer price index spiked 0.6% in May, core prices that exclude food and energy rose a modest 0.2%.

But policymakers may drop April’s reference to a “projected leveling-out” of energy and commodity prices as a reason that inflation should moderate. They’ve been burned on that forecast many times, and Bernanke himself noted on June 9 that “futures markets quotes have underpredicted commodity price increases in recent years, leading to corresponding underpredictions of overall inflation.”

Fed watchers don’t expect the Fed to adopt a risk assessment between growth and inflation. It opted against doing so in April.

Wall Street will also eye the statement for any dissents. Only the first fed funds cut of the cycle, on Sept. 18, was unanimous. The last two decisions had two dissents each, from Philadelphia Fed President Charles Plosser and Dallas Fed President Richard Fisher. They preferred a smaller rate cut in March and none at all in April.

But it’s one thing to dissent from a rate-cut vote — after all, doing so firms up an official’s inflation-fighting credibility and may even help the Fed by signaling vigilance on prices. But after a while — and especially when the Fed is no longer cutting rates — dissents risk being viewed as no-confidence votes.

Still, Feroli sees at least one dissent in favor of a rate increase. “Maybe Fisher,” he said.

Inflation Rate Jumps to 6-Month High

The inflation rate shot up in May at the fastest pace in six months, pushed higher by soaring costs for gasoline and other types of energy.

The Labor Department reported Friday that consumer prices rose by 0.6% last month, the biggest one-month increase since last November, as gasoline costs surged by 5.7%. Food prices, which have also been rising sharply, were up 0.3% as the cost of beef and bakery products showed big gains.

Core inflation, however, which excludes energy and food, edged up a more moderate 0.2% in May. That increase was right in line with expectations and should help relieve worries that the big increases in food and energy could be breaking through to more widespread inflation.

Ian Shepherdson, chief U.S. economist at High Frequency Economics, said that the moderate gain in core prices showed price pressures are remaining contained despite fears at the Federal Reserve.

The Fed, which from September through April was aggressively cutting interest rates to fight a mounting economic slowdown, is now indicating that its biggest concern has changed from the threat of a recession to worries about inflation.

In a speech Monday, Fed Chairman Ben Bernanke said that the Fed will "strongly resist an erosion of longer-term inflation expectations." Those comments have raised expectations that the Fed's next move later this year will be to start raising interest rates.

The 0.6% rise in overall prices was slightly higher than the 0.5% gain that economists had been expecting while the 0.2% rise in core prices matched expectations.

So far this year, consumer prices are rising at an annual rate of 4%, compared with a 4.1% increase for all of 2007.

Energy prices are rising at a 16.5% annual rate, compared with a gain of 17.4% for all of 2007, while food prices are rising at a 6.3% annual rate, up from a 4.9% increase for all of last year.

Analysts said the pressure in both the energy and food areas is likely to continue as global food shortages and rising demand push food prices up and energy costs continue to soar, reflecting a relentless surge in crude oil prices.

The energy increases have pushed the nationwide average for gasoline up to a record of $4.06 and private economists believe that price will keep climbing through the summer driving season.

The combination of rising inflation and weak wage gains contributed to another drop in weekly earnings. After adjusting for inflation, weekly earnings for nonsupervisory workers were down 1.2% in May, compared to a year ago, the Labor Department said in a separate report.

Energy prices were up 4.4% in May after being unchanged in April. The increase was led by a 5.7% jump in gasoline, the biggest one-month increase since last November, and gains of 0.9% for electricity, 10.4% for home heating oil and 5.6% for natural gas.

The 0.3% rise in food costs reflected a 1.5% jump in beef costs, the biggest rise in 13 months, and another steep increase in cereal and bakery products, which were up 1.6%.

Outside of food and energy, clothing costs fell by 0.3% and the cost of prescription drugs dropped by 0.7%, but airline tickets jumped 3.2%, the biggest gain in more than six years, reflecting the surge in fuel costs.

House Approves Jobless Benefits

The House approved extended jobless benefits for the long-term unemployed Thursday, with Democrats capturing a narrow two-thirds majority that could boost chances for action in the Senate.

Thirteen Republican absentees contributed to the victory, but the 274-137 vote was a lesson in the advantages of Speaker Nancy Pelosi (D-Calif.) backing up for a moment and avoiding the short-cuts that failed just 24 hours before.

Forty-nine Republicans Thursday joined in support of the package, which promises up to 13 additional weeks in jobless benefits to workers in all states and a total of 26 in states with a seasonally adjusted 6 percent unemployment rate — well above the national average.

The benefit paid would equal the amount paid under regular unemployment compensation, or an average of $290 a week, and would provide at least temporary aid to workers who have already exhausted the 26 weeks typically available at the state level. More than 3 million workers are expected to fall into this category before the program expires next spring, and the five-year cost is estimated to be $13.68 billion.

The White House has argued that the program is too costly and should be targeted to just high unemployment states. But the administration hasn’t ruled out some relief, and House Republicans offered their own plan, which they said would save at least $1 billion by targeting the extra assistance to about 22 states either with an unemployment rate of 5 percent or whose jobless rate has jumped by 20 percent in the past year.

This failed 243-170 given the Democratic opposition, but it underscores the appetite in both parties for some action after the national jobless rate jumped to 5.5 percent in May.

Pelosi had tried to move the same bill Wednesday, but under an expedited procedure that provoked some resentment and left her just short of a two-thirds majority. Thursday she came back and followed a more conventional route and also threw herself more into the floor debate.

“This isn’t about people sitting on their butts back home saying, 'Gee, I’m getting an unemployment check,'" Pelosi snapped back at House Republicans. “These people want to provide for their families. To imply anything else is an insult to millions of people who have lost their jobs through no fault of their own.”

Richard Rainwater Turns Bearish on Oil. For Now.

Billionaire investor Richard Rainwater has turned bearish on oil. Only temporarily bearish, mind you, but it still struck me as big enough news to write my column about this week. It's not online just yet (update: now it is), but in the interest of serving this blog's readers with the freshest possible news (and because Time's PR folks are about to start flogging the story), here are the basics:

Rainwater made his name managing the investments of the oil-rich Bass family of Fort Worth in the 1980s, steering them most famously into Disney stock when Disney absolutely was not cool. Then he struck out on his own, bankrolled the creation of hospital rollup Columbia Healthcare (which merged with HCA, after which some bad stuff happened, but let's not get into that here), and married Darla Moore (famously christened by Fortune as the "Toughest Babe in Business"). Then, in about 1997, he became convinced that oil prices would start rising soon, and committed much of his fortune to betting on that rise.

That bet has paid off to the tune of about $2 billion, a success that has been documented in detail in the pages of Fortune not once but twice.

I was working on a column on whether the price of oil has gotten ahead of itself or not, I remembered those Fortune stories, and I thought it might be interesting to hear what Rainwater thought of all the talk of an oil bubble. I asked Oliver Ryan, author of the most recent of those articles, to introduce me. Oliver called Rainwater, and reported back that Rainwater had something pretty interesting to tell me.

That he did. "I sold my Chevron," he said in the first few seconds of our phone conversation. "I sold my ConocoPhillips. I sold my Statoil. I sold my ENSCO. I sold my Pioneer Natural Resources. I sold everything."

Rainwater did this, he said, right after the price of oil passed $129 a barrel, which happened on May 20. He did it because he thinks oil demand is headed down in the U.S. as Americans change their habits in reaction to $4 gas. He remains a believer in peak oil; he just thinks prices have risen so much that we're due for a significant correction--after which he'll start buying into oil again.

Interestingly, Rainwater does not buy into the argument that "index speculators" (pension funds, endowments, and other institutional investors that have been buying into commodity indexes) are a big factor in the recent price rises. He also doesn't think it's the fault of oil companies, OPEC, or any other villain. "It’s just supply and demand, it’s as simple as that," he said.

Second Guessing the Fed

The race for the Great Fed Second Guess of 2008 is now well under way: First out of the blocks was former Federal Reserve chairman Paul Volcker, who worried aloud in April that forcing and partially financing the takeover of ailing investment bank Bear Stearns had taken the Fed to "the very edge of its lawful and implied powers."

Next came William Poole, a few weeks after retiring from the presidency of the Federal Reserve Bank of St. Louis, declaring in May that the Fed's actions — which, along with the Bear rescue, have included hundreds of billions of dollars in unconventional loans to banks — had created an "appalling" state of affairs.

On Thursday, two current members of the Fed hierarchy, Philadelphia Fed President Charles Plosser and his Richmond counterpart Jeffrey Lacker, joined the fray. In a speech at New York University, Plosser argued —without mentioning the seat-of-the-pants Bear Stearns rescue by name — that Fed actions ought to follow explicit rules. "Discretion in lending practices runs the risk of exacerbating moral hazard and encouraging financial institutions to take excessive amounts of risk," he said.

Lacker, speaking at the European Economics and Financial Centre in London, did mention Bear Stearns, warning, "The danger is that the effect of recent credit extension on the incentives of financial market participants might induce greater risk taking, which in turn could give rise to more frequent crises."

Regional Federal Reserve Bank presidents such as Plosser, a former dean of the University of Rochester's Simon School of Business, and Lacker, a veteran Richmond Fed economist, are not at the center of the Fed hierarchy. They serve on a rotating basis on the Federal Open Market Committee, which sets short-term interest rates, but neither was directly involved in the partially Fed-financed takeover of Bear Stearns by J.P. Morgan Chase. That deal was mainly the work of Timothy Geithner — who as president of the Federal Reserve Bank of New York, is the Fed's designated financial-crisis firefighter — with the approval of Fed chairman Ben Bernanke and the rest of the Federal Reserve Board in Washington.

Geithner and Bernanke defended their actions as necessary to fend off a collapse of the global financial system — and few in official Washington or the Federal Reserve System disagreed at the time. But as the crisis atmosphere of early this year has given way to calmer times, second thoughts are increasingly coming out into the open.

The likely result of the debate is stricter rules on exactly when and how the Fed can intervene in the affairs of banks and brokerage firms. The basic conundrum faced by the Fed will probably never be resolved, though: If banks and brokerages are never allowed to fail, lenders and investors have no incentive to monitor the risks they're taking. But in a crisis, otherwise perfectly sound institutions — and with them the entire financial system — can go under unless the Fed steps in.

Exports Prop Up Manufacturing Jobs

The best news about the dismal May employment report may be that it could have been a whole lot worse.

Manufacturing payrolls fell 26,000 last month — no surprise as they’ve now fallen almost two-straight years.

What’s unusual, economists said, is that given the weakness in domestic demand they’re not falling even more. In 2001, the last time the U.S. was in a recession, manufacturing lost an average of over 100,000 jobs per month. So far in 2008, it’s lost an average of 41,000.

The difference, economists say, is exports. “I think the story is, without exports the manufacturing performance would have been much, much worse,” said Nigel Gault, chief U.S. economist at Global Insight.

Still, for a sector that’s averaged 9% growth on an annual basis over the past four quarters, one might expect that exports would be able to do more than just limit manufacturing losses.
But there, exports may suffer from one of their strongest attributes: fast productivity. The sector tends to have higher productivity than the economy-wide average, so higher orders and output don’t translate into new jobs as quickly as they would in labor-intensive industries like health care and restaurants, which combined to add over 45,000 jobs last month.

“Our manufacturers are able to meet increased demand for exports even while shedding jobs,” said Jared Bernstein, an economist at the Economic Policy Institute.

Still, a durable employment and economic recovery is unlikely if manufacturing keeps losing 40,000 to 50,000 payrolls per month. Manufacturing employment held fairly steady from 2004 to 2006, a period of robust economic growth. A bottoming-out in housing would help, since half of last month’s manufacturing losses came in wood products and furniture.

Besides, “we can’t all work in hospitals and restaurants,” Bernstein said

The market is getting a big boost from the bulls in the early going, after a couple of reports this morning emboldened sentiment.

The same-store sales reports that came out had a lot of better-than-expected results, and that is giving a big boost to the retail sector. Wal-Mart (WMT) reported a +3.9% increase, and its stocks shot up to its highest level since April 2004. Costco (COST) also looked strong. I have to go throught the reports more, but it would seem that the discounters are doing better as consumers look to make their dollars go further in the face of record gas prices.

Also, weekly jobless claims fell 18k this week to 357,000. This was below the consensus for 375,000. Also, the 4-week moving average fell to 368,500, a level that is well below typical recessionary levels.

The 10-year yield got a boost from these reports, and is back above the 4% level (4.02%). The dollar is mixed this morning, with the Yen dropping again vs. the dollar, while the Euro is higher. ECB President Trichet said that the ECB might hike rates to counter inflationary pressures. I think he is risking a hard landing there, but that may be his goal.

Oil is trading higher this morning, back around the $123 level. The energy stocks are getting a nice bounce along with crude. And the steel stocks are big gainers after Nucor (NUE) raised guidance this morning.

I am always skeptical of strong opens, and we have seen a couple already this week fade into the close. So let's see if we can break the trend today. The Nasdaq looks to be in good technical shape as it breaks back above its 50-day.

Will High Gas Prices Bring On a Mad Max Future?

"I was watching that movie Mad Max, you know that movie where gas is so precious that people are killing each other for a few gallons. It was set in the future -- I believe it was August." --Jay Leno

Mad Max movies paint a grim picture of the future for civilizations dependent on oil: When the "black fuel" became scarce, explains the narrator in The Road Warrior, the world became a "whirlwind of looting and a firestorm of fear, in which 'men began to feed on men.'" Could the current oil crisis turn our world into such a wasteland?

Sadly, the narrator fails to tell us exactly how high gas prices got before "the gangs took over the highways, ready to wage war for a tank of juice." While law and order remains today, as prices hit $4 per gallon, it's clear trouble lies ahead. All across the country, gas theft is up: In Mcdonough, Georgia, thieves are going driveway to driveway, in the middle of the night, siphoning gasoline from cars and trucks; Todd Moser, of Washington State believes the gas thieves who stole 800 gallons of gas from a storage tank at his business also stabbed his dog the night before; and in parts of Illinois, people are 68% more likely to fill up at a gas station and "forget to pay" than they were this time last year.

You can buy a locking gas cap for $10 to $15 (next to the siphon pumps and tubes for $1.99 each) but that won't stop vandals willing to puncture the tank and fill up their container as the gas pours out. Imagine what desperate people will do as prices continue to rise and if, as analyst Robert Hirsch predicts, it gets up to $15 per gallon. Hirsch told CNBC's Squawk Box, "The prices that we're paying at the pump today are, I think, going to be 'the good old days,' because others who watch this very closely forecast that we're going to be hitting $12 and $15 a gallon, and then, after that, when world oil production goes into decline, we're going to talk about rationing." What's worse is his prediction that new types of energy and new technology aren't going to save the day. "There's no single thing that's going to solve this problem, because it's as massive as one can possibly imagine," he said.

Having to pay more for food or pay to check a bag at the airport may be the least of our problems when law gives way to reckless violence. Motorcycle gangs aren't fighting to control oil refineries yet but sales of scooters are up. Will well-intentioned purchasers, who started out looking for a fuel-efficient mode of transportation, don hockey masks, join together and kill for oil? Time will tell.