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Federal Reserve Misses The Target

Posted by Larry Doyle on December 13, 2012 8:21 AM |

Stand back.

A marksman with a powerful weapon not properly focused on an appropriate target is capable of wreaking real havoc.

Who is the marksman? Federal Reserve chair Ben Bernanke. What is his powerful weapon? Monetary policy. What is the appropriate target? The level of employment in our nation. What might be the havoc? The list is too long but let’s start with a breakdown in the relationship between monetary policy and inflation and work our way to civil unrest. Havoc does not typically connote a well defined set of outcomes.

Am I being overly alarmist? I think not given the size of Bernanke’s weapon and how wildly off target he really is in the message he sent the markets just yesterday. What did he say? 

As reported by the WSJ, Fed Ties Rate To Joblessness,

The Fed said it didn’t expect to touch short-term rates until it saw the unemployment rate fall to 6.5% or lower, as long as inflation forecasts remain near its 2% target. That would mean, according to the Fed’s economic projections, that it would keep short-term rates near zero into 2015.

That is a dangerous message folks. Why so? Recall that just last week we saw the unemployment rate drop from 7.9% to 7.7%. Indications of an improved labor situation? Anything but. The decline was due almost entirely to a decline in the labor force, that is, people had literally given up looking for work. I wrote last Friday,

As I have indicated previously, we could have an unemployment rate of 5%, the cheerleaders in Washington popping champagne, and be entering into a deeper recession. How so? If people continue to simply give up looking for work and exit the labor force. Just because these people are not counted when calculating the unemployment rate, does that mean they do not even exist?

The move down from an 8.5% rate was due almost entirely from a decline in the labor participation rate as detailed in this report at BusinessInsider

Conversely, if some of these people whom have exited the labor force reenter due to an improving economic condition we could very well see the rate move back up.  In that sort of scenario the markets would read Bernanke’s message as if he would be adding another chamber to his weapon when in fact he should be taking a few bullets out. To think that Bernanke can stop the weapon from misfiring based on a read of inflation data would be to convey on him a set of powers that nobody possesses. I am guessing that Ben is already aware that global food prices are at record highs. (see page 49 in this packet put forth by Doubleline.)

What should the target be? A focus on the overall unemployment rate in conjunction with the labor force participation rate. More accurate information allows Bernanke to fine tune his accuracy and market participants and business executives to plan appropriately. Why doesn’t Bernanke do this? I guess he would have to admit that the “keep them in the dark” practice of misinformation or less than full information is not consistent with appropriate public policy.

Be careful out there . . . and navigate accordingly.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

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