INSIGHTS

On August 23, 2012

Federal Reserve can be Flexible in Timing and Actions

The Fed’s minutes were released and the proposition of further Fed action was discussed and in many circles, assumed to occur in short order. The timing of such “promises” to support the economy if economic growth stutters also has other subtle influences. As we’ve discussed several times over the past few years, the perception of the politicizing of the Federal Reserve has swollen to historic levels when looking at headlines and platforms run on by Ron Paul and several others. When this as a backdrop entering a highly contentious election, it is natural for the Federal Reserve to attempt to mitigate any perceived political influence with regard to their potential actions by foreshadowing possible future support.

Another influence that appears to be a new favorite tool from the Federal Reserve is using their goal for more transparency to assist in supporting a stealth recovery with headlines versus outright action. Though actual Fed action may come, the utilizing of an abundance of press releases and press conferences assists in easing market anxieties to at least a subtle degree.

When looking at past Fed accommodative periods to inflation, you may remember the chart showing consumer inflation as it related to periods of Federal Reserve easing. The potential for inflation is real, though we don’t expect it any time before actual unemployment rates drop closer to the 5.50% level…some time away. By measuring how long the Federal Reserve has been accommodative, inflation will be a concern some time down the road. As evidenced by equities and housing, we still expect asset inflation to occur first.

Another interesting view is what has happened with inflation over roughly the last century. What one notices is an environment over that timeframe has actually allowed the Fed to have a dual mandate versus the more singular focus of the European Central Bank.

During the first 50 years, one notices that Consumer Price Index (CPI) averaged 2.50% but was extremely volatile with a standard deviation of 6.50%. Compared to the last 49 years, CPI averaged 4.20% (68% higher) but much less volatile with a 2.6% standard deviation. Even more dramatic is in the last 25 years the CPI has averaged 2.90% with a standard deviation of 1.32%. This stability has allowed the Federal Reserve to focus a bit more on the dual mandate versus emphasizing more singular price stability.

So as we move forward through the end of the year, the most recent stability in prices has allowed the Federal Reserve far more flexibility than it was afforded decades earlier. Though this doesn’t remove them from public scrutiny, it at least should give investors pause for thought that past limitations of the Federal Reserve may not correspond with the immediate future actions.

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