By Robert J. Swartout
The Daily Record Newswire
The Fed is facing is a delicate balancing act.
They need to prime the economic engine in the U.S. and avert a deflationary spiral like that which smothered growth in Japan for a decade. They must also be cautious that flooding the U.S. economy with money will cause asset price bubbles and inflation in the future.
The Fed, in response to the financial crisis in late 2008, has opened the monetary floodgates in the U.S. financial system.
Initially, this policy was used to stabilize the domestic banking system. Now, however, this policy is being used to spark economic growth.
The latest round of “quantitative easing” is directed at lowering the middle- and longer-term portions of the yield curve, which should keep mortgage rates low and encourage banks to take on more credit risk.
Unfortunately, low mortgage rates alone won’t spur home buying activity. The credit crisis and the failure of Freddie Mac and Fannie Mae have resulted in a much tighter credit approval process for homebuyers. Add to the tougher mortgage standards the fact that almost one in 10 adults are unemployed and the result is a continuing depression of home values.
The recent peak for the sale of existing homes was mid-2005, and the rate has been declining to a recent low set this past July. The supply of unsold homes in July was at 12.5 months and has only modestly improved to 10.7 months. So there is a large supply of unsold housing and even though mortgage rates are very low, there is not very much demand for housing.
As we all know, high supply and low demand equals falling prices.
The consumer price index is produced by the Bureau of Labor Statistics and it measures the prices of a basket of different goods and services, such as food and beverages, housing, apparel, etc. Housing represents almost 42 percent of the CPI index and the significant downward pressure on the housing market coming from tighter credit underwriting and high unemployment is depressing this measure of inflation.
Until employment improves and the credit underwriting process swings back to be more accommodative, there will continue to be downward pressure on the single largest component of CPI.
Near-term concern about inflation, as measured by CPI, would seem to be misplaced. However, there are other pockets of inflation that are creeping into our economy we as consumers are likely to feel. For example, here are some year-over-year changes in commodity prices that most consumers are already feeling: unleaded gasoline +14.95 percent, corn +42.62 percent, soybeans +19.81 percent, wheat +21.48 percent, coffee +54.63 percent, live cattle +22.24 percent, and cotton +54.85 percent.
Compare these commonly used products in our day-to-day lives and you have a different perspective than the headline October year-over-year CPI of up to 1.2 percent.
Inflation may be heating up in other parts of the economy, but until unemployment and housing improve, CPI will be benign.
Robert J. Swartout is a vice president at Karpus Investment Management in Rochester, N.Y. He can be reached at (585) 586-4680.
