June 2006 Update

On June 5 the Fed chairman gave a speech taking a strong stand on inflation.  His rational was that the core CPI (consumer price index minus food and energy) has been rising in the past months.  The DOW plunged almost 200 points by the time the day was over after his remarks.  The market’s fear was that the Fed will hike interest rates for overnight money to 5.25% at the June FOMC (Federal Open Market Committee) meeting. 

The significance of this is that it makes sense that the longer you borrow money the higher the interest rate is.  The longer time you lend money the greater the risk of not getting paid back, so a higher rate is reasonable.  But Fed chairman Ben Bernanke is about to turn this logic upside down.  The 10 year Treasury note is currently trading at a yield of 5.0%.  If the cost overnight money is raised to 5.25% it causes a condition known as an inverted yield curve.  If yields (interest rates) stay inverted for an extended period it is very likely to tip the economy into recession.  It has happened before.  Ben Bernanke is just another recent appointment by president George W. Bush who has made some dubious choice in the recent past.

To be fair the price of gold and other commodities are at very high levels and they are a good indictor of inflation.  The price of oil is also very high.  However the high energy prices are enough of a drag on the economy without the Fed slamming on the brakes any harder.  Let’s hope that reason prevails in June and the Fed pauses in its rate hiking frenzy so the economy doesn’t follow Republican poll numbers.   

Ken Mueller