Several recent developments could have prompted the Fed's seemingly sudden interest in longer-term inflationary issues. The recent report on rising labor costs could be one. According to the Labor Department, hourly output per worker slowed in fourth quarter 2012, to less than a 1.0% annualized rate of advance, even as compensation gains accelerated to about a 4% annual rate. The resulting 3%-plus rise in the labor cost of a unit of output may not in itself raise fundamental inflation fears, but it could be taken as an early harbinger nonetheless.
More fundamentally, the Fed also has received the signals that it long ago indicated would trigger a reappraisal of its policy. As far back as late 2009, Bernanke indicated that the Fed would reconsider its extremely easy monetary stance when it saw a substantive improvement in the jobs market and an increase in bank lending. Both have now occurred. Payrolls have picked up, growing on average at close to 250,000 a month of lateāa far from robust picture, but much improved over a year ago. Meanwhile, bank lending to businesses has also picked up along the lines sought by the Fed. In aggregate, commercial and industrial loans have grown at an annual rate of more than 12% during the last six to nine months.
Whatever the proximate cause of the Fed's new tone, Bernanke's sterilized QE plan, however, raises questions. According to his description, the Fed would create new liquidity to buy long bonds (mostly Treasury issues and mortgages), but then would sterilize any inflationary impact by borrowing the liquidity back short term at the low rates in what are called "reverse repurchase agreements." In one respect, this plan looks like a variation of the Fed's "Operation Twist," in which it sold short-term paper from its portfolio in order to buy long bonds. In other respects, this scheme looks a little like a shell game. In order to sterilize the funds over time, the Fed would have to renew the repurchase agreements ("repros") continually. Any slacking by the Fed would allow liquidity in the system to rise immediately. More fundamentally still, the Fed, to keep the short-term rates low for its repros, would have to provide ample liquidity to short-term money markets, raising questions of whether a net increase in liquidity would not otherwise take place anyway.
Still, for all the seriousness of such questions, this recent subtle change in the Fed's tone does offer encouragement of a different sort. Certainly, it suggests that the underlying economic and financial conditions have improved enough to allow the Fed, for the first time in a while, to consider longer-term matters. Previously, the Fed was so focused on emergency needs that such distant inflationary implications, though mentioned, were treated as little more than an academic exercise. With the economy on life support, so to speak, as it seemed to be in 2009, 2010, and in the middle of 2011, the Fed might even have worried that any reference to distant concerns would make the public fear a loss of essential monetary support. That policymakers now are ready to discuss such matters, even if action would wait for a future date, speaks to a conviction that perhaps the worst of the emergency has passed.
The new tone should also reassure investors that the Fed is aware of these long-term dangers and so, presumably, is also ready to deal with them when and if the time comes. Those who have worried about the ultimate inflationary implications of all the monetary ease should find comfort in such an acknowledgement. Even if the sterilized QE technique seems inadequate, it implies that the Fed stands ready to take other steps should the need arise. The overall picture may not assuage all concerns. It seldom does. But, generally, the change in tone helps, whatever the questions about the chairman's latest, novel policy scheme.
The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.
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