Fed Dilemma: Growth vs. Inflation - Ahead of Wall Street

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Friday, March 15, 2013

The Federal Reserve has a dual mandate - to ensure that prices remain stable and for the economy create plenty of jobs. Reconciling these two goals, however, is typically not easy because more jobs can lead to pricing pressures in the economy. But we are nowhere near those levels at present given how high unemployment is. This morning's February inflation data looks a bit 'hot,' but that's primarily due to elevated gasoline prices last month that have started come down this month already. This means that the Fed does not need to change its current easy-money stance on inflation grounds.

But while inflation may not be an issue for the Fed, growth in the economy could be. Recent data on the growth front, such as retail sales, non-farm payrolls, jobless claims and the ISM surveys, has been fairly encouraging. The Empire State manufacturing survey that came out this morning and the Industrial Production data coming out a little later provide further confirmation of this trend.

As a result, estimates for first quarter GDP have started going up in recent days despite the apparent drag from fiscal austerity. If this trend remains in place over the coming months, then investors will justifiably start worrying about the course of monetary policy.

We are unlikely to see any evidence of change to the Fed's policy stance, particularly on the QE program, in next week's FOMC meeting. But the accompanying economic forecasts from FOMC members and the Bernanke press conference would potentially give us clues to how the Fed sees the evolving economic landscape.

But the market could get ahead of the Fed once it factors in the necessary ingredients of the economic picture. Yields on treasury instruments have been creeping up a bit lately, but we are definitely not there yet. It will take us more than a couple of months of strong data to reach that point.

Keep in mind that we started the last couple of years with similar-looking positive momentum in the economy and the market, that proved hard to sustain beyond the Spring months. The improving housing trend is the new element this year, but it  may be premature to buy into the optimistic narrative.

Sheraz Mian
Director of Research



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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



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