Reply #36: Fed Faces Credibility Crunch [View All]

[54anickel]

http://www.thestreet.com/markets/marketfeatures/10340179.html

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So even as the January minutes show the Fed is close to a neutral policy stance, the central bank is now perhaps just as close to a credibility crunch. That's if inflation were to tick up toward 3% year over year, says James Paulsen, chief investment strategist at Wells Capital Management.

"Ever since Bernanke came to the chairmanship, the Fed has said that 2% or lower is their comfort zone, and they've acknowledged it is above the comfort zone, but they've said it would peak as the economy slowed," says Paulsen. "Well it's still above 2%, and it didn't peak. It went back up."

While many, including the Fed, have noted that oil prices could be the volatile commodity that impacts inflation, the real story is in the other raw materials, says Paulsen. Investors took note today, as commodities indices that exclude energy are at or a hair short of new all-time highs -- including the Journal of Commerce Raw Industrial Commodity Price Index, the Goldman Sachs Commodity Index ex-energy, and the CRB Raw Industrial Index.

Gold soared $23 Wednesday to $684 per ounce, while gold-based exchange-traded funds like streetTracks Gold Shares (GLD - Cramer's Take - Stockpickr - Rating) and iShares Comex Gold Trust (IAU - Cramer's Take - Stockpickr - Rating) gained 3% on the day.

IDEAglobal's chief economist Joe Brusuelas believes that inflation will remain "sticky" and bring higher readings for the next few months as home rental prices remain high. But more supply will come onto the rental market as developers shift unsold units to rental units, which he believes eventually will bring rental prices and core inflation back down. Brusuelas says this puts the Fed on hold for the remainder of the year. Next week brings the January reading of the Fed's preferred inflation measure -- core personal consumption expenditures. As of December, core PCE is running at 2.2% year over year.

As I said in a speech Tuesday night at a gathering of the Society for the Investigation of Recurring Events, or SIRE, there was too much liquidity in the world to suggest the Fed would cut rates even before Wednesday's CPI report. Junk-bond spreads are near all-time lows hit in 1997. M&A activity is running at 47% more by volume than it was in the same period of 2006. Risk appetite and animal spirits are alive and well in the markets.

That's why investors should perhaps have paid more attention to Fed Vice Chairman Donald Kohn's comments Wednesday in a speech at the Exchequer Club in Washington, D.C. Kohn warned of too much complacency in financial markets amid low interest rates and ample liquidity. Evidence of such complacency came Wednesday in markets' minimal reaction to the Bank of Japan's rate hike.

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