Most of Janet Yellen’s speech today about commodity prices and the economic outlook was about what you would expect, and we covered many of the same issues in our long discussion last week about inflation expectations.
To summarise, Yellen made the following points:
– commodity price rises are the result of global demand and recent supply disruptions;
– they won’t have more than a temporary impact on overall inflation unless they lead to an increase in long-term inflation expectations;
– but these expectations have remained stable;
– and at any rate monetary policy is unlikely to have caused much of the price spike in commodities anyways;
– the Fed should therefore continue its accomodative policies until the slack in the economy has lessened.
That’s the gist — a standard defense of current monetary policy.
But we were most interested in this line and the points she made in support of it (emphasis ours):
Turning now to the outlook for U.S. consumer prices, I anticipate that the recent surge in commodity prices will cause headline inflation to remain elevated over the next few months. However, I expect that consumer inflation will subsequently revert to an underlying trend that remains subdued, so long as increases in commodity prices moderate and longer run inflation expectations remain reasonably well-anchored.
That seems to us an important qualifier. As we said last week, it would be foolish to rule out the possibility that commodity prices — or at least oil prices — will continue rising for longer than anybody thinks.
It’s not that we disagree with the doves’ view that it is primarily the renewed higher demand from the emerging world and, more recently, the events in MENA that have driven oil prices higher. We’re less sure about the argument that QE2 is entirely blameless for higher prices — there’s a decent case that at least some of it has fed through.
But even conceding everything in the dove-ish case for further easing wouldn’t negate the problems that persistent commodities inflation would cause. That is, even if monetary policy shouldn’t be adjusted in response to higher commodity prices, and even if those prices don’t pass through to other kinds of inflation, the impact of higher long-term headline inflation itself would be damaging, especially (as even the doves insist) if it unmoors inflation expectations.
And until today, we hadn’t seen the Fed make the case for why this ongoing rise is unlikely. And we’re not the only ones worried about this — see the IMF’s latest report about future oil scarcity, or some projections made recently by Barcap.
So what’s the case that commodity prices are “likely to moderate”, as Yellen notes? From the speech, emphasis ours:
Now I would like to explain in further detail why I anticipate that recent increases in commodity prices are likely to have only transitory effects on headline inflation. The current configuration of quotes on futures contracts–which can serve as a reasonable benchmark in gauging the outlook for commodity prices–suggests that these prices will roughly stabilize near current levels or even decline in some cases. If that outcome materializes, the prices of gasoline and heating oil are likely to flatten out fairly soon, and retail food prices are likely to continue rising briskly for only a few more months. Consequently, the direct effects of the surge in commodity prices on headline consumer inflation should diminish sharply over coming months. …
Yellen then spends some time explaining why the pass-through effect of this scenario would be temporary. (Charles Evans of the Chicago Fed also has a paper out today making this case.) To be fair, she does include a lengthy passage in the speech of the risks that this outcome won’t materialise (and of the lessons we should recall from the 1970s), but essentially this boils down to a straightforward bet that the futures market and the Fed’s projections have it right.
And maybe they do. But against this we have the points made by John Kemp that we’ve cited a few times: a lingering political risk premium bolstering prices even if the events in MENA calm down; future supply shocks; continued demand from emerging markets; the increased sensitivity of financialised commodity markets; and further compression of the global output gap.
As this is something quite measurable, we can resort to that laziest of journalistic conventions (not for the first time) and say that we’ll know the outcome soon enough.
Related links:
Deflated inflation expectations – FT Alphaville
BarCap on oil-fuelled inflation – FT Alphaville