When You Get to the Fork in the Road…

Yogi Berra made this quote famous: "When you get to the fork in the road, take it." We somehow doubt he was alluding to Fed policy, but the comparison is apt. Today the Fed left short interest rates unchanged at 5.25% and generally intoned no policy shifts are likely in the near future. Inflation seems to remain the "predominant" concern for the Fed. While Fed futures are still pricing in a rate cut before yearend, Bernanke's statement today seems biased toward rate increases rather than cuts.

But the point is today the Fed sees economic growth, contained inflation, and no need to steer the ship in any new direction. Economists—who predominantly seem to believe unemployment is too low, growth is too low, and inflation pressures are too high—are saying the Fed is in a policy pickle.

Proclamations abound that the Fed has reached a "fork in the road," where a correct policy decision is essentially impossible. Raise rates and the economy sinks; lower rates and inflation explodes. And, it has been intoned, leaving rates where they are could lead to the dreaded stagflation scenario.

Here's how we see it:

• Unemployment is not too low. It's true we probably are somewhere near "full employment" in the US, where the labor market is too tight. This usually causes wage inflation, leading to broader inflation in the economy. But productivity continues to surge above expectations, which means price pressures aren't particularly high on employers. (See our past commentary, "Productive Ignorance" for more.)
• We aren't heading for a recession. Yes, GDP growth was relatively low last quarter, and yes, housing is a deadweight drag right now. But consumer spending is surging, US tax receipts are hitting record territory, and corporate earnings are beating expectations. For our money, we'll go with that data instead of a cumbersome government GDP statistic. And most importantly of all, the global economy is very strong. Today's world likely is far too integrated to have a strong global scene and a withering US economy concurrently.
• Inflation is not accelerating out of control. All relevant metrics are still signaling low inflation, including TIPS spreads. The 10 year US bond sits around 4.65%. Even for those stalwarts who continue believing gold is a leading inflation indicator, gold prices are basically flat over the last 12 months.

Fed policy, in our eyes, has been appropriate since Bernanke took the helm. We've written about the often hilarious "art" of interpreting fed-speak (see our past commentary "Critical Invasion"), but it seems very plain to us the chairman and his brethren see an accelerating economy with mild inflation. Because, well that's precisely what they said—no reading between the lines is necessary.

The financial press has created a fork in the road for the Fed to choose its course, but the fact is there is no fork to be had. Right now, it's just a smooth path forward. The Fed is doing the right thing by remaining steady.