A Fed Inflation Hawk Speaks

"I think we will probably have to begin raising rates sometime in the not-too-distant future," Federal Reserve Bank of Philadelphia President Charles Plosser told Dow Jones Newswires and the Wall Street Journal in an interview.

A renowned inflation hawk at the Federal Reserve is at it again, trying to pull more dovish Fed officials under his wingspan of influence to get them to do more to battle incipient inflation.

And the timing of Plosser's comment is interesting, notes Charles Brady, senior editor of the Fox Business Network.

The Fed is selling a record amount of weekly debt, $115 billion now coming up, a sum that tops the previous weekly record of $104 billion set just last month. The bond glut pushes yields higher because so many bonds means a lot of competition, which means the Treasury has to offer enticing, come-hither yields to lure investors in.

"The impending glut of supply has been pushing Treasury yields higher," says Brady. "What better way to try and keep a lid on rates ahead of this debt sale than to have a Fed official say that policy makers are likely to begin raising rates sooner rather than later."

Brady adds: "It's also interesting to note that Plosser is not a voting member of the Federal Open Market Committee, which helps distance Plosser's comments from the policy makers who actually do vote on rates."

Plosser, however, will become a voting member right when inflation may hit the US economy-in 2011, when the full force of the government's debt issuances starts to possibly crack the bond market, pushing yields higher. Expect Plosser to push the Fed to yank the liquidity punch bowl then, if it doesn't happen sooner.

But when is the right time to pull the punch bowl so as to avoid a double dip recession?

Plosser has historically been tough on inflation, breaking ranks with the official Fed view in expressing his deep concerns about the risks of promiscuous monetary policy.

Even in the fall of 2007, when the credit markets plunged into a Deep Freeze and were priced for the Ice Age, Plosser argued prior to the Fed rate cuts then that such moves weren't necessary, that instead the Fed could provide any needed liquidity through its open market operations.  

Plosser has been notably direct in saying that inflation must be higher on the Fed's list of priorities.

Why?

For one, the US central bank's gross exposure to the bailout programs is $6.8 tn out of the government's potential $23.7 tn. Because it's difficult to pull monetary levers when rates are effectively at zero, the Fed under chairman Ben Bernanke has made a quantum leap in its balance sheet, and the markets fear Fed officials cannot stop this science project from exploding into inflation.

Put it into perspective. One trillion is now the new billion, analysts say. A trillion is greater than the GDP of Australia, $1 tn is enough to buy the Toronto stock exchange, it is twice the cost of FDR's New Deal, and $1 tn could buy every home foreclosed in 2007 and 2008, estimates show.

And now, the bond market is bracing for $2 tn in government debt issuances within the next 12 months to pay for the government's spending programs, the $787 bn stimulus package and the $3.6 tn budget.

"If you sell it, they will come, is the US Treasury's Field of Dreams," quips Peter Boockvar, an extremely sharp, smart Wall Street analyst with a big following at Miller Tabak, where he is a managing director and equity strategist.

Boockvar adds that most of this debt should be easy to sell as most of the bonds have maturities of five years and less.

But he adds that "if the stock market is right and the economy in the second half of the year will have a strong rebound, then interest rates are going higher due to higher inflation and the demand on the part of foreigners, who own half our debt, and others for higher yields for the enticement of buying the enormous new supply."

The Goldilocks economy of strong growth and low inflation was 1990's fiction, Boockvar says. Unless, of course, gridlock over health reform in a rampantly reckless Washington might now create the new Goldilocks economy, jokes economist Ed Yardeni.

Boockvar notes that all of this spending is starting to sting the US dollar, which is now falling to just shy of its lowest level since December 2008 versus the euro.

And listen to what Richard Bernstein, Merrill Lynch's former chief investment strategist, is now saying, that America is still blowing bubbles with its heavy, excessive borrowing. The US government in a post-bubble environment simply is genetically incapable of waiting for economic growth to rebound to soak up excesses, and instead reflexively acts without thinking in the face of growing voter unease over job losses.

So the US has now embarked on Japan's post-bubble strategy, which it did during the 1990s, that is, to support excess capacity by reflating the economy via gunning the mints, moves which stymie the post-bubble consolidation forces, Bernstein notes.  

Easy money is like tequila, tasty, but dangerous, another inflation hawk, Dallas Fed official Richard Fisher, has warned.