Last Tuesday, Fed Reserve Chairman Ben Bernanke warned that the economy faces "numerous difficulties," suggesting that those risks remain his top priority. But surprisingly, Fed officials now expect the economy to grow 1% to 1.6% this year and have raised their GDP forecast. What about those inflation concerns? It seems Bernanke may be trying to dazzle us with double-talk.
In his Congressional testimony last week, Bernanke outlined a long list of risks, including "ongoing" financial stress, falling home prices, a weaker jobs market, and inflation in food and energy prices. The Fed Chairman expects the economy to "gradually" improve but warned that "considerable uncertainty" surrounded his outlook. It was painfully obvious to me that Bernanke really didn't want to testify in front of Congress, so he just read a prepared script that confused the pants off everyone.
But the numbers will spell out what Bernanke won't. For example, the Commerce Department announced retail sales only rose 0.1% in June-far below forecasts of a 0.5% rise. Complicating matters further, retail sales in April and May were revised down to 0.2% (from 0.4%) and 0.8% (from 1%), respectively. That's just 1.1% growth in three months instead a forecast almost twice that! Considering that the economic stimulus checks are still being sent out, the June retail sales report was especially disturbing. Overall, considering that consumers represent over 70% of economy, you can see why Bernanke chose to baffle Congress instead of talking straight.
The reality is that the economy and the dollar are both in a tough spot. At the last Fed meeting, some officials argued that the Fed should hike interest rates "very soon" to fight inflation. Others said the Fed had to aggressively cut rates to 2% to guard against downside risks to economic growth. This internal Fed debate may explain why Bernanke appeared so tired in front of Congress last Tuesday. Quite frankly, it looks like he doesn't know what to do next.
But one thing is certain-doing nothing certainly won't help either the dollar or the economy. Inflation is still a problem, and the numbers show it will continue to affect the economy and consumer spending. In the meantime, Sovereign Wealth Funds from the governments of China, Qatar, Singapore and other countries are scaling back their exposure to the dollar. These countries took big losses after helping recapitalize faltering U.S. banks. One big sovereign wealth fund in the Middle East has cut its dollar-denominated holdings from more than 80% a year ago to less than 60% now, while China's State Administration of Foreign Exchange has been looking to strike deals with private equity firms in Europe as a part of a strategy to reduce its dollar holdings.
Until we see some leadership from the Fed, a weak dollar and high commodity prices are here to stay. Since any politically unpopular decision will likely be delayed until after a new president is elected, I expect the status quo to reign for the coming months. That means more inflation and high commodity prices.
