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Fed Should Stand Pat and Stock Prices Should Surge

Prof. Peter Morici - 10/23/2006

On Wednesday, the Labor Department reported that the Consumer Price Index fell 0.5 percent in September, after rising 0.2 percent in August. The consensus forecast was minus 0.3 percent, and my forecast published by Reuters was minus 0.4 percent.

Seasonally adjusted, food prices were up 0.4 percent in September, after rising 0.3 and 0.2 percent in August and July. Energy prices fell 7.2 percent in September, after rising 0.3 and 2.9 percent in August and July.

Energy and food prices are quite erratic from month to month, and Federal Reserve policymakers pay close attention to movements in the core index. The Federal Reserve is particularly concerned about the pass through of higher petroleum prices into other sectors of the economy, and labor market pressures.

Core consumer prices—consumer prices less food and energy—rose 0.2 percent in September, after rising 0.2 percent in August and July. The consensus forecast and my forecast were 0.2 percent.

Since September 2005, core consumer prices have risen 2.9 percent, and the compound annual rate of change for the three months ending in September was 2.7 percent.

Core consumer price inflation remains above Ben Bernanke’s target range of one to two percent. However, core consumer price inflation in recent months reflected the continuing pass through of prior surges in energy prices to non-energy products. Those pressures are now reversing.

Slowing economic growth, moderating housing prices, and falling oil and natural gas prices should relieve pressures on both the broader consumer price index and core consumer prices. Inflation should decline the remainder of this year.

With the housing and automobile sectors slowing, raising interest rates further would serve no useful purpose. The Fed should not change interest rate policy before its January meeting.

Growth should recover to about 3 percent by the first half of next year.

Home prices are moderating, not collapsing, and overall these have risen nearly 50 percent over the last five years. Falling energy prices are bolstering consumer confidence, and consumers still have considerable home equity to tap. Holiday retail sales will demonstrate unexpected strength, and along with more robust commercial construction and business investment, will pump new life into to aging economic expansion.

Falling energy prices, moderating inflation and healthy holiday sales will strengthen corporate profits and investor confidence. The stock market rally should continue into the New Year.

Household savings performance will improve, and ordinary investors will shift from bigger mortgages and homes to stocks. Conditions are ripe for the long awaited bull market on Wall Street.