We’ve predicted it last week.
Ben Bernanke has now turned inflation hawk. But can he have it both ways?

So far, the Federal Reserve Board chairman also known as “Helicopter Ben� was the champion of monetary easing. These days are over it seems.

In a speech in Massachusetts on Monday [June 9], Bernanke switched gear and made a hawkish comment prompting the dollar to one of its biggest daily gains today up more than 1% against the Euro to $1.55.

So has Mr. Bernanke really turned inflation hawk? He’s getting there. But he’s no Jean-Claude Trichet. He wants it all. That’s the problem with the Fed’s dual mandate. Chances are you’ll always have a critic no matter what you do. It’s hard to fend off a recession while keeping inflation at bay. So at least, let’s admit that Mr. Bernanke has some guts. By trying to do everything, he is clearly embracing the great project of pissing everyone off. At least Mr. Trichet is popular among the enemies of inflation. Mr. Trichet is the king of the hawks. Where is Mr. Bernanke’s kingdom? Time will tell.

Just late last month, Mr. Bernanke was harshly criticized by the inflation hawks for letting the dollar collapse. Now he is unnerving those who worry about the recession and the financial mess.

What did Mr. Bernanke say on Monday at the Federal Reserve Bank of Boston’s 52nd Annual Economic Conference to shake up the dollar?
Here is the meat:
“Despite the unwelcome rise in the unemployment rate that was reported last week, the recent incoming data, taken as a whole, have affected the outlook for economic activity and employment only modestly. Indeed, although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.�

This is a signal that helicopter Ben may be in the garage for repair. The futures market is already predicting a rate hike at the next Federal Open Market Committee meeting on June 24 and 25. And the inflation threat is so clearly understood by the bond market that Treasury prices collapse today.

But wait a minute? Isn’t Mr. Bernanke confused about inflation?

Mr. Bernanke’s remarks on Monday come as a surprise after a recent speech at Harvard University in which he downplayed the inflation risk, stressing that today’s economy could not be compared to what happened during the stagflation of the 1970s.

So why worry then?
Well a Central Banker’s job should be to worry about inflation. I mean, that’s what the Fed is for. From the disciples of Milton Friedman who see in price instability the worse of all economic sins to the U.S. consumer currently fainting at the gas pump, Bernanke’s recent conversion should be good news for everyone.

But the U-turn could be a source of disappointments for those who don’t think that the risk of a recession is behind us. Those in particular point to Friday job report which saw the U.S. unemployment rate jump by a half percentage point to 5.5% in May one the biggest increase in more than 30 years in seasonally adjusted terms.

The best way for Bernanke to fend off all of his critics would be to convince the market that at this point he did pretty much all that could have been done to lift the economy and inject liquidity in the arm of Wall Street. Time to pay attention to Main Street and that’s why the Fed is upgrading the risk of inflation. And anyone who has visited a supermarket or a gas station lately knows that the surge in oil prices and the unprecedented commodity rally can pose a greater threat to consumer demand than a housing market slowing down after a huge bubble.

As Stephen Jen, global head of currency research at Morgan Stanley put it in an investment note today:

“Investors’ focus has shifted to inflation, in developed and developing countries. This is partly because the ‘stag’ part of stagflation has not been that evident, even in the US: except for last Friday’s labour report, data out of the US were not that bad. Bonds, equities and currencies are now reflecting this shift in focus from ‘stag’ to ‘flation’.�

This entry was posted on Tuesday, June 10th, 2008 at 7:16 pm and is filed under Monetary Policy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.