WSJ's Hilsenrath Says Economic Riddles Could Reshape Fed's Bond-Buying Exit, Questions September Tapering

Jon Hilsenrath of the Wall Street Journal just published a new article highlighting that the Fed's much feared tapering may be put off due to lower inflation, weak labor market dynamics, and potential "fiscal chaos."

In specific, he asks four questions that he expects Bernanke to address in his testimony tomorrow.

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Is Job Growth Sustainable?

"In the past nine months, the economy has generated a little more 200,000 jobs per month" writes Hilsenrath. "But according to most economist estimates, the economy has grown at a paltry annual rate of less than 1.5% over that period. That doesn't add up. The economy usually needs to grow much faster to get employers to add workers to their payrolls at such a robust rate."

Bernanke said in March 2012 that faster growth was needed to sustain job growth and growth has not accelerated, leading many to question if the strength in payroll growth recently is sustainable.

Is the Jobless Rate Overstating the Labor Market's Health?

The Fed has announced that both the end of QE and rate hikes would coincide with certain thresholds in the unemployment rate. Specifically, the FOMC has said that at 7.0 percent, the Fed would stop buying assets and at 6.5 percent, it would look to raise rates.

"That doesn't add up," continued Hilsenrath. "The economy usually needs to grow much faster to get employers to add workers to their payrolls at such a robust rate. Those unemployment thresholds that get so much attention in the markets, in other words, might turn out to be unhelpful guideposts for the Fed's actions."

Will Inflation Return to Target?

Bernanke has always been afraid of disinflation and more importantly deflation. In his most recent Congressional testimony, he said that low levels of inflation are dangerous because it increases real interest rates. Importantly, the PCE measure of inflation, a favorite of Bernanke, only rose 1 percent in May from the same period a year ago, only half of the Fed's target. Meanwhile, CPI inflation ran at a 1.8 percent annualized rate, below the unofficial target of 2.5 percent CPI inflation.

"St. Louis Fed President James Bullard dissented at the Fed's June policy meeting because he worried inflation was getting too low and wanted the post-meeting statement to express that concern. Minutes of the officials' meeting showed 'many others worried about the low level of inflation, and a number indicated that they would be watching closely for signs that the shift down in inflation might persist.'"

Is More Fiscal Chaos Coming

The Fed's forecasts last year for the economy were missed as new tax increases and spending cuts turned out to be bigger than Fed officials had expected. "Fiscal land mines once again loom, including a federal debt-limit debate this fall that could trigger financial-market turmoil. The Fed might find that other Washington policy makers are the hardest economic actors of all to predict, forcing central bank officials back to the policy drawing board."