The ‘Dismal Science’ Gets Riveting

This article was written with Oliver Pursche, the Co-Portfolio Manager of GMG Defense Beta Fund. It was part of a series of articles developed under an agreement with to work with a variety of contributors and assist them in delivering actionable investment ideas each week.

NEW YORK (TheStreet) — If you laid all the economists in the world end to end, they still could not reach a conclusion.

Except for this: Thursday’s Consumer Price Index reading will be a critical determinant of Federal Reserve policy going forward.

To understand why this is so, you would need to parse Fed Chairman Ben Bernanke’s remarks last Thursday. On balance, his remarks were classic economist “dismal science” stuff.

However, during the Q&A session, Bernanke made a revealing comment. He indicated that the Federal Open Market Committee members will be wrestling with the following question during its upcoming June 19-20 meeting: Is there enough economic growth to improve labor markets and lower the unemployment rate?

Not the stuff of potboilers per se, but consider this:

Given the sharp sell-off in oil in recent weeks, it is very possible the headline number (which incorporates food and energy prices) may be negative, and that the core number (which excludes food and energy prices) is near zero. Should this be the case, it will give the Fed the cover and power necessary to engage in further monetary policy operations.

Accordingly, there are three potential scenarios for the upcoming FOMC meeting:

1) A change in the language on how long interest rates will remain at or near current levels (current language is until late 2014);

2) Indicate an extension of Operation Twist — the snarky name given to Fed open market operations of buying and selling bonds to influence the yield curve. In the current environment, the goal of Operation Twist would be to push down long-term rates and spur investment

3) Indicate the heightened probability of a QE3 – where QE stands for Quantitative Easing, which is simply the large-scale purchase of Treasury securities in an attempt to flood the economy with liquidity. This rather blunt instrument I liken to turning on a fire hose, which is great for putting out fires but for stimulating an economy maybe not so much.

Perhaps because of this, option three is least preferable and least sophisticated. However, if the Greek elections on June 17 turn out as I believe they will, giving Alexis Tsipras’ left wing, anti-austerity party a clear and decisive win, then the Fed may well decide to counter the increasing risks of a Greek exit from the eurozone with additional quantitative easing.

However, this will only be possible with weak CPI print on Thursday. A hot number on the CPI indicating inflation is rearing its ugly head may well corner and handcuff the Fed in one fell swoop and leave us vulnerable to economic contraction with very few tools at our disposal to fight back.

It’s all coming to you this Thursday. Stay tuned.

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