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The Fed Takes a Step Into the Danger Zone

It could easily push the country into recession.

I have a problem with the Fed these days. Put simply, I think it's trying too hard. And too much work from the Fed threatens the current economic recovery.

The following quote from the last Federal Open Market Committee meeting is especially dangerous:

Nevertheless, possible increases in resource utilization as well as elevated energy prices have the potential to add to inflation pressures. The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives.

The FOMC needed to pause Tuesday.

The economy is clearly tapering. The real estate bull market is very obviously history, and the energy tax is still upon consumers in a major way.

Of course there are still some decent economic data as well. There always are in the slowdown period. Consumption has been very resilient and confidence is improving, and the jobs market is still firm. But for the most part, the turbo-charged stimulus from promiscuous money policy of the past few years is over.

And that's why the language above has me concerned.

Concerned about the increase in resource utilization? I am not.

Industrial capacity utilization is still historically low at only 81%. In the past, inflationary pressures built around the 85% level. We have a few more years of strong growth to reach that level.

Are elevated energy and commodity prices an issue? This one's a bit trickier, but many commodities have been firm for quite a while, yet core inflation remains subdued. I think there is a fair amount of speculation in many commodity prices as hedge funds follow the momentum trade. But even so, higher input costs have had a difficult time finding their way into actual widget pricing as Chinese exports keep a lid on many products.

Will labor costs accelerate with low unemployment and economic growth? Maybe not.

First, many workers are either underemployed or have left the labor force due to poor conditions. Like much of the government data these days, the employment numbers have been prettied up enough to make things appear better. My guess is that the true unemployment rate is closer to 10%, and I believe there are a few million workers ready to reenter the job market under more favorable conditions.

Anecdotal evidence from corporate layoff announcements and recent labor settlements also suggest that a major acceleration in worker compensation should not be concern. Corporate managements are too addicted to their stock option profits to permit outsized unit labor cost growth. If workers get too intransigent, there's always the ability to move engineering as well as production to China or India.

This time around, fortunately, spiking commodity prices have not found their way into unit labor costs. And as most know, those are by far the biggest inputs in the cost structure.

So for a whole bunch of reasons I believe that inflation concerns are yesterday's news. Even with $70-per-barrel oil.

Furthermore, since monetary policy works with a 12-18 month lag, the real economic impact of the last 14 -- count them, 14 -- rate hikes are still working their way through the system. The Fed cannot keep raising rates until the economy has visibly slowed. By then it's much too late to stop.

A real risk of recession then would be present and we do not need that at this point in the cycle. Last quarter's GDP, even with all its flaws, suggests my contention regarding slowing growth is correct.

What the Fed needs to do now is pause the rate hikes and watch the economy for a few quarters. It can easily resume in the latter half of the year if the economy has not mellowed to its liking. I mean, do these guys get paid by the rate change? If not, give investors, employees, consumers and managers a break. Unlike your 1% fiasco, get it right this time! Because if you give us one rate hike too many, things could get awfully ugly, very quickly. And then Ben would really need his helicopter!

Robert Marcin is the founder of Defiance Asset Management, a private investment management firm. Client accounts managed by Defiance Asset Management often buy and sell securities that are the subject of articles by Marcin, both before and after they are posted. Under no circumstances does this column represent a recommendation to buy or sell stocks. This column is intended to provide insight into the financial services industry and is not a solicitation of any kind. Neither Marcin nor Defiance Asset Management can provide investment advice or respond to individual requests for recommendations. However, Marcin appreciates your feedback;

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