No News Isn't Good News From the FOMC
June 28, 2008
By RANDALL W. FORSYTH
The central bank hints at rate rises, but risks to the economy will likely keep policy on hold.
AFTER ALL WAS SAID AND DONE,little new was said and even less done at this week's meeting of the Federal Open Market Committee.
To the surprise of absolutely nobody, the Federal Reserve's policy-setting panel left its target rate for federal funds unchanged at 2%. The committee's statement echoed recent speeches by Fed officials and press reports that their inflation concerns have escalated, although worries about the labor market and the financial markets remain.
"It was no doubt a lively FOMC meeting this month, with several members probably arguing for either a rate hike, or at least tougher language in the policy statement," according to BCA Research's Daily Insights. Once again, Dallas Fed President Richard W. Fisher dissented in favor of higher rates.
Right off the bat, the FOMC's statement changed its emphasis from the one coming out of the previous confab on April 30. "Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending," according to Wednesday's statement. By contrast, the economy was characterized as "weak" at the end of April.
"There is no mention of the very high probability that this is temporary, thanks to the tax rebates, or that auto sales are plummeting in truly alarming fashion," Ian Sheperdson, chief U.S. economist at High Frequency Economics, writes of the FOMC's characterization of consumer spending.
The FOMC concedes things don't look good. "However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters," the panel noted, much as it did in April.
As for inflation, the Fed continues to think the storm will abate "later this and next." But it's hedging its bets. "However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high."
The bottom line: "Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased." Which is what recent Fed-speak had implied anyway.
But that doesn't mean any rate hikes anytime soon. Indeed, odds in the fed-funds futures market were little changed in the wake of the FOMC decision. The futures put a 38% chance of a 2.25% target rate at the Aug. 5 meeting and a 68% probability of a 2.50% funds rate (with at least 2.25% a sure thing) by the Oct. 28-29 meeting.
"The case for an early tightening is still weak, in our view," argues BCA. "The underlying inflation picture is better than the headline data suggest, many market interest rates are still higher than before the Fed started to ease, and the credit system is not yet functioning properly. Market expectations of a 50 basis point rise in rates over the next six months are too aggressive."
Lena Komileva, head of G7 Market Economics for Tullett Prebon in London, sees the uncertainty about future rate hikes -- which has pushed up term (that is, longer than overnight) money-market rates -- working in the Fed's favor. "The Fed is now making a better use of the yield curve to meet its conflicting growth and inflation objectives. Low overnight rates and liquidity-supporting measures in short-term financial markets will help counter downside risks to growth. At the same time, higher term funding rates will provide a hedge against rising inflation risks."
But there are risks to this tack. "A steeper money market curve on expectations of Fed rate hikes has the effect of reducing visibility into the liquidity outlook, which will ultimately slow down the banking sector's remedial balance sheet efforts causing further damage to private-sector credit conditions," she adds.
Since the April 30 FOMC meeting, when the panel signaled it was finished cutting rates, and indeed since the mid-March rescue of Bear Stearns, monetary conditions arguably have tightened. As High Frequency Economics' Shepherdson points out, the M2 measure of the money supply is shrinking. And since that time, the dollar has stopped making new lows and gold is more than $100 off its high of over $1,000 an ounce.
"The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability," the FOMC concluded. The risk is that those economic and financial developments will be negative, which will likely preclude any rate hikes in 2008 and well into next year.
Source: www.barrons.com
The central bank hints at rate rises, but risks to the economy will likely keep policy on hold.
AFTER ALL WAS SAID AND DONE,little new was said and even less done at this week's meeting of the Federal Open Market Committee.
To the surprise of absolutely nobody, the Federal Reserve's policy-setting panel left its target rate for federal funds unchanged at 2%. The committee's statement echoed recent speeches by Fed officials and press reports that their inflation concerns have escalated, although worries about the labor market and the financial markets remain.
"It was no doubt a lively FOMC meeting this month, with several members probably arguing for either a rate hike, or at least tougher language in the policy statement," according to BCA Research's Daily Insights. Once again, Dallas Fed President Richard W. Fisher dissented in favor of higher rates.
Right off the bat, the FOMC's statement changed its emphasis from the one coming out of the previous confab on April 30. "Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending," according to Wednesday's statement. By contrast, the economy was characterized as "weak" at the end of April.
"There is no mention of the very high probability that this is temporary, thanks to the tax rebates, or that auto sales are plummeting in truly alarming fashion," Ian Sheperdson, chief U.S. economist at High Frequency Economics, writes of the FOMC's characterization of consumer spending.
The FOMC concedes things don't look good. "However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters," the panel noted, much as it did in April.
As for inflation, the Fed continues to think the storm will abate "later this and next." But it's hedging its bets. "However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high."
The bottom line: "Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased." Which is what recent Fed-speak had implied anyway.
But that doesn't mean any rate hikes anytime soon. Indeed, odds in the fed-funds futures market were little changed in the wake of the FOMC decision. The futures put a 38% chance of a 2.25% target rate at the Aug. 5 meeting and a 68% probability of a 2.50% funds rate (with at least 2.25% a sure thing) by the Oct. 28-29 meeting.
"The case for an early tightening is still weak, in our view," argues BCA. "The underlying inflation picture is better than the headline data suggest, many market interest rates are still higher than before the Fed started to ease, and the credit system is not yet functioning properly. Market expectations of a 50 basis point rise in rates over the next six months are too aggressive."
Lena Komileva, head of G7 Market Economics for Tullett Prebon in London, sees the uncertainty about future rate hikes -- which has pushed up term (that is, longer than overnight) money-market rates -- working in the Fed's favor. "The Fed is now making a better use of the yield curve to meet its conflicting growth and inflation objectives. Low overnight rates and liquidity-supporting measures in short-term financial markets will help counter downside risks to growth. At the same time, higher term funding rates will provide a hedge against rising inflation risks."
But there are risks to this tack. "A steeper money market curve on expectations of Fed rate hikes has the effect of reducing visibility into the liquidity outlook, which will ultimately slow down the banking sector's remedial balance sheet efforts causing further damage to private-sector credit conditions," she adds.
Since the April 30 FOMC meeting, when the panel signaled it was finished cutting rates, and indeed since the mid-March rescue of Bear Stearns, monetary conditions arguably have tightened. As High Frequency Economics' Shepherdson points out, the M2 measure of the money supply is shrinking. And since that time, the dollar has stopped making new lows and gold is more than $100 off its high of over $1,000 an ounce.
"The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability," the FOMC concluded. The risk is that those economic and financial developments will be negative, which will likely preclude any rate hikes in 2008 and well into next year.
Source: www.barrons.com
