Fed Minutes Say the End is Near

The FOMC meeting minutes for Bernanke's first meeting as chair were released. If you are looking for evidence the Fed will move to 5% and then pause, it's there. But if you feel there is a chance rates will go higher, statements about being vigilant toward inflation expectations and about risks being tilted slightly toward worry about inflation give support for that position as well. Putting the two together, the Fed wants us to get their message, repeated frequently lately with Janet Yellen as the latest messenger, that further rate moves beyond the move to 5% at the next meeting are data (and I would add forecast) dependent:

Fed Members Saw End of Rate Rises Likely 'Near' in March, Minutes Show, Bloomberg: Most Federal Reserve policy makers considered the end of their interest rate increases ''was likely to be near,'' while also citing the need for vigilance against inflation, minutes of their March meeting showed.

''Most members thought that the end of the tightening process was likely to be near, and some expressed concerns about the dangers of tightening too much,'' the record ... said. ''Members also recognized that in current circumstances checking the upside risks to inflation was important.'' Fed officials are now basing rate decisions on what incoming data say about their forecast of slower economic growth in the second half of 2006...

''I don't think there's any doubt they'll go to 5 percent in May,'' former Fed governor Lyle Gramley said in an interview. ''I expect them to sit still after that.''

Additional tightening, the minutes said, ''would be determined by the implications of incoming information for future activity and inflation.'' The Federal Open Market Committee also held discussions on the statement they issued after the meeting, including the phrase ''some further policy firming may be needed.''

Some members worried that the language, ''could be misconstrued as suggesting that the committee thought that several further tightening steps were likely to be necessary,'' ... ''Several members were concerned that market participants might not fully appreciate the extent to which future policy action will depend on incoming economic data.''

San Francisco Fed President Janet Yellen said today she's ''highly alert'' to the chance policy makers may lift rates too high. ...

Here's a bit more on Yellen's speech from the WSJ:

Minutes Show Policy Makers Thought Rate Moves' End Near, by Greg Ip, WSJ: ...While inflation risks are "tilted slightly to the upside," she also said she was "increasingly concerned about the well-known long and variable lags in monetary policy -- specifically, that the delayed effects of our past policy actions might impact spending with greater force than expected," in particular on housing. "I will be highly alert to the possibility of the policy tightening going too far."

Ms. Yellen said new data will change her views only if they surprise her -- for example by showing no slowing in growth, a rise in inflation or a more drastic pullback in housing. "It's not really data dependence, but more accurately, data-surprise dependence" that drives her forecast, she said.

I read that as saying fairly explicitly she is going to advocate a pause at 5% unless there are data surprises. As previously noted, I agree with her worry about lags in policy. The WSJ report also reinforces Bloomberg's analysis:

After raising interest rates in late March, Federal Reserve officials concluded they were almost done in the lengthy process of tightening monetary policy, the meeting's minutes show.

Released Tuesday, the record gave the strongest signal yet that an expected rate increase by the Fed at its next meeting May 10 may be the last for some time.

Update: Is today's CPI inflation report bad enough news to change the Fed's course? As David Altig says (as he notes qualifications to the report in both directions, but still does not like the overall picture), we shall see. This isn't the last data the Fed will see between now and the time when the decision to move past 5.00% must be made, so the Fed has no need to make that call yet. It's also worth noting that due to policy lags, recent tightening is not fully reflected in this month's data.

Comments

[anne]

Notice the stock market :) Tell investors that long term interest rates can hold, and the international bull market likely continues. This Federal Reserve cycle has been most benign for stock and real estate markets, and even little jarring for the bond market.

[anne]

So far I could not be more impressed with economic resilience through a Federal Reserve, indeed an international developed market central bank, tightening sequence. Remarkably real estate is holding, and holding not just here but in every other developed market with the possible exception of New Zealand where central bank tightening always is going to extremes.

[Johnson]

I noticed that the Stock Market will sell off whatever it gained. Rallies like that are trash.

Your view on Interest Rates is poor as well. The "Bull Market" is about dead on the Internationally.

[Johnson]

No, Anne, Real Estate is not holding. Prices fell in March, which is only the beginning for the US.

[anne]

Well, after 3 1/2 years this excellent broad and deep international bull market may have ended, but not today so tomorrow at the earliest. Bull markets, after all, end, and that is the reason for a nicely diversified portfolio. So, when the end comes tomorrow we can still be happy although not quite so happy as today :)

[anne]

There you have the worries, interest rates and real estate, while I am not for a moment content enough to think you wrong in your worries. The caution is warranted. Nice :)

[anne]

Imagine, Ireland banning smoking in pubs. Could it be? It be :)

[calmo]

The volatility that programmed trading can impart to the market is controlled by checks and delays only on the way down. Is this short-sighted?
Johnson more or less has my view: it is an outstanding daily gain but without several more, hardly a rally. The fundamentals ep RE continue to sour.
I find the word "tightening" in this article so obnoxious I want to stuff it down someone's throat. [Just another bias I thought I'd air now.] So with money supply up ~10% so far this year, you figure we'll expire from this merciless tightening?
Ok, I can bet too: barring catastrophic news in the housing market,[sales fall another 10%] there will be only 1 more increment.

[anne]

No; I find no evidence that money supply change has been a problem in general price control over the last 20 years. Who knows what the future may bring, but there is no reason to fret about money supply growth.

Somehow the energy price increase coupled with a central bank tightening sequence and now and then cooling of real estate just has not been a problem in developed economies. Remarkable.

[groucho]

"Somehow the energy price increase coupled with a central bank tightening sequence and now and then cooling of real estate just has not been a problem in developed economies."

Anne, with PONZI FINANCE, the game is not up untill either the lender or borrower quits the game. Currently, the lenders are still active, supported by Bernanke. Right now the FED is tapping the brakes(baby step 25bp rate hikes), while at the same time stepping harder on the gas(increasing money supply at high and soon to be much higher rates)
Borrowers are starting to balk. Home buyers/mortgage borrowers are giving up the game and soon the new mortgage guidelines will be coming into affect, reversing the mortgage debt pyramid.
Gee, I wonder why the FED would stop publishing M3 numbers at a time such as this.(never mind the Iranian situation)

[anne]

When I invest I do not care about this scheme or that, about the dread ever-expanding money supply, or about when American debt-bedraggled consumers will finally have shopped for the last ever time :) I look for relative value in international markets and buy, seldom sell, and remain fully invested. Betting on the end of the world, simply hasn't worked and though the reasons are always good as to why it should work it doesn't. "Ponzi" and "pyramid" and such simply frighten investors, but why? Buy relative value.

[anne]

Knowing valuations is important, as is not fooling yourself about valuations that make no sense but we are sure that this time there is a reason they make no sense :) The investment world to which we have ready access is broad and there are almost always attractions. So shop, and beware of bears who are angry that anyone ever finds value though hopefully they must for how else could they go on?

[calmo]

Trying to solidify my opinion about the relationship between money supply and inflation, I found this modest snippet from Edward Lotterman mulling over the same issue:

http://www.twincities.com/mld/twincities/business/columnists/14346050.htm

This bit sort of summaries my initial plank:

Milton Friedman [but really I could care less, as long as someone, even unknown Edward Lotterman, said it before me, (esp unknown)] taught us that inflation "is always and everywhere a monetary phenomenon." That is, inflation only occurs when excessive growth of the money supply allows it.

And my argument to follow is basically that money supply is more excessive than the official reports care to admit, more or less like the inflation reports downplay the general price level by ignoring housing and energy.

To get clear about the terms, Lotterman begins:

Inflation is an increase in the general price level. [Absolutely. Not mine or your's but the general's, who is fond of renting, bicycling, and long underwear as many have pointed out before.] We measure general price levels with carefully tabulated indexes like the Consumer Price Index and the Gross Domestic Product Deflator. [Ok, so far: when we talk about inflation, we aren't talking personal, but technical and formal: official inflation for official reasons, some of which make sense.]

In support of anne's view, some evidence that if money supply is central, it is, despite lack of M3 reportage now, easing from previous levels:

Yes, the U.S. money supply grew substantially faster than output from 2001 through 2004. But more recently, money growth has moderated [careful not to say that it now slower than output] while our nation's economy is growing quite strongly.

Further skepticism about the statement that money growth has moderated recently: Does this begin to track other forms of money supply that are not counted, say, in derivative transactions which have mushroomed in this period? I don't expect the notional amounts of derivative trades to register in the creation of money supply but I do expect that the non-notional amounts in the non-registered trades are not counted.

The following looks like stronger support for anne's position:

The idea that we need only look at money growth in our own country is obsolete. Asian central banks have bought up huge amounts of foreign currencies in the past few years. Some estimate that China now holds a trillion dollars worth of other currencies.[And in terms of overall money supply, how large is this?]

I am much more comfortable with this observation (and would add that Japan has approx equal US reserves) and like the correlation between foreign held US reserves and money supply. So the extension to other countries is easy for him to make, just not the mechanisms or financial instruments by which that is accomplished.

Of course no economist, however obscure, can end on a dismally dismal note, nor a pacifying sedative, so we have this tensioner:

One sobering perspective is that it is nearly impossible to find a time in the last 60 years when sharp rises in the price of gold and non-agricultural commodities were not accompanied by inflation. Hold on to your hat with at least one hand.

How many gold bars you figure are in Ed's other hand?

[anne]

Remember, though there has been no evident relation between inflation and money supply growth for at least a generation, an investor who worried about such a relation would still have a set of valuable alternatives from energy or materials indexes to real estates investment trust indexes, not to mention precious minerals and mining which is a curious investment class. Drug companies collectively are a fine hedge against inflation :)

[groucho]

"Remember, though there has been no evident relation between inflation and money supply growth for at least a generation"

Anne, You've got me completely confused on that one.

ALL INFLATION is generated by the expansion of the money supply. With out the constant increase in money supply we would be experiencing deflation.

Yet, I do expect deflation in the US because banks and other credit creators have loaded the final consumer with way too much debt. A very dumb idea. If Keynes were alive today, he would be shocked at the evolution of consumer economics. He would immediately call for an end to consumer credit and an immediate mandatory increase in consumer income.

[Robert]

I cannot resist weighing in on this. The markets will press and test. They will do this by continuing to speculatively push the metals up, and bonds down. On the one hand, Anne is sanguine and suggests it doesn't matter. Groucho, on the other is saying these things are moving towards where they should be.

I am sympathetic with the ponzi-analogy, but reject it since any bank would fall into the same category of ponzi as an issuer of scrip. Gov has created lots of new scrip, but it can move more towards the direction of fiscal balance that would be more acceptable (to markets), though the longer it waits the greater the probable future disclocation and the greater the "potential" inflation (in the sense of stored energy as "potential energy"). I think this is obvious since we've been persistently creating money at a faster clip than GDP and are approaching boundaries - not my boundaries mind you -but those tolerated by the collective market(s).

The crisis for Bernanke (and the nation) will likely come as inflation continues rising (which it is), and AFTER gold and silver have moved and caught the public imagination (wait to this weekend's Barron's or next week's Economist or Forbe's, or the July issue of Vanity Fair), and after bonds fall more substantially as investors get nervous and foreign purchases wane (which will happen as the carry trade falters and the parri-passu becomes apparent), after this, inflationary expectations will rise more generally, and the Fed will be forced to choose between watching all this unravel, and squelching a significant acceleration in inflationary expectations (and all it's attendant ripples), by his only response: raise rates more aggressively.

At any time, Congress and the executive branch could (or might have been able) to head this off by raising revenue in the countless ways that the Bruce's (and others) have laid out over and again, but in the absence of action, the Fed will be forced to choose: a market-led malaise of 1978/79 all over again, or '87-like hiking of rates that will ultimately be deeply contractionary. There are no good choices and I think, Anne, the more benign picture you see is the one in the rear-view mirror.

[anne]

There has been no evident relation between money supply growth and inflation for at least 20 years, and inflation has been moderate to low and no problem through this time. As for personal debt, we seem to have an endless ability to add to it :) Really.

[Robert]

One could suggest, Anne, that the 20-year window is pathetically short, coincided with US economic supremacy & dollar-dominance, and US political predominance with the fall of Soviets and re-invention of new-improved Chinese Communist Party, and de facto vacuum of liquid paper alternatives to grease the wheels of trade, ALL which have already reversed or are set to end. In this way, the "inflation potential" inherent in all the scrip accumulated during these part 20 years may be unleashed, to a greater or lesser extent, which will be dependent upon our actions, though one must admit, to date, even an optimist might find cause to worry...

[anne]

So, then, what am I going to worry about, at least after my bird walk :) We are now earning less in investment income from abroad than we are paying to international citizens. The change in income flow has just come, but the effects will be subtle and long in being noticed. The cost of energy may be near harmful. Curiously, I am sanguine beyond this though the occupation of Iraq bothers me continually.

[groucho]

"As for personal debt, we seem to have an endless ability to add to it :) Really."

Ahh, but all ponzi pyramids must come to an end.

[anne]

Possibly not, for if personal wealth is growing in proportion to debt than growth of debt can continue indefinitely. Similarly lower interest rates allow for easier carrying of debt. Still, I surely wish we had a signifiant personal saving rate and puzzle over the lack of saving. I am thinking of your argument, though thinking with a hungry conure chewing on my neck is more distracting than thinking.

[anne]

http://flagship2.vanguard.com/VGApp/hnw/FundsByName

Vanguard Fund Returns
12/31/05 to 4/19/06

S&P Index is 5.5
Large Cap Growth Index is 4.1
Large Cap Value Index is 7.1

Mid Cap Index is 9.6

Small Cap Index is 13.9
Small Cap Value Index is 12.2

Europe Index is 14.4
Pacific Index is 9.9
Emerging Markets Index is 18.7

Energy is 22.1
Health Care is 2.1
Precious Metals is 32.5
REIT Index is 11.2

High Yield Corporate Bond Fund is 1.7
Long Term Corporate Bond Fund is -5.5

[anne]

http://flagship2.vanguard.com/VGApp/hnw/FundsVIPERByName

Sector Stock Indexes
12/31/05 - 4/19/06

Energy 18.1
Financials 5.9
Health Care -1.1
Info Tech 6.8
Materials 15.5
REITs 11.3
Telecoms 14.4
Utilities 0.3

says...

http://www.msci.com/equity/index2.html

National Index Returns [Dollars]
12/30/05 - 4/19/06

Australia 14.8
Canada 14.9
Finland 24.6
France 14.1
Germany 16.6
Hong Kong 12.8
Japan 8.5
Netherlands 12.8
Norway 31.8
Sweden 19.8
Switzerland 11.1
UK 14.0

[anne]

http://www.msci.com/equity/index2.html

National Index Returns [Domestic Currency]
12/30/05 - 4/19/06

Australia 13.0
Canada 11.9
Finland 19.2
France 9.1
Germany 11.5
Hong Kong 12.8
Japan 8.3
Netherlands 7.9
Norway 23.1
Sweden 13.5
Switzerland 7.2
UK 9.4

[anne]

Again, tommorow begins newly but till today there has been a stunning broad and deep international bull market in stock and real estate. Bears have been 3 1/2 years in failing to understand these national general bull markets and far longer to understand the sector bull markets that were not damaged from 2000 to 2002.

[anne]

Notice the remarkable strength of emerging markets, and wonder at the extent to which China and India may be propelling or modelling growth from Brazil to South Africa. Bears have simply missed astonishing international strength.

[groucho]

Anne, yes, global liquidity has found many homes around the world. Of course, how much will stick and how much will run at the first sign of trouble is anyone's guess.

Do you follow Vivian Lewis (global-investing.com)?

[Robert]

It is indeed possible to over-intellectualize markets when the herd is running. And sympathetic with your observations, there was little reason to be bearish in 03 & 04 - since valuations were attractive around the world, real interest rates negative, and growth though tepid in developed markets was positive.

But investment is about looking forward, not backwards. And though there is some information to be gleaned from the direction of past movement in prices, this information is fickle and rarely applicable uniformly or generally. With this is in mind, some European and asian markets retain some attractiveness (looking forward), as perhaps do some emerging markets and resource-based economies, though its rather probable that significant growth and consumption has been borrowed from the future in the US, and how this resonates and ricochets in higher-growth emerging, and asian economies remains difficult to gauge. Historically, such effects have NOT been benign.

By constitution, I am not neither a pessimist nor a perennial bear, though I am a conservative - especially when it comes to investing in markets where pari-passu risk is elevated, likely as a result people mis-extrapolating historical returns, or the conditions responsible for those historical returns. Listening to IMFs Rajan speak soberly and candidly of the increasingly imminent need for US to address fiscal imbalances, and large probability of higher rates in the immediate future is a decent quality forecast of rough weather ahead.

[anne]

There is no reason not to be bearish, but be an intelligent bear as an intelligent bull and develop a long term investment portfolio that is accumulated by looking to relative value and is reasonably diversified enough to take you comfortably through difficult periods. Invest, however, for there is no alternative unless we are so wealthy that we can afford not to invest, and even then not investing is foolish for there are portfolios that are always conservative enough.

[anne]

A portfolio of Vanguard's S&P stock index and long term investment-grade bond funds would have been enough to conservatively thrive over 30 years. The Vanguard S&P index has returned 12.2% a year for 30 years, and long term bond has returned 8.8%. A 50 - 50 mix of these funds and a portfolio is conservative and diversified and would have returned over 10% a year for 30 years. Care to be more conservative, try 40% stock and 60% bond fund; less conservative 60% stock and 40% bond fund.

[anne]

Vanguard offerings allow for even better and broader choices with corresponding simplicity and safety. A conservative portfolio might include the American large cap index, Europe index, real estate investment trust index, and long term bond index. Diversified enough :)

[anne]

Vanguard, because there is superb quality and fair low cost. Play with the numbers, and be conservative as we wish:

25% American large cap stock index
25% Europe stock index
20% REIT index
30% long term bond index

mid cap index
health care fund
energy fund
intermediate tax free bond fund

[anne]

The need in investing is to go beyond the hysterics who dominate analysis and think to a simple diversified long term portfolio that is suitably conservative to personal needs or tastes. During a wonderful market such as we have been passing through, hysterics warn of falseness and imminent danger. But, through the difficult market earlier the warning was always things will get worse.

Brad DeLong, who is always a sound thinker, has been worried about American financial soundness and is completely invested abroad other than in real estate. Simple, an investor can own any of the Vanguard international indexes. Owning the Europe index alone, is a highly diversified reasonably way of protecting against a decline in the value of the dollar. There are the Pacific index and emerging markets index as well.

The need is to calmly set down investing ideas on paper and construct a portfolio, hopefully long sighted that will allow a realization of value in markets however conservative that have offered growth for generations. Remember, however worried we may be, Vanguard bonds funds are superbly conservative and have been a wonderful long term investment for decades no matter the sneering of eternal bulls :)

[groucho]

"The need is to calmly set down investing ideas on paper and construct a portfolio, hopefully long sighted that will allow a realization of value in markets however conservative that have offered growth for generations."

Now, THAT, is an excellent plan.

[dd]

Bears and Bulls are all a matter of perspective and most believe they are neither. All of us are shaped by our past and so the past is not so easily discarded. Saving is what most Americans can do and afford as they need access to their funds for unforseen downturns; yet saving has been discouraged and indebtedness encouraged via low interest rates. Why discourage savings? Why encourage debt? Why encourage spending over saving? Something is seriously wrong when prudence is cast aside and while it would be wonderful to have a nicely diversified portfolio and sufficient assets to fund same; that is not something in reach for most Americans.

[anne]

Though the argument is sound, there are in fact many Americans who do save and who do invest and they or we have interests and needs that must be attended to.

[dd]

Many Americans invest because we have moved from an insured defined benefit pension system backed by corporate revenues to an uninsured defined contribution system that transfers all the risk to retirees. Odd that we've had long debates about Social Security; but no discussion about the metamorphosis of mutual funds from an investment pooling tool to a retirement plan. The industry is untested in this regard as are the markets. That does not make it bad or good but it does argue for government policies favoring both investment and traditional saving. It also argues for independent study on the ability of the investment system to deliver on the promise of retirement and the ability of the SEC to monitor, manage and regulate an increasingly complex system with an ever growing number of unregulated financial products and investment pools.

[anne]

Terrific comment, as usual :) We must think further about this.

[Ed Lotterman]

Re comment in posting about my column above. I have no gold bars clutched in one hand but I do have 230 acres of Murray County Minnesota farmland. The 1980s proved it is far from perfect as an inflation hedge but ....

[Robert]

Inflation that migrates from incipient to actual, that gooses nominal interest-rates up, and raised nominal wages would together exert big negative pulls upon equity and traditional real estate values. If occuring coincidental with increasing agricultural terms of trade from their historically low levels, your 230 acres may yet prove to be an effective hedge when measured over longer periods.

[Blissex]

Most of these comments make me disappointed for the usual reason, that any discussion of ''inflation'' without clearly saying ''inflation of what???'' is so pointless.

Inflation of the prices of goods and services in the CPI basket? Of hourly wages? Of assets? Of bonds? Of stock? Of gold? Of hamburgers? of what?

The only hard to dispute things are that USA (and not just USA) monetary policy has been «ultra loose» (quote from the Economist) for over a decade, and money supply growth equally generous...

Also, ''inflation'', whatever that is, can happen rather suddendly.

[anne]

Interesting, as your comments are, but the Federal Reserve while knowing of all the relative indexes will pay most attention to the Consumer Price Index and more broad GDP price index. There are a host of curious critics who would have the Fed regulate asset prices, possibly because the critics always wish they had only invested when they should have or wish only they could take advantgae of market opportunities. I am not impressed. The bond market will tell us when to worry about inflation; not yet :)