Tim Duy: The Fed Yields

Tim reviews today's rate cut decision, and wonders what the Fed might do next:

The Fed Yields, by Tim Duy: Well, it is all over but the shouting. Like many, I was caught by surprise. I was comfortable with my 25bp call going into the meeting. Data and Fedspeak were not reliable indicators this time around, in my opinion. Kudos to those who were looking for 50bp, and even to those few brave souls still believing that the Fed would hold pat. This was not an obvious call by any measure.

Now the attention turns to the October meeting…one and done? The statement gives us little guidance; Bernanke & Co. considered the future too hazy to venture a guess on the path for economic growth. Can’t really blame them; too much risk of being wrong.  Moreover, the Fed did not want to commit to a particular path given the uncertainty. I think the Fed is hoping that a large move now will prevent the need for additional cuts later – the one and done theory.

Still, barring further Fedspeak, the safe bet for the moment is to expect that more cuts are coming, albeit not necessary in October. Given that the housing market is not likely to stabilize near the near term, we can expect a steady drumbeat of bad news from that sector alone. But more generally, economic activity is likely to look soft in the near term, giving the Fed basis for additional easing; this will especially be the case if core inflation continues to trend downward.

The Fed statement did claim that “some inflation risks remain,” but the concern rings hollow in the wake of a 50bp cut. Oil and gold gained on the news, while the Greenback sunk to a record low against the Euro before recovering. Were these, like the equity surge on Wall Street, just knee-jerk reactions? To some extent yes, but traders tend to get the direction right even if the magnitude is initially wrong. As I said last time, the Fed is ahead of the curve in many respects – cutting when manufacturing is expanding, cutting when inventory levels have corrected, cutting before significant upward movements in unemployment, etc. Also note that the yield curve is pointing to rebounding growth by next Spring.

In short, I remain concerned about the potential for inflation to gain significantly next year (but I am not expecting an upward surprise in this morning’s CPI report). The international response will play into this as well. Will global central banks respond with rate cuts of there own, in order to keep the dollar from sinking? Are we poised not just for a US easing, but a global easing? But these concerns aside, the bottom line is that the Fed has decided that inflation, if it were to be a problem, is one they can fight another day.

Comments

[spencer]

Very good-- if we are on the verge of significant economic weakness with the unemployment rate rising and capacity utilization falling the Fed is doing the right thing.

But, if the economy is not all that weak what we have is the Fed easing when the economy is still operating at essentially full capacity. In this case the move will prove to be in error and in a year or so we will see higher inflation as a consequence.

To me it is not clear which situation we are in.

It's funny, the older you get the less certain you get about forecast.

You pays your money and takes your chances.

[mark]

My guess is the Fed is following the only path it can. People don't want gradual smaller recessions. The yelling gets too loud for too long.

The only political way to quelch inflation is to let it rise high enough so people start yelling. Then give them a deep recession with lots of unemployment to cleanse the system of unprofitable businesses.

Short and deep is the only way to go in a politcally charged environment.

[psummers]

For me the biggest surprise was the unanimous vote for 50bps -- it'll be interesting to see the minutes when they come out.

My personal take is that they're trying to be pre-emptive. If not "one and done," then at least "one for now, we'll see what happens, but don't get your hopes up." Hence the lack of direction in the statement.

PS

[calmo]

This could be one of Tim's finer understatements:The Fed statement did claim that “some inflation risks remain,” but the concern rings hollow in the wake of a 50bp cut. You boaters out there know what a wake is, right? (You novices, it's not the time to be going through your nautical dictionary when one of those big cruisers thunders by you in your cute little dinghy.)
I see the word "recession" sometimes in the commentary, but hardly ever "deflation". A lot of ballyhoo about "inflation" but not much about actual price declines in housing. Could it be that this is the real unutterable concern: deflation. Why buy now if you can wait? It seems to me in this consumption-heavy economy, this might get a little more attention than that hollow, empty, wooden, misplaced and utterly Harry Frankfurtifiable BS, "inflation risk".