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Tuesday, September 06, 2005

The Fed’s Ears Are Burning!

Here are three views on Fed rate hikes from Bloomberg.  There is a news report followed by a commentary from John M. Berry both of which, while hedging their bets, suggest rates are going up at the September 20 meeting.  This is followed by a commentary from Caroline Baum suggesting that the Fed will pause, though she also hedges her bet.  And don’t miss the Fed Watch by Tim Duy in the post below this one as it provides perspectives over and above those in these three reports:

Fed May See Katrina Inflation Risks Outweighing Slowdown Fears, Bloomberg: The Federal Reserve is likely to conclude that Hurricane Katrina poses more risk of inflation than of an economic slowdown, and probably will raise rates on Sept. 20 while signaling it may pause later if there are lingering effects on growth and hiring. … Current and former Fed officials also are stressing odds that any slowdown will be temporary, and emphasizing their reputations for keeping inflation at bay. Together, the comments suggest policy makers aren't convinced they need to stop raising rates, even if their Sept. 20 statement is reworded to give them more room to pause later if data warrants.

''From 1994 and on, we have managed to convince markets we are capable and willing to do what it takes to prevent inflation from getting out of control,'' Richmond Fed Bank President Jeffrey Lacker ... Anthony Santomero, a voting member and Lacker's counterpart at the Fed Bank of Philadelphia, said in a speech after the storm that he expects the Fed to keep raising rates at a so-called measured pace. Fed Bank of Chicago President Michael Moskow of Chicago will comment on the economy in a speech scheduled for tomorrow in Chicago at noon local time. San Francisco Fed President Janet Yellen of San Francisco will speak on the economy the next day…

…''The Fed does need to have rates higher. The question is: At what pace do you do it?''… ''We need to remember the Fed's job is not only to manage growth in the economy,'' Lehman Chief Economist Ethan Harris said in an interview. ''They also have to keep an eye on the inflation picture. They can't just step aside if they see a major inflation shock coming out of this episode.''… ''We think the cost of a pause would be a larger bulge in inflation,'' John Ryding, chief economist at Bear Stearns in New York, said … With so much in flux, there will be greater scrutiny of Fed officials' statements, such as those of Moskow and Yellen, between now and Sept. 20. ... ''There is a lot more uncertainty in forecasting both the economy and the Fed right now,'' economist Harris said. ''The economy should be in reasonable shape and the Fed, which was in a very hawkish mood going into this period, probably just continues hiking rates.''

Next, here's the commentary from John M. Berry.  He also believes the Fed is likely to raise rates, though he isn’t positive about that prediction:

Fed May Raise Rates Even After Hurricane Katrina, John M. Berry, Bloomberg: …the outcome of the next Federal Reserve policy-making session, two weeks from today, isn't a foregone conclusion. The devastation caused by Hurricane Katrina …[is] going to slow economic growth. The issue for Fed officials is by how much and for how long. The odds at this point probably slightly favor another quarter-percentage point increase in the target for the overnight lending rate, which would raise it to 3.75 percent. One reason for that assessment is the rapid restoration of power in the area and progress in re-establishing interrupted oil and natural gas production and the flow of refined products through pipelines… Macroeconomic Advisers in St. Louis told its clients … ''… the severity of the hit to the domestic energy sector were probably overblown,'' …

Finally, Caroline Baum believes the Fed may give into political pressure to pause even if it is unsure if a pause is the proper policy.  She sees signs of weakness in the economy that existed prior to the hurricane and believes this is the correct policy in any case, though she also hedges her bet.  Thus, of the three Bloomberg articles, she is the strongest advocate of the view that the Fed will pause, and that assessment is due mainly to weakness she observed in the economy prior to Katrina:

Fed May Pause for Political, Not Policy, Reasons, Caroline Baum , Bloomberg: Before Hurricane Katrina … financial markets were expecting the Federal Reserve to boost its benchmark rate to 4.25 percent by early next year. No longer. And the Sept. 20 meeting is up for grabs… Will the Fed's response mirror the market's expectation, which has turned on a dime in the wake of Katrina's devastation? The answer isn't just a question of policy. Politics may be involved as well. …

Hurricane Katrina qualifies as a supply shock, which reduces output and raises prices. ... If Fed officials thought monetary policy was accommodative before Katrina, and we know from the minutes of the Aug. 20 meeting they did, by all rights they should not depart from their chosen course of removing that accommodation. A portion of the nation's productive capacity has just been damaged, disabled or destroyed, so pumping up demand for reduced supply is not exactly the correct policy prescription. But this isn't just about policy. It has a lot to do with appearances. How would the average citizen react to news on Sept. 20 that the Fed had just tightened credit again when television screens are showing thousands of people who have no homes, no means of support and inadequate food, water and medical care? … Besides, inflation expectations, the Fed notes often, are well contained. Long-term rates have fallen in conjunction with fed funds rate expectations, suggesting confidence in the Fed's inflation-fighting credentials. There's no harm in taking a pass at the Sept. 20 meeting. It would be in keeping with Mr. Risk Management's approach to address what he sees as the greater threat, weaker growth rather than higher inflation. … I still think …[t]he LEI was telegraphing a marked slowing in economic activity before Katrina was even a blot on the radar screen. The Fed, with the blessing of the bond market, may hold off on another rate increase in September because of the uncertainty surrounding the effects of Hurricane Katrina. What the Fed does for political reasons now may turn out to be the right policy prescription down the road.

    Posted by on Tuesday, September 6, 2005 at 12:33 AM in Economics, Monetary Policy | Permalink  TrackBack (2)  Comments (5)

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