Tim Duy is thinking about the Fed's next move:
Just Six Weeks to the Next FOMC Meeting!, by Tim Duy: Thank goodness that is over; I hope my heartburn finally eases. I appreciate the comments, and the good natured ribbing. I particularly enjoyed Ken Houghton's posts at Marginal Utility – “Tim Duy will be wrong, but correct” and “I Hate Being Right on this one, Tim.” Please think of me Ken as you boost your consumption spending on the back of that lower HELOC rate.
Of course, I was not surprised at all that the Fed cut rates today. When you take a contrarian view, you need to be prepared to accept the consequences. While I think the Fed was reluctant to cut rates, feeling pulled into it by market participants, the majority believed that it was the least risky strategy, especially given that virtually not a single position on the Street was prepared for anything but a rate cut. Still, if I had to be wrong on a call, I am glad I choose to be wrong on the “no cut” side of 25bp, because it was clear from the statement that that is where the action was during the FOMC meeting.
On that statement, I did get my wish, sort of. Last time out I complained that the Fed needs to stop repeating their forecast for moderate growth near potential if they are going to continue to cut rates. The statement now begins with a focus on near term weakness:
Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance. However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction.
Still, this is little comfort to me, as the Fed retains a benign medium term outlook:
Today’s action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time.
As many noted, the new reference to the September rate cut implies that this time they are serious, they are not anticipating additional easing. Alone, I do not find this to be a particularly credible indication of policy intentions, but they follow up with a clear shift to a neutral bias:
The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth.
All in all, these two parts appear to suggest that they intend to make the decision on the next rate move rather than leave it to market participants. Can they do it?
Interestingly, despite cutting interest rates, they actually heighten their inflation warnings. In September, the view was:
Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.
Yesterday, they suddenly cared that commodity prices were surging:
Readings on core inflation have improved modestly this year, but recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.
Note the “among other factors” portion. What exactly are these “other factors?” Does anyone else find it unusual, odd almost, that Fed Chairman Ben Bernanke claims to be striving for increased transparency, yet leaves us with a vague reference to “other factors”?
I can offer some suggestions. First, one might point to the falling (plummeting) Dollar. I doubt everyone at the Fed is completely confident that the pass-through to inflation will be limited, but the Fed really cannot complain publicly about the Dollar. After all, they are accelerating the fall by being completely out of step with every other central bank on the planet. Second, one might suggest rising labor costs via tight labor markets, but this doesn’t make since if they really fear near term weakness in economic activity.
Feel free to offer your own suggestions about these “other factors.” Hopefully the minutes will shed some light.
Altogether, the statement appears to offer something to everyone on the FOMC to get a consensus – an inflation warning for the hawks, a growth warning for the doves, and a benign medium term outlook for the moderates. Note that if you combine the inflation and growth warnings, you get stagflation.
But apparently, not everyone on the FOMC got something; Kansas City Fed President Thomas Hoenig saw nothing in it for him and offered up his dissent instead. His dissent confirms that the debate centered on the 0 or 25bp side of the equation – and if one person dissents, others are likely sympathetic.
Bottom Line: How does one handicap the December meeting based upon this statement? The Fed is telling us to follow the data, no cuts are guaranteed. Trouble is, does anyone expect this quarter to look good? To be sure, the underlying rate of growth is not the 3.9% rate reported for the third quarter – there will be payback in Q4, if on the import price issue alone. And I expect housing will be washing out in the months ahead. Will the Fed be willing to look through that weakness? The statement suggests that they know that the near term will be weak, especially housing, and they expect us to come out the other side by mid-2008 based on current policy. In other words, they want to look through the weakness (of course, I thought that this time). They will turn their attention to employment and business investment to determine if their forecast remains on tract. If these hold, the odds are for the Fed to be sit tight in December. If these deteriorate, expect a cut – this is not the Fed’s baseline scenario.