The Fed gazes ahead

November 20, 2007

As the Federal Reserve directs its crystal ball towards 2010, its notes from last month's meeting indicate that it's trying to balance the threat of rising inflation against the severe housing downturn while maintaining that the last rate cut was a "no brainer."

Hey, is that like those "no brainer" ads that Lenox Financial runs on the radio, in which a stern voice offers to help convert adjustable-rate loans (which they used to peddle) to the fixed-rate variety? And just in time for the holidays!

According to a story in today's Wall Street Journal, "Participants generally viewed financial markets as still fragile and were concerned that an adverse shock -- such as a sharp deterioration in credit quality or disclosure of unusually large and unanticipated losses -- could further dent investor confidence and significantly increase the downside risks to the economy," the FOMC said.

Other near-term (?) risks including the falling dollar (which is really more of a longer-term story but helps U.S. exports), rising energy costs (esp. for oil) and high unit labor costs.

But the fact remains that the Fed hasn't given the financial markets much confidence that it really knows what's going on (hence the forecast footnote: "Assumes appropriate monetary policy" (if only)). To help sort this out, the WSJ's Real Time Economics blog compiled some remarks from various economists:

Despite the tough talk and the “balanced risk assessment” it seems clear the Fed maintains its bias to ease [or cut rates]… The long-term projections seem to suggest and inflation target of between 1-1/4 and 2-1/4% rather than the 1-2% range widely believed. –Drew Matus, Lehman Brothers

There is no way that the FOMC was confident of anything, so that just because they thought they might be done on October 31 does not mean anything today or certainly on December 11 or January 30… The FOMC believes that growth will be modestly below trend next year. What is interesting though, is that the net effect of this is viewed as trivial. –Stephen Stanley, RBS Greenwich Capital

The FOMC is considerably more relaxed about the economy’s medium-term health than are markets and an increasing number of analysts. While admitting that downside risks to growth are greater than upside risks, FOMC members believe that sub-par growth is not likely to persist and that growth will pick up as housing bottoms, financial markets resume a more normal level of function, and the lagged effect of earlier policy easing is felt. These minutes underscore the disconnect between financial markets which are discounting another [percentage point] or so of Fed easing over the coming few quarters and policymakers who thought the last [quarter point] easing move was a “close call” and who don’t seem particularly eager to ease any further in the near term. –Joshua Shapiro, MFR, inc.

This does not sound like a close call to us, more of a no-brainer. The usual inflation worries linger … but we can be pretty sure that if the outlook continues to deteriorate and markets remain distressed, they’ll be easing again soon enough. It is clear they’d rather not ease again on December 11, but it is equally clear that fine, considered speeches count for naught when the sky is falling. –Ian Shepherdson, High Frequency Economics

The committee cut rates due to semi-functioning credit markets and to buffer investor confidence. The minutes reinforced the October policy communiqué that the rate reduction intended to provide a hedge against any unexpected weakness in financial markets. The committee expressed confidence that the easing did not post an outside risk to the inflation outlook… While the sanguine outlook [in the new forecasts] on core inflation over time should provide the Fed flexibility, the tenor and tone of the minutes reaffirmed the hawkish rhetoric of late and did not provide a compelling case for IDEAglobal to change its Fed outlook of a pause ahead of the December 11 meeting. –Joseph Brusuelas, IDEAglobal