Mar 22, 2005

Before the Fed

My take is that the Fed comes out of this meeting with a 25 bp hike and removes the "measured" language to gain some flexibility. I have heard some traders talk of a 50 bp move but don't see much reason for that. I would put the chance of keeping the word "measured" around 30%. That is just my feeling because the changes possible in central bank statements, oil prices, and labor demand before the next meeting will make it harder for the Fed to know what it wants to do. The Fed needs to prepare the market now to be more open minded at the next meeting.

If the Fed keeps the "measured" language U.S. stocks look like they are in position for a nice bounce. I don't think tomorrow means much to bonds (keeping measured may cause some buying of 5-yrs) while the dollar seems to be getting too much of a bounce in front of a widely expected move. The metal weakness looks like a knock-on effect from the dollar.

I liked these thoughts from the Capital Spectator:
Meanwhile, there's plenty of talk. Fed Governor Edward Gramlich opined last September that there are no easy monetary policy answers in managing oil shocks today than there were in decades past. "Today the question of how to respond to oil price spikes is better understood, but the outcomes are no more pleasant," he asserted. "It is virtually inevitable that shocks will result in some combination of higher inflation and higher unemployment for a time. But I must stress that the worst possible outcome is not these temporary increases in inflation and unemployment. The worst possible outcome is for monetary policy makers to let inflation come loose from its moorings."

The worst possible outcome is in fact what worries one David Gitlitz, chief economist with TrendMacrolytics, who warns in an essay to client today, "Record crude prices mean a monetary mistake could be not just dumb, but disastrous." Some at the Fed look at the recent past and conclude that since the economy's chugged along nicely despite the higher oil prices there's little to worry about on this front. "This reasoning," Gitlitz writes, "also accords with the idea that since the oil price moves have apparently been marked by significant speculative excess, they are not a 'fundamental' factor that need be of particular policy concern."
It is not clear to me that high oil prices are more than a short-term problem but agree that it is a risk the Fed should not really be playing with.

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