May 18, 2005

Tim Duy Weighs In

From Economist's View:
Why do I keep harping on the necessity for a significant slowing in growth before the Fed changes course? Just look at yesterday's comments by Fed Governor Donald Kohn, speaking to the Australian Business Economists: "... if growth is sustained and inflation remains contained, we are likely to raise rates further at a measured pace." And "The federal funds rate appears still to be below the level that we would expect to be consistent with the maintenance of stable inflation and full employment over the medium run." And, if that wasn't clear enough, "[W]e have not yet finished this task." These are remarkably candid remarks, and imply a high degree of confidence in the continuance of existing policy. The recent bearish feelings on Wall Street are clearly not receiving much validation in the inner circles of the Fed.
In reading these thoughts, I can't help but think about the FOMC's policy shift in January of 2001. Following the flow of statements from Dec 19th, to January 3rd, to January 31st the commitee shifts from "everything is fine, there is nothing to see here" (my flippant summary) to a call "for a rapid and forceful response of monetary policy" (their words this time). I bring this up to show how quickly the Fed is willing to change its mind when the data hits them with a 2x4.

At this point signalling an end to the hikes could relaunch the commodity rally (dollar fall) and bring about inflation but if we arrive at the June meeting with oil in the low 40's it seems to me the risks are tipping towards slower growth. The Fed doesn't know any better than anyone else if April's market moves are just volatility or a trend change so they lean towards maintaining the status quo. No harm no foul if they get it wrong in the statements leading up to the next meeting. Kohn can just change his mind.

Oil in the low 40's and credit spreads wider than today's levels, which seems very likely, and I expect the Fed will be done in June. A lot can happen in a month and a half though.

1 comment:

  1. Having read Mr. Kohn's recent speech and not just the headlines typed by some economic illiterate... One would be hard pressed to say that he was anything "uncertain" about what comes next..

    I should note that in the context of today's market and FED policy no one including the FED has any doubt about what the FED is likely going to do for the next two meetings.. 50 bps' more FED tightening are baked in the cake so to speak..

    The only question of any interest to anyone is What then???

    Here Mr. Kohn was suitably agnostic.. leaving any rational observer to conclude that given what we know today and the FED knows today.. the odds are close to 50/50 that they're done in September..

    Which not surprisingly is exactly what the market as a whole is pricing in today..