Expect the Fed to Hold Well into 2010

Green shoots - or, as President Obama says - the beginning of the end of the recession aside, the Fed will not be ready to reverse their accommodative policy stance anytime soon. New York Federal Reserve President William Dudley said as much in a speech today:

If the recovery does, in fact, turn out to be lackluster, the unemployment rate is likely to remain elevated and capacity utilization rates unusually low for some time to come. This suggests that inflation will be quiescent. For all these reasons, concern about “when” the Fed will exit from its current accommodative monetary policy stance is, in my view, very premature.

The Fed continues to expect that low levels of resource utilization will keep a lid on inflation. While some might object that emerging market economies can have both weak growth and high inflation, those economies still have an important transmission mechanism between higher prices and higher wages that appears to be missing in the US. Indeed, while the press focused on the old news "recession is ending" angle of the Beige Book, the money quote for policymakers was:

The weakness of labor markets has virtually eliminated upward wage pressure, and wages and compensation are steady or falling in most Districts; however, Boston cited some manufacturing and business services firms raising pay selectively, and Minneapolis said wage increases were moderate. Boston, Cleveland, Richmond, Chicago, Dallas, and San Francisco cited a range of methods firms are using to limit compensation, including cutting or freezing wages or benefit contributions, deferral of future salary increases, trimming bonuses and travel allowances, reducing hours, temporary shutdowns, periodic furloughs, and unpaid vacations.

Until economic growth is sufficient to propel wages upward, any residual price pressures are likely to be snuffed out by deteriorating real wage growth. Will the job market improve anytime soon? We get a fresh look at initial unemployment claims Thursday morning, but the July consumer confidence report from the Conference Board indicates that households see a deteriorating jobs picture:

The share of consumers who said jobs are plentiful dropped to 3.6 percent, the lowest level since February 1983. The proportion of people who said jobs are hard to get climbed to 48.1 percent from 44.8 percent.

Lacking a story that leads to strong wage growth in the near - or even medium - term, the Fed is almost certainly on hold at least through this year and likely well into 2010, allowing the size of the balance sheet to adjust according to the needs of the financial markets while keeping interest rates at rock bottom levels. That doesn't mean all that easy money will not show up somewhere - technical analysts are looking for US equities to explode on the basis of recent market action. But will the Fed lean against such an explosion without clear and convincing evidence that the labor market is poised for strong, sustainable improvement? I doubt it - and for those looking for it, therein lies the ingredients for making the next big bubble.

Comments

[Larry House:]

I agree totally. I think the economy will be so weak it will be necessary to hold rates here, but also I think if Bernanke has any hope of holding his job, he has to hold rates down. There is no way Obama would go along with higher rates while he is trying to inflate the balloon. Bernanke may already have sealed his fate with his current talk of fighting inflation and the dangers of increasing national debt. Obama wants a loose Fed. My fear is that, whether it is Bernanke or someone else, rates will stay too low for too long, and we will see inflation--high inflation.

Jul 30 10:03 AM

[SkiDad:]

I agree with the fed holding a lid on rates until utilization of capacity and real wages increase. The OTHER impact is the impact on the dollar, which will dive. The treasury markets are already seeing jumps in real interest rates (2 year auctions) and CNBC is all gloom and doom about the treasury auctions. The interest rate says it all. Contrast this with the artificial holding down of the yuan by the Chinese and Bernake may actually be trying to lower the dollar to be more competitive. Careful though, US purchases of Chinese goods has already fallen and could be another bubble burst. The yuan therefore may trace the dollar, particularly where the Chinese hold $2T dollars of treasuries. In a way, they are America too. It's going to be very interesting this Fall, which is usually when the financial blood flows.

Jul 30 11:12 AM

[Prudent Man...:]

Irrationality is in fashion and like all fashion will be short lived. The believers, who are determined to stay in denial, will be the losers. Those who believe in the myth of market discounting will be left holding the empty bag Goldman Sachs and Congress sold them.

The Fed has fired all of their shots and are irrelevant as to whether or not we have low or high interest rates. Central banks, like all institutions, have limited power that diminishes quickly when it loses credibility and public support. Politicians ratings being a case in point.

For now their are many who believe that the economy has bottomed. I believe them like I believe the weather man and sports writers. If they are correct it isn't because of knowledge but luck. Opinions are not facts. It is obvious that, in many cases, estimates are WAGS.

If virtually every major country was not printing money today we would see double digit mortgage rates. Of course the IMF, EU, World Bank, and those others who waste the middle classes hard earned money on their perks and dumb ideas want us to continue to print money. They don't want to be shown the greedy fools they are, or shall I say, the fools we are to give them the power over out families they have.

Heaping irrational monetary policy upon irrational monetary policy does not produce one good or service only increases their price. How long can our politicians get away with devaluing the saving of responsible citizens including, but not limited, to retirees on fixed incomes? Are investments in companies susceptible to the taxation and/or confiscation by avowed Socialists safe?

The U.S. and our markets have been faced with the foregoing challenges in the past. We will solve them, to a degree, again only if we aspire to the WWII "Greatest Generation's" value system. Either we have the right stuff or not but that will make no difference if we don't face reality.

Markets are not about making money, and an entitlement, but exchanging risks. So few understand this which is why so few consistently profit from those exchanges of risk.

Jul 30 12:34 PM

[Prudent Man...:]

On Jul 30 10:03 AM Larry House wrote:

> I agree totally. I think the economy will be so weak it will be necessary
> to hold rates here, but also I think if Bernanke has any hope of
> holding his job, he has to hold rates down. There is no way Obama
> would go along with higher rates while he is trying to inflate the
> balloon. Bernanke may already have sealed his fate with his current
> talk of fighting inflation and the dangers of increasing national
> debt. Obama wants a loose Fed. My fear is that, whether it is Bernanke
> or someone else, rates will stay too low for too long, and we will
> see inflation--high inflation.

Bernanke will only stay as long as he is needed for scapegoat when things go wrong. Summers is Goldman's man and what Goldman wants Goldman gets.

Jul 30 12:36 PM

[LKofEnglish:]

fed chairman has already said this. the only surprise will be if the fed actually raises rates--right up there with a member of the fed getting lucky.

Jul 30 12:41 PM

[MattZN:]

I don't think Bernanke actually believes he can hold interest rates this low through to early next year but he has to put on an optimistic face for the public. He's already accomplished a major part of his goal, which was to get home prices and thus the banks stabilized BEFORE inflation started to rear its ugly head.

From his history it is also pretty clear that he WILL in fact start raising interest rates earlier rather then later to prevent inflation from exploding to insane levels. I don't think he thinks he can stop inflation (again, the public face has to be different), but he certainly believes that he can prevent it from running 1970's wild and I think he can too. If he can keep inflation under 6% he will have accomplished his second goal.

-Matt

Jul 30 12:43 PM

[Jason Rines...:]

I am noticing an increased volume of negative comments from astute commenters. Seeking Alpha has made some enemies. That means what your doing is riling the MSM competition as we in the blogosphere news space race to normalize the market before government does.

Jul 30 06:59 PM

[conceptwizard:]

The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented. Banking was conceived in inequity and born in sin . . . Bankers own the earth. Take it away from them but leave them the power to create money, and, with a flick of a pen, they will create enough money to buy it back again . . . Take this great power away from them, and all great fortunes like mine will disappear, for then this would be a better and happier world to live in. . . . But, if you want to continue to be the slaves of bankers and pay the cost of your own slavery, then let bankers continue to create money and control credit.

- Sir Josiah Stamp, Director of the Bank of England, 1927

The FED is your banker and they control America.

Jul 30 08:06 PM

[Moon Kil Woong:]

The problem with Bernake is not low rates. The problem is QE and pumping up base money leading to instability in the US$ and higher US Treasury Bond rates. The Fed's got a credit card and has gone on a spending spree that is liable to leave the US in the poor house.

Personally, nothing against Canada, but when the US$ is worse less than the canadian dollar I really feel quite sad. I guess you can call it some sort of monetary patriotism (Unlike the Olymics no one is cheering for the US here and we are clearly loosing). I wonder how I will feel when no one wants to trade a Peso for a US dollar? If you think our monetary policy is working and it's helping America just reflect on what has happened to our poor poor US$.

Jul 31 12:02 AM