As dissension in central banking goes, Tuesday's discord was fairly tepid, but significant nonetheless.
The Fed's whopping 75-basis-point cut on Tuesday, which lowered the Fed fund rate to 2.25%, was approved by eight and questioned by two. Richard Fisher and Charles Plosser raised doubts about the wisdom of FOMC majority's analysis by voting against the rate cut. Quoting Tuesday's FOMC press release, we're told that the two holdouts on easing "preferred less aggressive action at this meeting."
Voting FOMC members who voice opposition to the Fed's will, in fact, has become routine of late. Since the central bank starting cutting rates last year, there have been dissents each and every time. In the last five FOMC meetings, four of the dissents were in favor of either no cut or a lesser cut. (The fifth dissent was actually in favor of an even bigger cut).
That compares with the previous run of unison in FOMC voting. By the standards of recent history, the rise of dissension in the ranks suggests that it's less than obvious that slashing interest rates is a no-brainer in the minds of those who steer the world's most important central bank.
Fisher, president of the Dallas Fed when he's not casting votes in the FOMC, has now voted nay twice this year. Reviewing his public comments in recent months leaves no doubt that he's more worried about inflation rather than slow economic growth and Wall Street credit ills.
Speaking in London a few weeks back, Fisher laid out his bias in no uncertain terms when it comes to choosing the central bank's priorities at this point in the cycle. In DallasNews.com he asserted that:
Containing inflation is the purpose of the ship I crew for. And if a temporary economic slowdown is what we must endure while we achieve that purpose, then it is, in my opinion, a burden we must bear, however politically inconvenient.
No one questions that inflation is higher these days, although there's still lots of debate about where inflation's headed. So it goes in trying to see the future by looking at the past. That said, the leading force for seeing the glass half full rather than half empty is the institution that oversees the integrity of the currency.
Officially, the Federal Reserve expects that inflationary pressures will soon ebb. "Inflation has been elevated, and some indicators of inflation expectations have risen," Tuesday's FOMC advised. But the release goes on to dismiss the idea that the trend deserves to derail the policy of printing more money, at least for the time being:
The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization.
It's no great challenge to find supporters of the Fed's easing. Robert DiClemente, chief United States economist at Citigroup, for example, wonders how much inflation risk lies ahead. "I’d like to know how you’re going to get inflation in an environment with suffocating financial restraint and pervasive slowing in demand," he told The New York Times yesterday.
To which we respond, be careful what you ask for. Yes, there's the possibility that the combination of a credit crunch and weakening economy will conspire to lessen demand generally, which in turn may drive prices lower. Meantime, the statistical evidence leans to the contrary in consumer and wholesale prices.
Still, as Tuesday's massive rally in the stock market suggested, there's a natural focus on how the liquidity injections will eventually counter the credit problems and economic downshifting. The prospect of another Fed-led recovery keeps optimism alive and no one should dismiss the powers of the central bank to engineer growth. The Fed wants a recovery, and will do everything in its power to engineer one. And the economy has yet to really fall into the cyclical ditch, despite what we read in the newspapers.
Yes, there are problems, and those problems could create a chain reaction of trouble. But so far, as downturns go, this one is still pretty mild, judging by historical standards. No matter, the Fed has already come out with monetary guns ablazin'. Maybe Bernanke should just drop Fed funds another 225-basis points and be done with it.
Last we checked, however, there's still no free lunch, in macroeconomic spheres or anywhere else. The conflicting forces of recession and inflation are now engaged, and one or the other may soon give way, which will unleash the next stage of the cycle. The clash is evident in the fact that while the stock market soared on Wednesday, the bond market became a touch more skeptical about the Fed's strategy. The yield on the 10-year Treasury jumped yesterday by nearly 14-basis points. Perhaps it's significant that the 10-year yield has now twice made a recent low in the 3.30% range and twice bounced higher immediately after, as this chart reminds. At least one corner of the capital markets reserves judgment on inflation's course.
Indeed, strategic-minded investors may also want to consider what awaits if the Fed's successful in sparking stronger growth in the economy. Might Bernanke and company feel compelled to take away the proverbial monetary punch bowl later this year or early in 2009 if the apocalypse is averted? If so, what are the implications for stocks, bonds and all the major asset classes?