Why the Fed Needs to Pause Today

No one wants to be in the shoes of the Federal Reserve today as they begin their two-day monetary policy meeting. Fed officials face a tough decision as they weigh the risk of deteriorating growth with the risk of rising inflation.

Unfortunately for the Fed, the problems with growth and inflation have only escalated in recent weeks. The US economy shed jobs for three consecutive months and job losses will continue into the month of April. We are in a recession and it is just a matter of time before the US central bank admits it.

As indicated by the tables at the end of this article, the housing market and the labor market have deteriorated since the last Fed meeting. The only dollar positive news are the increased inflation pressures and mild improvement in manufacturing sector activity. However despite the rise in service and manufacturing ISM, they both remain in contractionary territory, which is not dollar positive.

Federal Reserve Needs the Dollar to Rise

At this point the Federal Reserve’s options are limited since they cannot raise interest rates to combat inflation. One of their only options is to let the dollar rise. The strength of the Euro has helped the Eurozone fend off inflationary pressures, while the weakness of the US dollar has only exacerbated them. To cut interest rates by 25bp (rate cut expectations) and then signal that they will pause in June would be a simple gesture by the Fed that could bring significant benefits. Traders would assume that the Fed’s rate cuts are over, at least for the time being and as result, they may send the Euro back down towards 1.50 and USD/JPY back above 105. This takes away some of the benefits for US exporters, but it could help curb inflationary pressures.

To Pause Does Not Mean to Stop Cutting Interest Rates

Postponing any additional easing after their anticipated quarter-point rate cut on Wednesday will not mean that the Fed has put an end to their easing cycle. They are just giving the market an opportunity to absorb the 325bp of rate cuts that they have will have doled out since August and any temporary boost from tax rebates. If the economy does not respond, then they could easily pick up where they left off. Right now, they need to buy themselves some time by forestalling further inflationary pressures.

The US Economy Will Continue to Weaken

Although a pause from the Fed would be perceived as dollar positive, I continue to believe that the US economy will deteriorate further. Job losses will extend not only for another month, but for at least the next 3 or 4 months.

Over the past 3 decades, the US economy has gone through three recessions. During these contractions, there were a string of job losses that lasted for a minimum of 10 months. We are already beginning to see this trend unfold. It will be months before we will see the economy start adding jobs once again. The largest single-month job loss in each of the recessions was more than 300k. I wouldn’t be surprise to see the same degree of job losses in this business cycle.

Where the dollar is headed against the Euro is more complicated because it all depends upon who gives the market a bigger surprise. Weak US growth has pretty much been priced into the dollar and everyone is waiting for signs of an improvement. Whereas for the Eurozone, traders are waiting for signs of further deterioration.

Comments

[razormdthe2nd]

...why the world doesn't need more "sidewalk superintendents"?... they contribute nothing of value...the Fed is is lead by presumably intelligent, well trained individuals with access to vast stores of data as well as access to a vast network of expertise via the federal reserve banking system...one might reasonably presume that they're in a better position to judge appropriate monetary policy than someone who looks like they're barely out of diapers.

[karchad]

i think the fed should not cut rates tomorrow. Probably the market would decline right afterwards, but looking a little longer, it would send a signal that the economy is not that bad. Which it isn't. Plus the dollar would strengthen, oil would decline, etc. Show some balls, Bernard!

[L Moore]

Actually, we do need more independent analysis. The Fed may have all the data but they, and all the other gov agencies, are not giving that data to us straight up. It comes to us massaged by their ideologues. Those intelligent, well trained people are shills for the current administration who has driven the USD and rates into the ground. Question everything they say and all data they release.

[CarlosSlim]

"The Fed's options are limited; it can't raise interest rates to combat inflationary pressures, or cut them too much to counter deteriorating growth."

Welcome to the Goldilocks Economy! It's not too hot, not too cold!

Now, we just sit back and wait until someone named "Cinderella" comes along.

Meanwhile, let's rearrange these deck chairs...I'm sure the Bush administration has everything under control!

[Ames Tiedeman]

The Fed should, but will not stop. Look for 25 bp.

[Maquiavelli]

The FED knows there is inflation and that is actually something they want at this time so they will cut. If they actually wanted no inflation they would be raising not lowering or stopping. In his mind the only way out of this mess is to inflate out of it (since he does not want deflation)

[User 185317]

The Fed is led by intelligent people, but it does not mean that they do not make mistakes. Keeping interest rate at 1% in 2003-4 is seen by most people today as a grave mistake, and a major cause of the subprime crisis. It is not fair to judge people by look or age.

[icandoitdon]

there are lots of smart people who get it wrong. the federal reserve has lacked leadership since LTCM in 1998. those who trust them to get it right this time are whistling past the graveyard. they haven't gotten it right in the last 10 years as evidenced by our economy lurching from one bubble to the next and interest rate policy that looks like an oscilloscope reading.

[Alpha Seeker]

Kathy, how does your article contribute to seeking alpha? This is just a bunch on number throwing at the reader, without much value.

[MarkNotMoses]

Nice article. Ignore Alpha Seeker

[TraderGreg]

Nice article. Ignore the haters or ignorans. Good job.

[russ]

good article, the numbers and the charts added some documentation and facts to what we see as rambling personal opinons in so many other columns

[Bill W.]

Kathy, great article!

[tom kern]

the market is flooded with unsold items. non-durables(gas/food) not included in gdp should give usd a boost but not until the market need is met. no mun, no fun at this time. fed rate cut will inflate greenback along with stimulus package sometime down the road. the charts are good indicators Kathy,just a little confusing. 25 bp cut for sure. glad i don't have to make the decision. i do think this is a gift,but who am i to decide. gotta go pay the rent..

[sivere]

The system is broke. The banks had to borrow from the Fed to meet their reserve requirements! (see my linked site). We need to

TakeBackTheFed.com

[Mr. G]

Given the recent drop of the EURO BY ABOUT 5 CENTS, Its hard to deal with the counterintuitive move when nothing looks that great in the fundamentals released. Can CNBC talk up the dollar when its rise lacks any fundamental support? Even GE earning reports stunk.