What will the Fed do at the meeting later today? No one really knows except the FOMC members, but here’s my best guess. Recent economic data has been slowing, but core inflation has remained above the Fed’s comfort zone (2%). The recent surges in food and energy prices are unlikely to sway this decision much as the Fed is likely to view these price moves as “transitory”. Further, Europe seems to have bolstered confidence a bit (jaw boning is a good short-term strategy obviously) and the economic data in the USA is still very much mixed. Housing is showing some signs of stabilization, but manufacturing is appearing increasingly fragile. The employment picture is fragile, but still expanding.
All in all, there are a huge number of question marks regarding directionality on all of this and the Fed hates to act on uncertain data points. We have to remember that there’s also a Presidential election in November so one must wonder whether this plays into the Fed’s decision at all and influences their position as “apolitical”.
What does it all add up to? I think it adds up to more wait and see from the Fed. There’s another meeting in September and Dr. Bernanke will have the opportunity to answer questions at a press conference then. Not only will he have more answers regarding the economy, but he’ll be able to explain his thinking behind any policy decisions. If the economy slows further then this becomes a likely time for QE3. Not to mention, wait and see mode is a lot like having a bazooka on the table. We all know Dr. Bernanke will fire it at some point, but the very sight of it there on the table is enough to keep the Bernanke Put well in place. From the Fed’s perspective, another month of waiting and watching is a prudent move.
That’s my best guess, but bear in mind it’s just a guess. I don’t pretend to be able to predict the madness of central bankers…And nevermind that QE3 won’t fix our economic problems, but that’s a whole different discussion.
* Likely market reaction – a big dump followed by a comeback when investors realize the world isn’t going to end just because the baby didn’t get its pacifier. And if I am wrong and the bazooka gets triggered tomorrow, well, I’ll see you on the other side of a 2% rally.