Is the Fed Being Hawkish Enough?

The Federal Reserve is getting ready to raise interest rates but a rate hike is not imminent. For the first time since August, the central bank has left rates unchanged at 2 percent. Although the FOMC statement is hawkish, the US dollar has failed to react because currency traders were looking for more. They wanted reassurance that a rate hike was around the corner, but what they got was the minimum that dollar bulls were looking for. It wasn’t enough to send the dollar higher or to take it dramatically lower.

The central bank hopes that slower growth will ease inflationary pressures, but if that does not happen by the August 5th FOMC meeting, they will have to raise rates. Between now and then, there are 2 non-farm payroll reports and multiple inflation reports due for release, giving us a much better sense of how bad the US economy is faring and whether consumers and businesses can handle an interest rate hike.

As much as Fed officials will hate to admit it, oil is currently determining Fed policy. If they want to take inflation into their own hands, what they need to do is to raise interest rates, which will strengthen the dollar and weaken oil prices.

The biggest change in the statement is the line that says that “Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased.” In other words the risks to growth and inflation are no longer balanced – the scales are tilting in favor of inflation.

The decision is leave rates unchanged was also not unanimous – one member, Richard Fisher, voted in favor of a rate hike.

This officially draws a close to the Fed’s easing cycle and puts the central bank one step closer to raising rates. Given the tone of Wednesday’s FOMC statement, I expect the Fed to raise interest rates in September.

Having brought interest rates from 5.25 percent all the way down to 2.00 percent, the Federal Reserve does not have room to cut interest rates in the current inflation environment. It would take at least two consecutive months of negative retail sales growth and back to back job losses in excess of 100k before the Fed would lower interest rates again.

If the ECB raises rates in July and the Fed does not reassure the markets that a rate hike is coming as well, the US dollar could continue to give back its gains. However in the longer term, the US dollar has bottomed out alongside US interest rates and it will only a matter of time before it begins to trend higher once again.

Comparing the FOMC Statements

June 25, 2008

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters.

The Committee expects inflation to moderate later this year and next year. However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time. Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting.

April 30, 2008

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.

Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. 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. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred no change in the target for the federal funds rate at this meeting.

Comments

[moonbat1775]

If I, as an engineer, designed a system that required as much hands on intervention as the American monetary system requires via the Federal Reserve, I would be fired. Also, my design would be scrapped.

Imagine a steam boiler with no safety vents and no negative feedback system with a human operator in charge to keep it running at peak efficiency without blowing up. That's our monetary system.

[syruppy]

Imagine ... a go-for-broke system where you work like an bee and save like a Trojan, but your government steals your honey to buy enough votes to raise your taxes.

[moonbat1775]

syruppy,

Yep, that's the fiscal system. Between the monetary system and the fiscal system, we're screwed. But, thank God there's God.

[Wez]

At least there are estate taxes to take a big chunk of whatever you do end up with at the end.

[woofy]

You are right, inflation is rearing its head big time. As Warren Buffett said today, inflation is explosive right now. You look around the world, every country's inflation rate is going through the roof. The fact of the matter, in my opinion, however, is that this time it is different. The inflation is not because of too much growth, it is because of too much credit. Low interest rates for too many years have created this money bubble. The Fed's hands are tied however--it can't raise interest rates. It's lowering of interest rates over the last year have not done anything--just take a look at mortgage rates--they've been going up instead of down. They lowered interest rates, but the banks of the world are cutting credit on credit cards, on mortgages, on home equity loans, on leveraged buyouts, loans to each other, everything, you name it. If the Fed did raise interest rates, it would not lower inflation, not by much at least--it would simply make the banking system unstable--for it is slowly heading towards insolvency--read Reggie Middleton's blog if you wish to believe that it's actually heading quickly towards insolvency. So they can't. The inflation is a result of too much credit for too long on top of commodity prices. Sure, the commodity prices are going up, sure there are speculators involved, there always are with these kinds of things, but the fact is that the supply of commodities is becoming very limited very quickly, and each percent drop will result in an exponential increase in the price. In the 70's, a 5% drop in oil supply led to a 400% increase in the price. The world's major oil fields have already topped out, and since everything on the planet uses loads of oil, inflation has no choice but to spiral out of control, and no interest rate hikes will do anything--except bring about the failure of critical industries like the airline or the automotive industries--whose repercussions on the financial system will be untenable. So personally I'm not expecting any rate hikes by the Fed ... ever...again.

[CarlosSlim]

*Inflation is caused by too much money in circulation.

*If the FED raises interest rates, M3 would slowly decrease over time and inflation would decrease...over years, not days, not weeks, not months.

*Recessions ALWAYS kill inflation. Raising interest rates increases the chance of recession.

The heroin addicts are never in favor of decreasing their heroin supply, are they?

Yes, the lack of heroin causes withdrawal symptoms.

Well, DUH!!!!!

[lavalyn]

And people wonder why commodities, especially industrial commodities like oil and steel, are going up like crazy. Like it or not, those commodities will always have a use. A barrel of oil will always provide X BTU of energy, no matter how much you paid for it. There will always be somebody that needs those BTU...

[sedek]

special: "*If the FED raises interest rates, M3 would slowly decrease over time and inflation would decrease...over years, not days, not weeks, not months."

Given that there is about a $25 speculative premium in current oil, a 25 bp rate hike and expectation of more to come would have oil at $110 within a week. Quite the stimulus for the economy.

[hardball22]

"*Recessions ALWAYS kill inflation. Raising interest rates increases the chance of recession."
I beg to differ. I don't mean to be smug--and correct me if I'm wrong--but let's call a spade a spade:
In the situation we're facing, real income (even nominal income) isn't budging while commodity prices, followed by PPI and CPI, are headed skyward. Compound that with Headline price appreciation far outstriding core, and you've got a recession not killing inflation.
Right now, we're lucky for the BENEFITS of a weak dollar that amp our Exports. But look at the most recent US trade data: high oil prices widened our trade deficit.
OIL IS NOT CONTROLLED BY THE US, neither is food for the most part. Globalization means that even domestic food prices are positively correlated (however strongly or weakly you may argue) to global food prices. Demand is elastic ONLY TO A POINT SINCE OIL IS AN INPUT TO EVERYTHING, all the way from plastics to 10% of corporate expenditures. So how does a recession ALWAYS kill inflation in my scenario (as laid out above), or in many other forseeable possibilities?

[lavalyn]

sedek: back up your numbers, please? Where is this $25 number you're quoting?

Futures expired last week... that should have purged the front month speculators (who would roll to the next month)... and yet June futures did not close anywhere near $120.

[Melancholy Korean]

Still amazing to me Tricky's gonna raise rates in this environment. Germany (apparently Spain, Italy, Ireland don't count in the ECB's thinking) is now starting to show signs of a downturn, and they will go down as hard as the US. But while the American system has a lot of flaws, and is prone to booms and busts, our labor markets are flexible enough for us to adjust quickly.

1.3 trillion in mortgage losses? Whatever. As Michael Milken said at the Global Conference, we've had trillion dollar losses before; hell, we've had at least three of 'em in the past twenty years (Texas real estate, SNL crisis, dot com). The history of American capitalism is made up of booms and busts. As long as we let the system take the losses, as long as the we let the players adjust without trying to cushion the pain through regulation and artificial props (can you say Dodd housing bill?), the faster we will get out of the coming recession.

"However in the longer term, the US dollar has bottomed out alongside US interest rates and it will only a matter of time before it begins to trend higher once again." Absolutely agree. Of course, it's all in the timing!

[cook503]

Raise 'em. One of the catalysts for the down turn is the high price of crude oil, and strengthening the dollar will help. US investment banks should be thankful that they have been bailed out as much as they already have been. If we are really, truly going into a recession, let's get it over with instead of killing the dollar as well.

[bearfund]

"Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting."

And the approximately 299 million Americans who are neither reportable shareholders of a bank nor employed by one. Too bad none of them gets a vote.

[M.Cerulean]

Bernanke must be suffering from multiple personality disorder. Isn't this the same guy who a couple of weeks ago, was assuring the world that the US was committed to a stronger dollar?

He didn't fool Trichet. And today he became the markets fool. Here's a great picture of Mr. Bernanke caught in action at today's Fed meeting.

www.sliderontheblack.c.../

God help the US Dollar if Trichet raises rates. The US will have $150 oil and $5 gasoline by Labor Day.

[steveballmer]

I have to go along with the FED on this one guys!

[User 30121]

About as hawkish as a GERBIL! These FOMC loons are kinda like Congress....either on vacation or clueless. Just wait until Obama sit in the oval office. THEN you will REALLY see INEPTNESS in spades!