FOMC Meeting: Fed Talks Tough on Inflation

For the second meeting in a row, the Federal Reserve left interest rates unchanged at 2 percent. By now, everyone should realize that the easing cycle has come to an end and that the next move by the Fed will be a rate hike and not a rate cut. There was only one dissenter - Fisher, who voted for a rate hike for the second meeting in a row.

The Fed is talking tough on inflation and their hawkish comments indicate that they are afraid of getting too excited about the drop in oil prices.

With oil prices trading below $120 a barrel, inflation expectations have eased but the Fed refuses to acknowledge it. The Fed is afraid that just as quickly as oil prices have fallen, they could rise once again. Their hawkish comments were meant to appease potential dissenters like Fed Presidents Stern and Plosser and to hold them back from voting in favor of a rate hike. However don’t expect the hawkish comments to translate into a rate hike anytime soon. It is no secret that oil is determining Fed policy. Now that crude prices have cracked below $120 a barrel, the noose around the Fed’s neck has been loosened.

On growth, the Fed warned that the downside risks remain but they do expect the prior rate cuts to stimulate the economy over the next few months. It may not be until the fourth quarter or early 2009 before we seen some reasonable signs of growth.

High oil prices act as a tax for consumers and businesses, but it goes both ways meaning that the drop oil prices also acts as a tax relief for consumers and businesses. With oil prices inching towards $100 a barrel, half of the Fed’s problems have been solved. Consumers and businesses will breathe a sigh of relief and their spending should start to slowly pick up as long as the downtrend in oil continues.

Yes, the US economy still has a lot of problems including a weak housing and labor market. New home loans are difficult to get, but if consumer spending recovers, the rest of the economy will follow along as well.

The US dollar has had a great run. Over the past month, it hit a 6 week high against the Euro and traded within a whisker of its 7 month high against the Japanese Yen. The dollar continued to rally up to the last hour before the August FOMC meeting. No one expected rates to be changed, but there was less dissent within the Federal Reserve, which has pushed the dollar lower. Although the dollar has bottomed and is set to break 1.50 in the medium term, it has become overbought and could rally before it turns lower once again.

Compare the changes to the last 2 FOMC Statements (key changes are highlighted):

Release Date: August 5, 2008
For immediate release

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

Economic activity expanded in the second quarter, partly reflecting growth in consumer spending and exports. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee. 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; Elizabeth A. Duke; 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.

Press Release
Release Date: June 25, 2008
For immediate release

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.

Comments

[alex s:]

How is the fed talking hawkish about inflation?
First of all, the first highlighted paragraph of "differences" was just moved up. its essentially the same talk as last statement. The focus of the statement is "Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee." The language implies parity. Last statement the focus was inflation over growth concerns, here its equal, its pared! They put growth and inflation in the same sentence in two adjoining fragments using words like "although" and "also" Perhaps that's why the equity markets rallied because it signalled there was definitely not going to be a hike in the near term, probably in january. I dunno, prove me wrong but i didn't see this as a hawkish statement, it was a "we're in a tight spot" and don't know where to go statement. Prove me wrong.... and what did bonds do today?

2008 Aug 05 06:29 PM

[Archman Inv...:]

Give me a break.
The Fed is talking tough on d*ck.

Their statement was a joke. It was a statement that was meant to pacify every single person's view on the economy and the market. Wether bull or bear.

Things take a lot of time to work themselves out. The housing crisis is far from over and banks et al, still have a few hundred billion to go on write downs. (just wait for the BAC write downs, and if think they aren't coming then you deserve to lose your money)

Consumer debt is just a hair under 1 trillion dollars (thats not mortgages or HELOC's) but pure credit card debt.

Though some news has been rationalized as good news, there has yet to be any real good news out there, other than what Wall Street spins.

You can thank the Fed and their daily lending to IB's for the rally and thank the shorts who are covering hand over fist.

Next Fed move is lower, count on it.

2008 Aug 05 06:33 PM

[Neal Vander...:]

The national dept is so high that each american would have to pay 31k to pay it off and it's getting worse everyday. americans have are not only sunk from the national dept but everyone is in debt to their mortgage loans and credit cards. what happens when people and the government keep borrowing is they go bankrupt because they get trapped paying on only interest and eventually loose everything. the gdp was boosted by tax checks. everyone knows how bad it is. i used to be an independent trucker so who do you think your fooling? there's absolutely no economic strength. corporations can barely do business and the independents have a slim chance of surviving. the average age of the population keeps getting older and with less able-bodied workers. with debts so high and no earnings growth potential do you really think the economy will improve out of thin air? this is all propaganda to ease a patient at the operating table on their last legs. the problem is not even a global one because other countries are in different economic cycles. our government spending and bad economic policy has sunk the ship.
if you don't think the value of the dollar can go lower your just painting a false picture of hope. just because crude has corrected from record highs doesn't mean the dollar is strong. remember 100 a barrel was considered too high. this will only deteriorate over time. so it's not a panic overnight drop but in time it will erode with the macros being so bad. Remember a similar situation happened in Japan and it went though a very long period of deflation. The same is happening now.

2008 Aug 05 09:45 PM

[ChickenLips:]

I think I'll stay home away from the hi-five "short-term" party crowd until we get through the next year. Winter is coming up, natural gas/heating oil demand will increase all over the wealthy and developing northern hemisphere. Will this make commodity prices increase again? I need to heat my house this winter, how about you? Natural gas and oil are usually correlated in price, so they will probably go up in price together. Who knows how fast this price rise will be and if it will stick past the winter.

There have also been quite a few articles trickling around about the dramatic rise of the slaughter of cattle: farmers cannot afford to feed their cattle at current agricultural prices. This will lead to the inevitable rise in the price of beef and pork next year. We will see price inflation on all food products next year, not just in the dairy and grain foods that we saw this year. Americans love their steaks and hamburgers, higher prices on these favorites will negatively affect our consumer confidence.

There you have it, fuel and food prices will probably remain high throughout the next year. This doesn't appear to be a favorable combination for the economic recovery crowd. Credit contraction and high prices will stifle the American middle class, leading to more business failings and layoffs.

Drilling for more oil will fix all of this. ;-)

2008 Aug 05 11:01 PM

[Jason Rines...:]

I believe we will see one rate increase of .25 before the year is out. It is tied into politics and campaign statements. McCain feels we should ease short term rates to 1.5% . I can't stand Dems but this man is an economy mental dwarf and more or less acts the same way.

2008 Aug 06 12:45 AM

[OldLimey:]

FOMC said absolutely nothing. (See Paul Kedrosky's post in SA today for a succinct analysis.) Traders read into it what suits their books. Period.

2008 Aug 06 02:12 PM

[MHG:]

This Federal Reserve Board seems to have forgotten about open market operations to support the dollar to help keep oil prices low or, at least, to make oil prices less volatile than they now are. The nice thing about currency intervention to support the dollar is that other governments may decide to cooperate with our government, making the cost of conducting currency open market operations to the US taxpayer less than many other alternatives, such as raising interest rates, which adds to the amount of interest paid on the Federal debt. If foreign governments perceived that the Fed had a policy of defending the value of the dollar with open market operations, then there would be less pressure on the dollar from abroad to dump it. When is the Fed going to realize that support of the dollar via such operations is counter inflationary, especially if other governments cooperate? Why will they not use this tool? Can someone please explain?

2008 Aug 06 11:43 PM