Economists React to Fed

Tuesday, December 13, 2005 | 08:00 PM

WSJ 

The Federal Reserve, as expected raised interest rates for the 13th consecutive time Tuesday, lifting the federal-funds rate by a quarter percentage point to 4.25%. The central bank suggested it would raise rates again, but also hinted that it is less certain on its future rate actions than it has been in over a year. In the accompanying statement, the Fed said growth remained "solid", inflation excluding food and energy prices had "stayed relatively low," and inflation expectations were contained. But it also warned that the possibility of further erosion of spare productive capacity and high energy prices "have the potential to add to inflation pressures."

What do economists and other analysts make of the changes? Here's a sample of their commentary:

* * *

The Fed has finally taken the step that we have been pointing to for a while, in separating the two concepts of reaching neutrality and finishing the rate cycle. They kept "measured," as we thought they might, but now it refers to "some further measured policy firming" as opposed to removing accommodation at a measured rate. So, rather than being on automatic pilot in raising rates toward neutral, the FOMC now sees itself in the second stage of the rate hike cycle -- further moves will be perceived by Fed officials as taking policy toward a restrictive stance.

-- Stephen Stanley, RBS Greenwich Capital

* * *

The message from the FOMC appears to be that barring a major change in the tone of economic data, another 25bp tightening move will be implemented at Chairman Greenspan's last meeting on January 31. At that time, it is quite possible that the "measured phrase" will be jettisoned, leaving incoming Chairman Ben Bernanke with a clean slate for the next meeting on March 28. Our own view remains that the evidence concerning economic growth should be sufficiently strong in coming months to spur another three 25bp tightening moves, lifting the Fed funds target to 5.00% in the second quarter of the year. We think that growth will then be moderating sufficiently for the FOMC to cease tightening, even if core inflation drifts up mildly from its current levels.

-- Joshua Shapiro, Maria Fiorini Ramirez Inc.

* * *

The Fed announced: "Core inflation has stayed relatively low in recent months and longer-term inflation expectations remain contained." Quite frankly, we do not believe them. We know that beyond the rises in food and energy prices, nearly everything -- from healthcare to building materials to education costs to insurance to commodities -- costs more. And gold, the world's best inflation indicator, is well over $500 per ounce. Where ever we look, we see evidence that prices have limited stability and an upward bias.

-- Barry Ritholtz, Maxim Group

* * *

 

We do not see this statement as signaling that monetary policy is at neutral. The Fed continues to emphasize upside inflation risks and the potential need for further measured interest rate increases and we continue to look for three more rate hikes to take the funds rate to 5% by the middle of next year.

-- John Ryding, Conrad DeQuadros, Elena Volovelsky, of Bear Stearns

* * *

We note that the Fed has begun to make explicit reference to "possible increases in resource utilization" -- Fedspeak for the declining unemployment rate -- as a driver of future core inflation, for the first time in this cycle. We think this is extremely important, because it signals that the labor market has now moved again to center-stage in the Fed's analysis and policy making process. The Fed is no longer dealing with shocks and their aftermath; the cycle is reasserting its primary role in determining policy.
-- Ian Shepherdson, High Frequency Economics

There was little news in this statement. The Fed continues to remain purposefully behind the inflation curve (willing to live with underlying commodity inflation as long as we see continued growth), trying to walk the tightrope of curtailing housing market speculation without squashing growth, hoping the powerful balance sheets of corporate America can offset any weakness from the consumer. Whether it can continue to play this tenuous game without causing a financial accident is still a big question, but thus far one has to say, "so far, so good," a phrase I would not have expected to now be uttering just a few short months ago.

-- Chip Hanlon, Delta Global Advisors

* * *

The Fed stated that "some further measured policy firming is likely to be needed to keep the risks … balanced." With this change in language, the Fed is acknowledging that that stance of monetary policy can no longer be described as accommodative. Borrowing rates have moved up sharply over the past year, credit spreads have increased, and the demand for consumer and mortgage credit has dropped sharply.

-- Brian Bethune, Global Insight

* * *

The Fed eliminated the phase "monetary policy accommodation." However, this does not mean that the Committee does believe that monetary policy is now neutral or restrictive." In particular, the Fed also said that "possible increases in resource utilization ... have the potential to add to inflation pressure." This is a clear reference to their view that the economy is still growing more quickly than the economy's potential, which suggests that the funds rate remains below its "neutral" level and, thus, is still providing stimulus to the economy.

-- Steven Wood, Insight Economics

* * *

As expected, the dollar is falling across the board. We did indicate that any change in the statement should be dollar negative as was the case after the release of the Nov 22 minutes. Carry-trade enthusiasts are eyeing any change in signals from the Fed that would add some finality to the accumulation of the dollar's yield luster.

-- Ashraf Laidi, MG Financial Group

* * *

Keeping a "measured pace" for so long heightened the possibility of the committee painting themselves into a corner. This language gives them a way out while still maintaining the ability to press on with higher rates if inflation continues to pose a threat. It may take the market a couple days to sort it out, but at first glance, this language could work. I would still like to see it evolve, however.

-- William Polley, Western Illinois University

* * *

By changing the language as they have, the Fed is signaling that further rate increases are very likely, but not certain. Strong growth and inflation worries showing up in incoming data will continue to bring about further tightening, but any signal that growth is abating or that inflation is firmly under control will give the Fed reason to pause and reconsider whether further increases are warranted. … It will be interesting to see to what degree FedSpeak is used to set expectations as data arrive.

-- Mark Thoma, University of Oregon

* * *

Source:
Economists React
WSJ, December 13, 2005 3:28 p.m.
http://online.wsj.com/article/SB113450282046821489.html

Tuesday, December 13, 2005 | 08:00 PM | Permalink | Comments (3) | TrackBack (1)
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» Greenspanspeak Nears Peak: Fed Moves Toward Neutral On Rates from Matrix
Source: WSJ The Fed increased the Federal Funds rate to 4.25% [WSJ], the 13th increased since June 2004. However, for the first time since 2002, it omitted the word accommodative which means that rates are nearing the point where the... [Read More]

Tracked on Dec 13, 2005 11:16:07 PM

Comments

The following quotes best sum up my view of economists:

"There are 60,000 economists in the U.S., many of them employed full-time trying to forecast recessions and interest rates, and if they could do it successfully twice in a row, they'd all be millionaires by now...as far as I know, most of them are still gainfully employed, which ought to tell us something." - Peter Lynch

"ECONOMISTS BELIEVE THE COMING DECADE WILL BE A GOLDEN ERA. Many economists, and the Japanese government as well, say the classic theory of business cycle no longer applies to Japan, which has minimized instability factors and learned to drive slowly but steadily when necessary." - Japan Times, December 26, 1989

"One thing that economists do know is that the study of economics is divided into two fields, "microeconomics" and "macroeconomics". Micro is the study of individual behaviour, and macro is the study of how economics behave as a whole. That is, microeconomics concerns things that economists are specifically wrong about, while macroeconomics concerns things economists are wrong about generally." - P.J. O'Rourke

Posted by: PC | Dec 13, 2005 10:08:40 PM

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