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September 18, 2005
More speculation on interest rates
From Reuters:
Rate-setting members of the Federal Open Market Committee who gather in Washington on Tuesday, while mindful of Katrina's devastation, are expected to look past it to their goal of keeping prices stable and opt for an 11th straight quarter-percentage-point increase in the federal funds rate.
"The Federal Reserve cannot address directly supply disruptions and really the best support they can give in this situation is to keep the economy on a sound footing with low inflation," said Lynn Reaser, chief economist for Bank of America's Boston-based Investment Strategies Group.
The federal funds rate -- the U.S. central bank's key monetary policy tool for influencing borrowing costs throughout the economy -- now stands at 3.5 percent.
If this week's meeting had come in the immediate aftermath of Katrina, when calls were loudest for a compassionate act like a pause in rates and the economic fallout of the disaster was still evolving, the outcome might have been different.
Interesting thought. However I don't believe it is necessarily true. See below.
But Fed officials indicate they see the economy recovering from a slight dip in the second half when reconstruction kicks in fully early next year.
"Right now we're already starting to see that rebuilding is under way and energy prices are moving lower so that makes it easier for them to stick to their strategy," Reaser said. "They will likely conclude that the economy is showing a great deal of resilience and that it is able to withstand a higher level of oil prices."
Yes. Keep in mind that the current decline in energy prices (gasoline, especially) is just reversing the large spike that occurred after Katrina. Don't look for energy prices to trend lower for long. They will probably resume the same upward trend they were on before as we move into the fall and winter. (Much to the chagrin of those in colder climates.) In the long run, Katrina's impact will be minimal. The Fed should focus itself on the long run inflation picture (as it has been), ergo, it will probably be business as usual. Whatever trajectory they had in mind for interest rates into 2006 is probably the one they will stick with. To change course in response to Katrina's short run impact is the sort of fine tuning I wouldn't expect them to do.
A Reuters survey on Thursday of Wall Street's primary dealers found 16 of 21 expect a rate increase on Tuesday. On Friday, Goldman Sachs somewhat grudgingly joined those forecasting a rise, but noted that an energy-price shock worsened by Katrina and greater economic uncertainty had at least "created a rationale for a pause."
See above. If, before the hurricane, you thought that it was time to slow down the measured pace rather than keep it the same (or even pick up the pace), the hurricane might have added some weight to your argument. Perhaps Katrina strengthens an already existing rationale for a pause sometime by year's end, but I don't see it creating a rationale for a pause on Tuesday.
Skipping ahead...
Economist Dean Maki of Barclays Capital in New York had little doubt a rate rise was on the way.
"They will keep the measured pace and accommodative language in place," he predicted. "They still think that policy is accommodative, for one thing."
"Accommodative" is central banker talk for rates that are still adding stimulus to the economy.
Maki, a former Fed board economist, said he expected that the Fed will in its post-meeting statement "discuss Katrina ... but indicate they expect the impact to be transitory."
Quite likely. Such a statement could give them the opening to use language that would indicate either a change in the balance of risks (less likely in my mind) or simply that the the pace of rate hikes could slow (while still remaining "measured"). I am really looking forward to seeing how they word the statement because I'd be a little shocked if it remains the same as it has for the last few meetings. They have some inertia to overcome--any change will be seen as rather big news. And yet, change--sometime this year, early next year at the latest--is almost inevitable.
Posted by William Polley at September 18, 2005 2:03 PM
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