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May 10, 2006
Data dependence
For the first time in two years we enter the period between FOMC meetings not knowing whether a rate increase is coming. It would indeed be foolish to think that the Fed is finished raising rates for this cycle. One can easily imagine scenarios where we see one or even two more increases before this fall. The language in the FOMC statement is new, however:
The Committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information. In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives.
In other words, welcome to the world of data dependence. Notice also that there is nothing in the statement about the risks to price stability and sustainable growth being in balance. Last Friday's employment report notwithstanding, the Fed seems fairly confident in the ability to economic growth to continue. The FOMC's opening paragraph states:
Economic growth has been quite strong so far this year. The Committee sees growth as likely to moderate to a more sustainable pace, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.
Despite what a lot of people would have expected, the stock market has barely budged. They seem to be taking the news like grown-ups. That's good to see. Maybe Bernanke is getting through to them after all. Even the 10 year bond is up 2/32. From certain corners comes a sigh of relief that the Fed hasn't gone "dovish" on us.
Indeed they have not. I wouldn't be at all surprised to see another increase in June. Neither would King. It's just that now it's not a sure thing. It's about to get a little more exciting for Fed watchers than it has been in the last two years--more exciting than it has been since I started this blog. Throw away the record books--it's a new ball game. None of us knows what will happen in June, but each data point tightens the noose one way or the other. I will say that I think the bias is still towards a little more tightening. I'm inclined to expect another increase unless a preponderance of data points the other way. If the data remains status quo, then onward we climb--at least for a while.
UPDATE: Mark Thoma remarks:
The bottom line? I expect a pause at the next meeting if the Fed observes signs of the anticipated slowdown and if inflation remains moderate. However, they are very careful to signal that nothing is set in stone, the next move will depend critically on observations of the current and expected future state of the economy.
The question is how much of a slowdown and what level of inflation would trigger a pause? There will be no new GDP data before the next meeting, though there are other monthly indicators such as industrial production, manufacturers orders, sales, and inventories that will be important. There's only one employment report between now and the next meeting, and I don't think that they will pin everything on that. Inflation, I think it is safe to say, is the main point. There are a number of ways to look at it, and that should keep us busy for a few weeks.
UPDATE 2: David Malpass of Bear Stearns writes in the Wall Street Journal that the Fed should have been more aggressive in 2005 and now they're paying the price. In his mind, it has everything to do with the strength of the dollar.
Posted by William Polley at May 10, 2006 2:13 PM
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