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August 8, 2006
The long awaited pause
Today, the FOMC decided to leave rates unchanged for the first time since June 2004. We knew it was coming eventually. Beginning last summer many of us started to wonder if a temporary end to the rate hikes would come by year's end. By year's end, it looked like it would be this summer. Even up until a few weeks ago, one last rate increase today would have been seen as likely. That sentiment eroded and practically disappeared last Friday. Speeches by Fed officials, including Mr. Bernanke's congressional testimony cracked the door and the non-farm payroll data threw it wide open. And while the statement was not as hawkish as some might have hoped, the late afternoon interpretation seems to be that the market believes more rate hikes are possible. It is also possible that the thought of a slowing economy is starting to sink in on Wall Street as well.
Around the web, Mark Thoma compares the language of the last two statements. Several things do stand out. First, they report that economic growth has moderated as opposed to "is moderating". They removed the statement about productivity gains, likely this was in light of this morning's news revising productivity downward for the last couple years and lackluster gains in the 2nd quarter. They also removed the sentence, "In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives." I would like to know about the discussion that led to the removal of that sentence. Personally, I don't think that sentence provided any particularly useful information. If there is doubt on that issue, the rest of it doesn't matter. Perhaps they were trying to cut down the excess verbiage.
Barry Ritholtz does not approve of the decision or the statement.
From the NY TImes,
The Fed appears less concerned about a recession. In its statement today, it described economic growth as moderating, not stalling or slumping.
And that does add credibility to the notion that more rate hikes are possible. If they were really worried that a recession was immenent, this would be the end, not just a pause.
Greg Ip does his usual fine work in the Wall St. Journal. Read the whole thing.
Also from the Wall St. Journal On-line, in their "Economists React" page, there are a number of good entries. This one caught my eye,
Richmond Fed President Lacker dissented in favor of an increase, so the vote was 9-1. That should not, however, be taken as a signal that the discussion was not contentious… I would imagine that there may have been other who could have gone either way and perhaps even some non-voters who would have dissented if they had a vote. So, now the Fed, economists, and market participants will sit back and watch the incoming data to figure out whether the economy continues to cool and whether there is any sign of a moderation in core inflation. RBSGC believes that activity may pick up a bit and that core inflation will remain too fast, so we look for one more rate hike on Sept. 20. -- Stephen Stanley, RBS Greenwich Capital
It is indeed possible that this was very contentious. The dissent of one member speaks volumes. Generally only one member dissents, even if there is deep division. This may be one of those times. It is also interesting to see some of the television commentary on the decision. Former San Francisco Fed President Robert Parry was on Bloomberg shortly after the decision and while he was not overly critical, he did not think that the present policy stance was too restrictive.
This decision is going to be critiqued for some time to come. There are plenty of commentators out there who wanted one more hike. Of course, I would be remiss if I didn't point out that there are plenty who think the Fed has already gone too far. My opinion remains that the real interest rate is low enough (barely cracking 1%) that it is not terribly restrictive and has room to move upward. Also, the Taylor rule indicates that current policy is still accomodative. There is a good possibility that rates will indeed be pushed higher down the road, and I'd rather see it sooner than later. While I would stop short of calling this a mistake, I think it is risky. I'm more worried about the inflation risk than the recession risk at the moment, and I don't think that monetary easing is going to suddenly reverse the labor market weakness that has lasted throughout this recovery. Nor do I think that another 25 basis points would capsize the labor market.
But for now, the decision is made. The Fed is taking the chance that moderating growth and the lagged effect of past rate increases will keep inflation at bay. They have confidence in their forecasts. If core PCE inflation holds steady in the next couple months, this could be the breathing room that they have been seeking. But the big question on many people's minds is what if core PCE inflation continues to tick upward? How long will the Fed wait to address the issue? Would they act in September or hold out until October? Until the next round of speeches by FOMC members, it will be hard to say. I will be particularly interested in the release of the minutes of this meeting to see what kind of concerns were expressed regarding inflation and the level of restrictiveness that members perceived in the current policy stance.
Just for kicks, I looked at what I wrote on June 29.
I can envision scenarios in which there is a pause in August, and that is something that I could not say about the June meeting.
And so it goes. If anyone asks me right now what I think about September, my response would be, "What part of data dependent don't you understand!" We really are in a mode of waiting to see if the Fed's forecast of moderating inflation turns out to be true. Depending on that data, the next two meetings could go either way.
Posted by William Polley at August 8, 2006 4:44 PM
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Comments
The next move (after a lengthy pause) will be down. At least that is what the markets believe. Its not a question if there will b cuts -- its just how many.
Posted by: vincentm at August 8, 2006 7:49 PM