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June 28, 2007
Quo vadis?
Once again the FOMC decided to keep the fed funds rate unchanged at 5 1/4 percent. (Read the statement) There were some minor changes in the wording compared to the May statement. For example, in the second paragraph it is said that economic growth appears to have been moderate "despite the ongoing adjustment in the housing sector." Previously it had said that "adjustment in the housing sector is ongoing." Today's statement strikes me as conveying a somewhat more positive spin than before. No doubt many will think that is not warranted at this time.
The more important change seems to have been in the next paragraph. Here's the new language:
Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.
And here is what they said in May:
Core inflation remains somewhat elevated. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures.
The line about "sustained moderation...has yet to be convincingly demonstrated" is a clever way to word it. At the same time, they say that readings on core inflation "have improved modestly in recent months."
Reuters focuses on the first sentence: (Headline: Fed holds rates steady, nods to ease in inflation)
WASHINGTON (Reuters) - The Federal Reserve on Thursday held benchmark U.S. interest rates steady at 5.25 percent for an eighth straight meeting and dropped a description of core inflation as "elevated."
King Banaian focuses on the second sentence: (Blog post title: This'll be icky)
The Federal Reserve held rates steady, but the markets will not like the references to inflation here:
...
The Dow was up 50 when the news broke; I'd bet that won't last.
As of this writing, the Dow is up about 24 points. That's down from earlier, but hardly a sign that this news sent traders running with their tails between their legs. The bond market is another story. The 10 year is down 8/32 at this writing with the yield at 5.11%. King also points out that the WSJ Economics Blog says that tomorrow's release of the May PCE will be closely watched. Indeed.
But I'm of the opinion that nothing in today's statement is truly market moving news. Yes, bond traders are more touchy about this than stock traders perhaps. They may recover some of those 8 ticks today or tomorrow after mulling this over. This statement is not a clear sign that the FOMC intends to get back into a tightening mode. At least the market is not interpreting it as a clear sign, and that's what counts.
However the Fed doesn't want to telegraph its move quite yet. They don't want to be locked in on the off chance that the spillover from housing is worse than imagined, or something like that. That would cost them credibility. On the other hand, you can only sit for so long with core PCE outside your comfort zone without losing some credibility too. Before the end of the year, I think they will have to decide where they are going. If the growth picture looks about the same as it does today, and if core PCE is still on the high side, I think you know which way I would like them to go.
UPDATE: Dave Altig at macroblog links to some of the financial media coverage which was, as one might expect, all over the map. One of the more reasonable comments was from the Wall Street Journal (no link provided) which suggests that this really wasn't much of a substantive change. It's as if they were changing some of the wording (removing the word "elevated") just to keep people from fixating on the language that had been used for a while.
I'd like to think that's the case since it fits with a view that I have had ever since they overused a certain phrase a couple of years ago.
Posted by William Polley at June 28, 2007 02:24 PM
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