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October 29, 2007
Could the Fed hold rates constant? (Part II)
Tim Duy makes his stand.
And So It Begins, by Tim Duy: The Fed begins a two-day meeting today, with market participants widely expecting a rate cut. I am mentally prepared to be on the wrong side of this call, joining the lonely few, but I just can’t tease another rate cut out of the incoming data.
In my mind, the argument for a rate cut hinges on one crucial assumption – that the market is expecting a rate cut, and the Fed will not want to disappoint....
Agreed. He also says...
If the Fed fails to ease, so the story goes, they will be blamed for failure to communicate effectively. After all, given their push for transparency, shouldn’t they make an effort to send a signal when the markets are headed in the wrong direction? The problem with this view is that Fed Chairman Ben Bernanke does not believe it is his job to lead markets around by the nose like his predecessor. I think under the new regime, the Fed expects their comments to be taken at face value. And I think they are pretty effectively communicating their view on the economy: Outside of housing, there is minimal spillover, and whatever spillover exists is completely expected....
I do see Tim's point about Mr. Bernanke. But by the same token, Mr. Bernanke has to realize how his comments would be interpreted (in the October 15 speech to which Duy provides a link). If he didn't like it, there was time for him or others to refine the message.
If the Fed decides they are unwilling to defy the market, or that “risk management” requires additional rate cuts, I would have to conclude that regardless of what the statement says, that one must expect a series of multiple rate cuts. They will be responding to the deteriorating housing market, and I simply expect no stabilization in that market in the near future (don’t get me wrong – I am not a pie-in-the-sky optimist).
I know, and I've voiced my concern about this. But Tim is suggesting here that there is no way for them to issue a credible statement that really indicates that they are done. Obviously the September statement wasn't it. But I think it's possible to craft such a statement.
Bottom Line: I believe the Fed intended to take a pass in October with the 50bp rate cut. I believe market participants were correctly reading the data until they got caught up in the risk management story. I think the Fed has been explaining past actions, not future policy. For that, you need to look at their forecast. On the basis on the data alone, the Fed is already so far in front of the curve it is hard to justify another cut at this point. I absolutely do not expect the Fed to cut 50bp.
I also believe that they intended to hold rates constant now when they made their decision in September, and it is possible (likely?) that the risk management story got overblown. But I'm less convinced that they were explaining their past actions. I don't see them as being "far in front of the curve". I see them as wanting to get just a little bit below neutral. Given that potential growth may be slowing and inflation is mostly contained, they are probably not quite at neutral yet. I could accept another 25 b.p. as getting us close to where they want to be to end the year, or just a bit below. I think they would prefer to end the year at 4.5% as opposed to roiling the markets this week by throwing them a curveball.
Cut now, and make it clear that it's an early Christmas present and that they're not getting any more in December. Make it clear that at 4.5%, policy is neutral to slightly accommodative. I think they could sell that.
Tim and I agree on a couple things. A 50 b.p. cut is pretty much out of the question. He says he is mentally prepared to be wrong. So am I. But the more I look at the minutes of the last meeting, the Fedspeak, the continued uncertainty, and the general unease about growth prospects in the 3 to 9 month period ahead, the more I think that the decision to cut carries a bit less risk than the decision not to cut.
A thought occurs to me. The fact that we're having this last minute discussion about the possibility of no cut would, I believe, make it more credible for the Fed to announce that this week's cut (if there is one) is the last for a while.
Posted by William Polley at October 29, 2007 10:30 PM
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Comments
I think Ben's Fed has really tried to stay away from any commitments about the path of future policy moves. So I think your suggestion that they say that this will be the last cut is a nonstarter. However, what I do expect would be more guidance about the conditions for any changes - which may include taking back the rate cuts (imagine that!). That would unsettle but help inform the markets. The Fed clearly needs to lay out more clearly what they are considering when making decisions, especially in terms of their current forecast, and what might occur which would impact that forecast. This is the new trend under Ben, but clearly there is still a ways to go.
PS - it doesn't help to have the "bond king" shilling for bondholders and always ranting for cuts. I hate his commentaries, and I think he tends to say what his beliefs were six months ago, and never gives his current assessment of the market (in order to boost his sell positions)
Posted by: Kevin at October 31, 2007 7:18 AM