Monday, September 18, 2006

Fed Tells Ip What They Have Fed The Market ...... and something more

In the Saturday Wall Street Journal, Greg Ip, the erstwhile journalist and relayer of unattributed Fed thoughts to the masses (at least the masses that read the WSJ), wrote an interesting piece entitled "Outlook Divides The Fed, The Street" (I didn't bother with a link since you need a subscription to access the article online).

The article contained some points of interest. For one, there is this:
"Recent speeches by Fed officials suggest that while they are willing to stay on hold for now to see if their forecast of slowing growth and falling inflation comes about, they do not share the pessimism on growth, or the optimism on inflation, implicit in expectations of a rate cut by mid-2007."

In other words, don't expect anything in Sep or Oct or probably even Dec, since the Fed digests a flow of information before it decides to raise, lower, or hold. As of now, the information flow suggests that standing pat is the right stance.

The second message of this paragraph and one noted in this blog for at least the past month is -- "What is the market doing pricing an ease into next year?"

As Ip explains, the market is more pessimistic on growth than the Fed because they are more pessimistic on the impact of weak housing. Given the track record, it is better to bet on the Fed in a stakes race than on the "street". If you own a two-year Treasury, understand that the underlying bet is the flip -- against the Fed and with the street analysts/economists/etc. These street people are the same ones who told us last year that 3.5% was the neutral top and anything higher risks doom, destruction, and depression. The market, by the way, was forecasting a decline in the funds rate in 2006. As Casey Stengel used to say, "you can look it up"

Another thought is that while the bond market is trading at low yields reflective of the expectation for a Fed ease next year the stock market is doing very well, credit spreads are tight, and lending standards are easy. This combination is a recipe for expansion not contraction. Your money, your bet, your risk.

This line in the Ip article strikes me the most:
"Moreover, the Fed seems to think the economy's potential growth -- what it can achieve without straining business and labor capacity and thus fueling inflation -- is lower than many on Wall Street think."

When did this happen?

The whole rationale behind the Greenspan policy in the mid 90s and the "new economy" paradigm, etc., etc., etc., was that high productivity, global sourcing, technological advances, and capital deepening meant that the economy could handle a much faster rate of growth and resource utilization without triggering inflation. Now it can't?

Some explanation is in order.

Is the explanation that the good fortune on inflation in the 90s was as much because of external forces, such as bad policy holding down Japan, as it was because of intended domestic policy (monetary and fiscal) and policy with unintended effects (the peace dividend)? And if outside forces effected domestic inflation to the extent that the Fed went from new paradigm to old inside of one business cycle, how can the Fed run a long-term policy based on inflation targetting when inflation is not totally the result of our doing?

These are the more important questions than what the Fed does this week and what it says after its done nothing.

1 comment: said...

Best of luck to you and to Stan. You are two of the most thoughtful people I have worked with.