Tuesday, November 14, 2006

Close To An Ease . . . . .But Based On What Policy?

After Bill Poole's talk "U.S. Labor Input in Coming Years" to the Chartered Financial Analysts Society of Philadelphia, the most interesting answer he gave was to the question on long term rates. Rather than take the conundrum path he jumped onto the yield curve. And rather than play the trader's growth expectations vs the Fed's, as he did several months ago, he contrasted the bond market's view (eco bears) with the equity market's (eco bulls). He doesn't understand why there is a difference in opinion, so the only thing to do is to wait. Wait and then what? If the equity market moves to share the bond market's view on things does the Fed ease? Poole's comments suggest to me they might.

In the Q&A to reporters, Bloomberg news headlines are (in my order): "inflation expectations are well controlled", "price movements tend to lag general economy", "can't rule out slower growth behind oil-price drop", "outlook for Fed policy is roughly symetrical" and "don't want to hold onto tight policy too long"

There you have it. Stop trading on employment data, retail sales or inflation indexes, so advises the President of the St. Louis Fed, one data point won't move the Fed and the value of the information in the first release is suspect to say the least. Watch the equity market instead.

If you are so certain that the Fed will ease, why bet on March? CBOT Fed funds digitals are trading at an 8%/11% chance of an ease in January with a tightening at, inexplicably, 4%/9%. Put up $11 to make $100 if the Fed eases, great odds in my view. Poole is telling you that the Fed is ready to ease if the data break that way or equity traders give up on the prospect for good earnings.

The Christmas selling season is upon us. By the end of January the current weakening trend in the data will be known as a blip or something more meaningful. They won't wait till March. And if they don't ease in January, why believe they ease in the Spring?

By the way, what is monetary policy? Not the object, the management.

We know and have confidence in the goal -- long-term price stability. But by what basis do they know what funds rate is right? Can they be certain that targetting 2% in the short term doesn't foster higher or lower inflation down the road? What benchmark best gauges policy, since we live in a series of short-term periods that only sees price stability looking backwards?

The other day Bernanke tells us that in this hi-tech, global world without borders, money is no longer a reliable indicator for monetary policy. Today, Poole tells us that labor can no longer be a reliable guidepost for policy.

Okay, I give up, what should we be looking at?

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