Fed Moves To A Balancing Act

The Fed has reached its own conundrum . . . . move to a neutral bias without scaring equities or the FX markets. If they came out today and said the economy was weakening more than anticipated by what logic would they wait and not ease right now? By the same token, they are really afraid of inflation expectations getting out of line, in part because there is so much liquidity in the system and the credit creation process continues to hum along. So the Fedspeak is to talk tough on inflation, talk up the economy, and then shift to a neutral bias in mid December because things do seem to be unraveling a bit. The markets, however, can see through the tough talk all the way to a 4.75% funds rate -- at least.

Offering up the verbal strategy, we got remarks by Michael H. Moskow, President and Chief Executive Officer, Federal Reserve Bank of Chicago at the Carthage Business and Professional Coalition Luncheon Meeting at Carthage College in Wisconsin. If nothing else Moskow remains consistent in his view. He said:

". . . . my current assessment is that the risk of inflation remaining too high is greater than the risk of growth being too low. . . . some additional firming of policy may yet be necessary to bring inflation back to a range consistent with price stability in a reasonable period of time. But that decision will depend on how the incoming data affect the outlook."

As for the market's reaction, the probability for an ease in Jan is now up to 25%, halfway to the 50/50 or even 75/25 odds post the Dec 12 meeting. That Jan/Feb Fed funds spread went out today at -5, the other day it was trading -1.5/-2. The March odds are up to 47%, 64% by May, etc.

While I am convinced of the Dec shift, I remain on the sidelines regarding January. Regardless of my view, the Fed is creating for itself the same problem fiscal policy created in 60s -- the notion that they can fine tune policy to match growth and keep the train moving. It turned out wrong on the fiscal end, not sure it will turn out any better for the monetarists now at the Fed.

No rules. Only judgement of knowing where the economy really is, where it is going, and what is the proper rate in that environment. Those guys must be pretty smart.