Monday August 4, 2008 - 18:54:35 GMT
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Forex Blog - Fed Tightening Assumption Points at Parallel Universe
It does not take special
powers or an Ivy League education to realize the Fed does not always get the
economy or monetary policy right. Greenspan holding rates at 1% for far
too long and ignoring warning signs from colleagues and market participants of
the housing bubble filled with easy-credit helium was unsustainable comes to
mind. So too does Bernankeâ€™s and the Fedâ€™s assertions of a year ago that
housing prices would soon bottom and the subprime problem was contained.
So why are so many in the
market certain the Fed is going to hike rates at the first opportunity?
First the Fed had an opportunity to hike at the end of June and took a pass â€“
while not widely expected at the time capital markets were relatively tranquil
(pre GSE meltdown) and the equity market could have absorbed a tightening
But conditions have
deteriorated since then with the GSE backstopped before they could fail and
stocks having a heck of a time putting in the bounce in a proverbial bear
But for the Fed to hike, one
has to believe that inflation can thrive in a world of not just weak growth,
but in a protracted global recession. Look at oil today and in the last
few weeksâ€¦ignoring Iranâ€™s reckless leadership as it seemed to ignore overtures
for diplomacy from the US and broader calls for an end to its nuclear
enrichment program. Yet oil is lower. A tropical storm is now
heading through the Gulf of
Mexico toward Houston and could reach hurricane force winds by landfall
and oil is down over 3%. Nigerian rebels are actively sabotaging oil
facilities (pipelines) in the oil-rich region and oil prices are lower.
Why? Well maybe more than a few of us are questioning the Fedâ€™s assumptions
about growth and inflation ahead and see rising significant downside risks to
growth, not diminishing serious downside risks to growth as noted in the June
FOMC statement and minutes. Europe and Japan look like they will post negative GDP in Q2â€¦for Japan that would be back-to-back contractions. Chinaâ€™s political leadership has turned the governmentâ€™s
economic priority to supporting growth (because it is slowing) from preventing
economic overheating. Even the PBOC is â€śaskingâ€ť banks to increase lending
by 5%. Commodities leaving Brazil and Australia bound for China are beginning to show some moderation. If you
know Jefferey Dalmer is hanging around your neighborâ€™s kids, do you wait for
Mr. Dalmer to start the barbeque grill before alerting the police and the parents?
There is no way the Fed can
say what it did in the June statement and minutes â€“ inflation risks are
increasing and risks to growth decreasing, while most FOMC members favored a
rate hike when conditions allowed.
Why tighten when credit
conditions are as tight as they were when Fed funds traded at 5.25% a year
ago? Why tighten when oil prices are down about $25 a barrel from the
record high and levels seen at the June FOMC meeting? And who believes
that high oil does more to fuel inflation than clobber consumption?
Perhaps the Fed is less
inclined to talk about our universe because the outlook is so dim while droning
on about economic conditions in a parallel universe might do the consumer well
â€“ it is the Phil Gramm world where economic problems are in the minds only of
the public because of naysayers and bad journalism.
I am not suggesting the Fed
should ease rates again. Indeed the most it can commit to is that it does
not see Fed funds coming down more ahead. But why talk about rate hikes
when the US economy is about to do a face plant â€“ led by the
consumer? How does this help stressed households and firms much less Fed
credibility with the market?
So I come back to the
dollarâ€¦people who talk about a higher dollar as the US economy is some accounting principle of first in
first out should be scoffed at. The US economy has plenty in common with Japanâ€™s economy in the 1990â€™s. Sure the US economy is more resilient than Japanâ€™s,. But this simply means a five year
adjustment (stagnation) as opposed to a decade of stagnation (arguably still
living with the residuals).
The dollar has another
serious thumping ahead, as do equities and very probably oilâ€¦there will be a
time again when oil and the dollar move in the same direction. Yes Europe and Japan are also runners up in the ugly economy contest. But they are
also net creditorsâ€¦the US Needs their savings to thrive. In a global
recession, I think large deficit currencies (I donâ€™t see Australian deficit
financing, despite its large share of GDP as daunting) like the US dollar
suffer in what now seems to be an inevitable global recession.
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