Wednesday December 8, 2004 - 14:12:16 GMT
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INVESTICA Ltd - www.investica.co.uk
Fed set to tighten again
Fed set to tighten again
Despite the weaker than expected payroll figure last week, the net risks suggest that the Federal Reserve will increase interest rates at the December and February FOMC meetings. This would push US short-term rates to 2.5%. Thereafter, although rates will be low in historic terms, the Fed may have to consider a pause in the tightening. There will also be a risk of divisions within the Fed next spring, especially as Greenspanís authority will start to fade in his final year as Chairman.
FOMC meeting next week
The US Federal Reserve will meet next week for the final 2004 meeting. Since Jun, the Fed has increased rates four times, doubling the Fed funds rate to 2.0% from the historic low of 1.0%.
Payroll figure creates uncertainty
Confidence over a Fed rate increase has been dented slightly by the weak US payroll report last week. Employment growth for November was held to 112,000 compared with expectations of a 180,000 increase and the figures for the pervious two months were also revised down by a total of over 50,000. The economic data as a whole has, however, been generally favourable with the ISM indices both recording small increases for November. The Fedís Beige Book also reported that activity was still strengthening with a firmer labour market and increased lending. Recent comments from Fed officials also still suggest that the Fed wants to increase further.
Some concerns over inflation
There have been some reports that the Fed is concerned over inflationary pressure. Consumer price trends have remained under reasonable control over the past two months, but there was a jump in producer prices due to a rise in energy costs and there ahs been some increase in core inflation. Oil prices have fallen sharply over the past two weeks with crude prices dipping back to near US$40 p/b from a peak above US$55 p/b and this should ease concerns to some extent. The Fed will not want to avoid inflation expectations taking hold. The slowdown in productivity and increase in medical cots will increase the risk of higher business costs. In this context, there will be some concern that companies are having greater success in pushing up prices as it could start to put wider upward pressure on inflation.
The chances of a Fed rate increase on direct concern over dollar weakness is very unlikely in the short term and domestic factors will tend to dominate.
US rates are still low
In historic terms, the level of US interest rates is still low. Real rates are still close to zero compared with a Ďnormal levelí of 1.5-2.0% and this suggests that rates would not reach a neutral level until an increase to at least 3.5%. A neutral rate is where monetary policy is not providing any stimulus or restraint to economic growth.
High debt will deter tightening
The US consumers are still running very high debt levels and low interest rates have been vital in sustaining the housing market. These two factor combined suggest that the natural level of interest rates will be lower than would normally be associated with a cyclical upturn. The Fed will also be wary of raising rates too fast as this could destabilise the economy. Budget concerns will be significant as rising interest rates will increase US Treasury debt payments. This will not be a major short-term focus, although it will ensure that the Fed will want to avoid policy shocks. It may also restrain rate increases next year. This makes it unlikely that rates will increase towards 5.0%.
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