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Tuesday March 22, 2005 - 21:20:09 GMT
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FOMC Surprise: Watch What I Say Not What I Do

FOMC Surprise: Watch What I Say Not What I Do

Greenspan again proved to be the master wordsmith (yes he writes all the FOMC statements, before the meeting). He left measured, policy is accommodative and inflation expectations contained. But he made the assessment of risks to price stability conditionally balanced...conditional on the Fed getting tightening right. In other words there could be upside risks to price stability if the Fed falls behind the curve, something the Chairman and Fed is implying will not happen. In other words it will do what it has to to keep risks to price stability symmetric. But ask anyone what the Fed will do May03. Hike 25bps. So this is all about what the Fed does at the end of June and after. Hike 50? Maybe. But that will depend on the data and there are loads of data between now and June30. It is just as plausible that the Fed pauses by June30, depending on the data. Okay I can't rule out the Fed moving between meetings to stay ahead of the curve, but not even the biggest inflation worriers are producing economic forecasts that would drive between meeting tightening this year.

Oh by the way ask GM about pricing power.

Most monetary economic theory is based on how authorities influence money supply and economic activity by changes in official rates or some element of market liquidity. This is the watch what I do world of monetary economics. Greenspan's legacy is watch what I say not what I chapter in monetary economic theory (ad hoc and controversial). Greenspan is not eager to kill inflation before it makes an appearance by stepping up the pace of rate hikes. Rather he has given his blessing to higher market rates (deliberately moving them up) with carefully crafted wording of the FOMC statement. Policy by words. This is far easier to take back if the economy weakens say behind record oil prices, or softening in the housing market due in part to higher long-term rates than say Fed funds hikes of 50bps a move. What is remarkable is how slow the Fed has been in ending accommodative policy...deliberately slow. And by its own admission policy is still accommodative. In traditional monetary economics if the world looked more inflationary, the appropriate response would be to do more than what you have been doing. For Greenspan this is making the inflation assessment conditional and noting higher inflation pressures. And again talking yields higher. But for the rest of the monetary world this would mean hike half a point and declare risks to price stability are tilted upward.

Why all this room to maneuver behind language? Greenspan maintains maximum flexibility. All the fine tuning can be achieved via language (testimony, FOMC statements and "off-the-record" meetings with select journalists). One can only guess how fast the phone would ring if the Chairman accelerated the pace of tightening...this is the President Alan, what are you doing? For better or worse Bush is arguably the most opinionated president of any Greenspan has had to work with and the most difficult to please. I can think of no other president whom Greenspan has had as easy a time keeping content on monetary policy...Clinton was a distant second.

But apart from a desire to fine tune his way around Washington politics andthe more cumbersome tool of Fed funds rate (or the reserve requirement...this used to get changed), there is the Greenspan legacy. How many more FOMC meetings does he have left before leaving? Seven? Eight? He does not want to leave the Fed with the economy would be like Barry Bonds' home run records. An economy with a little bit of inflation is far more acceptable. So no bludgeoning of inflation with half point rate hikes even as you see and believe inflation is picking up. Instead the power of the word to shape the yield curve. But by walking softly on inflation without any big stick in itself exudes uncertainty, cautiousness and fear of economic pain. Paul Volcker. Old school. He only had a big stick when it came to inflation. Yeah he had lots of inflation and inflation expectations to crush (Greenspan should dedicate his memoirs to Volcker...but never would) compared to Greenspan.

Pardon my indulgence into why it is what it is...nothing to make money on.

So back to accepting this world, and to the point of what it is means. Greenspan endorsed higher market rates by altering the statement on inflation and making the risk assessment a conditional balance. This will put (has put) Treasuries under pressure, emerging mkt trades and currencies under pressure and carry trades under pressure (latter two have concentric circles). Stocks should suffer too because bonds are pricing in more inflation now that the FOMC has said there is more inflation. And the dollar should do well versus the majors. Keep in mind the credit spread trade should widen out (weaken too) and this could see flight to quality in buying of Treasuries, though not initially. Markets will remember today's statement and volatility. The cyclical story will get stickier. The payroll data for March are out a week from Friday and this too will make the US cyclical story sticky. As much as I do not like the dollar for structural reasons, the dollar has some upside ahead...lots of leverage in carry and emerging trades could get washed out as well (my bet is the statement falls short of a major market risk aversion trade...important but not monumental). But I suspect that the Chairman leads markets back in from the inflation ledge in the not too distant future as oil, housing and higher borrowing costs take their toll.

David Gilmore


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