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Tuesday May 4, 2004 - 17:13:39 GMT
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Self Indulgence - Why The Fed Should Hike

Self Indulgence - Why The Fed Should Hike (FXA)

Okay I am practical enough to not call for a Fed rate hike today. But I can't help but get a tad self-indulgent and say why the Fed should hike 25 basis points today. First of all the Fed has the Funds Rate targeted to 1.00%, a 46-year low. It really should be in a bind over having to explain why rates are still this low this late into the recovery should be guiding the current Fed policy debate among market participants. Instead the Fed is preoccupied with trying to convince markets that removing patience from the statement today does not imply any change in the Fed's urgency to tighten. And for every 1 person who dares to say the Fed is behind the curve on monetary policy, there are 9 who think the Fed has it right once again.

For goodness sakes with Fed funds at 1.00% and data indicating labor market is strengthening, input prices rising and firms demonstrating some willingness to raise prices, the Fed should lay down the gauntlet today and hike. Show some leadership. Spoon feeding monetary policy to the markets under the guise of transparency and expectations management reminds me of all the over parenting of kids I see these days (every minute if the week filled with planned activities, educational strategies finely tuned and little sign of self-reliance or independence upon exiting the household).

Greenspan simply thinks he knows what is best in all conditions and at all times and that markets can only handle parts, but not the whole, truth. Truth about the data (highly random even within trends, making monthly forecasting laughable), truth about Fed forecasting record (as dismal as the markets' record) and truth about policy (the Fed has no better idea where funds should be than markets).

As such a rate hike today would represent a break with the Fed's borderline neurotic approach to making monetary policy. It would demonstrate that the market can handle the truth. Or in the parenting analogy, that the child can entertain himself and organize play independently. Moreover, a rate hike today would take the monthly focus on payroll growth somewhat off the table as the key trigger factor for Fed policy (rate hikes and expectations management). Pinning policy to a monthly data series that is riddled with randomness, significant revisions and questionable statistical significance (300,000 rise in non-farm payrolls represents about 0.2% of the workforce) is misguided. Look at the last two years of FOMC statements on labor market conditions. The correlation with the latest payroll release is strong...as if payrolls captures the entirety of labor market conditions monthly. By not tightening today, the Fed is emphasizing the importance of Friday's release of April payrolls. In other words the Fed could not dare hike today ahead of April payrolls. Talk about sending the wrong message and creating a red herring out of payroll data.

Perhaps the Greenspan "risk management" approach to monetary policy is no more apparent than in the Fed watchers effort to predict the Fed's message today at 215PM. The Fed removes patience, but also carefully words its message so as not to suggest impatience and a June30 rate hike. Yuck. I am nauseous. June30 is a lifetime away in terms of financial market
expectations, economic data and relevant events. Indeed this no longer patient but not impatient notion these hallowed interpreters of the Great One parrot will be quickly forgotten on Friday if say payrolls growth 200,000 or more. No I am not pretending to know what Friday's number will look like...remember I believe it can't be accurately forecast month-to-month and there is a high element of randomness created by measurement problems in the firm survey and seasonal factors in the adjustment process. But a strong number Friday would instantly put a June30 rate hike on the table and a follow-up Aug10 rate hike as well before any pause is anticipated.

The only explanation for the Fed's extreme caution when the economy is growing faster for the last three quarters than it has in any time in the last twenty years is that the Fed senses a deeper problem than simply getting the timing right for the first hike from four decade low in rates. It is a undisclosed fear that the credit markets (property market) are a bubble and unless perfectly finessed by the Chairman and FOMC, it could all end badly.

Still raising rates today by a mere quarter point to 1.25% is not likely to burst the credit market bubble. If anything it may help let the air out in a more controlled fashion, avoiding the feared spike in market rates and rout for the dollar. It would be a demonstration too of confidence in the recovery and could help firm and household sentiment. And it would reorient market thinking away from noisy data in isolation, like one month's payroll result. But then again this is Greenspan's Fed and no one knows better than Greenspan.

David Gilmore
FXA

 

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