Tuesday August 8, 2006 - 19:13:20 GMT
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Fed Pauses, But Elevates Inflation Alarm
If the Fed were the Department of Homeland Security, it just went from a code yellow to code orange (for those who forgot...highest security threat is red followed by orange followed by yellow).
This is what is real meat and potatoes of the statement. The Fed paused as was widely expected. But it noted very distinctly that core inflation was picking up momentum since the June 29 statement as well as high capacity utilization rate and high energy and commodity prices. In the June 29 statement, the Fed simply concluded that some inflation risks remain...far more confident assessment.
So the Fed is pausing when core price pressure are building and this poses an asymmetric risk.
However, the Fed's growth assumption is for sufficient slowing to check even the more recent up tick in core inflation. In other words the fed is confident that past rate increases and first round energy price effects will slow consumption and bring even higher than forecast inflation back down.
My read is the statement is hawkish. That said the Fed is also operating on the assumption that it has enough in the pipeline to handle even the latest inflation development, suggesting the basis for a more prolonged pause. I have said for days that surely the Fed would move to a pause only if it felt that it was to last for more than one FOMC meeting, otherwise it would not be undertaken...there would be little meaning to Fed pause if say the Fed came back and hiked in September. I am not ruling this out, but it is highly unlikely. If the Fed forecast assumptions (growth and inflation) are proven wrong, then it could come back in October to hike without losing face.
I think the market will settle on the statement being bearish for the dollar in as much as traders will accept the Fed's core view on price pressures - contained (inflation expectations stated as contained). Where the dollar can find a bid in the next 12 weeks, all else being equal, is on data suggesting the Fed's assumptions on growth and inflation are off the mark. So we are still living to some extent in a world of uncertainty and data point to data point.
Final point is that the Lacker dissenting vote for a 25bps rate hike likely represents more than simply Lacker dissenting. As is custom, the minority often concedes and votes with the majority to demonstrate unity of view while the dissenting group can be represented in a single dissenting vote.
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