Wednesday August 11, 2004 - 16:41:35 GMT
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Forex: Fed Sails Toward September Rate Hike
Gee if only oil prices would come down then the economy would be on the Greenspan saddle path to eternal prosperity. While the FOMC statement is not a complete display of intellectual dishonesty, it is pretty darn close. Blaming all the US economic maladies on oil and at the same time maintaining the rise in the price of oil is transitory is incredulous. How many months before oil north of $35 a barrel goes from temporary to minimally quasi-permanent? Moreover, the duration of the rise becomes irrelevant if it is resulting in a significant slowing in growth.
But what about other factors generating the headwind for the expansion? For starters there is a sluggish stock market (down on the year) running at high historical valuations. Also cheap money in the last two years has turned future consumption into current consumption and this is now fading (with or without higher rates). Furthermore fiscal policy stimulus is going away this year without new legislation. And the terror threat creating uncertainty for households and firms (and oil is up for more than geopolitics...world demand is up or is China just an illusion) is dampening sentiment and spending. It is also worth mentioning the heavily indebted public and private sectors (households more than firms)...arguably all borrowed out, all spent out.
The Fed is sailing a course toward a September21 rate hike come hell or high water...well almost. Why? Because the firebreak it built around deflation and never really needed has put the Fed in the unacceptable corner of negative real Fed funds rate nearly 40 months into a recovery and a keen desire to normalize rates even with output and the labor market flagging. Frankly the Fed is where it is because of the last two rate cuts in 2003 and failure to hike May04.
Will another soft jobs report for August and still elevated oil prices force the Fed to hold off September21? Probably not. In other words it will take a very weak August payroll result to get the Fed to hit the pause button in September. Data matters for sure but not that much. This is about getting rates up to check future (potential) inflation. Otherwise the Fed pause button will not be hit until funds target is lifted to 2.00% minimum.
I suspect the Bush administration will be comfortable with the Fed tightening today...it is a sign of a strong economy. But admin patience with the Fed will be exhausted quickly if the August payrolls post another stinker of a number.
My problem with the Fed's approach is more practical than theoretical. And my bet is the Fed will find ignoring the growing headwinds this expansion is now facing will be increasingly difficult.
I see risks for the dollar and bonds if investors, especially foreign ones, question the ability of Greenspan and the FOMC to get it right. So far its forecasting record on employment, prices (oil) and growth are mediocre at best and not a confidence builder. Saying the rise in oil prices is transitory is highly presumptuous. And former Fed Governor Meyers was onto something today when he told CNBC that stagflation is a significant risk. And we have a Fed intent on tightening. This could prove a dangerous cocktail.
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