Wednesday September 22, 2004 - 10:47:37 GMT
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Forex: FOMC Upgrades Growth, Jobs But Downgrades Inflation
FOMC Upgrades Growth, Jobs But Downgrades Inflation
FOMC statement today upgraded its assessment of growth and employment but downgraded its assessment of inflation. Clearly the long
end of the bond market welcomed the statement by rallying. Meanwhile the dollar, which was weak much of the day versus most currencies except the yen, fell noticeably, even breaking a key euro/dollar trend line from the high in February near 1.2300.
While I admittedly may be at risk of reading too much into the market reaction to the statement today, I did sense that the market is noticeably paying less attention to Greenspan's take on the economy (soft patch is behind) and relying more on its own take (soft patch is more like an extensive marsh with the economy still knee deep in muck and looking for the way out). Could Greenspan be losing his hold over the markets? It appears so, though hardly grounds for a divorce. It can be argued that the market chose to focus on the inflation downgrade rather than the growth upgrade. But surely markets are not buying the statement assertion that the impact of the rise in oil prices has largely passed noting lower bond yields (inflation expectations). I would argue that the impact of oil is still being felt (wait until winter and people see home heating oil prices). And that is the first round effects...impinging on consumer spending and sentiment. The second round effect of broadly higher prices is down the line. This is no time for complacency on not simply inflation but stagflation. Another assertion the statement makes is that labor market conditions have improved...as if the 144,000 gain in payrolls in August put Humpty Dumpty back together again. After the poor job performance in the spring and early summer, payroll data demand a critical eye that the Fed seems to not have deployed.
But to be fair to Greenspan, who we can assume authors the statement, his desire for surprise was not present in the wording of the statement. His early September testimony in the House of Representatives included the upgrade on growth and downgrade on price stability threat.
What does this mean for Fed funds ahead? Pretty much as it was laid out by Greg Ip of the WSJ a few weeks back. Phase one is getting Fed funds to 2.00% by year-end (could be 2.25% even) largely independent of incoming data. This will end the ultra accommodative stance that was put in place to check deflation through early 2003. Phase two will be getting funds rate to neutrality of between 3-5% based on incoming data.
Meanwhile the ECB is getting on board the rate normalization train. No G7 central bank wants to stare down $46 oil with official rates at record lows and despite a still uneven recovery. A rate hike by year-end is probable. And Japan? It looks like deja vu all over again...another false start. No wonder euro/yen is catching a bid, and this one should prove to be more than transitory.
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