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Posted by warren mosler (65.113.90.26) on 11:25:35 10/29/07
Subject: Fed countdown
Quotes from past Fed meetings:
'We don't want to turn a relative value story into an inflation story'
in reference to 'negative supply shocks' of food and energy.
'Core cpi indicates the Fed has successfully kept food and energy a
relative value story, at least so far.'
I tend to attempt to determine the Fed's 'best move' within their
theoretical framework. If they do something different, I look at how
they look at the results of their actions, and them move on to the
next decision.
On Sep 18 I thought their best move was to leave the fed funds rate
unchanged and cut the discount rate to at least the ff rate, and
remove the stigma from using it.
Instead, the cut both the ff rate and the discount rate 50, to
'forestall' which to me meant they were in uncharted waters and were
concerned a major meltdown was possible, such as some kind of general
run on the banking system that may have shut it down.
Given this condition of facing 'extreme unknowns' a few of the fed
hawks sided with the doves and agreed to cut 50 as 'insurance' just in
case, etc. with the notion that they would be quick to take it back
presumably if the credit crunch stabilized.
The economics and inflation issues remain as outlined in my 'recap'
from a few days ago. Since Sep 18 the economy has been shown to be
substantially firmer than subsequently modified numbers were
indicating before that meeting. The banking system didn't shut down
and the credit crunch is not now what it was then, though risks
remain, as they always do and always will. Bank losses have been
minimal, and equities remain firm around the world. Yes, housing is
weak, has been weak, and will continue weak, but at least so far
exports have made up for the lost demand.
Meanwhile, the hawks have to be alarmed by the insurance premium they
probably feel they paid regarding inflation- food, energy, the dollar,
and (headline) cpi on a steady tear towards 4%, as markets now have
priced in a series of additional ff cuts, and markets also presume the
Fed considers it too risky to disrupt the markets by not cutting, and
thereby risk a 'liquidity' relapse.
Given this, I again see the Fed's best move this week is to leave the
ff rate unchanged and cut the discount rate to the ff rate.
When they discuss this possibility, they will expect the term
structure of interest rates as well as equities to adjust, the $US to
firm, and commodities to moderate. They would also assume a positive
influence on inflation expectations. The discount rate cut and
removal of the stigma should result in the further converge of ff and
libor, and markets continuing to function. Leaving ff unchanged will
also nip in the bud the notion that market expectations limit options
for the Fed's next next moves.
A rate cut at the meeting will be problematic for the hawks. The last
thing they want to do is support demand in the face of negative supply
shocks and increase the risk of turning a relative value story into an
inflation story, which carries far higher risks to output and growth
(in their theoretical framework).
While this is my take on the Fed's best move it is not a prediction.
The results of the last meeting showed the Fed is now highly
unpredictable, and may want it that way.
The unknown is the same 'fear factor' that drove the inflation hawks
to cut 50 in the face of $80 crude and a weak $. Now they are looking
at $92 crude, $800 gold, and an even weaker $US.
And it's not the economy that drove them to cut on Sept 18, it was
about the financial structure.
Comments welcome!
warren
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