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Apr-25-2008Vital Signs: The Fed's Next Move(topic overview)
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Monetary policy "hawks" like Dallas Federal Reserve Bank President Richard Fisher have repeatedly warned about inflation risks. Fisher said on Tuesday that Fed policy was not getting much "bang for the buck" to explain why he has dissented from recent cuts. The Fed has cut its fed funds rate by three percentage points to 2.25 percent since mid-September to shield the economy from falling U.S. house prices, rising mortgage defaults, and a global credit squeeze since last summer. [1] How much cheaper should the Federal Reserve make borrowed money? Amid the bleak news still dominating the financial world and a darkening economic view across many business sectors, the latent inflation threat is forcing monetary policy makers to confront the question. The Fed is widely expected to cut its benchmark interest rate by a quarter of a percentage point next week -- a typically moderate policy move for the Fed but one that would.[2] Since last September, the Fed has reduced the federal funds rate by 3 percentage points -- a large change by historical standards. The decisions to make these rate cuts have not been unanimous, which raises the question: Why? To answer that question, we must understand the Fed's role and its past policy decisions. Congress has given the Federal Reserve two sometimes conflicting mandates: It should maximize economic growth and restrain inflation. The former apparently requires low interest rates; the latter, high ones.[3]
The steep rise in commodity prices of all sorts has some investors using the b-word. In a recent video interview with Money Magazine, billionaire investor George Soros said that "a new bubble is developing in commodities" and that this is leading to rising food costs and other inflation pressures. That's one way of looking at it. Another way is to note that with stock markets muddling along and house prices falling sharply in the U.S., the U.K. and Spain, the easy money set has been left with few other winning trades. "The guys who screwed up the mortgage markets are bringing their awesome skill sets to bear on physical commodity markets," Simons quips. Hamilton believes these investors are buying commodities in part because of Bernanke's rate-cutting spree. The Fed has cut its key federal funds rate to 2.25% from 5.25% back in September. At its current level, this overnight lending rate is below the annual rate of consumer inflation - creating what economists call negative real interest rates. Negative real interest rates give investors an incentive to buy goods like oil and gold rather than watch their cash lose its purchasing power.[4] The specter of global inflation has caused a shift in expectations for the central bank's next decision on interest rates, which will be announced next Wednesday. The futures market was recently pricing in a 96% chance of a 25-basis point cut to the fed funds rate, and a number of economists predict the Fed will halt its series of rate cuts after its April meeting. "After next week, they're going to be in a wait-and-see mode," says Ryan Sweet, economist with Moody's Economy.com. "More likely than not, they're going to leave the fed funds rate at 2% and see how the economy rebounds in the second half of the year."[5] Between late-January and mid-March, America's central bank slashed short-term interest rates by two percentage points, to 2.25%, as it staunchly sought to cushion America's economy from the fallout of the credit crunch. Earlier this month, Fed funds futures indicated that financial markets expected the trend to continue, with at least a quarter-point cut on April 30th and a 50% chance of a half-point move.[6]
The alacrity with which the Fed has cut, especially in the past three months, and the continuing bleak economic consensus for the U.S. have seemed to suggest that the rate reductions would go on for a while yet. Most financial market economists assumed that the central bank would reduce the funds rate several more times over the coming months, with a sizeable number of analysts expecting short-term rates to go as low as 1per cent by the fourth quarter of this year.[7] Harvard University economist Martin Feldstein, who for almost 30 years has headed the group that decides the dates of recessions, called for an end to Fed rate cuts. Investors are increasingly taking such talk, along with economic data and company earnings, as signs that the Fed will leave interest rates unchanged for the rest of the year after a quarter-point cut on April 30. The central bank has already reduced rates three times this year, to 2.25 percent.[8]
While the Fed has cut rates by 3 percent - or 300 basis points, in Wall Street lingo - the average rate on a 30-year fixed-rate mortgage has fallen very modestly. These mortgages recently averaged 5.88 percent compared with 6.17 percent last year. That's a drop of only 0.29 of one percent, or 29 basis points. The Fed has cut the interest rate it controls 10 times as much as banks have cut what they charge would-be homeowners. That's not even the biggest problem.[9]
Yesterday's ECB signals that interest rates will remain at least on hold or perhaps be raised in case inflation gets to uncomfortable levels has been somewhat offset by the fact that Fed watchers no longer expect a half point cut next week, and even a quarter point is beginning to look less than certain. According to Bloomberg, it is becoming apparent that: "Federal Reserve policy makers, sensing both renewed inflation dangers and a possible economic boost from government rebate checks, may be nearing a pause in interest-rate cuts after the fastest reductions in two decades. In remarks this week, Fed Governor Kevin Warsh, San Francisco Fed President Janet Yellen and three other district- bank presidents voiced concerns about rising prices.[8] Since last August, Bernanke (54) has twice cut interest rates by 75 basis points, made Federal Reserve loans available to investment firms for the first time since the 1930s, lowered the rates at which banks can borrow from the Fed and launched an unprecedented rescue of Bear Stearns, the struggling investment bank. (A basis point is 0.01 percentage point.)[10] WASHINGTON -- The Federal Reserve is likely to cut its short-term interest rate by a quarter of a percentage point next week -- but then may be ready for a breather. The Fed, meeting Tuesday and Wednesday, is likely to make what would be its seventh cut in eight months.[11] THE vast majority of experts still think the Federal Reserve will reduce interest rates next Wednesday, but this time the betting is for a modest quarter-point cut. There is a growing sentiment - now 18 percent, up from zero in recent weeks - that the Fed might call a halt to its monetary stimulus.[9] The Federal Reserve will hold a policy-making meeting Tuesday and Wednesday. With signs of stability, the Fed is expected to cut interest rates only slightly, if at all, a shift from its large cuts through the first three months of 2008. "We're going to find out whether or not we fell into recession, how severe it's going to be, and how the Fed is dealing with it," said Richard Yamarone, chief economist of Argus Research. "This is going to be a huge week."[12] After weeks of signaling a preference for sharp cuts in interest rates, Wall Street is sending the Federal Reserve a new message: It's O.K. to be a little less aggressive now. Based on futures contracts as of Apr. 23, the probability of only a quarter-point reduction in the Fed's target rate, to 2%, at its Apr. 30 meeting was 84%, with no chance of a half-point move and even a few bets for no change.[13] TOKYO (Reuters) - The Federal Reserve is likely to cut interest rates by a quarter percentage point at a policy meeting next week but may then be ready to take a break, the Wall Street Journal's online edition reported on Thursday.[14] WASHINGTON (Reuters) - The U.S. Federal Reserve may put monetary policy on hold after cutting its benchmark interest rate by a further quarter percentage point next week, though it may publicly retain a bias for further easing.[1]
WHILE the European Central Bank and Bank of England have been reluctant to cut interest rates aggressively to ward off the worst effects of the financial market turmoil of the past year, the U.S. Federal Reserve has shown no such caution.[7] Lower interest rates could raise the already high prices of energy and food, which are already triggering riots in developing countries. In order to offset the inflationary impact of higher imported commodity prices, central banks in those countries may raise interest rates. Such contractionary policies would reduce real incomes and exacerbate political instability. lowering interest rates stimulates economic activity to a point at which labor and product markets cause wages and prices to rise. That is unlikely to happen in the U.S. in the coming year.[15]
Rising overseas inflation may soon pressure other central banks to raise interest rates, which would add to the downward pressure on the dollar, further muddying the U.S. inflation outlook and complicating the Fed's policy decisions.[13] Rate cuts are killing the value of the dollar as well as America's reputation; causing a sharp rise in inflation, including commodities like gasoline, and bringing monetary policy to the brink of impotency. The heat is coming especially from Europe, where their central bank has been refusing to go along with the rate cuts - although injecting plenty of money into the financial system - because it, unlike our Fed, fears inflation more than economic stagnation.[9] "But we must be careful to not ask policy to do more than it isrightly capable of accomplishing." Warsh's remarks echo those of other economists -- inside and outside the central bank -- who are concerned that the Fed's aggressive rate-cutting moves are subject to distinctly diminishing returns as financial institutions deal with the detritus of the sub-prime mess. None of this means the Fed will not cut rates again when its policy making committee meets next week, as the market currently expects.[7] A quarter-point cut in the funds rate to 2 per cent seems more or less guaranteed and the central bank has done nothing yet to steer financial markets in a different direction. Don't be surprised if the Fed statement next week hints that this seventh rate cut may be the last.[7] Financial markets remain fragile, as does the outlook for the overall economy, in the view of Fed leaders. They will remain ready to cut rates again if the crisis in financial markets returns or if the economy appears to be falling into a deep recession, rather than the mild one implied by economic data of recent weeks. If conditions remain comparatively stable, as they have this month, then the Fed would be reluctant to cut the federal funds rate to less than 2 percent. It is currently 2.25 percent.[12] Because some Fed officials are concerned that lowering interest rates could add to inflationary pressure with little benefit for growth, the option of standing pat is also likely to be on the table, it said, without quoting a direct source. "If it does cut rates, the Fed could signal in the statement accompanying the decision an inclination to pause and assess the impact of its cuts, which have lowered the federal funds rate to 2.25 percent from 5.25 percent since last year," the newspaper said.[14] Two policy makers who have been strong supporters of lower interest rates hinted last week at a change of heart. Janet Yellen, president of the San Francisco Fed, suggested for the first time that she thinks rates might not have to go much lower. In a speech in California last week, she described the current Fed rate as "accommodative" and suggested the current low level of interest rates, combined with the tax cuts that will start to feed through to consumers in the next few months, might be enough for now. She said: "Such accommodation (is) an appropriate response to the contractionary effects of the ongoing financial shock and the housing downturn and I anticipate that the resulting stimulus, combined with that of the fiscal package, will foster a moderate pick-up in growth later this year."[7]
The shifting sentiment doesn't mean the Fed thinks the worst is past for the economy. It is almost certain to signal continued concern about economic growth and a willingness to cut rates further if the outlook worsens. Officials would like to see whether their rate cuts, the Fed's other steps to lubricate credit markets and imminent tax rebates help produce a second-half recovery. While they think inflation is headed lower over the next year, they are sensitive to the risk that additional rate cuts could stoke inflationary psychology. Once embedded, such psychology can make a temporary rise in inflation permanent.[11] Reports are expected to show the economy continues to weaken, but some policymakers fear that more rate cuts could fuel inflation. Given the success of the Fed's various lending facilities in boosting liquidity and calming anxiety in the credit markets, especially since the Bear Stearns ( BSC ) crisis, most economists are betting policymakers will cut their target rate by a quarter-percentage point, to 2%, on Wednesday, Apr. 30, while issuing a statement (due at 2:15 p.m.) that continues to emphasize the downside risks to the Fed's outlook for economic growth.[16]
Coming after three interest rate cuts, totaling two percentage points in only eight weeks--for a total of three points since September--a return to gradualism at the Fed would be a milestone. It would suggest the Fed's work for this policy cycle is winding down. Some analysts and policymakers believe the moment is near when the Fed can shift its policy priorities from shoring up a frail economy to assuring inflation stays under control. Even within the Fed, policymakers have voiced concern about the U.S. inflating its way out of its problems. Dallas Fed President Richard Fisher, one of two policymakers who dissented from the size of the Fed's Mar. 18 rate cut, indicated on Apr. 17 his "very strong reluctance" to further easing.[13] Jimmy Carter'''s tenure as president was marked by interest rates as high as 18 percent, with double-digit inflation. It was Mr. Carter who nominated Paul Volcker as chairman of the Fed in 1979; he tightened the availability of money and succeeded in lowering inflation to 1 percent by 1987. The timing, though, coming near the end of his term, meant that Ronald Reagan, not Mr. Carter, got credit for the fixed economy. George H.W. Bush was elected in 1988 on the strength of that economy, but when it faltered in 1991 and 1992, Bill Clinton persuaded voters he would "focus like a laser" on fixing it again. Mr. Reich has said that the Clinton administration consulted with Fed Chairman Alan Greenspan early in the first term, and Mr. Greenspan told the president to make deficit reduction a priority before tackling other policy initiatives such as health care reform.[17] During the Greenspan-Bernanke era the Fed has embraced the view that stability in the economy and stability in prices are mutually consistent. As long as inflation remains at or below its target level, the Fed's modus operandi is to panic at the sight of real or perceived economic trouble and provide emergency relief. It does this by pushing interest rates below where the market would have set them. With interest rates artificially low, consumers reduce savings in favor of consumption, and entrepreneurs increase their rates of investment spending.[18] The Fed's past decisions to opt for money tightening probably reflected an extreme anti-inflationary bias at a time when memory of the 1970s' "great inflation" was still fresh. That memory seems fainter and less influential today, given the Fed's dramatic interest rate cuts in the wake of climbing oil prices.[3]
The latest indications from the various regional purchasing managers' surveys suggest that production might actually be edging back up. Inflation pressures continue largely unabated, with the surge in global food prices strengthening the voices of those within the Fed who have been arguing the central bank should hold off from further rate cuts for fear of adding fuel to the flames. Wall Street's reporting season is in full swing and this too has contributed to a sense that perhaps the worst is past.[7] One economist believes Bernanke could reap huge benefits simply by standing pat. By holding the line on rates, the thinking goes, the central bank's policy-making committee could send the prices of oil, gold and other goods tumbling - while serving a timely reminder that the Fed isn't letting inflation out of its sights.[4] The nation's central bank, writes Greg Ip, may be close to ending rate cuts for now. This is the first sign that U.S. officials are worried about the plunging dollar and may be willing to do something about it. Fed officials have Ip's ear, and when he writes about what they're "likely" to do, it's almost as good as hearing Bernanke say it himself.[19] Futures markets anticipate the Fed will cut the rate a quarter percentage point next week and then stop at 2%. The European Central Bank, meanwhile, is holding its key rate at 4% and shows no signs of preparing to cut it. For the first time in months, the economic outlook confronting officials will be little changed from their prior meeting.[11] The Fed has cut rates six times in the past seven months by a cumulative total of 300 basis points. With its latest rate cut last month, the central bank has taken the Fed funds rate down to 2.25 per cent, its lowest level in four years.[7]
Now the Fed is warning that there's only so much a central bank can do: "Monetary policy alone could not address fully the underlying problems in the housing market and in financial markets." That is the Fed's way of introducing the new guiding principle of our economy: Have high hopes, but low expectations. Last week the International Monetary Fund added to those low expectations when it announced that the global banking and financial system would suffer losses of about $1 trillion due to the mortgage crisis and that "systemic risks have risen sharply." If the IMF estimate is even close to correct, this will make our current problems the most expensive financial crisis in history, according to the Financial Times.[20] Paulson endorsed the Fed's moves to stabilise the economy and proposed the central bank be given a permanently expanded role as watchdog over the entire financial system, including commercial and investment banks, insurance companies, hedge funds and mutual funds.[10]
Ben Bernanke has a lot in common with the next president. The pinnacle of his career will mostly involve cleaning up someone else's mess. When he took over as chairman of the Federal Reserve Bank in 2006, Bernanke stepped into a quagmire so deep and wide that he sometimes has that stunned, wide-eyed look of a drowning man. Meanwhile his predecessor Alan Greenspan is telling anyone who will listen that it's not his fault that the economy might slide into a crippling recession and that the nation's financial system is teetering on the edge of systemic failure. Greenspan is worried about his place in history and the yet-to-be-written books that will trash his record as America's economic steward. Even Paul Volcker, the stern and widely revered Fed chairman who preceded Greenspan and wrestled inflation to a standstill in the 1980s, has lately been wagging his finger at Bernanke for orchestrating the rescue of Bear Stearns and at Greenspan for his Wall Street boosterism that helped to get us in this mess.[20] Paul Volcker, the former Fed chairman who slayed inflation in the 1970s by cranking up interest rates -- despite howls of protest on Wall Street -- said in a recent speech at the Economics Club of New York that the U.S. dollar is in "crisis" and inflation is a concern.[5] The only one who can really save the dollar now, is Bernanke. All he needs to do is indicate that the rate cuts are over and the bleeding will stop. Bernanke has already cut the Fed Funds rate from 5.25 per cent to 2.25 per cent since September. (way below the 4.1 per cent rate of inflation) It's clear that he sees a deflationary tidal wave about to hit sometime in the next few quarters. Why else would he slash rates so aggressively. Last week, former Fed chairman Paul Volcker took the unusual step of publicly chastising Bernanke in a speech he gave to the Economic Club of New York.[15] Martin Feldstein, chairman of the Council of Economic Advisers under Ronald Reagan, joined Volcker in blasting the Fed and calling for an end to the rate cuts. "It's time for the Federal Reserve to stop reducing the federal funds rate, because the likely benefit is small compared to the potential damage.[15]
Credit remains unusually tight despite Bernanke's cuts to the Fed Funds rate or the creation of various "auction facilities" that remove mortgage-backed securities (MBS) from banks balance sheets. Businesses and consumers are still having a hard time getting funding, which means that the velocity of money in the financial system is decelerating rapidly and this increases the likelihood of a system-wide freeze-up.[15] Bernanke's critics have only been emboldened by the Fed's aggressive response to the current credit crunch. While six rate cuts since last summer and expanded lending plans have helped forestall a broader financial crisis, they haven't quieted skeptics who fear a sharp rise in inflation.[4] A month ago, the market saw 100% odds of a 50-basis point cut and 64% odds of a 75-basis point cut. The shift has come as the stock market has clawed back from its 52-week low and credit fears have eased, but economists say the decline in odds of a rate cut has more to do with rising signs of inflation and fears that further monetary easing from the Fed will allow prices to spin out of control.[5] Richard Fisher and Charles Plosser dissented from the Fed's decision to lower rates by 75 basis points in March, preferring less aggressive action at the meeting. The Fed minutes from its March meeting revealed that both men dissented out of concerns that expectations for inflation in the U.S. economy will become "unhinged" as the dollar drops in value while commodity prices rise.[5] Even while downside risks to the economy persist, officials remain unsettled about inflation. While they expect rising unemployment to put a cap on wages and prevent a wage-price spiral, they worry that inflation fears may be feeding a fall in the dollar and the rise in commodity prices, and that further rate cuts could aggravate that inflationary psychology. More fundamentally, officials want to give the actions they have already taken time to boost growth.[11] The U.S. economy is likely in recession, and while the inflation rate is high, a leveling off of commodity prices and rising unemployment should bring it down.[21]
The general weakness of the economy will keep most wages and prices from rising more rapidly.But high unemployment and low capacity utilization would not prevent lower interest rates from driving up commodity prices. "Lower interest rates induce investors to add commodities to their portfolios.[15]
U.S. short-term interest rate futures show that investors see a roughly 80 percent chance of the Fed lowering interest rates by 25 basis points to 2 percent next week, and a 20 percent chance that the Fed will hold rates steady.[14] The Fed has tried to attack the problem of elevated Libor with targeted moves, as have other foreign central banks, though the situation would offer a reason to cut interest rates next week.[12] One week ago, the market was priced for 40% odds of a 50-basis point cut, which would have brought the Fed's key short-term interest rate target down to 1.75%.[5]
Many U.S. loans, including adjustable-rate mortgages and business debt, are tied to Libor, leading to higher interest rates for some Americans despite Fed rate cuts.[12] The private sector will not be a big player in the housing market for the foreseeable future. The same is true in the U.S. If the Fed can't bring Libor down with interest rate cuts, then it will have to develop a back-up plan.[15]
As Greg Ip reports, the officials likely will cut U.S. interest rates a quarter of a percentage point, but a bottom in rates may be in sight.[21]
Within weeks, deteriorating market conditions forced the Fed to signal a resumption of rate cuts. "They can't give the all-clear signal, but they can say there's a presumption in favor of a pause" in rate cuts, said Laurence Meyer, a former Fed governor now at economic forecaster Macroeconomic Advisers. A gloomy outlook figured in the Fed's decision to lower its target for the federal-funds rate, which banks charge each other for overnight loans between banks, by 0.75 percentage point in March.[11] Prices on options markets indicated there is a 1-in-4 chance that the Fed will not cut that rate further next week, a 68 percent chance that it will cut that rate by a quarter percentage point and a small chance of a sharper rate cut.[12] Hamilton concedes that there are "a long string of other fundamentals" driving up the prices of oil and food, but believes a decision to hold rates steady would get "immediate feedback" in the form of a broad selloff in commodities. Hamilton notes that the price of gold fell from its all-time highs after the Fed cut rates by three-quarters of a percentage point back on March 18 - a steep cut that, coming on the heels of the near collapse of Bear Stearns ( BSC, Fortune 500 ), was actually less than some market participants expected.[4]
In an article found on CNNMoney.com entitled, "The Fed's golden opportunity," Fortune senior writer Colin Barr says some think Fed chief Ben Bernanke could halt the roaring commodities rally by keeping rates steady, but most think the Fed will cut rates again next week.[22] "The shifting sentiment doesn't mean the Fed thinks the worst is past for the economy. It is almost certain to signal continued concern about economic growth and a willingness to cut rates further if the outlook worsens," the newspaper said.[14] The Journal article also points out that a pause in rate cuts would not necessarily signal the end of the financial turmoil in the U.S. economy. "It is almost certain to signal continued concern about economic growth and a willingness to cut rates further if the outlook worsens," Ip wrote. The FOMC will announce its rate decision on April 30.[23]
Well, that sure doesn't sound good. How bad are things? If you listened to Bernanke's testimony before the Senate Banking, Housing and Urban Affairs committees, you heard him say "Clearly, the U.S. economy is going through a very difficult period. Among the great strengths of our economy is its ability to adapt and respond to diverse challenges. Much necessary economic and financial adjustments have already taken place, and monetary and fiscal policies are in train that should support a return to growth in the second half of this year and next year." Minutes of the Fed March 18 policy meeting were recently released and they paint a decidedly darker picture.[20] China's savings surplus and America's savings deficiency largely determine our trade imbalance with China. The U.S. Treasury should have learned this lesson after years of forcing the Japanese to adopt an ever appreciating yen, which destabilized Japan's economy without doing a lick of good for trade balances. Until the Fed dumps inflation targeting and the U.S. abandons its weak-dollar policy, inflation will rule the day.[18]
The frustration and fearfulness of the Fed rate cutters is nearly palpable. Usually they speak in nearly indecipherable jargon about economic growth, inflation, and what they're planning on doing with the short-term rates they use to control the flow of money into the economy.[20] Fed watchers said a statement due at the end of a two-day policy-making meeting on April 30 will be adjusted to acknowledge that although downside risks to economic growth remain the gravest peril, inflation risks are also a concern. "I think they will go to 2.0 percent (fed funds rate), make a note that inflation problems are on their minds, and leave the door open to more," said former Fed Governor Lyle Gramley. "the magnitude of the reduction will also indicate to markets that the Fed is a little reluctant to be as aggressive as it has been in the past," he said.[1]
A little over a week ago, investors had seen a roughly 50 percent chance of a deeper, 50-basis-point rate cut. Such market expectations have since disappeared, due to a series of warnings from Fed policymakers about the risk of inflation.[14] A willingness to pause in rate cuts could help reassure investors the Fed takes the inflation risk seriously.[11]
America's central bankers, too, are becoming more worried about inflation, Two members of the Fed's rate-cutting committee, Richard Fisher of the Dallas Fed and Charles Plosser of the Philadelphia Fed, who voted against a big rate cut at the last meeting on March 18th, were already worrying that inflationary expectations could become "unhinged". Lately even some doves, such as Janet Yellen of the San Francisco Fed, have sounded concerned.[6]
The world is awash in dollars which are steadily losing value. Pension funds and foreign central banks are diverting dollars into commodities rather than keeping them in corporate bonds or the sagging stock market. "Inflation is rising throughout the world due to dollar weakness, and the prices of such commodities as oil and corn have soared.As former Fed Chairman Paul Volcker noted last week, we are already in a "dollar crisis".[15] The oil price hit a new record of almost $120 a barrel on April 22nd. The same day the dollar fell to a new low of $1.60 against the euro after members of the European Central Bank's rate-setting council expressed concern that inflation in the euro zone might not fall sufficiently fast from its 16-year high of 3.6%.[6]
Dollar fell against the Euro yesterday and touched a new all-time low, after recent comments by European Central Bank officials stirred talk that the ECB\'s next move may be to raise interest rates.[8]
Take the issue of another reduction in interest rates. While the Fed has been diligently ratcheting down its funds rate - which is the amount banks charge each other to borrow money - those lower costs aren't being passed on to borrowers.[9] If the Fed had reduced interest rates to prevent oil-shock-induced output losses, it would have risked higher inflation.[3] True to form, the Fed has panicked again, pushing interest rates down and flooding the economy with liquidity.[18] The possibility of the Fed lowering interest rates to 2 percent next week and then pausing is in line with market expectations, market players said.[14] Lower short-term interest rates, which are a big factor behind the dollar's swoon, are the Fed's main weapon against a recession.[19]
"The housing recession and credit crisis is testing the limits of traditional monetary policy, so the central bankers are more likely to focus on the new lending facilities that have been created in an effort to relieve some of the pressure on interbank lending rates." The Fed has slashed its rate target by 300 basis points since the outbreak of the credit crisis last summer.[5] The Fed has also introduced a series of new liquidity management tools that have helped to ease some of the strain in credit markets, but conditions remain fragile, and short-term interbank funding markets are particularly stressed, muffling the impact of easier monetary policy. "I think the sense of the committee as a whole is that they are more concerned about growth. If what you're doing isn't really contributing to growth, there is not a lot of point in pushing hard if this aggravates inflation," Gramley said.[1]
Earlier, Kevin Warsh, a Fed governor, had suggested in a speech in New York that there were limits to what monetary policy could achieve in the face of the financial difficulties confronting the economy. "Fed policy -- both with respect to liquidity tools and monetary policy -- is partially offsetting the consequences of the liquidity and credit pull-back on real activity," he said.[7]
Fed governor Kevin Warsh said last week that as credit markets begin to operate more smoothly, more of the Fed's interest-rate cuts will filter through to the economy. "The problems afflicting our financial markets are indeed long-in-the-making," he said.[11] The Fed's aggressive response to the current credit crunch has brought six rate cuts since last summer and expanded lending plans to forestall a broader financial crisis.[22]
The reason: Some officials see a case for more insurance against a deeper recession. Others are concerned a cut could contribute to inflationary pressure with little benefit for growth. That means the option of standing pat will likely also be on the table. If it does cut rates, the Fed could signal in the statement accompanying the decision an inclination to pause and assess the impact of its cuts, which have lowered the federal-funds rate to 2.25% from 5.25% since last year.[11] Some think the Fed is partly to blame for the spike in commodity prices since rate cuts have helped to weaken the dollar.[4] When rates are low, portfolio investors will bid up the prices of oil and other commodities to levels at which the expected future returns are in line with the lower rates." Additional cuts will probably have negligible effect on housing and consumer spending, but they could be a savage blow to the dollar. It's not worth it.[15]
A broad measure of the money supply (MZM) reported by the Federal Reserve Bank of St. Louis increased at an astounding annual rate of 37.7% from the end of January until Mar. 24. With this money supply surge and February's price gains (from February 2007) of 4% for consumer goods, 6.4% for producer goods and 13.6% for imported goods, it's no surprise that inflation expectations have risen. It's also no surprise that the dollar remains debilitated, which makes Secretary Paulson's Beijing weak-dollar message so bizarre, particularly since it is based on an incorrect premise propagated by many prominent economists.[18] Some think that if Federal Reserve chairman Ben Bernanke holds interest rates steady, that could lead to lower oil prices.[4] When the Federal Reserve's Federal Open Markets Committee meets next month, the foremost topic of conversation is likely to be whether to continue lowering interest rates.[3]
YET another big rate cut: until recently that is exactly what many investors were expecting of the Federal Reserve's next policymaking get-together on April 29th and 30th.[6] April 24 (Bloomberg) -- The U.S. Federal Reserve may consider pausing from interest-rate cuts after next week because it is concerned about inflation, the Wall Street Journal said. Policy makers may indicate they are ready to pause in their statement next week, Greg Ip wrote in the newspaper.[24] U.S. Treasury Secretary Henry Paulson's blundering is becoming more breathtaking with each passing week. At the end of March he rolled out a grand plan to crown the Federal Reserve as the nation's new financial stabilizer. The Fed a stabilizer? That's who created the financial mess we're in. If this wasn't bad enough, Secretary Paulson then donned his cheerleader's uniform and encouraged Beijing to let the Chinese yuan appreciate against the greenback. All the while favoring in this fashion a debasement of the U.S. currency, Paulson proclaimed that we should remain calm and confident because the economic fundamentals are sound. He reminds me of the stockbroker who performed a valuable service to his partners by always being wrong.[18] McCAIN's Coalition: "Hey, buddy! Sell some volume of the Federal Reserve's Gold Bars to Middle East Muslim to generate U.S. dollar cash revenue for bailout; MORE Economic Stimulus Rebate Checks to American taxpayers once a while; McCAIN : "NO new tax hike"; start to grow and build our American national Biofuels storage-banks."[20]
With food and energy prices soaring around the world and the value of the U.S. dollar declining, financial markets are starting to ponder the limits of easy-credit policies from the Federal Reserve.[5] U.S. Federal Reserve has forgotten the most essential rule. They should first do no harm. In a rush to bailout the bankers from their self inflicted mortgage mess, Federal Reserve has seriously distorted the U.S. monetary system. In this week's graph are plotted the year-to-year dollar change for several Federal Reserve balance sheet items.[25]
In essence, Federal Reserve has reallocated money from Main Street to Wall Street. This massive shift of funds to Wall Street aways from producing sectors of U.S. economy has some strong implications.[25] The fate of the economy may be most influenced by a seven-member body that does not answer to the American voter. The Federal Reserve, observers such as former Treasury Secretary Robert Reich have said, is a largely unaccountable fourth branch of government.[17]
The event was a 2002 conference at the University of Chicago to celebrate the Nobel laureate Milton Friedman's 90th birthday. When Ben Bernanke rose to speak, he said that the Federal Reserve, of which he was then a governor, had come around to Friedman's view that the central bank's blunders were to blame for the Great Depression.[10] NEW YORK (Fortune) -- The soaring price of crude oil isn't good for most people, but it could spell opportunity for Ben Bernanke. The Fed chief's inflation-fighting credentials have been in doubt since he said in a 2002 speech that central banks could prevent deflation by dropping money out of a helicopter.[4] Widened credit spreads only began to narrow after the Fed aided JPMorgan Chase's JPM purchase of Bear Stearns BSC, which was on the brink of bankruptcy in mid-March, and extended credit to Wall Street investment banks through a series of new lending facilities under authorities the central bank had not exercised since the Great Depression.[5]
Bernanke, who hails from rural South Carolina, took office in February 2006 in the shadow of former Fed chairman Alan Greenspan, who held sway at the central bank for 18 years. Bernanke, a Republican, is now well on his way to becoming the most powerful Fed chairman ever.[10]
"You don't want to cut much more," said Dean Croushore, an economist at the University of Richmond who wrote a textbook with Fed Chairman Ben S. Bernanke. "It is time to think about the future.[12] Fed Chairman Ben Bernanke and his colleagues are unlikely to take rate cuts off the table entirely.[11]
Several prominent economists and even some Fed members have expressed concern that rate cuts are doing more harm than good.[9] Thanks to the rate cuts so far, there is a lot of monetary stimulus in the pipeline. The economy is about to get a fiscal boost, as millions of Americans receive their tax-rebate cheques in the next few weeks. Economists disagree on how much of this money cash-strapped and debt-laden consumers will spend, but it will doubtless provide some benefit.[6] As for the broader economy, the impacts of previous Fed rate cuts are only starting to ripple into Americans' pockets.[12] Investors are betting the Fed will cut rates when it meets again next Tuesday and Wednesday.[4] Expectations have shrivelled in recent days, and the price of Fed funds futures now imply that investors see no chance of a half-point cut and an almost 20% likelihood of no cut at all.[6]
The Fed is also still concerned about the risk that more rate cuts could fan inflationary expectations, the paper said.[24]
In some sectors. it is probably going further than is necessary." Another concern is that while stock prices and most corporate and household borrowing rates have declined in the past month, the London interbank offered rate, or Libor -- a benchmark rate at which banks lend to each other in offshore markets -- has moved sharply higher, reflecting increased reluctance by banks to lend cash they might need suddenly. Fed officials have mulled additional steps to combat this unwelcome condition. They could, for example, expand from its current $100 billion the size of their term auction facility, through which the Fed lends money directly to banks against a wide variety of collateral at a competitive rate for 28 days. They also could lengthen the term of such loans to three or six months. They would have to weigh the uncertain benefits of such moves against the distortions they would create in the credit markets.[11] First bar is for Reserve Bank Credit, which is essentially the change in Fed's total assets. It is monetary base from which money is created.[25]
The Fed was created in 1913 as a means of providing for a more "elastic" currency; that is, to expand and contract money supply to control the economy. The Fed was to be a safeguard against what had become frequent banking "panics," such as the one in 1907 that saw many Americans withdraw savings for fear of losing them, which in turn crippled banks.[17] Although America's economy is still heading downhill, the Fed's calculus about the benefits and risks of even cheaper money is shifting fast.[6] The Fed has appeared willing to run the risk of inflation in order keep the economy buoyed.[3] The Fed's strategy 1980s and '90s earned it considerable credibility as an inflation fighter. The Fed has been less successful in responding to negative supply shocks, such as spikes in oil prices, that raise firms' production costs and increase the risk of overall inflation.[3] Ip also said the Fed is concerned that further easing could aggravate rising inflation expectations as food and oil prices soar to new records.[23]
Now, Mr. Reich says, the Fed has decided that "the threat of recession is worse than inflation, so it'''s lowered interest rates." That move has devalued the dollar, which in turn contributes to the high cost of oil, gas and food. "Can you imagine if Congress caused this to happen?" Mr. Reich asks.[17] Most Fed officials are betting the weak economy will trump inflation. History is on their side: Inflation has always cooled after a recession, as pricing power ebbs and wage gains slow.[13] We worry that further delays induced by excessively accommodative policy will result in a vicious cycle of higher inflation, increased inflation expectations, reduced Fed anti-inflationary credibility, slower capital reallocations and, eventually, a weaker economy.[3] The Fed is also worried about rising inflation and wants to signal the bond markets that it hasn't fallen asleep on the job. It has a deteriorating economy to deal with.[19]
The optimal outlook for Wall Street and the Fed would be steady healing of the credit markets, nothing worse than a mild recession, and signs that inflation pressures are easing.[13] Bernanke is trying to thread the needle. This also suggests he believes the worst of the Wall Street credit meltdown may be behind us. The Fed, meeting Tuesday and Wednesday, is likely to make what would be its seventh cut in eight months.[19]
Editor's Note: Skyrocketing oil prices, the falling dollar, the credit collapse and mortgage crunch -- suggest to the author that Ben Bernanke has his work cut out for him holding the financial system together.[20] Bernanke's rate cuts were followed by the release on March 31 of a sweeping proposal by U.S. Treasury secretary Henry Paulson to revamp government supervision and regulation of the financial system.[10] From here you can use the Social Web links to save Next U.S. interest rate cut could last to a social bookmarking site.[7] The credit market problems cannot be solved by traditional interest rate cuts. They ultimately require an infusion of capital in affected institutions, and that is a fiscal and not a monetary issue.[3]
Sooner or later, we must shift our investment from housing to energy, and that shift will not be painless. Loose monetary policy might induce households and business to postpone making those changes -- but that will prolong and perhaps increase the total amount of economic pain. The FOMC's policy disagreements over interest rates reflect its members' different perceptions and preferences about how quickly such adjustments should be promoted via monetary policy.[3] Economists at Barclays Capital say soaring commodity prices partly reflect ultra-easy monetary policy. They calculate that global central-bank rates have been exceptionally low for five years and represent a level of policy ease not seen for that long since the 1970s.[13] The economist Paul Krugman does not think that "low interest rates and irrational exuberance" are responsible for the high prices. He thinks they are the result of "rapidly growing demand and constrained supply". This is certainly possible.[15] Low inflation -- and expecations of low inflation -- mean stable wages, interest rates and prices, all of which tend to encourage work, innovation and production.[3] Besides, lower interest rates don't necessarily increase demand or make credit more easily available. The only way to spark demand is to make sure that wages keep pace with production so that workers can buy the things they produce. That's the only way to create a prosperous economy, too; build a strong and well-paid work-force.[15]
Banks serve as the transmission point for credit to the broader economy via business and consumer loans. When they're bogged down by their own bad investments or when risks increase, rates go up and the whole process slows to a crawl.[15] The economy is showing some positive points. Some borrowing rates, held high by lender risk aversion, have begun to ease, such as on 30-year mortgages that are insured by Fannie Mae or Freddie Mac and for companies with strong credit quality.[11]
"How does that stimulate the economy," Redler asked, if the banks aren't passing much of the rate reduction on to consumers. "That's problem No. 1," said Redler, who volunteered that he has a strong 795 credit score and probably got a better deal than most people could get.[9]
Remember, our high household debt ratio -- 136 percent of income -- means tens of thousands of households are barely able to shoulder the monthly payments even when rates are low. The U.S. economy has lost at least 230,000 jobs since the start of this year. Meanwhile the number of people who stopped looking for jobs because they didn't think there were any out there rose to 401,000 in March.[20] As former chairman Greenspan put it, "We face new challenges in maintaining price stability, specifically to prevent inflation from falling too low." (Given the U.S. economy's productivity boom, the Austrians viewed the prospects of some deflation as just what the doctor ordered.)[18] You've heard of that fabled "soft landing" of our falling economy? Well, there are a lot of reasons we could lose altitude in a hurry. Consider these sobering facts: Oil now costs $117 a barrel and commodity prices across the board are hitting new highs. The dollar continues its steady downward retreat.[20] Employment has declined for three straight months, home construction is plunging, and retail sales are weak. Some things, such as food and oil prices, have gotten worse. Late Wednesday, Starbucks Corp. unveiled a weaker-than-expected estimate of fiscal second-quarter earnings and lowered its forecast for the year, with Chairman and Chief Executive Howard Schultz describing the economic environment as the "weakest in our company's history, marked by lower home values, and rising costs for energy, food and other products that are directly impacting our customers." Oil prices earlier this week reached a new high in futures markets of just under $120 a barrel.[11]
Mr. Meyer says the latest $10 increase in the price of oil per barrel would reduce economic growth by as much as half a percentage point. Its rise has hurt consumers as well as energy-sensitive industries such as airlines, which have seen their share prices slump and some small players file for bankruptcy protection.[11] Economists expect first-quarter economic growth to be essentially zero, perhaps either a small plus or a small minus. They expect consumer spending and business investment to post gains, but much smaller than in the fourth quarter, and they look for another very large drop in home construction.[16]
Financial markets are starting to function more normally, banks are raising billions of dollars in capital, and the latest economic figures, while weak, aren't much weaker than had been expected. Taken together, these signs of stability make for the calmest economic period the nation has experienced in months. Now economists are grappling with whether the crisis will continue to ease, or whether this is merely the eye of the hurricane, with more big problems coming soon. The Census Bureau said sales of new homes in March fell to their lowest level since the early 1990s, and the Commerce Department said orders for durable goods fell for the third straight month.[12] There have been several periods of calm in the last nine months -- in October and early February, for example -- but each gave way to more tumult. In the view of both private economists and Fed leaders, financial markets remain susceptible to hard-to-predict problems in the months to come, which could worsen the economic outlook in a vicious cycle.[12] In the Fed's defense, the current economic situation involves more than just an oil supply shock; the housing sector has weakened and the financial markets are suffering liquidity shortages.[3]
"The problems afflicting our financial markets are indeed long in the making," Kevin M. Warsh, a Fed governor, said in a speech last week.[12]
Stock prices, while gyrating, have risen 7% since the Fed's meeting last month as investors conclude all the bad news about loan losses for financial companies has been factored into prices.[11]
The Fed is likely to lower the federal funds rate from the current 2.25 percent at a two-day policy meeting that ends next Wednesday, the Journal said in an article written by Greg Ip, the paper's Fed reporter who is sometimes seen as reflecting the views of senior policymakers.[14] It'll still be months before we will really know whether the six rate cuts that added up to a 3 percent drop in the federal funds rate are doing much good. It could be even harder to figure how much May's tax rebates will help.[9]
Volcker's comments indicate the level of frustration with the Fed's dollar-savaging rate cuts which have caused problems around the world.[15] Volcker said "The recession is not the Fed's problem. It's the government's. The Fed's job is to defend the currency and fight inflation--exactly the opposite of what this Fed is doing." The former Fed chief thinks Bernanke should raise rates now, because if he doesn't, he'll have to raise them even more later, "with even more awful consequences."[15] Some think Fed chief Ben Bernanke could halt the roaring commodities rally by keeping rates steady.[4]
While Bernanke's attack on the U.S. economic malaise has been fierce, friends say the Fed chairman is anything but. "He is very even-keeled, with a pleasant demeanour, a level temperament,'' says Richard Newell, an economist at Duke University who studied under Bernanke when the Fed chief was chairman of the economics department at Princeton. "He's not inclined to hit one over the head with the depth of his knowledge -- that makes him an effective communicator.''[10] What started as a meltdown for subprime mortgages has turned into a worldwide credit and economic crisis. Bernanke, now the Fed chairman, has responded with the most aggressive expansion of the Fed's power in its 95-year history.[10]
Bernanke's Fed has already grabbed some of the power the Treasury proposes to give it by inserting itself into the back offices of the investment banks. "Since we've begun lending to dealers, including the remaining investment banks, we have put examiners on the ground in those firms,'' Bernanke told Congress's Joint Economic Committee in testimony on April 2.[10] Depreciating home values also cause lopsided bank balance sheets with too many non-performing loans eroding bank capital. Those capital losses are triggering cutbacks in lending to viable borrowers who, in turn, reduce spending on consumption and investment. This leaves the Fed with lousy choices.[3] A rising Libor puts the Fed and the Bank of England in a tough spot. They're trying to keep rates artificially low so the banks can increase their lending and recoup their losses, but the market is not cooperating.[15]
The Fed will have a good idea of what the economy looked like in the first quarter, given that the GDP data will come out on the morning of the Apr. 30 rate decision.[16] Fed Vice Chairman Donald Kohn recently described the tightening of lending conditions as "necessary" but said it is "accentuating the downside risks for the economy as a whole.[11] Pausing would signal that the Fed "takes the inflation risk seriously,'' the report said.[24] The Fed did that in October by saying weak growth and inflation were of equal concern.[11]
In the U.S., middle class families spend only 15 percent of net earnings on food. In poorer countries people spend upwards of 75 percent of their income just trying to feed themselves. That's why riots are breaking out everywhere; the Fed's monetary policy is a catalyst for political instability.[15] The next step would be "quantitative easing"; a monetary policy that was implemented by the Bank of Japan in 2001 "to revive that country's economy that was stagnant for a decade. Quantitative easing entails flooding the banking system with excess reserves, resulting in pushing the benchmark overnight bank lending to zero." (Reuters) There are indications that Bernanke is already preparing for this radical option, but there's little chance that it will succeed.[15] For the Austrians a stable economy might be consistent with a monetary policy that had prices gently falling.[18]
"The economy will be improving. The inflation pressures are only intensifying at this point.'' At last check the dollar was shown at 1.5897 against the euro and at 71.85 on the index, while oil was trading about $2 lower (at $117.87) than its all-time record high seen on Tuesday. [8] Wages are already slowing, and measures of inflation expectations remain tame. In this environment--so goes the argument--overall inflation, driven by pricier food and energy, will end up pushing core inflation lower as those costlier necessities cut into the purchasing power of incomes and reduce demand for other discretionary items. Inflation hawks, however, worry that history may be less relevant this time, partly because the global economy is now more inflationary.[13] After a series of rate cuts, officials will want to assess whether lower borrowing costs and other easing measures taken are helping the economy, Ip wrote.[24]
If the case for more rate cuts is weakening, the risks of cutting further are becoming ever clearer.[6] Steep rate cuts were partly meant as a (blunt) tool to forestall financial calamity.[6]
Financial companies' earnings remain grim, of course, but other sectors seem to be holding up and equities overall have had a surprisingly buoyant April. Other financial market indicators also suggest interest rates may not need to go much lower.[7] Depending on how you measure inflation, real short-term interest rates are already around zero or negative.[6] In the past week or two there have been signs that perhaps we might be closer to the bottom of the interest rate cycle than we had previously thought.[7] If Bernanke continues to slash interest rates, the problems will only get worse.[15] Another thing: once long term interest rates start to rise, the interest on the government debt will rise sharply, putting the deficit into warp drive.[20]
The yield curve -- the gap between rates on longer and shorter dated debt -- has steepened significantly in the past month or so, a possible early sign that the recession may be short-lived. Now, on top of all this data, we have some words to digest from Fed officials. [7] The Fed could raise rates by 50 basis points tomorrow and the commodities bubble would explode overnight, but that doesn't look likely.[15] "So last month figured, with Fed lowering rates so many times I could refinance to a great rate for the long term."[9] Earnings of financial institutions in the first quarter are down 70 percent from the same time last year. Unless the banking industry causes another panic the Fed could be finished with its magic for a while.[9] Recently, Volcker told the Economic Club of New York that our "bright new financial system" had failed the test of the marketplace. It was lost on no one that Greenspan had played midwife to the birth of that new system and for years had defended it against criticism and calls for regulation by many in Congress. That of course made Greenspan a hero on Wall Street and -- so long as the good times kept rolling -- he was feted by the media as a financial god.[20] Well, the good times have stopped rolling. "We have moved from a commercial bank-centered, highly regulated financial system, to an enormously more complicated and highly engineered system," Volcker told his audience. Much of today's financial activities "takes place in markets beyond effective official oversight and supervision, all enveloped in unknown trillions of derivative instruments," he added. "The sheer complexity, opaqueness and systemic risks embedded in the new markets'complexities and risks little understood by even most of those with management responsibilities'has enormously complicated both official and private responses to this the mother of all crises."[20]
The Bank of England was forced to intervene on Monday. Mervyn King, the UK's central bank governor, launched a "Special Liquidity Scheme" to "improve the liquidity of the banking system and raise confidence in financial markets while ensuring that the risk of losses on the loans they have made remains with the banks."[15] The plan will provide $100 billion for "illiquid assets of sufficiently high quality" (Mortgage-backed securities) to "unfreeze" bank lending. "The Central Bank's move allows financial institutions to add government bonds to their inventory of liquid assets and make it easier for them to raise cash and lend, especially to consumers seeking home loans.[15]
The G-7 finance ministers met in Washington last week and announced their "resolve" to minimize the volatility in the currency markets. Many people took this to mean that foreign central banks would take a more active role in shoring up the dollar.[15]
Libor, which means London Interbank-Offered Rate, is the rate that banks charge each other for loans. It has a dramatic effect on nearly every area of investment. When the rate soars, as it did last week, it means that the banks are either too weak financially to lend to each other or too worried about the ability of the other bank to repay them back.[15] While the market is still widely expecting a quarter-point cut, as recently as a week ago, some thought that even a half-point rate cut was possible. That now appears to be off the table.[4] Sterling fell against the dollar as the expectation of rate cut remained unchanged even after the release of BOE minutes.[8]
Fed fund futures imply a 90% chance of a 25bp cut with a 10% chance of no change.[23] I locked in a 6.5 percent 30-year fixed mortgage when fed funds were 5.25 percent," says Scott J. Redler.[9] Former Fed vice-chairman Alan Blinder says Bernanke's actions are justified. Paulson and President George W Bush have done little to address the mortgage crisis, he says.[10] In 2002 then governor Bernanke set off a warning siren that deflation was threatening the U.S. economy. He convinced his Fed colleagues of the danger.[18] The Fed board'''s seven members, nominated by the president and confirmed by the Senate, serve 14-year terms. This body, according to Mr. Reich, "pretty much runs the U.S. economy."[17]
If the economy could be controlled like our TVs, with the press of a remote control, we'd simply change the channel. Ben Bernanke's Fed is finding this economic downturn to be different from others.[9] Though government regulatory arms have succeeded over the past 70 years in steering the economy from extremes like the Great Depression, recent history reveals the Fed'''s heavy-handed presence and its mark on the political realm.[17] America's economy is not deteriorating any faster than the central bankers had expected. According to the minutes of the Fed's last meeting, its staff and several governors believed output would contract in the first half of 2008.[6] At the same time as indicated by second bar, Fed has extracted from rest of economy nearly a like amount.[25]
As usual, the Fed will take center stage with a policy decision that comes at an especially crucial time.[16]
For the first time in months, the economic outlook confronting Federal Reserve policy makers when they meet next week will be little changed from their prior meeting.[21] You might want to keep your seatbelt fastened during this week. The markets have a number of high-profile economic reports to digest, as they brace for the results of the Federal Reserve's policy meeting.[16]
Massive economic recession now rolling across U.S., and into Canada, was created by misguided policies at Federal Reserve.[25] U.S. recession will be deeper and longer. Rather than allowing system to purge itself of weak financial institutions, Federal Reserve is providing them with special funding.[25]
Jagadeesh Gokhale is senior fellow at the Cato Institute and formerly was senior economic adviser to the Federal Reserve Bank of Cleveland.[3] Federal Reserve has lent more than $200 billion to the creators of the mortgage mess.[25]
The IMF puts the chances of our borrowing binge ending in a worldwide recession at one in four. Some economists are arguing that the losses will be a minimum of $1 trillion and are likely to exceed that if there are unforeseen shocks to the system: Say, for example, a major international bank collapses or the U.S. military attacks Iran or one of the world's current riots over escalating food prices seriously destabilizes an important country such as Egypt. [20] Now, another round of misguided policies has been initiated. This latest set of actions is not a cure, but a prolonger of the disease and rot. These actions will only exacerbate long-term Bear market for U.S. dollar. Over time, $Gold's price will benefit from these actions.[25] Some of the rise in commodity prices can be explained by simple supply and demand. People in places like China and India are eating richer diets as their economies expand, and energy use is surging as industrialization moves forward. "The Western world is finally sharing its prosperity with the rest of the world," says Robbert Van Batenburg, head of global research at Louis Capital Markets. Prices also reflect other factors, such as subsidies, trade barriers and tariffs. The U.S., for instance, has earmarked a substantial amount of its corn crop to the production of ethanol - a decision that has made corn scarcer as a foodstuff at a time when global demand for grain is increasing and stockpiles are at longtime lows. Of course the dollar has continued its multiyear decline against other major currencies.[4] Even the IMFtypically the temple of devaluationists--is alarmed by the dollar's fall. Dollar weakness has already contributed to soaring commodity prices that have walloped U.S. consumers just when their spending is most needed to offset the housing slump.[15]
Nasty-looking March price indexes, a relentless rise in commodity prices, and the swooning dollar's upward push on import prices only fuel the growing inflation debate.[13] When the dollar falls; speculation will increase and prices will rise. Currently, the U.S. is exporting its inflation and fueling political unrest in the process.[15]
I can tell you now that the gold price, being more than three times higher than it was back in 2001, is severely impacting the jewelry sector in a much more negative way than it is being portrayed by mainstream media. While most of America is reluctant to use the terms, "Recession" and "Inflation", we, in this market, have been dealing with the reality that inflation over the past four years has led us into this recessionary period.[8] The March consumer price index was reassuring only if you believe soaring energy and food costs will not seep into other prices. For the quarter, the consumer price index rose 4.2% from a year ago, almost double its rate this time last year, but the core index, which excludes energy and food, was up only 2.4%, slightly below its year-earlier clip.[13] Asset prices are excluded. (The Fed's core measure for consumer prices, of course, doesn't even include all goods and services.)[18] The Fed's monetary policies have triggered a run-up in commodities prices which is driving up the cost of everything from corn to copper.[15]
To prevent a wider crisis, the Fed risked the U.S. government's money by lending $29bn backed by Bear's mortgage-backed securities.[10] In the past, the Fed responded to oil shocks by tightening the money supply, but that often led to recessions.[3] Those are just some of the questions the Fed will be dealing with next week when the problem of the inability of people and companies to borrow money will be front and center.[9] "Core" measures of inflation--which exclude food and fuel and which Fed officials tend to prefer--have improved of late, largely because rents are no longer rising as fast as before. Some market measures of inflationary expectations, such as the gap between inflation-indexed Treasury bonds and others, have fallen in recent weeks.[6] Fed officials don't want the institution to become the main source of funding for the financial system.[11]
Unless you're Alan Greenspan. Mr. Greenspan'who in fairness is not responsible for everything that has gone wrong, just a whole lot of it'recently told the Wall Street Journal that he doesn't regret a single decision he made while he was chairman of the Fed. Let's hope that Ben Bernanke isn't quite so sure of himself.[20]
Without government intervention, nearly two million homes will face foreclosure over the next two years. Most option ARM loans'those adjustable rate mortgages that have low teaser rates and let you pay less than you owe'have not yet adjusted upward. When those loans adjust up to the new higher rates and the lenders demand full payment each month, the other shoe in the mortgage crisis will begin to fall. [20] The percentage who hold a negative view of the economy is up 33 points over the last year, and the percentage who rate the economy 'poor' has increased 13 points in the last two months.[15] Polls show the top issue among voters this election year is their fears about the fate of the economy. Voters can grill congressional candidates at town hall meetings and on call-in radio shows and they can get a fix on the presidential candidates''' economic plans through campaign news coverage.[17] Economic data have confirmed officials' expectation that the economy has likely entered a mild recession.[11]
The reason: Some officials see a case for more insurance against a deeper recession. Others are concerned a cut could contribute to inflationary pressure with little benefit for growth. That means the option of standing pat will likely also be on the table.[19] If so, that could turn into a drag on second-quarter GDP growth, as companies cut output on order to bring inventories into better balance with sales. This quarter promises to be much weaker than the first quarter in terms of overall GDP growth. Consumers are facing up to growing uncertainty about the outlook, soaring gas prices, and rising unemployment, even as housing shows few signs of stabilizing, and as businesses are becoming increasingly hesitant to increase their capital spending and expand their operations.[16]
The global economy is also more interlinked and somewhat less sensitive to U.S. growth.[13] You have an economy on an unsustainable growth path. This, in a nutshell, is the lesson of the Austrian critique of central banking developed in the 1920s and 1930s.[18]
While data since the last meeting continue to show the economy is losing momentum, increases in food and oil prices have intensified and banks are still reluctant to lend, the Journal said.[24]
For a change, the precious metals responded to a declining crude oil and rising U.S. dollar value. Gold broke through the $900 level for the second time this month as participants continued to be frustrated by the metal's recent lack of response to outside drivers and by investor apathy.[8] If you think gasoline is expensive now, you don't want to think about what $150 a barrel oil will do to the world. Even if we leave aside those dire possibilities, there are many current realities that suggest we may soon find ourselves caught up in a rough cycle of financial crisis followed by deeper economic downturns.[20]
The implicit government backing of investment banks and mortgage giants like Fannie Mae FNM and Freddie Mac FRE also was welcomed by financial markets.[5] Officials acknowledge that some key parts of the financial markets have improved since March. They worry that banks' and markets' tighter lending standards could make for a worse-than-expected downturn.[11]
Redler called up Chase Bank but the new rate had only dropped to 6.18 percent. [9] "We are close to the end of rate cuts,'' said Dean Maki, chief U.S. economist at Barclays Capital Inc. in New York.[8]
"I'm not an economist - just using common sense from experience." Banks have been the hardest hit in this economic downturn, so it's understandable that they don't want to be generous to customers when they can use the money themselves.[9] Austrian economists warned that price-level stability might be inconsistent with economic stability. They placed great stress on the fact that the price level, as typically measured, extends only to goods and services.[18]
Producer prices rose at an annual rate of 9% in the first quarter of the year, while prices of intermediate goods were up by 15%.[6]
Since the Bear Stearns ( BSC ) crisis, stock prices have rallied 8%. Yields on super-safe Treasury securities have risen, and various benchmark credit spreads have narrowed somewhat, all indicating that investors are increasingly willing to come out of their bunkers and take on a little more risk.[13] The yield on two-year Treasury bonds has risen sharply, to 2.35 percent yesterday from 1.6 percent at the end of March, reflecting that investors' money is not gushing into ultra-safe investments with the same eagerness. Markets for mortgage-backed bonds, corporate debt and other forms of credit, while still troubled, are functioning more normally than they had in March.[12]
Officials say the case for lowering rates further rests primarily on the value of additional insurance against a worse-than-anticipated economic scenario. [11] James Hamilton, an economics professor at the University of California, San Diego, says a decision to pause now could reverse some of the gains in commodity prices and bolster the value of the dollar.[4] If people expect low inflation, prices and wages will not spiral up together.[13]
SOURCES
1. Fed may go on hold but retain language bias for ease | Special Coverage | Reuters
2. Free Preview - WSJ.com
3. Jagadeesh Gokhale and Thomas Firey - The Fed Walks a Tightrope - washingtonpost.com
4. Commodities runup gives Fed chief a chance to show mettle - Apr. 23, 2008
5. Inflation Fears Could End Feds Fiddling | Market Features | BAC BSC C FNM FRE JPM MER - TheStreet.com
6. Interest rates | On second thoughts | Economist.com
7. Next US interest rate cut could last | The Australian
8. Why the Fed must stop cutting rates now
9. New York Post
10. Fed boss gets aggressive in battle with Depression - World, Business - Independent.ie
11. Fed Weighs Pause After Next Rate Cut - WSJ.com
12. Economy Showing Signs of Stability - washingtonpost.com
13. The Inflation Debate Grows Louder
14. Fed may pause after cutting rates next week: report | Reuters
15. Mike Whitney: Enough With the Rate Cuts, Already!
16. Vital Signs: The Fed's Next Move
17. Unelected Economy Czars
18. Panic Time At The Fed - Forbes.com
19. baltimoresun.com - Jay Hancock's blog: The Fed worries about its credibility, the dollar
20. Federal Reserve Chair on the Hot Seat - NAM
21. Free Preview - WSJ.com
22. Resource Investor - Blog - Could a pause in Fed rate cuts reverse some gains in commodities?
23. Canadian Economic Press - Welcome
24. Bloomberg.com: Worldwide
25. US Fed Takes Money From Main Street to Give to Wall Street :: The Market Oracle :: Financial Markets Forecasting & Analysis Free Website
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