January 31, 2006 6:47 p.m. EST |
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DOW JONES
REPRINTS
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visit: Economists React The Federal Reserve, in its first meeting of 2006 and final meeting with Alan Greenspan sitting at the head of the table, raised interest rates by a quarter percentage point for the 14th time in a row, bringing the federal-funds rate to 4.5%. The central bank dropped the word "measured" from its closely watched policy statement, writing that the committee "judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives." What comes next for interest rates? Economists weigh in: * * * The Greenspan legacy came to an end this afternoon
with a resounding yawn. … We do not believe the omission of the "measured"
reference is significant. The minutes from the December meeting revealed
that there was considerable discussion regarding this phrase and it was
retained at that time simply in order to avoid any confusion regarding the
magnitude of future rate hikes. Since rate hikes are no longer guaranteed,
there was no need to describe the size of the rate hike. My take away is that the FOMC is a bit less dovish
at this point than the November and December statements and minutes
suggested. I am not sure whether this reflects a recalibration of the
communications strategy or a change of heart by policymakers. Perhaps it
reflects the removal of Chairman Greenspan, who I suspect was hoping that
getting to 4.50% and neutral would be enough to allow him to ride off into
the sunset as a hero. In any case, the flow of the data will determine what
the Fed does going forward, and we look for strong economic figures and a
gradual pickup in core inflation to force several more moves this year. The Fed is no longer signalling an intent to move as
it looks towards the March 28th meeting. While the outcome of this meeting
is not clear cut, there is however, a bias for rates to move higher.Given
the greater uncertainty about the outcome of the March meeting, the
committee no longer felt a need to qualify possible further action with the
word "measured". The removal of the measured pace phrase, which has been in
the statement throughout this tightening cycle, should not be seen as
conveying any additional information, beyond the shift from an intent to a
bias. Our own view remains that the evidence concerning
economic growth should be sufficiently strong in coming months to spur
another two quarter-point tightening moves, lifting the Fed funds target to
5.00% in the second quarter of the year. We think that growth will then be
moderating sufficiently for the FOMC to cease tightening, even if, as we
expect, core inflation drifts up mildly from its current levels. We think strong data will leave Mr. Bernanke with no
choice on March 28, but views were split ahead of the meeting. Also, the
FOMC repeated the Dec 13 language on "resource utilization", which in plain
English means they are scared the low unemployment rate could spark higher
inflation. Greenspan will depart the Federal Reserve having
completed (or very nearly so) his final task of restoring a "neutral"
monetary policy. Ben Bernanke, confirmed today as his successor, will
inherit a policy that will likely require little if any "fine tuning." His
first task, however, will be to explain to Congress the actions his
predecessor has taken in the waning months of his tenure, Undoubtedly, many
will be keenly interested in his take on why the FOMC found this last move
to be necessary in the wake of the slowest advance in real GDP in three
years. The risk suddenly increases that the U.S. may
experience a less than graceful soft landing this year. That's because the
weakest link in the economy right now is the consumer. Americans have been
spending far more than they earned the last five years, borrowing an
additional $3.8 trillion during this time and bringing total household debt
to a record $10.7 trillion. That may be manageable when borrowing costs were
low, but with rates now 3.5 percentage points higher than just a year and a
half ago, the burden to service much of that debt becomes more difficult.
With household finances already under considerable stress, one has to wonder
if another round of rate hikes will lead to a more severe cutback in
consumer spending in the months ahead. After 350 basis points of tightening, the Fed
acknowledged that monetary policy is a lot less stimulative that it was.
However, they did not indicate that they had reached "neutral" nor did they
say they would not have to become restrictive. What they did imply was that
future Fed actions will become even more data dependent and that further
tightening cannot be ruled out. … There are a number of significant
imbalances that may challenge the new Chairman and his colleagues. We wish
both gentlemen well. The dollar is rallying across the board because
markets saw little change in today's FOMC statement. As we said in our
morning note, a statement that conveys little or no change will keep the
door open for a March rate hike, hence further enhances the dollar's yield
advantage relative to other currencies. This statement leaves the door open for further
upward interest rate adjustment by repeating concerns about reduced slack
and elevated energy prices as well as by saying that "some further policy
firming may be needed." We do not believe, however, that the omission of
"measured" suggests that these adjustments will be anything other than
quarter-point moves. We really do not believe that Fed policy matters
that much except to the degree that they achieve their goals of containing
inflation without killing the economy. All the evidence is pointing toward
decent levels of economic growth in 2006 and inflation is underneath the 2%
upper bound which Bernanke has spoken of targeting. We see nothing in this
report that would make us less bullish on equities. Maybe the simple fact
that another piece of uncertainty is removed would mean a slight positive
for stocks. It's time to ask, "what's next?" It's now all about
the data. The Fed is essentially at neutral and Mr. Bernanke will have to
decide whether to actually start a tightening process. With inflation at the
top of the desired level and with the pressures building slowly, the guess
is he snugs again. We would not read much in the elimination of the now
famed word "measured." Indeed, the December FOMC minutes were quite clear
that it would be a misinterpretation to believe its elimination would be a
signal of potentially larger policy adjustment increments in the near
future. Back then, the Fed already thought that the number of additional
firming steps required would not be large. … For now, we still believe that
recent changes in financial regulation and tighter supervision for mortgage
lending limit the need for a further usage of the overnight rate as a policy
tool.
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