Fed Holds Rates Steady; Statement Mixed
A: Hmm, an expected decision yet confusing statement. As I read over this statement, I have to lean on the dovish (rate easing) side, as opposed to the hawkish (rate hike) side. It's hard to imagine the fed cutting rates when inflation threats remain and commodity prices have risen as far as they have, but if you look at the past few weeks commodity prices have come down fairly significantly. Lots of differing views on this latest fed decision and issued statement.
FED STATEMENT
Let me break it down by downside risks statements and inflation statements, to make it easier for us to review. Afterwards, I want to get into Ron Insana's interesting take after the decision, warning the fed that they are missing the boat on the bursting commodities bubble and the deeper slowdown that we are facing.
DOWNSIDE RISKS STATEMENTS
* Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee. (hmmmmmmmm)
* Tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth over the next few quarters.
* However, labor markets have softened further and financial markets remain under considerable stress.
INFLATION STATEMENTS
* Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated.
* The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.
Fisher dissented and wanted to hike rates. Tough statement to break down. As CNBC had the economists and analysts break down this report, there were vastly differing views on whether this was a hawkish or dovish statement. It was very interesting to hear Ron Insana, whom I consider one of the voices of reason on the program, discuss:
a) the current bursting commodities bubble
b) the deeper recession
c) that the fed needs to cut rates and not worry about inflation that will ease as commodities tumble
Interesting. Certainly, the inflation that is out there is resulting from commodity inflation and is passing through to consumers in the form of higher food & energy prices. The inflation that most economists fear most is that of rising wage inflation and the money supply. There are so many definitions of inflation, that for this argument, we need to focus on the right ones.
Putting aside commodity inflation, I just do not see wage inflation or an expansion in money or credit. Do you? In fact, I see massive credit deflation out there and massive destruction of wealth in the shadow banking system; which ironically saw a massive build of wealth in the past decade to the tune of approximately $10 trillion dollars by early 2007. Boy how times have changed. Write-downs thus far in the banking system are around the $450 Billion mark and estimates range from total credit losses of between $1-$2 Trillion before all is set and done.
Should commodities continue to fall as Insana predicts, we could see a significant fall in inflation expectations as a result. My only problem with this is that if the fed has to cut rates aggressively to combat the deep slowdown, the US dollar will likely fall again and that could lead to a rise in commodities priced in dollars. But hey, he is Ron Insana and I am Noah Rosenblatt of Halstead Property! Time will tell.
In meantime, I think the fed is talking tough about inflation and may have to cut rates before raising them should the credit markets / housing markets continue to deteriorate OR if an event occurs to stabilize markets before trading re-opens; so I'm more on the dovish side while I see Barry Ritholtz on the hawkish side. Until then, I see continued pressure in the pipeline for housing, a rising threat to commercial real estate and the mortgages that back them as seen in widening CMBX spreads, rising lending rates, continued wide corporate spreads, and a tapped out consumer.
Posted by jeff
Tue Aug 5th, 2008 08:41 PM
Noah,
For my part I think the fed will continue to pay lip service to inflation fighting to keep inflation expectations from getting out of hand and to keep currency specs nervous about jamming down the dollar in favor of the euro...until the ECB is finally forced to start cutting. But rates are up and money is being destroyed worldwide, including in the US and commodities are finally feeling the heat of lower consumption. You and I both know that the mountain of debt yet to go bad means more money destruction and a long period before banks will do anything but borrow from the Federal Home Loan Banks and buy treasuries or lend to the very best credits. So inflation just can't get a lasting foothold. However, I just have a sneaking suspicion that somewhere some how, someone is getting use out of the "posted" negative real rates the fed is offering and that this money will somehow make it back into the economy to offset the money destruction...to think otherwise is to bet on financial Armaggedon, which isn't in my genetics (because it hasn't worked since 1929). Alternately if the posted rates don't result in some kind of money creation the Fed will be forced to quantitatively ease (which many Fed heads were recommending that Japan do during their financial crisis)....buy up the paper no one wants in order to raise the bid and force money back onto balance sheets. This is something they are effectively already doing with all their borrowing facilities and the promised Fannie/Fred bailouts. Of course this increases the future national debt, but at this point we are like Donald Trump in the early 90s, no one would dare to call in our debts...they are all in too deep. So there's your rosy scenario...pretty thin I'll admit, but I actually think that's the way it's gonna go. Apparently, some players in the stock market may even agree.
Posted by Noah
Wed Aug 6th, 2008 09:29 AM
Hmm, interesting Jeff. I agree with your ""posted" negative real rates the fed is offering" statement.
factoring in inflation, real fed funds is negative. How does gold play into your story there? Sounds to me like you think we have a new leg down for our peso, but will not see or enormous debts called in; hopefully you are right.
Im going to place my bet on a rate CUT before a rate HIKE. I still think we have some EVENTS yet to occur, and thats when I think Ben will pull out his arsenal again. Until then, like you said, they will stealth ease by allowing an orderly unwind of these toxic holdings onto the fed's balance sheets via their facilities.
Posted by Query1
Wed Aug 6th, 2008 11:18 AM
What are your thoughts about the household balance sheets? We certainly are seeing money destruction from the write-downs and losses in the financial sector which, in turn, cause a further money contraction in the real economy. I believe Bill Gross estimated a contraction of $5 T in the real economy for $1T in financial losses. But, as you note, the Fed is there to help the recapitalization effort of the financial sector as the contraction is occurring.
But nobody can do that for the households. There is no discount window or auctin faciity for them. That means when they delever that contraction is pretty long-term. The only way I see them being helped is with inflation. So, my wild hunch is the last phase of this will be the Fed. buying a lot of government debt to put money into the economy to inflate wages (hopefully from a relatively low point) to help households get back on their feet. So, I am saying we may see some wage inflation but it won't coome until after the other sectors have stabilized.
Posted by Noah
Wed Aug 6th, 2008 11:24 AM
Query1 - hmm, what a great question. I dont know because right now Im in the camp that consumer is tapped out, and that we are in a consumer driven recession. In this scenario, and with lagging commodity prices hitting profits, I just dont see wages rising for a while. As you said, household balance sheets are in disarray, and they will be dealt with pesky credit costs and rising commodity inflation making it harder on their remaining funds.
We are talking nationally here. I think we will see wage inflation coming back, but that is likely to be a 2011-2012 phenomenon. I think the next few years will be rough and that wages will stagnate and jobs will be lost as we deal with all this.
I wish I had a better outlook or vision, but I just cant at this stage.
Posted by jeff
Wed Aug 6th, 2008 04:14 PM
Query 1,
I think the real estate levered consumer will get wiped out and his debt will become bank debt/charge offs. The consumer in general will be de-levering for the next 10 years, driven by sane underwriting coming back and the demographic bubble of people facing retirement. I definitely see this period of worlwide weakness being followed by a period of slower growth and higher rates, but it will be helped in the US by increased exports and export related job growth and major convergence of worlwide growth rates from the unsustainable divergences we saw in the last few years. The world can't sustain India and China growth of the rates they have been putting up, or even close and this will be contained by tighter money....hopefully it won't result in political mayhem in these nations. The weak dollar will help re-balance our trade deficit as will falling consumption. Can all this happen with out us devolving into a depression....I hope so.
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