Economists React to Fed

WSJ 

The Federal Reserve, as expected raised interest rates for the
13th consecutive time Tuesday, lifting the federal-funds rate by a quarter
percentage point to 4.25%. The central bank suggested it would raise rates
again, but also hinted that it is less certain on its future rate actions than
it has been in over a year. In the accompanying statement, the Fed said growth
remained "solid", inflation excluding food and energy prices had "stayed
relatively low," and inflation expectations were contained. But it also warned
that the possibility of further erosion of spare productive capacity and high
energy prices "have the potential to add to inflation pressures."

What do
economists and other analysts make of the changes? Here’s a sample of their
commentary:

* * *

The Fed has finally taken the step that we have been
pointing to for a while, in separating the two concepts of reaching neutrality
and finishing the rate cycle. They kept "measured," as we thought they might,
but now it refers to "some further measured policy firming" as opposed to
removing accommodation at a measured rate. So, rather than being on automatic
pilot in raising rates toward neutral, the FOMC now sees itself in the second
stage of the rate hike cycle — further moves will be perceived by Fed officials
as taking policy toward a restrictive stance.

— Stephen Stanley, RBS
Greenwich Capital

* * *

The message from the FOMC appears to be that barring a
major change in the tone of economic data, another 25bp tightening move will be
implemented at Chairman Greenspan’s last meeting on January 31. At that time, it
is quite possible that the "measured phrase" will be jettisoned, leaving
incoming Chairman Ben Bernanke with a clean slate for the next meeting on March
28. Our own view remains that the evidence concerning economic growth should be
sufficiently strong in coming months to spur another three 25bp 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 core inflation drifts up mildly from its current
levels.

— Joshua Shapiro, Maria Fiorini Ramirez Inc.

* * *

The Fed announced: "Core inflation has stayed relatively
low in recent months and longer-term inflation expectations remain contained."
Quite frankly, we do not believe them. We know that beyond the rises in food and
energy prices, nearly everything — from healthcare to building materials to
education costs to insurance to commodities — costs more. And gold, the world’s
best inflation indicator, is well over $500 per ounce. Where ever we look, we
see evidence that prices have limited stability and an upward bias.

—
Barry Ritholtz, Maxim Group

* * *

We do not see this statement as signaling that monetary
policy is at neutral. The Fed continues to emphasize upside inflation risks and
the potential need for further measured interest rate increases and we continue
to look for three more rate hikes to take the funds rate to 5% by the middle of
next year.

— John Ryding, Conrad DeQuadros, Elena Volovelsky, of Bear
Stearns

* * *

We note that the Fed has begun to make explicit reference
to "possible increases in resource utilization" — Fedspeak for the declining
unemployment rate — as a driver of future core inflation, for the first time in
this cycle. We think this is extremely important, because it signals that the
labor market has now moved again to center-stage in the Fed’s analysis and
policy making process. The Fed is no longer dealing with shocks and their
aftermath; the cycle is reasserting its primary role in determining
policy.
— Ian Shepherdson, High Frequency Economics

There was little news in this statement. The Fed continues
to remain purposefully behind the inflation curve (willing to live with
underlying commodity inflation as long as we see continued growth), trying to
walk the tightrope of curtailing housing market speculation without squashing
growth, hoping the powerful balance sheets of corporate America can offset any
weakness from the consumer. Whether it can continue to play this tenuous game
without causing a financial accident is still a big question, but thus far one
has to say, "so far, so good," a phrase I would not have expected to now be
uttering just a few short months ago.

— Chip Hanlon, Delta Global
Advisors

* * *

The Fed stated that "some further measured policy firming
is likely to be needed to keep the risks … balanced." With this change in
language, the Fed is acknowledging that that stance of monetary policy can no
longer be described as accommodative. Borrowing rates have moved up sharply over
the past year, credit spreads have increased, and the demand for consumer and
mortgage credit has dropped sharply.

— Brian Bethune, Global
Insight

* * *

The Fed eliminated the phase "monetary policy
accommodation." However, this does not mean that the Committee does believe that
monetary policy is now neutral or restrictive." In particular, the Fed also said
that "possible increases in resource utilization … have the potential to add
to inflation pressure." This is a clear reference to their view that the economy
is still growing more quickly than the economy’s potential, which suggests that
the funds rate remains below its "neutral" level and, thus, is still providing
stimulus to the economy.

— Steven Wood, Insight Economics

* * *

As expected, the dollar is falling across the board. We
did indicate that any change in the statement should be dollar negative as was
the case after the release of the Nov 22 minutes. Carry-trade enthusiasts are
eyeing any change in signals from the Fed that would add some finality to the
accumulation of the dollar’s yield luster.

— Ashraf Laidi, MG Financial
Group

* * *

Keeping a "measured pace" for so long heightened the
possibility of the committee painting themselves into a corner. This language
gives them a way out while still maintaining the ability to press on with higher
rates if inflation continues to pose a threat. It may take the market a couple
days to sort it out, but at first glance, this language could work. I would
still like to see it evolve, however.

— William Polley, Western Illinois
University

* * *

By changing the language as they have, the Fed is
signaling that further rate increases are very likely, but not certain. Strong
growth and inflation worries showing up in incoming data will continue to bring
about further tightening, but any signal that growth is abating or that
inflation is firmly under control will give the Fed reason to pause and
reconsider whether further increases are warranted. … It will be interesting to
see to what degree FedSpeak is used to set expectations as data arrive.

—
Mark Thoma, University of Oregon

* * *

Source:
Economists React
WSJ, December 13, 2005 3:28 p.m.
http://online.wsj.com/article/SB113450282046821489.html