Aggressive Rate Cuts End -
What's Next? by Guy Baker
The period of aggressive rate cuts from the Fed comes to an end.
As expected, the Fed cut the Fed funds target rate by a quarter percentage point to 2.0 percent. They also cut the discount rate a quarter percent to 2.25 percent. As they did in March, Fisher and Plosser voted against the rate cut, preferring no change in the target rate.
Forecasters and market participants are largely left in the dark regarding the Fed’s next rate move, perhaps because the FOMC itself has little confidence in its next steps. The April statement drops the reference in the March statement that “downside risks to growth remain” and added the reference that there has been “substantial easing of monetary policy to date” However, it comes well short of signaling a near-term pause in interest rate cuts. Another rate cut in June is still on the table, though we believe it is an unlikely occurrence.
On inflation, the Fed sounded positively dovish, noting that core inflation has improved, while energy and other commodity prices have increased. The committee is still looking for inflation to moderate as resource utilization wanes and energy and commodity prices peak.
Expect the Fed to continue to actively add liquidity through the TAF and other credit lending facilities as its main weapon of defense against ongoing stresses in credit and financial markets.
Bottom-line: Barring another major blowup in credit and financial markets, the Fed may further ease off the monetary accelerator (no rate cut) come June, preferring to monitor the monetary medicine already administered and how it interacts with the fiscal stimulus package and developments in the financial markets and economy.
If It Walks Like A Duck and Quacks Like A Duck, It’s A Duck!
This is not about the recession “duck,” rather about the stagflation “duck.” Economists are saying the alignment of economic indicators is very similar to the 1970s and 1980s, even if the Fed Chairman tries to dismiss the similarities. The question is will it last longer?
Some of the effects are masked because exports have been a contributing factor to the no-recession call. Even the service sector’s results were good during the first quarter of 2008, contributing 1.43% to GDP growth while exports contributed 0.67%. It seems clear, despite all the doomsayers; the U.S. economy is not collapsing. Otherwise, with so many crises piling up, i.e., housing crisis, sub-prime crisis, credit crisis, etc., it would have tanked already.
It could be argued that while growth was weak, inflation was also weaker than the previous quarter again masking the slowdown. But does that matter? Inflation is always going to be with us, so what matters is real growth. Another question relates to the fiscal stimulus package. It may give prices a strong boost because consumers will use it to defend themselves against higher prices today. But what happens when the rebates abate? The pressures on wages and salaries will persist and inflationary pressure will continue to build. This is not good news for the Federal Reserve and for the economy in the coming quarters.
Perhaps the better question is tax rebates versus government expenditures: Politicians’ love “tax rebates.” But the multiplier effects of tax rebates effect the economy less than an increase in government expenditures. At a time when our economic infrastructure is in such state of disrepair, shouldn’t politicians use the money to rebuild rather than give consumers money for iPods?
I am a supply sider at heart, but we could use these same tax dollars to create work for the construction sector until the housing market rebounds. Increasing consumer spending is much more inflationary than rebuilding our decaying infrastructure. Nothing against iPods, Apple or XBOX, but it is interesting to see how Apple stock has grown in the face of a falling market. This has not been true for Starbucks coffee from an earnings perspective. So there you have it, iPods are necessities and Starbucks coffee is not. Please pass the Latte.
The Labor Market Rises – Predicting Stagflation Rather Than Recession
Labor market numbers for April confirm the prognosis is stagnation rather than recession. Of course, the numbers were not pretty but they were not as terrible as 99.9% of analysts were expecting. Thus, the markets are celebrating! And the clearest sign that the economy is not collapsing is the unemployment rate. The rate of unemployment dropped, from 5.1% in March to 5.0% in April, rather than increasing, as 100% of analysts had predicted.
Many tell us not to pay attention to this rate, but the rate has a very distinctive characteristic, it is stable data. Thus showing that again the economy is not collapsing; it’s just weak. But some suggest it will remain weak for a long time. And the biggest reason is that monetary policy, as well as fiscal policy, is postponing the being used to delay the day of reckoning. It is estimated the housing market crisis will be with us until the first quarter of 2009. However, that will depend on how many policy mistakes are made. Right now, it looks like, because of the election, the fiscal and monetary policy is only going to delay the real impact of the housing market crisis even though policymakers argue that what they are doing is just the opposite.
Thus, the risks for the economy today seem to be still high while the politicians posture. But take heart, these risks are not the risks of an economic collapse, just of an extended period of economic weakness, a longer lasting stagflation.
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