Despite the posturing, the hawkish tone, the never-ending warnings
about inflationary pressures, much like we anticipated, the Fed did not
raise interest rates in its June meeting. Being buffeted by a series of
negative shocks, a continued house price decline, a rapidly slowing
economy, and an excessively volatile financial sector, the Fed decided
to maintain its accommodative bias. I, for one, concur with this
decision, at least for now.
There are however, dangers associated with this scenario. Inflationary
pressures have escalated and oil prices continue to set record daily
highs. It won’t be long before the current high energy costs filter
through the economy placing further upward pressure on other prices.
The excess liquidity provided by the Fed over the past nine months will
certainly add to the current build-up of inflationary pressures.
Ironically, it seems that the Fed has run out of ammo this time.
It lowered its target rate by 350 basis points in a span of seven
months – the most aggressive move in history. It designed conventional
and unconventional tools to bail out the financial sector (remember
Bear Stearns). In maneuvering and imagination, the Bernanke Fed has
vastly surpassed its predecessor – the Greenspan Fed. The irony comes
from the fact that Bernanke’s Fed was supposed to be the more hawkish,
more willing to fight inflation, and less concerned with financial
market developments than Greenspan’s Fed. But Wall Street jitters of
late last summer seem to have spiked a high fever in the Fed, followed
by an unprecedented overreaction.
Where does this leave us now? With an ammo tank almost empty, and a Fed
that jumped the gun a few months too soon, and a few hundred basis
points too low, we’re pretty much on hold. The Fed is unlikely to
tighten over the next few months given that housing market blues are
far from over (an optimistic scenario would put it half-way through)
and we have yet to see a bottom to the current economic slowdown. In
the meantime, I see little hope of a drop in oil prices. Against this
backdrop, I cannot help but feel that the only bullets left for the
Fed, at least for the time being, are hawkish words and a concerted
effort to anchor the ever-increasing inflationary expectations without
taking any drastic policy actions in the near future.
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